Balance your Web services outsourcing

Outsourcing Web-based services is clearly a trend among Fortune 500 companies. For busy chief information officers, the possibility of buying software and services “by the drink” is enticing. These services not only deliver more flexibility and lower cost, but they also promise economies of scale and improved service from focused experts. Savings vary but could run into millions of dollars per year. Which Web services should you outsource? And will the benefits deliver value to your company and customers?

These providers offer many capabilities, from Web hosting and file storage to sophisticated data mining and customer relationship management services. The more complex services require deeper customer commitment but can provide greater returns.

First, you’ll need to determine which capabilities are key to your business. Those that aren’t strategic are prime candidates for outsourcing. Examples might include e-mail, storage and security services. But if the technology is essential to a core competency, keep it in-house. By using Oracle Corp.’s hosted sales force application, for example, you risk having your rivals match your sales management capabilities if they choose the same service.

Once you’ve determined what’s strategic to your company, consider the following issues:

Can you customize it? In-house systems can be easily customized for your needs. The same isn’t always true of outsourced services. Moreover, capital improvements you make to your own assets will later help improve earnings before interest, taxes, depreciation and amortization and may increase gross margins. Strategically, keeping the capability in-house preserves the option to develop the outsourced service into a core competency. But fiscally, internal development is usually a shared resource, so it’s hard to know the actual costs that support a given revenue stream.

An outsourced service offers greater operational visibility, which should help management prioritize where to attack revenue and costs. And strategically, the service should be one that you’ve decided to rely on someone else’s competence to provide. Therefore, preserving this capability shouldn’t be important.

Can you control it? Web-based service providers often trumpet their products’ security and redundancy features. But before outsourcing, take a hard look at the consequences of both minor and catastrophic service failures, because when an externally managed system fails, you’re at the mercy of the service provider.

Can you afford it? Although good outsourcers should help grow profits, your costs could go up if the service isn’t managed properly. You could end up paying for the outsourcer, the employees to manage the outsourcer and the in-house staff replaced by the outsourcer who haven’t been redeployed yet. In a flat-growth economy, you might have to lay off employees or eat added personnel costs while waiting for growth.

To avoid these pitfalls, negotiate ironclad service-level agreements that specify the penalties if the quality isn’t acceptable. Experience with these services is limited, so the CIO will need to be closely involved from the start. Also, it could be wise to hire a consultant to help with the agreement structure. If you need customization, put the code in escrow and lay out terms for termination of the deal. Finally, be prepared for the potential increase in total costs and plan beforehand how you’ll redeploy the affected staff.