&(175( )25 5(6($5&+ ,1

,1)250$7,21 0$1$*(0(17
:25.,1* 3$3(5 6(5,(6

LIMITS TO IT OUTSOURCING
Michael J. Earl
London Business School
CRIM WP96/1

Copyright © Centre for Research in Information Management, London Business School,

1997. These papers are part of a series of early publications by faculty at London Business
School. They are accessible in electronic format free of charge to Sponsor companies who are
part of the CRIM research programme and the I:Lab Founding Sponsor programme.

These papers should not be reproduced in any format for any purpose save non-profit
educational purpose without permission of the authors.
 Limits to IT Outsourcing

ABSTRACT

Large corporations continue to outsource IT services. However, the issues of

whether to outsource and how to do it still generate strong emotions. Fortunately,

recent articles have shown the way on how to tackle questions of sourcing strategy

with due care and diligence. Many practitioners and academics would now argue

for selective or smart sourcing and this is probably a sensible approach in seeking

to balance efficiency and effectiveness in provision of IT services. Such a strategy

admits that insourcing is sometimes the preferred option. This paper argues that it

might be safest to first ask the question why not insource IT? This perspective is

based on an analysis of eleven limits to outsourcing identified in discussions with

both buyers and vendors in the IT outsourcing market-place.

Keywords: Information Technology; Outsourcing; Insourcing

 LIMITS TO IT OUTSOURCING

Michael J. Earl, London Business School

INTRODUCTION

Outsourcing of IT has been a trend of the 90's. However, external sourcing of IT services is not
new (Fig 1). For example, systems development has been sourced from outside through
application packages or software houses for many years and has not seemed abnormal. It was
perhaps the large facilities management contracts in the late 1980's that caught executive
attention. The practice signalled a timely convergence of supply and demand factors. On the one
hand, major, well-known vendors started to offer facilities management and other outsourcing
services. On the other hand, managements tiring of year on year IS budget growth and
sometimes elusive business benefits saw the opportunity to cut IT costs, downsize the IS function
and do in IT what they were doing in other parts of the business, namely subcontracting. The
announcement of two seemingly revolutionary outsourcing contracts - Eastman Kodak and
General Dynamics - then may have given confidence to business to take on IT outsourcing (Loh
& Venkatraman, 1992) on an ever-widening scale and the issue was established on corporate
agendas.

Figure 1: Evolution of IT Outsourcing

"ERA" EARLY GROWTH ACCELERATION CONTINUATION

GROWTH HIGH IMPACT WIDER SCOPE SELECTIVE

PRACTICE Subcontracting Facilities Outsourcing Smart Sourcing

Management

Data Centres
ACTIVITIES Mainly Systems Mainly Data Data Centres Networks
OUTSOURCED Development Centres Networks Desk Top
Management

Cost Savings Focus on Core

RATIONALE Work Smoothing Coping with Competencies Alliances
Buying Expertise Legacy Systems Reengineering the Eclectism
IS Function
CRIM WP96/1 - Limits to IT Outsourcing 2

The objectives of outsourcing are reported generally to be cost-cutting, a desire to focus on the
business not IT (or on "core systems not the total application portfolio"), or subcontracting
responsibilities for operating and maintaining legacy systems. Whatever the objective, the
possibility of outsourcing tends to generate strong emotions among both IS professionals and
general managers. Thus research on the myths and realities of outsourcing was welcome (Lacity
& Hirscheim, 1993). This work has been followed by "how to do it" literature aiming to help
companies implement outsourcing, not only in terms of managing contracts and relationships
sensibly (Cross, 1995; MacFarlan & Nolan, 1995; Lacity, Willcocks & Feeny, 1995), but also in
terms of how to select sourcing options (Feeny, Lacity & Willcocks, 1996). These prescriptions
help both those companies who are bold protagonists of IT outsourcing and those who feel that
they will have to do some outsourcing and would appreciate guidelines on how to be selective.

