Outsourcing is becoming a penny-pincher's business. While outsourcers talk about building partnerships and providing access to specialized skills, most of their customers are primarily interested in saving money. Nearly two-thirds of the companies that hand off tech work to a third party--whether a domestic services provider or an offshore vendor--say cost cutting is the main reason for the move, according to an InformationWeek
Research survey of 420 business technology professionals, the third in a series of surveys on outsourcing trends conducted over the past four years.
With cost such an important consideration, it's not surprising that more IT execs are giving work to overseas service companies that typically employ lower-paid workers. "If we use too many on-site people, we will not save money," Sue Powers, CIO at travel software and services provider Worldspan, says bluntly. Worldspan has outsourcing engagements with Tata Consultancy Services and InterGlobe Technologies, both based in India.
Money hasn't always dominated the agenda. In our 2004 survey, the most important factor driving outsourcing was access to operational expertise, cited by 47% of respondents. Now that's the most important factor for only 26% of companies surveyed. That a well-established vendor will get the job done right is increasingly taken for granted.
Dial Up or Down
|Accenture is one of the few Western IT services providers to consistently report strong growth in its outsourcing business in recent quarters. The company reported outsourcing revenue of $6 billion in fiscal 2005, an 18% jump over the previous year. That shouldn't be surprising. Known more for its consulting expertise, Accenture under CEO William Green has made the outsourcing business a priority. It's where the growth is, after all.
Accenture gets high marks across the board from customers, with an average score across 13 categories of 7.6. Its highest mark, 8.0, is for its reputation, which could be thanks to its well-regarded consulting arm. Its lowest score is 7.1, for cost/value.
Outsourcing is on the increase. Worldwide sales grew 6% to $624.4 billion last year, Gartner says. An important factor behind the growing popularity is that outsourcing gives companies the ability to vary IT capacity. With in-house personnel and IT systems, companies are limited in what they can do to reduce expenses when business is slow. When outsourced, IT resources can be dialed up or down depending on business cycles. That explains why 41% of survey respondents listed the flexibility to increase and decrease IT usage as their main motive for outsourcing--making it the No. 2 reason behind cost.
It's largely why paper and packaging company MeadWestvaco earlier this year signed a five-year, $200 million IT services deal with Affiliated Computer Services. ACS will provide MeadWestvaco with services ranging from application maintenance and support to midrange and mainframe management. "If you do it all yourself, it's a fixed cost," says MeadWestvaco CIO Jim McGrane. "It scales up pretty well but doesn't scale down worth a damn." That's an important consideration for a company like MeadWestvaco, which has undergone a series of acquisitions and divestitures.
Just over half of companies surveyed are spending $1 million or more on outsourcing. Increasingly, service providers based in India are the beneficiaries. For every dollar spent on outsourcing, 25 cents goes to an offshore vendor, up from 19 cents two years ago. The remaining 75 cents goes to a domestic service provider, which in turn could be doing some of the work offshore, too.
|HP CEO Mark Hurd, like his counterpart at Accenture, is determined to increase the company's services business. "We'll be very, very focused on services," Hurd said last fall.
Hewlett-Packard is a relatively small but fast growing player in the market for broad, comprehensive outsourcing contracts. Its IT outsourcing revenue last year was $3 billion, up 24% from the previous year. This year also could be strong as the company begins work on a $700 million, five-year services engagement with General Motors.
Survey respondents give HP an average satisfaction score of 7.1, ranking it most highly in reputation, with a score of 7.5. Its lowest score, 6.6, is for cost/value.
As companies become more comfortable sending work to India and other low-cost destinations, the stigma and controversy of offshoring is subsiding. One out of five companies reports that it's more likely to publicize the use of foreign IT workers compared with a year ago, or at least not cover it up.
"Global sourcing is being accepted as just the way things are done these days," Worldspan's Powers says. "At first, everyone thought it was a good idea for someone else; now we all just accept it." Worldspan handed off a variety of application development and maintenance tasks to TCS.
One of the more common knocks against Indian outsourcers is that their strength lies in brute-force commodity work, which lets them throw low-paid manpower at a job. For work requiring in-depth business expertise, they're supposedly less adept. However, that's not necessarily so, Powers says. She ditched IBM, a vendor known for its vertical industry strength, in favor of TCS. "IBM didn't have travel and transportation expertise. TCS did, and they were also more flexible and easier to work with," she says.
