Profit Magazine - November 2007

Outsourcing is closely tied to organizational innovation. Done well, it helps businesses focus on what they do best while learning from partners. Done poorly, it causes businesses to surrender their strategic advantages. Martin Curley, senior principal engineer and global director of IT Innovation and Research for Intel in Dublin, Ireland, thinks about this conundrum every day. Intel outsources some of its business processes while also performing outtasking.

Curley and his team at Intel have been instrumental in forming the Innovation Value Institute, a joint venture between Intel and the National University of Ireland at Maynooth. Other partners include Microsoft, SAP, Boston Consulting Group, and the U.S. Department of Defense. “As part of our Open Innovation Consortium at the Innovation Value Institute, we’ve identified 36 critical processes that are very important for IT organizations to be good at, to maximize the value that they deliver.” While many of these processes are candidates for outsourcing, Curley says, “one of those critical processes is outsourcing.” Although it’s becoming more important to corporations, many organizations are not mature in the way they approach outsourcing and in particular how they build the business case. “Building the business case for outsourcing is critically important,” Curley says. “Many of the business cases that I see are far from complete. They show the IT view of the world rather than displaying the full spectrum of both benefits and cost.”

Much of the Innovation Value Institute’s work on outsourcing has been influenced by Ronald Coase, a Univer-

sity of Chicago economist who won the 1991 Nobel Prize in economics for his work on transaction costs and property rights. Coase said that companies will expand until the costs of organizing an extra transaction within the firm (whether for customers or for internal use) become equal to the costs of carrying out the same transaction on the open market. It’s a way of determining when to outsource and when to do the work in-house, and it’s a flexible framework that accommodates both economies of scale and changes in technology. For example, there are times when it makes sense to handle IT in-house, but during eras of rapid technological change or if the firm’s employee compensation is higher than market rates elsewhere, sending the process outside may be a better choice. This principle, known as Coase’s Law, should guide the business case for outsourced computing. If the total cost of outsourcing is less than the total cost of doing the function in-house, then management should consider sending the function out. “It’s a good guideline, depending on your strategic objectives for outsourcing,” Curley says.

However, Curley says, “ Outsourcing should not be based on economics alone. Another lens is provided by resource-based theory, which advocates that companies should particularly focus on strengthening their core competencies, as this is what differentiates them in the marketplace. Selective outsourcing may allow a firm to really focus on and take advantage of its core competencies, or to acquire external capabilities that it does not have in-house.”

“Companies are outsourcing for dif-

ferent reasons,” Curley explains. “Some are outsourcing call centers to reduce costs, or maybe looking for flexibility or avoiding fixed costs, and some are outsourcing for improved capabilities.” Rather than rely on generalizations, Curley says, a good business case has to start with why outsourcing makes sense for a specific organization at a specific time. “Aligning the business case with that, and really doing the due diligence taking into account all factors, not just the labor rates, is particularly important,” he says.

Curley recommends that firms considering outsourcing as an economic decision include four key elements in their consideration process: the assets currently used by the service, the cost of running the service on an ongoing basis, the investment required to outsource the service, and what he calls the “ service change investment”—the effect on internal and external customers. “The service change investment is sometimes minimal, but very often it is underestimated in IT business cases,” Curley says. Firms considering outsourcing for strategic control outsource IT activities that are not strategic so that they can concentrate their investment and focus on specific resources and processes that can add superior value to the firm. When a firm can align both the economic argument and the strategic argument, this is often a win-win scenario.

Having a strong business case for IT decisions, Curley says, is key to survival. “Every year it’s more competitive, it’s more risky, and companies really have to differentiate themselves with their core competency.”

almost US$1 billion on US$3.9 billion in revenue and US$8.2 billion in assets. By 2006, the company earned US$655 million after taxes on US$5 billion in revenue and US$7.4 billion in assets. Despite the trimmer base, Agilent’s people had the information they needed to generate more profits on more sales. “From an IT cost perspective, we have gone down to about 30 percent of what we were five years ago,” Vaidyanathan says. “We consider

that a tremendous ROI.”

Vaidyanathan believes that Agilent could not have hit those numbers with an in-house IT infrastructure. “Outsourcing has definitely helped us in terms of cost savings,” Vaidyanathan says, and it’s allowed his team to work on projects that generate more returns for the operating units. “If we had kept the systems work in-house, our cost structure would be about 120 percent or 130 percent higher, and we would