Offshore Outsourcing of in-house systems development
Category : I. T. Papers
Table of Contents
- The Nature of Information Technology..................................... 2
- Role of IT in Businesses..............................................................4
- IT Outsourcing and its Framework.....................................................8
- IT Offshore Outsourcing.....................................................................12
Due to the increasing needs of information technology and systems driven by the fast paced technology, businesses have become e-businesses today, integrating and capitalizing information technology in every aspect of the business. However, having an information and development system costs a lot to the company which includes the cost of the units, maintenance and expertise to run the system properly and effectively. Some companies have opted to outsource such systems to companies that provide in-house development systems with the aim to reduce cost and to focus on their core businesses.
This paper aims to examine the role of IT in businesses and to determine the reasons why even though IT is a critical aspect of a business, most companies are still deciding to outsourced parts or their entire IT system offshore. The paper is organized as follows: the first part is all about the nature of IT followed by its role on the businesses. On the third part, IT outsourcing is discussed which includes the IT outsourcing frameworks and its composition while on the fourth section, offshore outsourcing is tackled.
1. The Nature of Information Technology
Defining Information Technology, it is used to obtain, process, and distribute information that has been integrated in every functional area of a company. It consists of a computer network, telecommunication system, databases and computer programs used within the business (1999). Just like any other technology, information technology is used to improve business processes, increase profitability and gain competitive advantage.
IT is composed of hardware such as the computers and peripheral devices including the printers, monitors, video recorders, servers, etc. In industries, the hardware components of IT also involves devices such as machines and other robotics which aid in the flow of information for the different departments in a company ( 1999) commonly used in the production functions.
Another component of IT is the software which is used to run the hardware. Software commonly used in businesses includes operating systems, database programming, and software use in Computer Aided Designs (CAD).
Databases are also part of IT. It is where the vast amount of company data and information are stored usually information on sales and projections, human resource information, financial records and many more. Telecommunications is also a very important component of IT for it allows networking of computers and connection to other communication devices such as telephones and fax machines. Through telecommunications, Internet technology was made possible.
With the components of IT mentioned above, it can be seen that integrating IT in a company requires human resource and financial capitals to be able to sustain an effective IT system. Generally, IT offers substantial advantages such as reduced cost of information exchange; increased speed of information transfer and retrieval; increased customer involvement in and control of transactions; and greater flexibility of using the marketing mix (2000). The internet is used in businesses for communications; market research, customer services, market penetration, product development, cost savings through process reengineering, direct marketing, advertising and product delivering ( 1996, 1996 , 2000).
2. Role of IT in Businesses
Information technology system has been an integral part of the strategy of most businesses today. For technology driven company such as the PC manufacturers, appliance and gadget manufacturers, audio and video equipment makers, pharmaceuticals and others, their research and development are heavily reliant on information technology. Other companies rely on IT for marketing their products as well as in improving their supply chain management.
Generally, IT is central to business initiatives such as reengineering, knowledge management, the creation of electronic channels of distribution, and the development of digital business strategies (1993; 1996; 1995 ).
Modern information technology has the power to radically redesign business processes in order to achieve dramatic improvements in performance (Hammer, 1990). This means that through the use of IT, companies have been able to improve and innovate many aspects of product development, from research, design, to its production processes. IT has made obsolete some of the traditional processes such as the creation of prototypes. Through IT, companies were able to test new products through different software minus the prototyping. They have created software for design and automation of some processes that helped improve the production process.
Supply Chain Management
IT has also been integrated in the supply chain management. It has become an important component of the supply chain, building better partnerships among suppliers and companies, and improved communications between customers and companies. In the supply chain management (SCM) lies the sustainable competitive advantage of organizations (1999). Through effective SCM, companies were able to reduce cost and improve services and product quality (1996).
