IT Outsourcing: Breaking The Catch-22

read On May 2, 2023, the blog section had a post that took 8 minutes to read.

Outsourcing IT is not just choosing between making or buying. It's a process that needs the right strategy and collaboration between IT and procurement.

Outsourcing decision isn't always straight forward. It's not just about making or buying something. IT leaders should consider various factors.

You can either keep IT work in-house or contract it out to another organization. However, there are now sourcing models that allow for a more strategic relationship between companies and their suppliers. These models create value and encourage innovation. But to make it work, IT leaders must think differently about outsourcing partnerships. Many fall into the trap of wanting a strategic solution, but only implement a transactional contract.

Companies find that traditional sourcing and contracting methods aren't leading to the innovations and efficiencies they need. Service providers aren't taking risks to improve because they fear buyers will steal their ideas. Companies want solutions but don't want to invest in areas where they lack expertise. IT organizations are stuck because both buyers and service providers want innovation, but no one wants to make the necessary investments due to the traditional commercial structure.

One can choose a different path. There is an alternative solution. It is possible to take a different approach. We can opt for a different course of action. There is a different avenue to explore.

Source Continuously, Never Stop

Research shows that there is a dilemma with choosing between making or buying. Dr. Oliver E. Williamson from the University of California challenged this traditional view. He suggested a third "hybrid approach" for complex services with high dependency. In such cases, companies cannot switch suppliers easily and insourcing may not work. Williamson recommended building longer-term relationships with suppliers to balance weaknesses found in market or insourced approaches. Williamson won the Nobel Prize for his work in 2009.

We at the University of Tennessee created Sourcing Business Model Theory. Our work started with using hybrid approaches. The theory suggests that sourcing should be thought of as a business model between two parties. The goal is to optimize the exchange. We identified seven sourcing businesses that align with Williamson's economic theory. You can see these seven in Figure 1.

The picture above shows a model for sourcing business. It is divided into three main categories. These categories are improving and innovation, optimization and integration, and outsourcing and offshoring. Improving and innovation is the category for businesses that are focused on improving their internal processes. Optimization and integration is for companies that are looking to streamline their operations by integrating with others. Outsourcing and offshoring is when a business outsources certain functions to another company or moves its operations to another country for cost savings.

The business school at the University of Tennessee is called the Haslam College of Business Administration. It is located in Knoxville, Tennessee. This is a well-known business school in the United States. At this school, students can study business, accounting, finance, and other related topics. Many students graduate from this school and go on to have successful careers in the business world.

There are two models on the left that follow "the market." On the right are two models that follow "corporate hierarchies." Three models in the middle are for complex contracts and use a hybrid approach. William recommends flexibility, improvement, and innovation for these contracts. To get the most out of outsourcing, it's important to choose the right model and tailor the deal points accordingly.

Choose The Ideal Sourcing Strategy

Choosing the best model for your business is important. Each model has its own benefits. It's important to know the economics behind each model. Here's a breakdown of each one.

This model offers fixed prices for certain products or services. It's good for cheap, standard items with lots of options. Only use it in markets with many suppliers.

The Approved Provider Model buys stuff from suppliers who meet certain standards. The suppliers are selected based on quality, performance and other criteria. This model has a limited number of suppliers, and buyers can pick from them. If one supplier isn't good enough, they can be replaced.

To succeed in sourcing, build stronger relationships with suppliers. Many organizations fail to do this. They use buzzwords like "strategic partner" and "innovation" but don't invest in changing their approach. This leads to a catch-22 situation. To escape, align your outsourcing deal with the sourcing business model. Use Figure 2 as a guide.

To improve relationships, IT organizations can start by using a Preferred Provider Model. They sign multi-year contracts with a master services agreement to make repeat business easier. The model still uses transactions, but the parties work together more efficiently. It's not just about buying and selling – they focus on achieving common goals.

The Performance-Based Model is a long-term agreement. It helps with strategic thinking. It's also called the Managed Services Model. The model focuses on achieving set goals. The goals are well-defined and easily understood. The goals are called "outcomes" and are finite in nature. The model is based on achieving specific achievements. It's not based on activities. For example, meeting service level agreements or saving money. The model is a relational contracting approach.

The Vested Sourcing Business Model is about working together. Both the buyer and the supplier have an interest in each other doing well. They work to create value for both, not just for themselves. It's not just about buying or selling things. This model is about creating outcomes and sharing values. The vested model is good for big changes or new ideas. If a company can't do it alone or with normal ways of doing business, vested sourcing can help.

The insource options are on the far right of the continuum. A company invests in internal operations instead of working with suppliers. The Shared Services Model centralises processes into a "shared service" organisation that charges members for services used. The model allows outsourcing parts of the work under a market-based or hybrid-based model.

Equity Partnerships have different options like working together, buying or investing in a smaller company. You should only think about investing when your company can't do everything itself, but also doesn't want to share work with another organization. An Equity Partnership makes a formal agreement and is harder to change or leave.

IT leaders and procurement departments often fall into a trap. They can't get aligned. This can lead to problems when buying IT services. For example, if you want a strategic partner, but your procurement team uses the wrong method, you could end up with the wrong outcome. You might not get the innovation you need. It could be like trying to put a square peg in a round hole.

It's important to plan the business side of a relationship well. You can use Figure 2 for help. You could also read Strategic Sourcing in the New Economy for more information. The University of Tennessee has a free course to help you choose the best Sourcing Business Model for your situation. Just so you know, I'm a professor there and I co-wrote the book.

In short, it's up to you. Using the wrong sourcing model can lead to a bad outsourcing trap or higher costs. Choose wisely.

The second figure on the blog is a cheat sheet for a business model. It can help people figure out a plan for their business. The cheat sheet has different sections, such as customer segments, value proposition, channels, and revenue streams. It also has a section for cost structure and key partners. Using this cheat sheet can be a helpful tool for anyone starting a business.

The Haslam College of Business Administration is located at the University of Tennessee. It is a top-ranked business school. The college offers undergraduate, graduate, and executive education programs. The faculty is made up of highly respected professors and researchers. Students have access to many resources, including career services and international study opportunities. The college also has partnerships with industry leaders, providing students with valuable real-world experience.

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Kate Vitasek knows a lot about collaborative relationships that benefit everyone. Her research has won awards and she created the Vested® business model. She has written seven books and teaches at the University of Tennessee’s Haslam College of Business. She has been on TV channels like CNN International and Fox Business News.