How to Understand The ROI Analysis Failure of Outsourcing

Executive Summary

  • Outsourcing often has a negative ROI, which is in part due to its ineffective outcomes.
  • The article explains why the ROI of outsourcing was never performed.

Introduction

When reviewing Brightwork Research & Analysis analyses, software vendors will typically respond that the internal support amount should be lower. Often they only estimate their own support costs, and when they do acknowledge the internal support costs, they will only estimate the internal IT resources required to support their application. While that approach was never accurate, it is even less accurate now because companies are responsible for more “self-support” today than ever before. And this is, in part, due to the IT outsourcing trend. Outsourcing makes CIOs look great from the perspective of costs. However, in the vast majority of cases we have reviewed, outsourced IT support means a reduced IT support level.

Outsourcing Media Coverage

Some journalists will state that the main issue is offshoring—that is outsourcing to low cost countries—but that outsourcing is viable. In fact, if we look at SaaS, this is “outsourcing” much of the IT support for an application—although it is of a different nature as the software vendor has a comparative advantage in their own application and they host and control it. However, as practiced, outsourcing refers to a large consulting company offering resources from countries with very low wages. The consulting company then bills out these resources at a much higher rate than they pay them. This is the predominant method of outsourcing, and this is what I am referring to in this section. There seems to be a great number of apologists for outsourcing in the IT press. All the major consulting companies are advertisers in these outlets, and they will interview their advertisers on various issues to determine the editorial approach they should take. Articles that don’t gel with advertisers don’t get covered. The evidence on the advertising’s impact on media content is very well established, and is from multiple sources.

One of the best known research being the investigation into the coverage of the health issues of tobacco with media outlets that took advertising money from cigarette companies. Those media outlets that took cigarette advertising did not report information on tobacco’s connection to cancer. Advertising’s influence on the media output in enterprise software is covered in the book, Gartner and the Magic Quadrant: A Guide for Buyers, Vendors, Investors.

The Warner Brothers Example

One very well known media company provides a perfect example of how not performing a proper TCO estimation can result in making a poor decision. Warner Brothers made the decision to outsource its IT department back in 2008. Warner Brothers itself did not want to outsource, but was forced to do so by their parent company Time Warner. Leading up to this decision, no studies of any kind were undertaken and certainly no true TCO was performed to inform this decision. Instead estimates, taken from Cap Gemini, were used to justify the change and explain the expected cost savings. Of course Cap Gemini was going to take over part of the outsourced workforce, so they had a powerful bias in proposing that outsourcing would save Time Warner a great deal of money. These cost savings were believed (by Time Warner at least, if not Warner Brothers), and the program
was announced to the media in January of 2009. Eight hundred employees, or ten percent of the Warner Brothers work force at the time, would be outsourced.

“The 800 positions break down as follows: 200 open positions around the world; 300 outsourced (with a third being offered employment opportunities with Cap Gemini and continue to be based in Burbank), and 300 lay-offs.” — Warner Bros. Announces 800 Layoffs

This initiative was, in part, a PR stunt intended to boost the stock price. Warner Brothers had experienced some down quarters, and it needed to do something to increase the stock price. Outsourcing communicated to the financial markets that Warner Brothers was “doing something” to reduce its costs. Information from inside of Warner Brothers indicates that the outsourcing program was a failure, and Warner Brothers has since brought many of these jobs back in-house because the quality of the IT support that was received was so poor. However, Warner Brothers did not make this announcement because it had no PR value. Wall Street wants to hear about outsourcing stories—not insourcing. Warner Brothers would in effect be admitting that their program had failed. And Wall Street analysts—who know less than nothing about running a business and do not consider the effect of the quality of IT support on the operations of a business—merely view various announcements through a conformist lens: outsourcing good, insourcing bad.

The Effect on the Stock Price

Analysts would have penalized Warner Brothers because after all, “insourcing simply increases costs.” Again, all information that is released must have a positive impact on the stock price because to a large extent the executives are compensated in stock. In fact, responsiveness to the financial markets is a big reason why initiatives are taken, and has very little to do with improving the condition of the company. In part, companies implement systems like ERP and initiatives like outsourcing not because there is any evidence that they benefit the company, but because the company needs to demonstrate to outsiders that they are doing “all the right things.” The financial analysts who evaluate stocks have no experience with ERP and have never participated in IT outsourcing, so they do not know whether these things have any inherent value either way—but they do know what is trendy and topical. These “right things” change depending upon what happens to be trendy at the time.

When I discussed this book with a colleague, who is quite experienced in these matters, he questioned whether a service to provide TCO analysis would have a market. He stated:

“Who would be the market? It’s not the consulting companies, because any company that offered honest TCO evaluation services would be their enemy. It’s also not the purchasing companies, because this type of information would interfere with their stock options and their ability to get rich.”

