Grading Criteria for Assignment 1: Research paper

Clear Objectives and thesis 5%

Logical development of body and thesis 50%

Sufficient depth of research 15%

Appropriate reference methods and reporting 15%

Proper grammar, spelling, syntax and

punctuation; Appropriate format

15%

TOTAL

This is very well done! I like your application

of the archetypes and consider it a

demonstration of your mastery of one of the

major course concepts--Great job and full

credit!

100%

Research Analysis Paper:Corporate Outsourcing:

The Hidden Costs

Date of Issue: 28-Apr-23

Tina M. Sharer - 1093075

PM505 – Systems Concepts and Thinking in Project Management

8/1/03 – 10/10/03

Instructor: Barbara Endicott-Popovsky

Abstract

Using system archetypes, this paper discusses the hidden costs of IT outsourcing.

I intend to show that IT outsourcing increases unemployment, increases corporate costs,

and over the long term increases dependency on the outsourcing vendor. Several

peer-reviewed articles along with observations and magazine articles were used to obtain

and corroborate this conclusion.

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Introduction

Corporate outsourcing will change the job outlook for many workers in the

coming years. Outsourcing call center functions have been common in the past however,

outsourcing is now starting to reach into the high-paying technology jobs such as

software programming, test engineering, and documentation. The primary reason a

company chooses to outsource their information technology (IT) functions is to reduce

costs, especially in a downturn economy. Although a company may reduce their initial

costs through outsourcing, the final costs of outsourcing can be more than originally

expected and can adversely affect the economy as a whole.

For many years, a large number of jobs in the United States and other Western

countries have been moving overseas, particularly to China, Russia, and India. Moving

positions overseas leads to job cuts in corporations’ home countries. As the outsourcing

partners take on more responsibility, corporate dependence on that partner increases, thus

making it harder for a company to take IT in again if corporate financial fortunes were to

permit.

In addition to reducing the number of available jobs, outsourcing adds stress in

the workplace. Remaining employees suffer the uncertainty of the economy and fear for

their jobs. Team morale starts to suffer, and project productivity can decrease.

Background

When Eastman Kodak outsourced their IT department in 1989, information

technology was viewed as a commodity. Managing commodities was not considered

strategic to the company as a whole.(Senn & Gefen, 1999) Smith, Mitra, and

Narasimhan (1998) cited five reasons for IT outsourcing: (1) cost reduction, (2) focus on

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core competence, (3) liquidity needs, (4) IT capability factor, and (5) environmental

factors. Today, the key driver of IT outsourcing is cost reduction.

Next to personnel, IT spending is considered the second largest investment for a

corporation. IT outsourcing is viewed as a way to reduce IT spending. (Bansal, 2003) It

has been estimated that 30 percent of large companies will outsource their IT department

in 2003 (Gentronics et al., 2002) and the trend does not seem to be slowing. In the

United States, offshore IT spending is increasing, with close to $10 million of IT services

sent to India in 2002. (Karamouzis, 2003) It is estimated that outsourcing will grow 143

percent between the years 2002 and 2007. (Hite, 2003)

But what are the real costs of outsourcing? For every one US-based job, there

exist five jobs in India. (Ahles, 2003) India, as a country, has made a large investment in

technical education; technical workers from India are technically knowledgeable and paid

far less than their counterparts in the West. For example, India currently has around

500,000 computer programmers working for as little as 10 percent of Australian rates

(Kirby, 2003). Large companies such as Microsoft® , Electronic Data Systems, and

General Electric have outsourced their IT functions abroad. In fact, Microsoft® has

confirmed that they have outsourced much of their technical support to India, and if that

turns out successful they plan on sending more jobs in the coming years. (Ahles, 2003)

Outsourcing to India may appeal to financial analysts because it brightens

corporate balance sheets, but the practice does involve initial costs. When companies

initially decide to outsource, turnover rates such as transfers, resignations, and

terminations typically exceed 30 percent in the first year. (Kennedy & Whittaker, 2002)

Costs increase due to the additional administrative expenditures and project and quality

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control management entailed in outsourcing. (Kennedy & Whittaker, 2002) A company

can expect an additional expense of three to five percent for corporate layoffs and an

additional six to ten percent just to manage to the outsourcing vendor. (Overby, 2003)

Moreover, when corporations decide to outsource, they essentially send their knowledge

base to outside vendors creating less knowledgeable workers at home.

