Sunday, October 25, 2009

When is Outsourcing NOT an Option?

The decision to outsource the IT functions of an organization depends on the costs and benefits associated with it. The primary objective of outsourcing is to reduce the operational costs while gaining some competitive advantage over other competitors. At the same time, we must also consider the risks and long-term impact to the organization. Once we outsource certain functionality, the organization starts depends on those sourcing organizations and may face new uncontrollable risks. In this context, it is worthwhile to find out the possible disadvantages of outsourcing so that we can assess the impact of them on our outsourcing objectives.

The most important question we should answer is “what to outsource?” The rationale behind outsourcing is that those sourcing firms will be able to perform the functions better than we will. Therefore, we should identify which functions we perform better and in which functions we create less value compared to the effort we put. We should identify our core competencies and other non-critical tasks. It is not a good idea to outsource our core competencies, as they can be the primary source of our competitive advantage.

We may outsource a certain function because we cannot perform it well, but can the sourcing firm perform it well in the first place? It can be the case that the sourcing firm lack experience on performing that function. In that case, outsourcing might be risky as well as costly.

Outsourcing can make intellectual property right issues more complicated. The organization either loses some rights of the intellectual properties or may need to pay loyalties to the sourcing companies. Furthermore, the knowledge and experience retain with the sourcing company and the organization will increasingly depend on them. Therefore, it is better to develop and manage highly creative software products or services in-house rather than outsourcing to a third party so that the organization has the full control of its intellectual properties.

In the case of outsourcing the IT functions to a foreign country, there can be many other constraints such as cultural and language differences or country specific rules and regulations. For instance, we may find cheap labour in China, but in order to operate in China we may needed to comply with certain rules and regulations. These rules and regulations may affect our potential advantages of outsourcing. The cultural and language differences could also affect our outsourcing prospect as they can result communication issues and poor co-ordination of the functions. The time differences and geographical distance could further fuel these issues. Therefore, outsourcing may not be an option on those kinds of situations.

The involvement of more parties can always increase the possibility of disputes. Of course, we can minimize them via proper agreements among the parties, but still there can be misunderstandings. Once such issue arises, it can take some time to resolve the issue and worst there can be extra costs attached to it such as legal fees. In addition to the costs, there can be discontinuities of the service or production and this will badly effect our organization both short term and long term. Therefore, we should avoid outsourcing critical IT tasks, which may result these kinds of issues.

The economic and political situation of the sourcing country is also a very important factor. Suppose the sourcing countries economy develops extremely fast and as a result, the wages keep increasing. In this case, we can expect that our current cost advantage of outsourcing will not last for long and therefore it may be better to invest on organizations’ capacity building rather than outsourcing. In addition, if the political situation of a country is not stable (e.g. war), and then outsourcing to that country can be risky as it is possible to experience discontinuities of service or production.

Finally, the number of potential firms, which could undertake the IT tasks, can also be an important factor. If there are very few sourcing firms capable of performing a given task, then outsourcing that task might be an issue. For instance, suppose there is only one sourcing firm capable of performing a given task and we have outsourced that task to that firm. In the case of a dispute (with the sourcing firm or within the sourcing firm), we will be in a weak position as we have no alternative options.

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