Moreover, effective supply chain management requires information to be shared and transmitted beyond the boundaries of the organization (2006). Thus, effective information system is necessary in any company. Currently, traditional distribution channels are being transformed by the effective use of information technology (2006). Internet related technologies are acknowledged as the latest and most powerful tool to support supply chain management initiatives that open new opportunities within the supply chain (1999). Clients can now place order and make necessary research about the products through the internet while the company can communicate from its suppliers from time to time via the internet. Through IT, suppliers and companies can also facilitate redesigning of products; effective collaboration of a company and its suppliers can help build good partnerships and long-term relationships. One good example of company that has effectively integrated IT in its supply chain is the Dell Computer Company. According to Michael Dell himself, the founder of Dell:
“The world will be changed forever by the Internet... The Internet will be your business. If your business isn't enabled by providing customers and suppliers with more information, you're probably already in trouble. The Internet provides a dramatic reduction in the cost of transactions and the cost of interaction among people and businesses, and it creates dramatic new opportunities and destroys old competitive advantages. The Internet is like a weapon sitting on a table ready to be picked up by either you or your competitors” ( 1999).
This statement could mean that through IT, information flow between organizations involve in the supply chain will be efficient. According to , there are basically three types of IT use in SCM. The first type of IT use is transaction processing, which stands for the use of IT for increasing the efficiency of repetitive information exchanges between supply chain partners (2006). The second type of use is supply chain planning and collaboration which represents the use of IT for sharing planning-related information such as demand forecasts and other demand information (2006). Order tracking and delivery coordination is the third IT use which refers to the monitoring of individual orders or shipments with the aim of coordinating delivery or conveying timely information ( 2006).
When a company has effectively integrated IT in its SCM, it definitely has some advantages over the competitors which still use the traditional SCM. Such advantages may include the opportunity to reduce costs, elimination of human errors, speeding up of information transfer, timely delivery performance, and increased market due to reliable demand forecasts.
Information technology is definitely an important aspect of the business strategies such as marketing which includes pricing, promotion and customer service. Because of IT, global competition has been possible, providing companies to further expand their businesses. Another role of IT is to help improve customer satisfaction by providing them convenience, making customization possible and providing them timely information about the products. Most companies today have their website where the companies promote their products and where customers can place orders. Even restaurants, book publishers, electronic companies, and even schools have utilized IT to be able to attract more customers and eventually increase market share and sales.
Customers today have sophisticated demands and needs that businesses should be able to meet. As (1996) stated “A company must deliver greater value to its customers or create comparable value at a lower cost, or do both”. To accomplish this, effective implementation of a business strategy which depends upon insightful use of information technology to redesign business processes, improve supply chain management, and increase the value provided to the customers by having timely and comprehensive information to make good marketing, production and distribution decisions (1999) is needed.
Another strategy is the way companies handle knowledge management. As for any company, knowledge is the intangible assets that accounts for a company’s intellectual capital such as employees’ competence; the internal structure of the organization including the company’s concepts and processes, its IT infrastructure, and the different systems being implemented in the company; and its external structure which is defined by its relationship with customers and suppliers, the company’s brand identity, image and reputation (1997).
3. IT Outsourcing and its Framework
According to the General Accounting Office, (2001) of the United States, IT outsourcing in general describes the activities associated with acquiring IT services from one or more external providers. During outsourcing, a company transfers responsibility for one or more IT services to one or more external providers, and this responsibility is executed through control and management of the processes, people, and technology associated with these services ( 2001). IT outsourcing also refers to the third party management of IS assets, people and activities required to meet pre-specified performance levels (1995). These activities include the operating of data centers, network and communication management, systems development and maintenance, and training.
According to (2006), there are three strategic intents for IT outsourcing: information system (IS) improvement, commercial exploitation and business impact. These intents an also be considered as the benefits that can be gained through IT outsourcing.
Many companies see the importance of improving their information system resources such as the hardware, software, networks, human resources and processes involved in managing and operating the technology. With this intent, the company believed and realized that through the help of external IT providers, the company’s IS will improved. The company selects only the processes or the resources needed to be improved and let the expert external IT providers do the improvements needed. Transformation and upgrading of IT resources and skills; introduction of new IT resources and skills; and improvement of productivity of existing IT resources (2006) are some of the benefits that can be gained with the intention of improving IS.
Business impact is another strategic intent of IT outsourcing. This is basically the utilization of IT with the combination of business skills to significantly improve critical aspects of business performance. The goal is better alignment of IT resources with business needs and delivery of IT-based business capabilities and competencies (2006). This may include IT-based marketing, automating order fulfillment, inventory management, or the use of technology to gain competitive edge such as the use of particular software that can improve process or product design.
