The outsourcing boom

In better economic times, companies outsourced IT to get access to scarce IT talent. But in today’s down economy, saving money has bubbled to the top as one of the primary reasons for making outsourcing deals.

Many of the other factors that make outsourcing appealing for some, such as better access to skills and improved time to market, remain crucial in recessionary times as well.

But at the highest levels of the executive ranks, the question that’s increasingly driving outsourcing is: “Can someone else do this for less?” say users and analysts.

Take Fireman’s Fund Insurance Co. in Novato, Calif., which last fall signed a 10-year, US$380 million outsourcing deal with CGI Group Inc. in Montreal.

As part of the agreement, CGI will provide Fireman’s Fund with IT support services to some 80 locations across the U.S. CGI has taken over the insurance company’s Phoenix data centre, and about 300 Fireman’s Fund employees have become CGI employees.

The growing challenge of maintaining and staffing Fireman’s vital-but-aging legacy systems was a primary driver of the deal, says CIO Billy McCarter. The decision to hand over legacy operations to CGI has left Fireman’s with a leaner IT organization focused on developing new applications that it hopes will give it a competitive market edge.

“The way we looked at it, we could run the best data centre in the world and Fireman’s market cap wasn’t going to grow,” explains McCarter.

But the contract with CGI has also resulted in a substantial 21 per cent savings in infrastructure costs a benefit that has assumed even bigger significance in today’s economy, McCarter says.

The huge fixed costs associated with owning an 800-MIPS data centre have been eliminated because CGI owns it instead. Most of Fireman’s infrastructure costs today are based on actual usage, an arrangement that has proved to be a far more efficient and economic model, according to McCarter. And CGI uses Fireman’s data centre to deliver services to other customers as well, so the costs are spread among multiple customers. For instance, a large printing operation that Fireman’s Fund previously ran at half capacity out of its data centre is now being used around the clock to deliver print services to other customers, resulting in lower printing costs per customer.

“We are not unlike any other company that’s being asked to contain IT expenditures during these critical times. If we can reduce infrastructure costs, we can shift the savings to our development organization while we retain a flat budget,” McCarter says.

That kind of thinking is what’s driving outsourcing growth in a sluggish economy. Stamford, Conn.-based research firm Gartner Inc. predicts that the IT outsourcing market in North America will grow from US$101 billion in 2000 to US$160 billion by 2005 as corporations try to lower IT spending while converting unpredictable costs into fixed costs.

“There is no doubt that this economic slowdown is boosting outsourcing,” says Humberto Andrade, an analyst at Hampton, N.H.-based Technology Business Research Inc. Pointing to the financial results of IT services companies such as Electronic Data Systems Corp. and IBM, Andrade says, “These are the only kind of companies that are still doing well, while every other IT company is suffering.”

A Welcome Bonus

For users that have already outsourced IT operations for other reasons, the cost savings are a welcome bonus in tight times.

The economy had little to do with Allmerica Financial Corp.’s original decision to outsource legacy operations to Keane Inc. in Boston two years ago. But since then, the recession has sharply accelerated the company’s efforts to off-load work to Keane, says Allmerica CIO Greg Tranter.

Over the past six months, the Worcester, Mass.-based insurer has transferred 139 IT employees from its payroll to Keane’s. The transfer was originally supposed to occur in about two years, but if those employees had remained at Allmerica, the insurer would have had to lay off 42 of them by now, Tranter says.

Allmerica’s outsourcing strategy has allowed it to off-load legacy applications to Keane while freeing its IT organization to focus on developing cutting-edge applications, such as an Internet-based point-of-sale application, he adds.

Cost wasn’t the most important consideration when Allmerica signed up with Keane. But the resulting 20 per cent savings in application development and maintenance costs has been vital, Tranter says.

Technology complexity is another consideration, says Ed Flynn, CIO at Philadelphia-based FMC Corp. a US$2 billion chemicals manufacturer. Handing over complex technologies to companies with the know-how is both economical and efficient, Flynn says. It eliminates the risk and time involved in developing that knowledge in-house.

FMC uses a variety of outsourcing vendors including IBM; Digex Inc. in Beltsville, Md.; Genuity Inc. in Woburn, Mass.; and Aventail Corp. in Seattle.

“Cost has been an important priority in all these relationships. But our view on costs doesn’t change based on the economy,” says Flynn. “We are in some very competitive industries, and we look at costs all the time.”

Indeed, the procurement specialists who negotiate contracts with outsourcers are becoming a lot more aggressive in seeking cost savings and productivity gains, says Tim Barry, a senior vice president of application outsourcing at Keane.

“Right now, in this economy, cost savings is the No. 1 criterion” for an outsourcing deal, Barry says. “It’s forcing companies like ours to come up with creative ways to deliver services.”

Beyond the usual domestic and offshore outsourcing options, Keane and several other outsourcing firms offer “near-shore” application outsourcing, meaning the IT services are performed in nearby countries such as Canada.

Keane’s near-shore services from a facility in Nova Scotia are targeted at customers who want the cost savings of an offshore model but want it close to home, Barry says. Because of the favourable currency exchange rate and the lower cost of labour in Canada, U.S.-based companies can deliver some services from Canada for 20 per cent to 30 per cent less than they could from the U.S.

“People are looking for opportunities to go near-shore and offshore much more than they have done in the past,” Barry says.

Some of the services that Keane is delivering for Allmerica are from Canada. Similarly, CGI is using its Canadian data centres to support some 500 Windows NT servers and large Unix platforms for Fireman’s Fund.

“Right now, we are bidding on more projects than we have ever bid before,” says Michael Fliak, a senior vice-president at CGI. “We have $5 billion [worth of orders] in the pipeline,” driven largely by companies hoping to save money, he says.

“A recession many times is very good for outsourcing companies,” he says.

The Boomerang Effect

Be prepared to bring outsourced operations back in-house

The key to IT success in this economy is to figure out what it costs you to do something internally and compare it with market costs, says Allan Cytryn, CIO at professional services giant Deloitte Touche Tohmatsu in New York.

If a process or service can be delivered more cheaply and efficiently by another party, then off-load it. If not, keep it in-house. But do the analysis on a continuing basis, and be prepared to flip things around as often as needed, Cytryn says.

Last year, for instance, Deloitte contracted with Aventail for managed security services. Under the arrangement, Aventail provides Deloitte with services such as a managed virtual private network, managed firewalls and intrusion detection.

The service went live in Deloitte’s New York office near the World Trade Center on Sept. 12, one day after the terrorist attacks that levelled the complex and several weeks ahead of schedule.

Going with Aventail allowed Deloitte to quickly and cost-effectively implement an important new service in an economy where the staffing and training budgets for new projects are simply not there, Cytryn says.

At the same time, Cytryn advises, be prepared to bring things back in-house, if needed. Deloitte recently did that with some previously outsourced print services, after an analysis showed that it was cheaper to do the same things internally.

“We have got to be nimble in this marketplace. There is no one model that works all the time,” says Cytryn. He says his company’s hybrid approach has resulted in a 10 per cent increase in IT productivity as measured by the number of end users supported his organization.