By Accenture
Over the past two decades, outsourcing has dramatically changed the way companies create and distribute value. From a hardware operations play, the practice has moved first to applications and software, and then to higher-level business processes and service.
In business history, the day in early October 1989, when Eastman Kodak Chief Information Officer (CIO) Katherine Hudson decided to outsource the bulk of the company’s IT functions marks a seminal event ― one followed by major and innovative outsourcing deals made by such industry leaders as DuPont, and the Dow Chemical. These companies legitimized a previously experimental sourcing strategy.
Since then, the growth of outsourcing has been extraordinary. Today, it is a global market estimated to be worth more than $350 billion ― a number that could top the $450 billion mark sometime in 2013, according to IDC.
Now, the pressing questions are: what outsourcing will look like, and what will it mean to the competitive nature of organizations around the world?
The next wave of change will take companies to unexplored territory: strategic value and innovation.
To understand that wave, an understanding of the history of outsourcing, and the insight to see where the trajectory of value redistribution will lead is required. As Adrian Slywotzky writes in his book Value Migration, in the late 1980s, many large, successful companies were sensing that the old rules of market share and scale were no longer working.
Instead, value redistribution had begun. For example, companies like Microsoft and Intel were about to transform the technology world by “disaggregating,” the PC industry, so that customers could go with the best provider for each part of the value chain.
In this context, outsourcing can be seen as a disaggregation of the enterprise itself.
The first part of the enterprise to experience the diminishing value of running a function internally was the hardware side of the IT shop. As a result, many of the early outsourcing contracts focused primarily on IT infrastructure. The value from such an arrangement was measured primarily in cost reduction.
These were also financial arrangements. The outsourcing provider would write a big check to the client for its hardware — which, in theory, could then be used to serve multiple clients as a data center provider. To an extent, it worked.
There was one major drawback to outsourcing hardware alone, however; some companies had IT operations that were costly, and inefficient, so in effect the client was asking a provider to “fix” that situation for them while also saving them money.
By the early 1990s, the central question for both companies and their providers was: Where else can value be created by disaggregating the functions and processes of the enterprise?
In outsourcing, the key to delivering ongoing value to both parties was to move higher up the ladder of business value.
For their part, providers had to move beyond commoditization and build a business case that didn’t rely only on the cost side of the equation. A new generation of outsourcing arrangements would also need to be about quality and effectiveness.
One innovative example of how both client and provider could hold on to some of that value came in 1992 at the London Stock Exchange. At the time, the exchange’s trading and information systems were showing signs of age. However, the LSE did not have the available capital to adequately fund the transformation program developed with its provider.
So the two parties worked out an arrangement whereby funding for systems development would come from savings derived from outsourcing. Through the plan, some £50 million of savings were redirected into the implementation of new systems.
The next rung on the business ladder was to manage a company’s software. Running a company’s applications well would prove to redistribute value in a manner that was less fleeting than a hardware play because it required higher-order skills.
Canada Post was one of the first major organizations to leverage an application outsourcing relationship at scale. In the early 1990s, Canada Post executives felt that their organization lacked the skills internally to accomplish distributed computing alone. By using an outsourcing provider, Canada Post could reduce both risks and costs, and was able to focus on its core business and customer obligations.
Another milestone was reached in the mid-1990s with chemicals giant DuPont’s decision to outsource both IT infrastructure and applications with two providers.
The deal was especially influential because DuPont was recognized as a leader in IT cost efficiency. The deal focused on cost reduction and efficiency, and other important business metrics: improving productivity, the speed of delivery and the value of the company’s IT investments. DuPont and others were learning to discriminate between the parts of their IT departments that could be commoditized ― and higher-level work, where the goal was to deliver more business value.
DuPont itself achieved several important goals: increased variability in spending, greater flexibility in responding to business needs, and access to diversified, state-of-the-art business solutions. DuPont’s decision indicated that approaches to governance were evolving to support a more complex environment, and that client and supplier were both working to improve the ways they managed the outsourcing arrangement.
Such delivery capability was a significant step in the industrialization of the outsourcing industry. Providers were demonstrating that, at scale, they could redeploy employees where necessary to work with other clients on similar work. This approach boosted productivity and decreased costs.
Notable in these early examples was the realization of how critical effective transition management is to realizing the full value of the deal. At BP, for example, as part of the initial agreement, European legislation dictated that a large group of BP employees (about 200) would have to be transferred to the provider.
Such a transfer was a key part of BP’s strategy to move core players to the outsourcer, due to those employees’ knowledge and experience. According to, Alan Eilles, who was a key member of the BP team at the time of the landmark deal, recalled that if the transition of the work hadn’t happened “soundly and peacefully,” “the relationship and deal [would have gotten] off to a really, really bad start from which it would have been tough to recover.”
Companies were beginning to recognize that business process outsourcing could bring radical change. For example, BP’s decision to outsource its finance and accounting functions was intended as a shock. “It was a radical signal to the employees,” confirmed Eilles, “that the world had changed and our corporate culture was also changing.”
The move toward transformational outsourcing has led companies and academics to reconsider the merits of sourcing to multiple providers versus a single provider. Recently, companies have begun to realize that the hidden costs of managing multiple providers substantially decrease the value of the deals and overall collaboration.
A 2009 IDC research report estimates that the governance costs in a multisourcing arrangement “can range from approximately 5 percent to 8 percent of the contract value.” In addition, the report notes that shorter deals add to procurement costs. “In some cases,” cautions IDC, “these hidden costs have actually nullified the additional price benefits that organizations managed to extract from their suppliers during the first phase of negotiations.”
By combining functions and processes to a single provider, companies can generate significant synergies resulting in both better cost savings and a greater impact on the business.
Some bundled approaches can involve only the IT function or they can bundle the management of multiple business processes. Or they can combine IT and business processes under a single arrangement.
Unilever, for example, has gained from bundling the management of its applications and its HR functionality. A comprehensive bundling arrangement has helped the company adjust to challenges, and has helped the company in its productivity and transformation initiatives.
Companies can implement a bundled approach in “big bang” fashion, though the approach is often sequential. BT, for example, decided to expand its business process outsourcing strategy over time ― from HR, learning and then to finance and accounting.
If a company plans to outsource additional business processes or functions in the future, then careful consideration of the services offered by competing providers is especially important.