The GAO of the United States constructed an IT outsourcing framework that best describes how IT outsourcing works. The framework consists of seven phases and the best practices on each phase. The framework also identifies the three critical success factors in IT outsourcing (see: recommended reading).
Discussing the first four phases of the framework, the first phase in IT outsourcing is to determine sourcing strategy (2001). It is basically the determination whether internal capability or external expertise can more effectively meet the company’s IT needs (2001) before deciding to outsource. This is done by identifying clearly the IT sources of a company and determining whether these sources are able to meet the strategic objectives of the company. Optimizing of internal IT processes provides a company with the information to make sourcing decision of whether to continue with the internal provision of IT services or changing to an outsourced arrangement with external providers (2001).
A well-designed strategy strikes the optimum balance between delivery requirements, risk, cost and desired benefits ( 2003). If cost saving is the primary objective, the strategy would be to shift much work as possible offshore; a need for 24/7 support or operation may lead to spreading work across development centers in multiple countries; and a highly interactive project may demand the involvement of the internal IT organization (2003).
The phase 2 of the IT outsourcing framework is to define operational model. An operational model helps the company compare its plans against the expectations to ensure whether these plans will enable the company to meet those objectives ( 2001). Part of the model is an understanding of how the company plans to communicate with the provider which is done by having an IT management structure that will facilitate the alignment and integration of IT with the company’s business units
Phase 3 is to develop a contract. It is the company itself who will establish the legal terms for the IT outsourcing relationship. The contract must include the expectations for service levels, delivery of services, continuous improvement and protection for both the company and the provider. It is stated in the contract all the requirements of the company that is why a company must specify its performance requirements based on the needs of the company and how much the company can afford. It is also a practice of most companies to use third-party assistance in negotiating and developing contract ( 2001).
Phase 4 is to select provider/s. After having gone through the above phases, the company can now identify the provider that meet its needs. Some companies opted to have more than one provider but managing multiple providers thus alliance among a group of providers are formed. Common practices of companies are to conduct research on state of the market, providers, and technology before defining the criteria they are looking for in a provider, verify the providers’ capabilities and specifying and defining the services and expected level performance (GAO, 2001).
Provider/s may be onshore/nearshore or offshore. When selecting offshore IT providers, policy and rules such as labor laws, import licenses, the country’s infrastructure and many other factors are taken into considerations.
4. IT Offshore Outsourcing
Since IT systems provide a number of advantages and play significant roles in businesses, companies have the desire to having IT systems. Companies have long realized the importance of IT systems in their development. Thus, an effective IT system should be well incorporated with the company’s strategies, goals, organizational structure and needs. However, while there are companies that can easily have IT systems, some companies have the needs for cost reduction and owning an expensive IT system will not be possible aside from the lack of the resources and expertise needed to acquire an IT system.
Many research studies have seen outsourcing of some of the companies’ activities, even IT activities, as the solution to reduce cost and for the companies to focus on their core businesses. Outsourcing is a global sourcing strategy; it can be nearshore or offshore, allowing companies to take advantage of lower salary structures and operating costs in other countries (2003). Nearshore refers to development centers located within the country or the neighboring countries ( 2003). For US companies, the most common choices for nearshore outsourcing are Canada and Mexico.
Offshore outsourcing, on the other hand, refers to the subcontracting of IT projects anywhere in the world (2003). The most common location for IT offshore outsourcing today are India, Russia, China, Philippines and Israel. The Silicon Valley Outsourcing Inc. (2003) outlined the following benefits of offshore outsourcing:
· Increase focus on core competencies - allows a company to focus their internal resources and energy on what they do best, gaining competitive advantage by reallocating critical resources that do not add significant competitive advantage. Manufacturing companies can focus on their businesses than on the complicated IT systems.
· Improve time-to-market and minimize risks – companies can significantly reduce the time necessary for building teams, infrastructure, processes and procedures needed in developing IS.
