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Eugene Gilerson, TD Waterhouse
Eugene Gilerson, TD Waterhouse
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(mis)Alignment of IT Offshoring

Outsourcing software projects offshore is one of the hottest topics in management consulting.

Outsourcing software projects offshore is one of the hottest topics in management consulting. The most respected online and print publications are flooding the market with analyses of the benefits of offshore technology outsourcing. Many companies, especially software vendors, are rushing to strike outsourcing deals. As a result, the software-development services market in India is projected to grow exponentially over the next several years. Interestingly, this frenzy reminds careful observers of the Internet mania that occurred only a few years ago.

"Operational effectiveness is not strategy." That is how Michael Porter begins his now-famous "What Is Strategy" article in Harvard Business Review. The common belief is that outsourcing technology efforts offshore cuts costs and therefore makes companies more efficient. I would argue, however, that in the long run it makes little strategic sense for most financial companies to outsource significant portions of their IT projects to cheap-labor countries.

Understanding Outsourcing

When making a decision to outsource an information technology project offshore, it is important to understand that aside from the obvious cost-savings upside, there are in fact significant downsides to the process, such as potentially low levels of innovation, additional costs associated with management of developers or vendors located overseas, and most important, the barrier of communicating the business needs of the project. The more difficult the business problem, the higher the tangible and intangible costs related to building a high-quality solution offshore.

As we talk about cutting costs in any business, it is rather easy to get carried away with creative ways to save a buck or two. Take Wal-Mart - the company has become the largest retailer in the world and literally destroyed competition by improving productivity and cutting costs. Similarly, Southwest Airlines has now become a model of providing highest value to its customers in the airline industry, and the company earned more last year than all other airlines in the United States combined.

Does the same logic apply to the Goldmans and the Merrills of the world? Not quite. These firms are full-service shops, providing high-net-worth clients with a wide range of innovative solutions. Financial-services companies do not compete on cost; instead, they're differentiators, and they compete on the quality of their products and services.

Strategic Approach

With so much of a company's revenue riding on information technology - from electronic trading to stock ratings systems to analysts' tools - why should a firm bet on a cheaper technology source halfway across the world instead of engaging its own intellectual resources or a software vendor across the street?

In January 2004, David Norton, Harvard Business School professor and cocreator of the Balanced Scorecard - a management methodology used to monitor business results - had broken down the value proposition of for-profit organizations into the following four categories: Lowest Total Cost, Customer Solutions, Product Leadership and System Lock-in.

- Lowest Total Cost - These firms "deliver a combination of quality, price and ease of purchase that no one else can match," Norton states. The list includes such companies as McDonalds, Dell Computer, Southwest Airlines, Vanguard Mutual Funds and Wal-Mart. At least four out of five of these companies (McDonalds may be the lone exception) rely on technology to achieve overall cost leadership. Would you outsource the driving force behind your firm's competitive advantage offshore? In the long term, neither should the firms in this category.

- Customer Solutions - These companies "build bonds with customers [and] provide them with a complete bundle of the products and services they need," according to Norton. The list includes IBM, Goldman Sachs and Mobil. Many large Wall Street firms would fit this description, including Merrill Lynch and Lehman Brothers.

These companies charge premium prices for premium services, and they focus on building long-lasting customer relationships and maintaining high overall customer satisfaction. As a result, firms in this category have significant variable costs (of managing each customer relationship), while fixed technology costs are small, especially when high product margins are taken into consideration. Instead, technology plays a strong supporting role to the main line of business, and therefore, from a strategic standpoint, cutting technology costs should not be the focus of these companies. In fact, Merrill Lynch has proven this with a recent $1 billion investment in a domestic outsourcing relationship with Thomson Financial and a host of other U.S.-based technology providers.

- Product Leadership - This group, says Norton, includes firms that "continually develop products that offer superior performance for customers," such as Sony, Mercedes, Merck and Intel. Product-leadership strategy can only be achieved by means of continuous technological innovation, which is exactly where companies in the product-leadership category invest the most. Clearly, information technology can provide for both breakthrough products and incremental improvements, and product leaders who outsource IT projects offshore would inevitably face a strong challenge from competitors who decide to emphasize innovation.

- System Lock-in - These companies, Norton suggests, "provide the platform for the largest number of buyers and sellers to come together." Essentially, they hold a near-monopoly position in their markets, which is often achieved with strong network externalities effects. Examples include Microsoft, eBay, Visa, MasterCard and Yellow Pages, but no financial services company has a dominant-enough position in the market to be a part of this category.

All in all, cutting costs by outsourcing information technology projects offshore comes at a cost (no pun intended). For companies with a focus on products and services, especially large financial firms, it makes little strategic sense to outsource IT to cheap-labor countries because the lack of innovation may hurt their client relationships and the quality of their product offerings in the long term.

About The Author

Eugene Gilerson, TD Waterhouse

Eugene Gilerson is a lead software architect at TD Waterhouse and an information technology strategy adviser for small- and medium-size businesses in the New York metro area. He can be reached at eugene@learson.com.

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