Indeed, there is a trend now towards selective or "smart" sourcing and a recognition of
alternative sourcing strategies, whatever the objective. Fig 2 is a typical framework for analysis to
aid these decisions, where the guiding parameters are business value of a technology or
application and operational performance of the associated service. It suggests, for example, that
outsourcing of information systems central to business strategy may be a dangerous diversion,
especially if IT operations are already efficient. In-sourcing in this situation is preferred. If
business value is high but operational performance is weak, then market testing (or
benchmarking) could make sense, at least to see what performance improvement might be
possible by either internal or external sourcing. However, if operational performance is weak and
business value of the particular technology or application is low, then outsourcing is a more
obvious route to improvement. Finally, smart sourcing could be a means of simplifying the IT
domain where elements of it are satisfactory in terms of operational performance but not central
to business capability or strategy.
CRIM WP96/1 - Limits to IT Outsourcing 3

Figure 2: IT Sourcing Strategies

Core

MARKET IN-SOURCE
TEST

BUSINESS
VALUE OF IT

OUT-SOURCE SMART
SOURCE

Commodity
Anxieties OPERATIONAL Satisfaction
PERFORMANCE
OF IT

Such arguments are intuitively appealing at an analytical and general level. The trouble is that
they can be simplistic in practice. They do not take into account a number of complexities which
permeate the management of information resources. In 1991, I wrote that companies should ask
themselves whether they should outsource IT services because it was a good question to ask,
even if the answer was no (Earl, 1991). Such questions provided an acid test of how important
were a firm's information systems and how well the IS function was performing, the criteria
underpinning Fig. 2. I do not retract that conclusion. However, on the basis of experience -
namely discussions with both vendors and customers in Europe and North America - I would
change the balance and scope of the question to why would outsourcing make sense and why
would it work? There are, I suggest, many risks which in practice indicate that there are limits to
outsourcing. I sense that there are often more regrets by those who have outsourced than they
would admit and more anxieties amongst vendors than they care to confront. CIO's in firms who
are currently on the cusp of deciding to outsource also confide to me apparently sound cautionary
instincts, but top management momentum can be difficult to stop. Furthermore, frameworks for
analysis like that in Fig 2 whilst highlighting different sourcing options also give a momentum to
the outsourcing movement, because they imply that the market place has a significant potential in
the supply of IT services, albeit in different ways, whatever the difficulties involved.

So this paper is, unapologetically, a plea to CIO's and CEO's to "proceed with caution" on IT
outsourcing. Indeed, it could be interpreted as a recommendation to rephrase the IT sourcing
question, namely "why should we not insource IT services?"
CRIM WP96/1 - Limits to IT Outsourcing 4

ELEVEN RISKS OF OUTSOURCING

1. Outsourcing is Not a Substitute for Management

If an IT service scores low on the operational performance dimension of Fig 2, the temptation
clearly is to outsource it to a third party. This is true whether poor performance is "real" or
imagined, or whether top management's views are rational or emotional. Yet let us consider the
likely causes or context of poor performance.

Cost or Quality problems may be due to inadequate economies of scale. Then outsourcing can
make sense although there may be internal solutions available through centralised rationalisation.
Collaborative joint information processing ventures with other similar companies are another
option. However, whatever option is adopted, you still need capable IS executives who know
how to manage IT operations so that they can be informed buyers and demanding customers. If
outsourcing is selected, they also have to know how to manage contracts and relationships with
third parties.

Alternatively, the IT activity may have been badly managed in the first place, so will the IT
managers be any better at managing an external provider? Indeed, does executive management
want to give the benefits of improving an inefficient operation to the market-place? In this
situation there are at least two possible responses. You can buy better IT Managers and/or you
can try and turn round internal performance first, before subcontracting to the marketplace. These
are sensible precautions, and probably should precede any outsourcing based on dissatisfaction of
operations.

However, once outsourcing has been initiated, managing IT operations on the outside is still far
from trivial. As one company well known for its IT outsourcing has put it: "There is always
another hill to climb". If the third party is not necessarily better, you have to enhance your hard
management of vendor skills and your user-placating gifts. If the third party chooses to change
the way it provides the service - a different platform, a different location, a different modus
operandi - you have to learn about new mechanisms in a domain you thought you could leave
alone. If there are changes in the vendor's personnel or organization, you have to invest in
building new partnerships and understanding how things are done in the new regime.

In other words, to reduce initial risks in outsourcing you must be capable of managing the IT
service first. We have seen vendors pull out at the first stage when they have learnt how weak
CRIM WP96/1 - Limits to IT Outsourcing 5

the customer's IT management is; they recognise that weak management is not an opportunity for
profit-taking but a recipe for conflict and dissatisfaction. Second, if firms do outsource, they are
likely to need to enhance their commercial and legal competences in the IT domain. Third, in the
long run, the management tasks neither go away nor remain static. We can conceive of customers
pulling out at the later stages because managing outsourcing can be as difficult, but more remote,
than managing internal supply.