IT staffs sometimes shrink as a result of outsourcing: 23% of respondents report that their IT staff levels diminished, on average, by a third. But that's not true for all companies. More than a third of businesses that have outsourced work report that the size of their tech staffs increased. "This was never about replacing people," says a technology executive at a gaming systems and software company that outsourced a number of integration and implementation tasks to India's HCL Technologies.
|IBM is still the King Kong of IT services and will just keep getting bigger in that area as it reduces its focus on hardware. CEO Sam Palmisano is putting his stamp on the company by aggressively leveraging India and its tech-savvy, low-cost workforce. Earlier this month, Palmisano said IBM would invest $6 billion in India over the next three years.
The company also is snapping up smaller, niche-focused service providers to get into specialized areas such as logistics and procurement. Despite all the moves, IBM's services business isn't growing much, and its IT outsourcing sales are actually decreasing--down 5% in the fourth quarter of 2005 and down 3.3% in the first quarter of this year. IBM's size can at times work against it, making it tough to convince would-be buyers that it's not just top-tier customers that get top-tier service.
Customers give IBM an average satisfaction score of 6.6, with a top mark of 7.2 for reputation and a low score of 6.2 for both strategic advice and innovation--surprising for a company that last year spent $5.8 billion on research and development.
That move was made in part to free up company IT staffers from mundane tasks like maintaining legacy systems. "We first went offshore so people here would have a career path to move onto new stuff like Java," he says.
Outsourcing gives MeadWestvaco a better chance to access top technology talent. McGrane is realistic about the challenge his company faces in attracting and retaining top computer science graduates. "We're not the kind of place a young tech grad thinks about first," he says.
Another reason an increasing number of companies are tapping offshore service providers is that they see it as a means to mitigate risk by spreading work across geographies. Office equipment maker Ricoh was using domestic outsourcers Accenture and BearingPoint for integration projects and Sarbanes-Oxley compliance work. When Ricoh needed development work performed on the firmware applications that run its copiers, it tapped Indian provider Satyam Computer Services. "We didn't want to put all our eggs in one basket," says Aliou Niane, Ricoh's manager for IT network integration services.
Despite the rising popularity of offshore outsourcing, it's still not for everyone. McGrane would be uncomfortable handing over his company's critical IT operations to a foreign services provider. Though several offshore vendors have rosters of blue-chip customers and sales pushing $2 billion a year, he doesn't consider them in the same league as the largest U.S. providers. "We're talking about the operational assets of the corporation, so we need global reach, global capacity, and that includes the United States," he says.
However, McGrane is all right with ACS performing a number of functions under its contract with MeadWestvaco from foreign locations. Help desk support, for instance, initially will be performed in the United States but then moved to India or possibly Panama. "We'll do it gradually," he says.
For some companies, offshoring isn't on the table; they don't even want to send work to another state. Propack, a logistics services company in Blaine, Wash., previously outsourced Web hosting and development work to a vendor in Atlanta. "There were communications challenges that led to us not getting the service we hoped for," says Daniel Lucht, Propack's operations VP. The company ultimately handed the work over to WCI, a telecom service provider out of Seattle. Propack also has tapped small, local firms for network monitoring and data security management, and Lucht prefers the personal relationships that allows. "I'm able to meet daily with my service providers," he says.
|It appears that EDS has finally turned the corner financially and operationally after struggling for years under the weight of a problematic Navy-Marine Corps Intranet project and major airline customers that were bankrupt or close to it.
Under CEO Michael Jordan, the company has been solidly profitable since reporting a $1.7 billion loss in 2003. Sales in 2005 were flat year over year at $20 billion. But earlier this year, EDS retained a sizeable chunk of its key General Motors business as the automaker awarded it a contract worth $3.8 billion over five years. Like IBM, EDS is looking to India for growth. This month, it completed its acquisition of a majority stake in Indian outsourcer Mphasis for $380 million.
EDS garners an average satisfaction score of 6.3. Customers like its globally consistent operations, giving the company its highest score, 6.9, in that category. Its low score, 5.7, is for strategic advice. One possible reason: EDS sold off its consulting unit, A.T. Kearney, last year.
It turns out the vendor-selection process differs depending on the type of outsourcer a company is evaluating. The most important criterion when considering a U.S. outsourcer is reliability, followed closely by cost, value, and technical skills. When considering an offshore outsourcer, cost is the leading criterion, cited by 85% of IT executives. Reliability and technical skills also are important, but not as important as the chance to save money.