The increased shift of jobs overseas can push up unemployment rates in the home

country and hurt the overall economy. In Australia, where up to 70,000 IT jobs may be

in jeopardy, IT unemployment runs as high as 11.9 percent. (Kirby, 2003) Rising

numbers of job losses mean fewer people can pay for goods and services.

Analysis

From a business perspective, the benefits of outsourcing are too hard to pass up.

Managers are continually being asked to cut budgets, and outsourcing becomes an easy

solution to a complicated problem. Not only do companies save money by sending work

to countries with cheaper labor costs, they realize tax benefits because outsourcing fees

are tax-deductible business expenses. (Takac, 1993) However, by looking at the short-

term gains, companies become blind to the extensive long-term negative effects that

outsourcing has on corporate expenses, management costs, and the economy as a whole.

Take a look at the initial problem that most companies face – the need to cut

costs. When large companies such as General Electric and Microsoft® tout the cost

savings benefits of outsourcing, it is hard to imagine that there could be a more effective

approach.

Viewing the outsourcing problem from a systems thinking perspective you

become aware of the negative side effects that outsourcing creates. There are many

archetypes that could clarify the outsourcing issue, and I have chosen to analyze the

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outsourcing problem by using the “Shifting the Burden” archetype. Generally in this type

of archetype, a problem is defined that needs immediate attention.

Usually, the “Shifting the Burden” archetype involves two solutions to a problem

– a fundamental solution and a symptomatic (or quick fix) solution. In most cases, the

fundamental solution takes more time to implement, with increased initial costs. The

symptomatic solution is relatively easy to implement, solves the problem quicker, and

costs considerably less at the outset. Given the pressure to cut costs within a short time,

outsourcing can be an attractive solution for a company. Outsourcing becomes the

symptomatic solution to the problem of cutting costs.

When you look deeper into the problem of cost reduction, you find that there

could be a better way to cut costs without all the negative effects. A fundamental

approach would be to improve work efficiency and redefine job tasks. Implementation of

this fundamental solution would initially raise costs as a company invests in new

processes. However, over time this approach would yield more revenue for the company

because products are produced more efficiently.

As with all “Shifting the Burden” archetypes, the symptomatic solution usually

yields negative side effects. As Figure 1 shows, these side effects include increased

management costs and decreased economic stability. The outsourcing archetype also

includes a negative reinforcing loop that involves an increasing dependency on the

outsourcing vendor. As a company increases outsourcing, the number of in-house

specialists decreases – increasing the dependency on the outsourcing vendor. Over time,

the outsourcing vendor becomes the only party that can carry out a given task, thereby

increasing the reliance upon outsourcing.

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Figure 1: Shifting the Burden Archetype -- Outsourcing

Companies focus on the initial benefits of outsourcing, but in the long run

outsourcing erodes the main market on which companies depend – consumer buying

power. (Mieszkowski, 2003) As more jobs are sent abroad, more people in the

company’s home country become unemployed. As the unemployment rate rises,

consumers are less likely to purchase goods and services. Without consumer spending,

the already sluggish economy slows further, increasing the need for companies to reduce

costs. This negative cycle is illustrated in Figure 1.

Managing outsourcing costs is considered one of the largest hidden costs.

(Barthelemy, 2001) As companies increase outsourcing, the expenditure of management

resources on outsourcing also increases. Outsourcing vendors are often in time zones at

great distance from the home office; and managers must put in long hours maintaining

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information flow. Managers are often on call at all hours in order to answer questions

from the outsourcing vendor. Eventually managers go from managing in-house activities

to managing the outsourcing vendor. (Lundquist, 2003)

Communication infrastructures in the countries where outsourcing vendors are

located can be less developed and more fragile than in the West. As communication

infrastructures and processes stretch, the time and energy spent trying to relay

information increases. For example, Company A decides to outsource its software

programming of a new product. The outsourcing vendor selected is in China. Due to

political unrest, electricity is turned off for three days. During these three days, the

outsourcing vendor is unable to produce software code and Company A is unable to

communicate with the outsourcing vendor. For three days, software code is not sent to

Company A therefore, the project schedule ultimately slips. If this pattern continues,

extra time is built into project schedules in order to compensate. Eventually, project time

lines become longer and the amount of time it takes to produce products increases.