2. Vendors Do Not Necessarily Have Better People

One argument for outsourcing is that specialist IT companies are likely to have better IT
specialists. This could be true. Conversely, relatively new IT services businesses do not
necessarily have either the best expertise or solid experience. Worse than this, in facilities
management contracts with even the most established IT service businesses the customer's staff
may move to the vendor. As one company put it "All we did was transfer our weaker staff and
then we had to deal with them all over again". In retrospect, they would have sought to avoid
such a personnel policy.

This risk becomes even starker when you recall that some of the largest outsourcing contracts
were made in order to "transform a resistant and slack IS function". In this situation, even the
most macho company would seek to transfer some of its IT staff to the vendor to ensure some
continuity of service and understanding in the short run. But again would this appeal to the more
able IT staff?

The biggest doubt, however, is this. When a large outsourcing contract is awarded to a major
vendor, why is it that simultaneously the headhunters are calling up their network of contacts
with this frantic request? "Do you know anyone who could manage a large facility that has just
been outsourced to XYZ Company?" or "Do you know anyone that has experience of managing
FM contracts and can head up the rapidly growing outsourcing division of ABC Company?" If
the answer to either question is someone working for the company who has just decided to
outsource - which has been the case - the chances are that he or she will be retained by the
original company anyway, or will prefer to work for another user company, where his or her
experience is better suited.

In other words, shrewd personnel policies can help mitigate some of the risks at a time an
outsourcing contract is signed. However, capable IT staff are not commonplace and there is
every chance that the customer company will want to keep them or that they will choose to
determine their own future themselves.
CRIM WP96/1 - Limits to IT Outsourcing 6

3. Business Certainty is Rare

If a firm decides to outsource IT services for cost or focus reasons, an assumption is being made
that the future direction and needs of the business are clear. A financing company which suffered
losses for the first time was asked by its parent to cut costs. The CEO saw that IT was the
highest single cost centre in the business and outsourced as many IT services as possible to save
costs. Once the business was in profit again, the CEO began to craft strategies for growth.
"Everything we planned to do depended on IT and I realised that we had sold our most
creatively, relevant people and devalued the platform of our future electronic distribution
channels" This was not just signing a long term contract in an uncertain world, it was signing
away a resource that would take time to replace.

This CEO could be written off as "just dumb". Or perhaps such short-term actions were justified
by the need to survive. However, when cost is the driver of outsourcing or variabilising fixed
costs the declared aim, is it not likely that crucial competences or capabilities are sacrificed? We
can conceive of other cases like this. I think of a MNC which has grown by acquisition and been
excellent at assimilating acquiree IT operations, not only achieving economies of scale by
centralising IT operations in-house but improving the bought companies' IT management
capabilities. It is now under some pressure to outsource its IT, largely one suspects because it is
the trend. It is not clear that acquisitions (or disposals) have stopped. Because the size of the
total business will wax and wane and the business demands on IT will vary, the parent no doubt
will decide to sign short-term outsourcing agreements or agree possible future amendments to
contract. There is no doubt that the vendors will demand premium prices or penalty clauses for
these privileges. So will IT outsourcing prejudice future returns form mergers and acquisitions
either by delaying the delivery of synergy or handing some of the returns from IT rationalisation
to the market-place?

The IT market-place, of course, may offer more variety of services and suppliers than any one
corporation can. Thus unknown future business needs in principle may be satisfied when they
arise. However the above examples suggest that there may well be long-term opportunity costs as
well - which can increase if business certainty is low.

4. Technology Skills Can Become Dated

When a company outsources an IT service to a third party at time to, how can we be sure that the
vendors' skills are still up-to-date at time tn? As one vendor put it "We have won some good
business by taking over legacy systems. The trouble is we now have legacy IT skills and our
CRIM WP96/1 - Limits to IT Outsourcing 7

customers are sometimes technologically ahead of us". Does this matter?

