Will IT Outsourcing Reverse?

January 29, 2013 1 Comment »
Will IT Outsourcing Reverse?

With all the hype about the cloud and other IT outsourcing, GM’s about-face last year in regard to its IT strategy raises questions about whether the hype has taken the industry too far in one direction. Is “insourcing” the new wave, or are GM and recent declines in outsourcing growth simply bumps in the road?

Differentiating Between “Outsourcing” and “Offshoring”

Because so many people have visceral reactions to the word outsourcing, it’s important to note that outsourcing does not always mean “sending jobs overseas.” Hiring a Chinese or Indian firm to tackle an IT or other project is, for this reason, better labeled offshoring. Offshoring is a subset of outsourcing; the two are not identical.

Outsourcing Takes Hit in 2012

The rush to outsource IT showed signs of weakness in 2012—particularly in the second half. According to technology analysis company ISG, the global outsourcing market saw a drop of 11% in 4Q12 compared with the previous quarter, or a 27% decline year over year. For the full 2012, the global market fell 3% from the previous year. These numbers are for commercial outsourcing contracts whose annual contract value (ACV) is a minimum of $5 million. A set of slides from ISG shows a more granular breakdown of the outsourcing market by region and several other criteria.

According to Network World, research firm Everest Group reported that the number of new publicly reported IT and business-process outsourcing contracts fell from 472 in 3Q11 to 381 in 3Q12. Furthermore, the total annualized value of these contracts in 3Q12 declined to $1.5 billion, roughly a 44% year-over-year decrease.

Although GM’s plans to move its previously outsourced IT operations back under the company’s umbrella is not necessarily indicative of a larger market trend, it does raise the question. Forbes notes that the automaker’s planned budget shift would reverse its current 90% outsourced/10% in-house mix to 90% in house/10% outsourced. The company hopes to accomplish this goal within three to five years.

What’s Driving (No Pun Intended) the Change?

In light of 2011 being a record year according to ISG, a 3% drop in the 2012 global IT outsourcing market may not be as bad as it would otherwise seem. A breather in a fast-growing market is not necessarily surprising. Possible factors contributing to the 2012 decline include a weak economy in Europe and the U.S. The debt crisis in Europe, which is in the midst of a second recession, is troublesome owing to the obvious need for major governmental reforms. The U.S. is following the same path as the federal government puts on political theater over raising the debt limit (is there any doubt that the debt limit will be raised as often as requested by the president or Congress?). The stagnant economy may well return to recession in 2013, barring effective efforts on the part of the Federal Reserve in attempting to create faux growth by further debasing the dollar. These conditions have broad economic effects, and IT outsourcing is no exception.

ISG partly blames the recent U.S. elections and hurricane Sandy as possible contributing factors to the quarterly market decline. Furthermore, with offshoring getting a renewed lashing from politicians as they struggle to bring down a stubborn unemployment rate, many companies have hesitated to sign contracts with foreign providers. Network World cites Everest Group’s practice director for global sourcing, Salil Dani, as saying that “banks in the U.S. in particular delayed decisions relating to offshoring to locations like India and the Philippines because a number of them have taken funding from the government, and didn’t want to be seen as offshoring while the political rhetoric was at its hottest.”

GM’s decision, however, may reflect a more fundamental issue with outsourcing that is independent of the current economic and political climate.

Are All the Supposed Benefits of Outsourcing Real?

Listing many of the espoused benefits of outsourcing is simple, mostly because these benefits make logical sense. For instance, by outsourcing IT operations, a company can focus its time and energy on building its core business rather than on maintaining and developing peripheral infrastructure. In addition, outsourcing eliminates many of the capital costs, typically converting them to ongoing operational expenses—presumably yielding savings as service providers amortize capital costs across many customers. The quintessential example of IT outsourcing today is the cloud.

DatacenterDynamics’ Ambrose McNevin summarizes one of the concerns of outsourcing to the cloud: “Why tie up your capital when you can outsource to a third party who will manage the IT headache for you? Sound familiar? However what many forgot was that you can only outsource once and the savings don’t accrue, the costs do…[W]hat GM is telling us is that nothing is free and the price of savings is control.” This lack of control begets various difficulties; for one, data and services are entrusted to third parties rather than being kept in house—a deal breaker in some industries, but a questionable matter in others. Dissatisfaction with service providers can also be a headache, as such matters can be more difficult (and expensive) to handle compared with in-house issues.

Although outsourcing sounds great—and no doubt works out well in many cases—it is not a panacea for all situations and all needs. CIO.com predicts that GM’s move back toward in-house IT signals a trend in which “low-level and routine tasks will remain with third-parties while higher value positions like capacity planning, architecture, and configuration management will move back in [house].”

Industry Seeks Balance?

GM may be a manifestation of an approach to IT that has moved too far to an extreme—outsourcing—in search of cost savings and a leaner business strategy. Certainly, hype can drive an industry to overreach in one direction, leading eventually to a rebound from the extreme. On the other hand, GM may not be the best indicator of a viable business approach. The automaker, known not-so-affectionately as “Government Motors” for its recent federal bailout, has yet to prove that it can maintain a profitable business without extensive outside supports. Bailouts, far from creating an atmosphere of corporate responsibility, simply remove the risks of bad business practices. Other examples of returning to in-house IT might serve as a better, if less remarkable, indicator of market directions.

For offshoring in particular, rising standards of living in foreign countries mean that the cost of doing business with companies in these nations will increase. Such changes will reduce the benefits of offshoring in favor of dealing locally, which avoids the hassles of foreign laws, language barriers, physical distances and so on. This trend, however, would be a longer-term effect and would not necessarily stifle the overall outsourcing market.

Another important point is that GM is a large corporation and thus does not necessarily represent the IT trend for smaller businesses. Mega companies have more capital resources than small companies, so the task of moving IT in house after having already outsourced is—although still expensive—less high of a hurdle. Thus, IT outsourcing trends may differ significantly depending on business size, as well as industry.

Conclusions

IT outsourcing probably hasn’t reached a major turning point, but GM’s plans to bring most of its IT back in house offers companies a reason to pause before blindly outsourcing. The consequences of moving IT operations outside the company are certainly not all positive, but the balance sometimes tips in favor of keeping IT under the company’s roof.

Photo courtesy of kenteegardin

About Jeff Clark

Jeff Clark is editor for the Data Center Journal. He holds a bachelor’s degree in physics from the University of Richmond, as well as master’s and doctorate degrees in electrical engineering from Virginia Tech. An author and aspiring renaissance man, his interests range from quantum mechanics and processor technology to drawing and philosophy.

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