Conclusion

As with many problematic issues, more than one archetype can be at play and

there are many opinions as to the pros and cons of outsourcing. Many people would

agree that outsourcing jobs to vendors abroad increases the unemployment rate at home.

Some would say however, as more consumers become unemployed, they start to

purchase products based more carefully, paying particular attention to price. You could

go on to say that if outsourcing makes it possible to produce products more cheaply,

companies can afford to lower the overall sale price of that product. Eventually as the

product price decreases, consumers are more willing to purchase. And as more products

sell, companies ultimately make a profit. This profit conclusion might sound promising,

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but as you apply systems thinking to the scenario, you must ask yourself one question –

What are the side effects of this solution?

Outsourcing may lead to the end of outsourcing. Countries that provide

outsourcing eventually will see an improvement in living standards, including higher

wages. (Wiggins & Morello, 2003) As wages rise in countries such as India, companies

may no longer find that outsourcing lowers production costs.

Ultimately the outsourcing trend will slow down as companies realize the

negative effects. But by that time, it may be too late to reverse the process because many

companies will have outsourced a large proportion of their work functions. Sometimes, a

seemingly simple solution such as outsourcing is not always the best one. In today’s

economy, companies need to think strategically and think long term. Perhaps, by

spending a bit more money now to increase efficiency, companies will be in a better

position to prosper when the economy improves.

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References

Ahles, A. (2003, July 21) More U.S. High-Tech Firms Shift Jobs to India’s Cheaper, Educated Labor Market, Knight Ridder Tribune Business News

Bansal, P. (2003) Success Is Not Guaranteed – Many Outsourcing Mega Deals and Few Produce Any Savings The Banker March 2003 i925

Barthelemy, J. (2001) The Hidden Costs of IT Outsourcing MIT Sloan Management Review V42 I3 60-70

Gentronics, IDG Research, CIO Magazine custom publishing (2002) Outsourcing Directions and Decisions for 2003 CIO.com Retrieved August 1, 2003 from the World Wide Web: www.cio.com/sponsers/120102getronics/index.html

Hite, R, (2003) DOD Needs to Leverage Lessons Learned From Its Outsourcing Projects Federal Document Clearing House (FDCH) e-Media, Inc GAO-03-371.

Karamouzis, F. (2003, July) A Look at India for Offshore Sourcing Options Gartner Research Retrieved July 29, 2003 from the World Wide Web: http://www4.gartner.com/resources/116500/116562/116562.pdf

Kennedy, D., Whittaker, J. (2002) Strategic Partner or Trojan Horse? A Case Study Engineering Management Journal v14 i4 25-30.

Kirby, J. (2003, March 6) Australian Jobs Go West Business Review Weekly (Australia)

Lundquist, E. (2003, April 28) Face Up to Outsourcing eWeek.com v20 i17

Mieszkowski, K. (2003, July 2) White-collar sweatshops Salon.com. Retrieved August 1, 2003 from the World Wide Web: http://www.salon.com

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Overby, S. (2003) The Hidden Costs of Offshore Outsourcing CIO.com Retrieved September 9, 2003 from the World Wide Web: http://www.cio.com/archive/090103/money.html

Senn J., Gefen D., (1999) The Relation Between Outsourcing and the Return from Corporate IT Spending: Perceptions From Practitioners Proceedings of the 32 nd Hawaii International Conference on System Sciences 1-6.

Smith M., Mitra S., Narasimhan S. (1998) Information Systems Outsourcing: A Study of Pre-Event Characteristics Journal of Management Information Systems Vol. 15 n2 61-93.

Takac, P.F. (1993) Outsourcing Technology Management Decision v31 Iss.1 26-38.

Wiggins, D., Morello, D. (2003) Outsourcing Backlash: Globalization in the Knowledge Economy Gartner Research Retrieved July 31, 2003 from the World Wide Web: http://www3.gartner.com/resources/116600/116614/116614.pdf

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