If cost reduction is the objective in an outsourcing deal, the hope is that the cost-base at time to is
reduced and probably that over periods time ti to tn there are further cost reductions due to
learning and technological change. Indeed, these improvements may be built into the contract at
the outset or negotiated at annual reviews. However, if the vendors' skills do not advance, cost
reduction potential is impaired and possibly, unless further market testing is done, target setting is
sub-optimal. The option is then to find another vendor. However as one company recently
discovered, alternative suppliers are rare, especially if a large-scale contract is involved. The
market is immature and the more that legacy systems are outsourced, the more it will be a
timewarp market.

If focus is the objective, the customer may be willing to pay for future inefficiency. However, as
several vendors have pointed out, customers often require cost reductions as well as any other
objective they first had in mind. The same can be true of those whose original objective was just
to get rid of the legacy systems.

A counter-argument, of course, is that the market will correct itself; vendors will respond to
market pressure or customers will invent alternative solutions. Unfortunately, the transitional
phase cannot be guaranteed to be comfortable.
5. Uncertainty is Endemic in IT
IT operations and development always have been inherently uncertain. Users are not sure of their
needs, new technology is risky, business requirements change, and implementation is full of
surprises. We know that a systems project management regime that demands no changes to
specifications and rigid time and budget control can produce applications that do not achieve their
full potential scope or can create user-specialist conflicts. Likewise, we should be wary of
outsourcing contracts that are set in concrete. There is plenty of advice in the outsourcing
literature to build in contract variation clauses, agree annual reviews, sign short-term contracts
and so on as a result - if the vendors will agree.

Reality can be different. One year reviews may invite costly annual contract amendments. Short-
term contracts will attract cost premiums. Contract variation clauses do not forsee all
uncertainties. An airline who both supplies services to others and buys services from the market
place recently reflected on this dilemma very succinctly: "You can buy flexibility, but you have to
pay for it". A US food company discovered that development of new systems was going to take
longer than expected as business requirements were changing. It had outsourced running of the
CRIM WP96/1 - Limits to IT Outsourcing 8

legacy applications that the new systems were replacing. The food company approached the
vendor in question to seek a non-punitive revision of contract. The vendor's reply was the
equivalent of caveat emptor and "we knew what we were signing if you didn't."

Being willing to pay for flexibility may be better than specification of tight performance contracts
with penalty clauses followed by litigation. One of North America's most successful lawyers in
this field observed to me that he was happy to take legal fees from clients who believed that IT
was a game of certainty and discovered that it was not, but he would prefer to earn money by
educating them. His first principle was that companies when they met contractual problems in IT
really should wish to solve them not sue the third party. Thus IT contracts of any sort should set
out early on to agree a process of conflict resolution and problem solution to follow when the
inevitable uncertainties occur.

However, the more likely that uncertainties will materialise, the more a company might wish to be
in control of its own destiny.

6. Hidden Costs
Where cost reduction is the objective of outsourcing, the typical promise is early cash flow
benefits and long-term cost savings. Certainly vendor costs can be compared with current costs
and also technology and learning curves can be built into future cost schedules. Conversely,
future possible cost savings may not be known and technological discontinuities not foreseen.
These issues are probably matters of judgement.

Two tendencies, however, are worrying. First, companies have reported that set-up costs can be
underestimated. These include redeployment and relocation costs. More particularly, they can
include the longer than expected hand-over or parallel running costs. One European division of a
US Corporation recently was asked to provide for $700,000 of these costs in the first year. The
local management was not amused!

The second set of unforseen costs tends to be management costs. Even one UK company who
believes its outsourcing has been a success reports that "We never anticipated the management
resources and time - and thus cost - that we have had to put in". Fortunately, perhaps,
companies rarely record the costs of management.

7. Organisational Learning
Much learning about the capability of IT is experiential. Organizations tend to learn to manage
CRIM WP96/1 - Limits to IT Outsourcing 9

IT by doing; they do not appreciate the challenges, nor how to cope, until they have experienced
them. Thus the informed buyers of IT services are likely to be people who have themselves been
providers of the particular service before. An anxiety therefore is where do the informed buyers
of tomorrow's technologies come from - unless firms first insource future new technologies
before they decide to source them from the marketplace.

The organizational learning phenomenon, however, becomes more important in the applications
domain. Managements tend to learn the value of IT applications (or of an infrastructure) by using
them and seeing further opportunities for development. Many of the so-called strategic
information systems which have been written about were discovered in an evolutionary fashion.
For example, several airline reservation systems began as automation initiatives to save clerical
costs before they were seen as stock (seat and yield) optimisation systems and electronic
distribution channels (Copeland & McKenney, 1988). Thus the strategic scope of systems often
emerges as users learn what is possible and as the business context and needs change.