· Achieve superior performance – offshore outsourcing of IT gives the company access to professionals with highly specialized skills that can meet the requirements of the company. Many software programmers are available in India, Philippines and other countries.
· Maintain flexibility – companies can readily scale the number of resources being used in accordance with the demand.
· Minimize capital expenditures and operating costs – companies can avoid the fixed costs associated with location-based IT facilities, personnel, IT infrastructure, and other capital expenditures. Operating costs are also reduced due to the lower salary structure of offshore suppliers based in developing countries (2003).
Dell, GE, Microsoft, Lucent, Oracle and Motorola are just few of the many companies that opted for IT offshore outsourcing. Dell Computer Inc. has offshore operations primarily in India. According to (2002) who was a general manager at Dell and who set up Dell’s offshore operation, Dell started their own captive call center and back-office operations and at the same time outsourced these similar activities to a local Indian Outsourcer. Other companies that do not have much knowledge on IT systems such as banks and pharmaceutical companies also outsourced their IT systems. About one third of Silicon Valley companies outsource some portion of their research and development to India ( 2003), and an increasing number of major US companies are turning to India not only for product and software R&D but also for back office support centers (2003).
Case Study: GE Strategy
In the early 1990s, GE Chief Executive that time announced that “70-70-70” would be the company’s rule for sending technology work offsite. That is 70% of technology works would be done by outside suppliers, 70% of that overseas, and 70% of that in India, recreating the company using mostly offshore resources especially that of India. Generally, GE is focused on four corporate initiatives which are globalization, services, Six Sigma quality, and e-business. Globalization is seemed to be the most prominent of these initiatives which centers on a high-quality labor pool, low-cost suppliers, and engineering and manufacturing plants in less expensive countries such as Mexico, China, India and Russia.
As of 2003, GE had about 20,000 employees in India, performing six categories of activities such as local market sales and services; sourced software in global development and engineering centers; GE-owned technology and software operations; backroom services such as call centers and legal and accounting processes; exports and components of products made by GE; and sourcing of components from key suppliers for export to GE’s global manufacturing locations, providing the company revenues and orders of more than $1 billion in 2002. GE is considered to be one of the pioneers of outsourcing in India. 
Most companies have chosen India to be their first choice when outsourcing IT. This is mainly because India have a great number of graduates per year mostly came from the emerging computer training institutes, making their graduates gained various levels of IT skills. Aside from that, India also has a good infrastructure and regulations suitable for becoming an IT hub. The country has the established Software Technology Parks, providing incentives and concentration of facilities, and 100% foreign ownership is permitted in IT enabled services industry. Generally, the availability of highly-skilled, yet low cost manpower, along with adequate infrastructure and technological developments are the bases when choosing an offshore location.
Risks of Offshore Outsourcing
The Silicon Valley Outsourcing Inc. (2003) outlined the following risks posed by offshore outsourcing and are needed to be mitigated:
· Outsourced tasks do not meet expectations which generally occurs due to breakdown in communications such as not clearly defined requirements; conflicting and informal communication of requirements; lack of proper background information, and unexamined cultural and geographic differences; and inaccuracies
· Local and offshore teams fail to integrate due to differences in communication, culture, processes and procedures; and goals
· Quality issues such as inadequate service infrastructure, poor quality of personnel, unsatisfactory transitioning processes, hidden inefficiencies and lack of experience of the provider resulting to unsatisfactory delivery
· Loss of control due to difficulties in monitoring and ensuring progress towards the IT projects quality, schedule and cost objectives
· Risk to intellectual property since outsourcing involves transfer of ownership of the process to an external provider especially when the offshore country has poor policy on intellectual property.
Because of the roles and importance played by IT in businesses, lack of resources such as human resources and physical resources is not a hindrance in acquiring a good Information System, systems development, and other IT-related activities and systems because of IT outsourcing. IT offshore outsourcing also helps companies reduce costs and expenses and at the same time focus on their core competency. The significance of IT outsourcing offshore has been clearly identified in this research study. However, IT outsourcing also poses some risks that is needed to be mitigated that is why a framework is important. The IT Outsourcing framework plays a significant role in assisting companies decide on outsourcing their IT and IS while avoiding the risks associated with IT outsourcing.
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