Conclusion

Applications are utilized at a lower level and problems take longer to fix. The major consulting companies produce most articles on this topic; as they have significant outsourcing businesses themselves, the information they provide is unreliable. Furthermore, none of the major consulting companies have demonstrated that they are competent at performing IT support versus selling IT support. At client after client I have worked with the outsourced support is mismanaged and the business unhappy with the support that they receive. Essentially outsourcing has made IT less efficient and while outsourcing may have resulted in fewer IT resources within companies, it has also meant negative externalities in the form of lower support that must be performed by the business. Therefore, the lowered costs (although at very high margins with little money paid to the workers providing the support—mostly in India) have not been able to maintain quality levels. It is possible to imagine high-quality outsourcing, but while that may exist hypothetically, the reality of outsourcing is a movement to reducing costs while ignoring reduced quality. Therefore, the total cost of supporting applications is far greater than simply the costs of IT resources assigned to support the application.

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References

TCO Book

TCO3

Enterprise Software TCO: Calculating and Using Total Cost of Ownership for Decision Making

Getting to the Detail of TCO

One aspect of making a software purchasing decision is to compare the Total Cost of Ownership, or TCO, of the applications under consideration: what will the software cost you over its lifespan? But most companies don’t understand what dollar amounts to include in the TCO analysis or where to source these figures, or, if using TCO studies produced by consulting and IT analyst firms, how the TCO amounts were calculated and how to compare TCO across applications.

The Mechanics of TCO

Not only will this book help you appreciate the mechanics of TCO, but you will also gain insight as to the importance of TCO and understand how to strip away the biases and outside influences to make a real TCO comparison between applications.
By reading this book you will:
  • Understand why you need to look at TCO and not just ROI when making your purchasing decision.
  • Discover how an application, which at first glance may seem inexpensive when compared to its competition, could end up being more costly in the long run.
  • Gain an in-depth understanding of the cost, categories to include in an accurate and complete TCO analysis.
  • Learn why ERP systems are not a significant investment, based on their TCO.
  • Find out how to recognize and avoid superficial, incomplete or incorrect TCO analyses that could negatively impact your software purchase decision.
  • Appreciate the importance and cost-effectiveness of a TCO audit.
  • Learn how SCM Focus can provide you with unbiased and well-researched TCO analyses to assist you in your software selection.
Chapters
  • Chapter 1:  Introduction
  • Chapter 2:  The Basics of TCO
  • Chapter 3:  The State of Enterprise TCO
  • Chapter 4:  ERP: The Multi-Billion Dollar TCO Analysis Failure
  • Chapter 5:  The TCO Method Used by Software Decisions
  • Chapter 6:  Using TCO for Better Decision Making

How It Works

How It Works

Each TCO calculator is self-service allowing you to continually change different elements in order to see the impact on costs. They are designed to adjust to the specific project factors such as the number of users, the general level of customization, the number of post go live adjustments to the application, etc..

The TCO calculators can improve your ability to plan your purchase.

How It’s Unique

How It’s Unique

Our self-service calculators have been developed through detailed analysis verified by many years of project experience combined with all the available research – all in order to develop a series of uplifts to costs based upon inputs. The formulas used are nuanced, and do not simply “scale” in direct proportion with changes to the inputs.

  • Our TCO calculators are designed to scale to any sized implementation and different levels of implementation complexity and customization.
  • We offer a true TCO by estimating internal costs (such as the time spent by internal resources on implementation and support) as well as the external costs. In comparison with the very limited TCO studies that exist on enterprise software, our TCO calculations are easily the most comprehensive.
  • Having performed this analysis for many applications, we have brought key observations between these applications as well as between various software categories.

What Is Included

What Is Included

Each package is a combination of two analyses. The first analysis is the interactive TCO Calculator which is provides a total TCO based upon the individual costs of software costs, hardware costs, implementation costs, maintenance costs as well as Lifetime Improvement Costs (the costs of the estimated improvements and adjustments to the application over its lifetime). Both these individual component costs as well as the aggregate of all the costs constantly change given your input to the calculator.

What It Is

What It Is

This offering provides buyers with the detailed information they need to for both the total cost of ownership of a single application, as well as the comparative total cost of ownership between multiple applications. This is the only self service TCO calculator that exists on the Internet, and it is available currently for 57 of the most well known enterprise software applications. This calculator receives input from you and automatically adjusts the costs so that they are customized for your intended way of implementing and using the software.

Transforming a Complex Analysis into a Simple Cost Breakdown

Even though all of the calculations behind each TCO calculator are complex and have been extensively tested and validated, they are easy to use. All that you need is basic information about your project such as the number of projected users, whether the implementing is more simple or more complex, etc..

Each package covers a single application including a comprehensive total cost of ownership analysis that takes into account the following costs:

  • Software Costs
  • Hardware Costs
  • Implementation Costs
  • Maintenance Costs
  • Lifetime Improvement Costs