Thus if a firm pursues the logic of the vertical axis of Fig 2, it can write off the value of an
application today, classifying it as tactical, commodity or low value only to discover that it
becomes strategic, core or high value tomorrow. We see this happening with sales transaction
systems in food and drink companies which were seen as essential but not special. These
companies now tend to see them in a different light as they seek to outwit retailers with better
and more current information and practice micro-marketing techniques with deeply segmented
data. Likewise an airline reported that more and more of the information linkages it needed to
build as it competes on knowledge were located in segments of its infrastructure it had previously
classified as commodity and thus had relaxed its control over.

Of course, there is no reason why a third party cannot operate or enhance or rebuild an
application which has been reclassified as strategic. However, in other areas of business,
responsibility for strategic assets is not so easily delegated to the marketplace. Recovery from
such errors of judgement will be sought by shifting the contractual relationship with a vendor
from a transactional contract to a more strategic partnership. Unfortunately, there is no guarantee
that either party knows how to create or sustain such a "strategic relationship". Vendors in
particular have suggested to me that "strategic" is a customer shorthand for "please share our
uncertainties but don't expect to be more involved in our plans or win better prices."

8. The Source of Innovation

More than likely in the long run, a company would like to maintain an innovative capacity in IT.
CRIM WP96/1 - Limits to IT Outsourcing 10

New ways of providing IT services will be expected and new ways of exploiting IT for the
business desired. If IT services have been outsourced, and especially if downsizing has occurred
in parallel, a company's ability to innovate may be impaired. Innovation does need slack
resources, organic and fluid organizational processes and experimental and intrapreneurial
competences - all attributes which external sourcing does not guarantee.

So the following factual scenario is not a surprise. A CIO expressed his frustration in this way:
"We want innovation from our vendors and partners. The marketplace should be better at
innovation and technology development than we are. We have been disappointed so far"
The chief executive of one of the vendors responded quite openly: "We didn't know that we had
to innovate. We thought the deal was all about cost. We will have to think about how to rise to
the challenge."

This scenario does not prove that innovation cannot be bought. It only suggests that partners
have their limitations too and that expectations must be properly managed. However, if some
innovative ideas are generated by others in the market-place, they may then have to be
implemented with the vendors who could not innovate in the first place but who now have
operational control of the IT resources concerned. The web of relationships becomes more
complex. While such complications are not impossible to cope with, they raise the management
costs again. In particular, they raise the search costs of innovation. There are two types of
search: identifying people in the market with ideas and locating people who have the
technological capability to translate an idea from the business into an application and implement
it.

The likely complex web of relationships with the market place also limits the opportunities for
users who understand the business to interact with specialists who understand the technology on
a continuing and informal, as well as formal, basis. Outsourcing does not seem a good fit with
some of the established processes of innovation.

9. The Eternal Triangle

Some years ago when IT specialists and users could not understand each other, companies
created a new role to act as an intermediary or interpreter between the two parties. Often called
business analysts or client managers or systems liaison officers, they sought to understand user
needs and convey them to the specialists, while being able to represent the specialists' concerns
back to the users. That was the theory. In practice the liaison roles succeeded only in keeping the
two communities apart and creating more confusion.
CRIM WP96/1 - Limits to IT Outsourcing 11

In examining how a major outsourcing programme has worked in one company, I have seen
history repeating itself. The residual IT personnel act as conduits or consultants between the line
managers and the vendors. What do the line managers say? "Why can't we speak directly to the
vendors?" What do the vendors say? "Why can't we get near to the business people who
matter?"
The solution may seem simple. Take out the middle-men! Curiously the company managers then
often claim they want to work with people who belong to, and understand, their culture. The
vendors say they must undertake another reskilling exercise, namely to teach their specialists
more about business and building organizational relationships. At the same time, vendor
personnel may be located in the client's organisation for long periods in order to become
"accepted as members". Meanwhile the residual IT personnel are likely to rethink how they can
add value and probably will hone up their skills in project management teamwork, negotiation
and conflict resolution. I have seen organisations stand still in their IT evolution as these
learnings take place. Outsourcing can recreate "the eternal triangle" for some time.