"This was largely about cutting costs," says Tony Lombardi, director of infrastructure services at Armstrong World Industries, a manufacturer of flooring and building products that has dispatched much of its IT work to India's HCL Technologies. In Chapter 11, Armstrong let go of about a third of the IT workers in its infrastructure department after outsourcing a number of management and maintenance tasks. "It's always been like a family around here, so people were shocked," says Lombardi. "It was rough. But we had to run things like a business." The company offered incentives to retain key internal IT personnel during the transition.
But saving money comes at a price, and using an offshore IT service provider raises its own challenges--possible layoffs being just one of them. "The time difference [between the United States and India] can be difficult to manage, and there are going to be cultural differences," says Powers. For Worldspan, it's worth it. Powers has found that Indian service providers offer a "want-to-please culture, though they are very formal."
So how is outsourcing working out for most businesses? Half of those responding to our survey report that the experience has been a success. But 17% characterize it as a disaster. For companies that believe an outsourcing engagement didn't live up to its expectations, nearly half cite poor customer service, including slow responsiveness and lack of flexibility, as the primary reason for the disappointment. Two out of five encountered hidden vendor costs, and a third found the vendor had insufficient technical expertise.
Mistakes Were Made
|Wipro Technologies, like its Indian peers Infosys, Satyam Computer Services, and Tata Consultancy Services, is enjoying fast growth as more businesses get comfortable with the idea of placing key IT functions offshore. The company's sales jumped 30% in its most recent fiscal year, and it's using some of that revenue to fund acquisitions as it looks to broaden its offerings beyond application work. This month alone, Wipro acquired wireless design services vendor Saraware and retail systems provider Enabler. Chairman and managing director Azim Premji has led the company since 1966.
Wipro's ratings reflect larger perceptions about Indian outsourcers. With more CMM Level 5-certified operations than in the United States, they're known for strong process control, but most of them find their origins in routine programming, maintenance, and legacy work. Wipro's highest mark, 6.6, is for its ability to adhere to internal standards. Its low score, 4.5, is for innovation. Its average score is 5.6.
Pete Romfh, technical manager for messaging services at Continental Airlines, found out the hard way that it's not just a company's outsourcing partner that needs technical expertise--the knowledge must extend to the subcontractors they use. Through EDS, Continental's outsourcer, Romfh tapped Avaya India to install a new phone network at the airline's base in Delhi airport in India. "It was a total mess," he says.
Avaya India, a subsidiary of Avaya Inc., assigned to the job people who were inexperienced in telecom work, Romfh says. "I had to fly over there and show them how to do it," he says. Buyers of outsourcing services need to hold their service provider accountable for all work done by subcontractors. "If you're on a Continental flight and we screw up your meal, we can't go into a lengthy explanation of how the caterer messed up," he says. "Our customers won't accept that."
As tech professionals spend more time with outsourcers and evaluate the partnerships, a surprisingly high percentage reverse their decisions. One out of five companies has reeled in a major project, and an additional 26% report bringing a minor one back.
In many cases, such a move can be costly. Companies usually have to pay a penalty to the vendor if they terminate an outsourcing agreement early without good cause. For that reason, Romfh says, businesses need to work hard to make their outsourcing agreements work, even if there are some rough spots. "Too many times people want to just charge into court without really trying to make things work. But it's like a marriage--you have to work at it," he says. Romfh concedes "there's been times I've wanted to strangle the guys from EDS ... but then we work it out and go have a beer."
Illustration by John Sledd
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Customers Rate Their Outsourcers
|At CSC, the big "For Sale" sign could be having an effect on sales and operations at a vendor known mostly for its high-level IT outsourcing and integration work in the federal and defense sector. In April, chairman and CEO Van Honeycutt said the company had retained Goldman Sachs to help it explore "strategic alternatives," leading to a possible sale.
CSC last month reported revenue of $14.62 billion for fiscal 2006, a 4% increase over the previous year. For the current quarter, it expects revenue to drop 2% to 5%. The company had been on the block unofficially for several months before Honeycutt's announcement. Despite that, CSC continues to win some key contracts, including a five-year, $1.9 billion renewal from BAE Systems announced in May.
Survey respondents give CSC its highest mark, 6.0, for its ability to adhere to internal standards--not surprising for a defense IT specialist. Its lowest mark, 3.9, is for innovation. CSC's average score is 4.9.