Outsourcing’s dirty little secret

Outsourcing has been a part of IT for more than 20 years. During that time, outsourcing models have changed dramatically, but the fundamental strategy has always been the same—arbitrage. Arbitrage is basically taking advantage of price differences for similar products available in different markets. You buy low in one market and sell higher in another.

The dirty little secret about these old outsourcing models is that, like all arbitrage activities, the opportunity eventually disappears as markets adjust to changing conditions.

It’s time for a New Deal in outsourcing that offers a permanent solution, not a temporary fix, to the most pressing problems CIOs face today—waste, security, flexibility. It’s time to fundamentally change the way businesses buy servers, disk drives, networks and desktops.

Operations Arbitrage—Your Mess for Less

The early days of outsourcing focused on data center operations. Businesses were competing for scarce skills to run their IT shops. The demand for these skills caused the price to go up. Yet few businesses had enough work to keep these highly skilled and narrowly focused professionals busy all day. These were the days of high-priced network managers, storage managers, capacity planners and database administrators. An arbitrage opportunity existed to apply these expensive and underutilized skills across a larger number of businesses.

A similar arbitrage opportunity existed from a data center and equipment perspective. It cost less per data center square foot, server cycle, storage gigabyte and network circuit when you bought in large quantities. But most businesses did not need that amount of IT resource. If businesses could consolidate their demand, they could get a better price for a shared resource.

So companies like IBM and EDS leveraged scale economies in operations, facilities and procurement to offer businesses 20 percent to 25 percent savings in their annual IT budgets. With this model, the customer’s applications, equipment and staff would be transferred to the outsourcer’s data center. The savings came from sharing IT staff and facilities across multiple customers and lower pricing on equipment upgrades that were acquired using volume purchase agreements. The outsourcer also used long-term (7-10 years) big dollar ( more than $1 billion) “mega-deal” contracts to effectively lock in the arbitrage opportunity and extend the arbitrage window.

This approach didn’t solve IT problems. It moved them. It was just “your mess…for less.” And in the end, the market adjusted, eliminating most of the cost savings. IT operations at most businesses have become more efficient and the benefit of volume purchasing was reduced as the IT industry moved closer to an “everyday low pricing” model. The result is that today many of these mega-deals are being cancelled or allowed to expire as businesses bring IT operations back in-house.

Employee Arbitrage—A Band-Aid Approach

During the last ten years, powerful networks and a more educated global IT workforce have enabled employee arbitrage where low-cost, highly trained application development resources in one country can be made available to a distant country where similar resources cost more.

While there were many management, cultural, social and political issues associated with this model, the economics were compelling—50 percent to 75 percent savings for the same skills. Companies like Wipro, Infosys and Cognizant emerged to offer U.S. companies deep engineering and application development skills at a fraction of the cost of those skills purchased locally.

Unfortunately, this model is just another arbitrage opportunity that will evaporate as the market adjusts and the price delta between offshore and on-shore skills disappears. The arbitrage window may open and shut over time as the lowest priced resource pool shifts from India to China to Russia, etc…. But in the end the window will close. This approach is just a Band-Aid covering up the skills/price gap between the United States and other countries.

IT Utility Services—A New Deal for Business

IT utility services represent a New Deal in outsourcing that’s not an arbitrage opportunity, but a fundamentally new way to deliver IT infrastructure. With IT utility services, businesses stop worrying about what “boxes” to buy and start focusing on the applications that drive their operations, generate customer value and create competitive differentiation. All the server, storage and network capacity you need is available as an on-demand service, not as a bunch of boxes.

Why is there such excitement about utility services? Because it solves some of the pressing problems in IT today:

Waste How many IT departments congratulate themselves for negotiating a 1 percent higher discount on a server that ends up running at 20 percent capacity? The problem isn’t pricing, it’s waste. Prices keep dropping on computers and there is more than enough competition to ensure you get the best price on technology. But, pricing cannot fix the waste problem. With utility services, you buy only what you need and pay only for what you use. Utilization is maximized and waste is eliminated.

Security Everyone knows that securing data has become a critical business requirement. The answer is a “defense in depth” strategy where every IT infrastructure asset is secured. However, this strategy is difficult to implement, complex to manage and expensive to acquire. Utility services solve this problem using automation software to define on-demand firewalls to protect each server and storage device while new thin client desktops eliminate the local disk drives and memory that can be an easy target for hackers.

Flexibility The form factor for traditional IT is “the box.” You evaluate the box, you buy the box, you run the box and you depreciate the box for as long as the CFO tells you to. What happens when you want to change the box in the third year of its five year depreciation cycle? You wait…and your business stalls. With utility services, technology is continually refreshed and you can scale up or down as your business needs change.

It’s Time to Get Started

Utility services are a New Deal for IT, but luckily it’s not an “all or nothing” proposition. You don’t have to throw away what you have in order to integrate utility services into your IT architecture. You can start with a single application or business unit and then gradually migrate the rest of your application portfolio and your business units to the utility platform. No changes are required to your application code.

It’s time to get started leveraging IT utility services. Otherwise, you won’t just loose ground to your competitors; you’ll never be able to catch up.

–Jim Leach is vice president of corporate marketing at SAVVIS, a global IT utility services company. He can be reached atjim.leach@savvis.net.

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