10. Technological Indivisibility

Outsourcing may be attractive and workable when it involves management of mature, or legacy
or separate activities such as running data centres and corporate wide area networks or
commissioning separable application developments. Advice from prior research and experience
(Lacity and Hirschheim, 1993; Cross, 1995; McFarlan and Nolan, 1995) can help mitigate risks in
these domains - for example employing benchmarking, service level agreements, efficiency
incentives, annual reviews and so on. However, there is much of IT that is not so divisible and
capable of "ring-fencing". Information systems today, for example, are increasingly integrated or
inter-connected and problems can occur at the interface of responsibility between different
vendors or between the vendor's domains and the customer's domain.

A contemporary and common outsourcing issue is "the desk-top", comprising personal computer
service, and software maintenance, local area networks and user support. Corporations would
like to outsource this "headache" activity, but are nervous - not least because of obvious
uncertainties about the direction and pace of change of hardware, operating systems and
applications suites.
CRIM WP96/1 - Limits to IT Outsourcing 12

Let us consider "the desk-top" in a typical knowledge-based organization. There is a PC

hardware platform (which may be both PC's and Macintosh). There are also the operating
system platform (DOS, Windows, Windows 95, MacOS, etc) and common, shared or local
packages (word processing, spreadsheets, database, graphics etc). Behind these are probably a
local area network and perhaps a corporate (and beyond) wide area network. In front of these
are personal knowledge-working tools and applications perhaps interfacing with enterprise-level
groupware.

Now recall "the old days" of data centres when arguments with vendors about responsibility
when something went wrong were commonplace. Was it the fault of the mainframe supplier, the
disk supplier, the communications vendor or the customer? Translate this into "the desk-top" and
imagine the fault-blaming routines! More important, think about solving a user support query.
Where in the various components of a desk-top architecture does the problem lie? Is it something
to do with the interface between the user's highly knowledge-specific, local application and the
technology architecture or is it a problem of incompatible software releases? Is it a local area
network fault or a server problem? And so on. More particularly, does the new support person
from the outsourcing supplier understand the problem and can he or she sort it out quickly? It
can be difficult to bound or delineate "the desk-top" and create at the same time sufficiently
generic support skills and specific user-oriented capabilities. There are too many
interdependencies.

A general manager was heard recently to observe that on a scale of 1 to 10 the IT utilities in his
company rated at least 9 in performance. On desk-top service, the rating was 3 or 4. Is this a
comment on the company's IS function, on the inherent complexity and indivisibility of "the desk-
top" or on the very visible nature of distributed and end-user computing environments? What is
certain is that if a third party were bought in to take over desk-top service and could not cope,
the levels of satisfaction would only decline further. Given the inevitable company-specific nature
of the desk-top domain, advice would seem to be to think twice about outsourcing in this and
other such indivisible areas of IT. Indeed one knowledge-based organisation learnt this lesson
from the market-place. No vendor would bid for a contract to manage the desk-top.

11. A Question of Focus

Outsourcing is essentially concerned with the supply side of IT. The market-place in principle
can provide IT operations, development, service and training. It is not so able to provide
CRIM WP96/1 - Limits to IT Outsourcing 13

acceptable, innovative application ideas, the challenging effort and commitment required in
systems implementation and the harvesting and delivery of IT benefits.

I asked a large MNC recently what it had achieved in IT in the last five years. The reply came that
they had downsized and outsourced. Certainly there had been a clear need for cost-cutting and IS
performance improvement. Also the corporation may not have countenanced investment in any
visionary, transformational application of IT until the credibility of the IS function in terms of
delivery was restored. However, when asked the supplementary question what have you done
that you are proud of in terms of achieving some degree of IT-enabled business change, the
response was that we built a new architecture in the process of outsourcing and downsizing. This
might pay off, but after five years it is neither evidence of, nor a recipe for, achieving sustainable
business added value or competitive advantage.

A real problem, then, with outsourcing is that it concentrates on the how of IT, not on the what.
It focuses on the supply side, not the demand side. And because it occupies substantial
management resources and executive time, it can become unwittingly another form of
denominator management rather than revenue creation - which, as a new era of technological
threats and opportunities for business unfolds, may not be a prescription for long-term success.

