Three Steps to Outsourcing IT

How to get it right

CIOs must consider three factors when deciding whether to outsource IT functions: which functions to outsource, the internal costs of those functions compared to outsourcing costs, and managing the costs of an external supplier.

When deciding which functions to outsource, the rule of thumb is "don't give away the strategic functions." But how do you determine what's strategic and what's not? The link between corporate strategy and IT functions must be determined in conjunction with the leaders of the business units. A relatively simple methodology is to list an organization's explicit goals. Once that is done, goals can be ranked in terms of importance to business success. The IT functions linked to the highest-ranking goals are the ones CIOs should consider keeping internal. The remaining functions might be considered "non-strategic" and eligible for outsourcing.

The next step is to determine how much it costs to perform the non-strategic IT functions. A common error is to understate costs. A specific, measurable "as is" internal service level must be established for each function. Then the CIO must define all current direct internal costs associated with providing that service level.

Begin the process by defining all of the physical assets and the annual operating costs needed to provide the service level. Then, for each asset, list all the operational labor activities needed to use and support the asset. For each activity, define the standard cycle time required to perform the activity and the cycle frequency. For each cycle time and activity, define the skill level of the person(s) performing, as well as supervising, the activity. Finally, for each skill level, define the labor costs (salary and benefits). When taken together in aggregate, an internal service level/cost baseline has been established. This baseline will be the insource benchmark for evaluating external supplier offers.

To do a full cost comparison between the internal service level/cost baseline with an offer from an external supplier, estimated transaction costs must be added to the fees of the external offer. Transaction costs are the new costs that will be incurred through managing both the outsourcing process and the outsource partner. A risk in managing a partner is trying to manage the partner's activity instead of managing the service levels provided by the partner. In general, transaction costs will be highest when organizations use internal personnel to manage the service levels. Transaction costs are likely to be lowest when the organization and the supplier create a detailed service level contract using well-defined service levels and industry-accepted processes. When the outsource contract is rigorously defined, excessive transaction costs can be avoided.

Following these steps gives a CIO a basic but sound methodology. Whatever the final outsourcing decision is, it can be made with confidence that the evaluation has been methodical, rigorous, and transparent.

Warren Ritchie is involved with the establishment of regional IT governance for North and South America with the Volkswagen Global Brand Group.