CONCLUSIONS
These eleven limits to (or risks of) outsourcing are not present in every sourcing decision.
Conversely, they are not unusual or esoteric risks. To be sure, some of them can be avoided or
reduced by actions I have suggested, by the advice of recent managerial articles or by selective
sourcing in some careful way. Indeed, it may well be that as corporate learning of IT Outsourcing
continues to advance, the strategy of selective or "smart" sourcing becomes the norm as implied
by the fourth era in Fig.1. After all, the common reasons for outsourcing IT services - cost
reduction, business focus and subcontracting legacy systems - remain sensible goals.

However, a pragmatist might observe that if these eleven limits or risks are real, even if they are
not universally present, then outsourcing looks like a very complex and uncertain activity to
manage. The same pragmatist then might suggest that the most appropriate question to ask is are
the benefits of outsourcing so great that the risks are worth managing or are the risks so
manageable that the benefits are worth having - a sort of risk/return tradeoff. This logic could
lead companies mostly towards outsourcing only the most commodity-like, utility IT services and
CRIM WP96/1 - Limits to IT Outsourcing 14

towards adopting some mix of selective or smart sourcing.

Risk-averse executives, however, concluding that outsourcing IT services is not easy might go
one step further. They might reframe the question as why should we not insource IT? Hard-won
experience may be suggesting that risk aversion is attractive in the complex and uncertain world
of IT services. This may be especially the case if effectiveness, business value and the demand
side are of equal or more interest than efficiency, cost-cutting and the supply side. For managing
IT to achieve sustainable competitive advantage requires continuous executive energy in
identifying and implementing innovative uses of IT, without dissipating and diverting it on supply-
side issues. This logic was behind the observation of a senior executive in a vendor company
which had provided IT services to a major multinational for some years. "They [the client] have
become very good at managing the supply side - but that's what we're good at and its our
business. The question is has their effort been balanced in terms of creating shareholder value?"
The same logic was perhaps underpinning the disappointment and dismay of a newly installed
CEO when he heard his CIO's response to the question what is the IS function doing for the
business right now. The reply was "we are very busy outsourcing and trying to make it work."

Drucker (1964) observed a long time ago that the important business results are on the outside, in
the domains of markets and customers. The same applies to IT results. There are limits to the
returns from investing in the domains of sourcing and vendors. The big gains are likely to come
from concentrating on IT-enabled business transformation, and particularly on concentrating the
attention of IS executives on deploying IT to improve the revenue side of the business.
CRIM WP96/1 - Limits to IT Outsourcing 15

References:
Copeland, D. G. & J. L. McKenney "Airline Reservation Systems: Lessons from History", MIS
Quarterly, Vol.12, Iss.3, September (1988).

Cross, J. "IT Outsourcing: British Petroleum" Harvard Business Review, May-June (1995).

Drucker, P. F. "Controls and Management" in C. Bonini et al. Management Controls: New

Directions in Basic Research, (1964) McGraw Hill.

Earl, M. J. "Outsourcing Information Services". Public Money and Management Vol.11, No.3,
(1991).

Feeny, D. F., Lacity, M. C. & L. P. Willcocks "Sourcing Information Technology Capability: A

Framework for Decision-Making". In M. Earl (ed) Information Management: The Organizational
Dimension, Oxford University Press (1996)

Lacity, M. C. & R. Hirschheim "The Information Systems Outsourcing Bandwagon" Sloan

Management Review, Fall (1993).

Lacity, M. C., Willcocks, L. P. and D. F. Feeny "IT Outsourcing: Maximise Flexibility and Control"
Harvard Business Review, May-June (1995).

Loh L, & N. Venkatraman "Determinants of Information Technology Outsourcing: A Cross-

Sectional Analysis". Journal of Management Information Systems, Vol. 9, No. 1. (1992).

McFarlan, F. W. & R. L. Nolan "How to Manage an Outsourcing Alliance "Sloan Management

Review, Winter (1995).

Centre for Research in Information Management

- Fax No. +44(0)71-724-7875 or email [email protected] -
http://www.lbs.ac.uk/crim/

The CRIM Working Paper series is a publication of the Centre for Research in Information
Management at London Business School. The papers are original work by Faculty within the
Centre, and provide the earliest dissemination of Centre research, and may be published more
formally in other journals at a later stage.

For ordering a publication list and order form please contact Linden Selby at the above numbers.

We gratefully acknowledge the contribution of Andersen Consulting, who have provided funding for
the publication costs of this series

The Centre is sponsored by Companies who subscribe to membership of our Research Programmes.