Cost Control Next "Killer App" as IT Outsourcing Ramps Up

IT managers must become more conversant in the language of business as process management issues gain importance, Yankee Group asserts

IT managers must become more conversant in the language of business as process management issues gain importance, Yankee Group asserts

Boston — December 19, 2003 — With global or offshore outsourcing of information technology (IT) services accelerating, the next "killer app" for the companies' IT departments will be tools to control services costs, concluded a recent report from technology consultancy Yankee Group.

The global or offshore sourcing trend has accelerated during the past three years. The Indian IT services market alone grew at a 56 percent compound annual growth rate (CAGR) from 1997 to 2002 and is expected to grow 22 percent in 2003, according to the Indian industry association NASSCOM.

The reason for the rapid growth in the face of technology sector recession is threefold:

  • Cost: Buyers remain very cost-conscious; and cost savings can easily run 20 to 70 percent depending on location and skill set.

  • Experience: Enterprises are learning how to effectively manage offshore sourcing, and providers are learning how to effectively manage non-domestic engagements.

  • Credibility: Major providers are growing into large, stable enterprises with significant quality control initiatives such as the Software Engineering Institute's Capability Maturity Model (CMM).

India is the largest offshore destination for global enterprises, but even with its explosive growth during the past six years, it constitutes less than 2 percent of the total world IT services marketplace, and its IT professional workforce is less than 10 percent of the size of the U.S. IT workforce.

Other offshore centers such as Mexico, China, Ireland, Malaysia, the Philippines and Eastern Europe are much smaller markets with less developed industry infrastructure.

Yankee wrote that while the offshore trend reportedly has resulted in U.S. technology job losses, in fact, the growth of IT services as a percent of total cost of IT ownership (more than 80 percent typically) over the past decade has resulted in the search for methods to control services costs, including technology initiatives such as utility computing and integration software (Web services), and delivery initiatives such as offshore delivery and business process outsourcing/management.

In past technology recessions, professional services firms retooled their employee skill sets for the next "killer app," or "must-have" technology, according to Yankee. As technology spending improved, so did the fortunes of the integrators.

Today, however, that will not work because the next killer app is control of services costs. Leaders in the professional services sector will need to retool their business models, incorporating these technology and delivery initiatives in order to prosper. Most of the skill sets migrating offshore are either low-value skills sets (programming, not systems design; Level 1 help desk) or "sunset" technologies (COBOL programming, not Web services programming).

In the United States, at the worker level, this trend adversely affects older workers with legacy skill sets and entry-level workers with limited skill sets. Workers in these categories currently have a 2 percent higher unemployment rate than the rest of IT workers.

At the vendor level in the United States, the trend adversely affects firms that follow a traditional integrator or outsourcer business model. U.S. firms in these categories have seen their margins erode over the past three years by almost 50 percent. This is leading to a bifurcation in business performance between skilled workers and firms that have reskilled and refocused toward the new initiatives, and those waiting in vain for a recovery.

With the IT services marketplace undergoing a change in the way it does business, Yankee believes that U.S.-based services firms will be more business-process-oriented and less pure-IT-oriented.

If this holds true, Yankee asserted that IT managers must become more conversant in the language of business. Business process management issues will become the domestic engagement face to enterprises, and pure IT will become more of a "behind the curtain" set of issues.

In addition, Yankee called on IT managers to target maintenance, support and sunset systems for the offshore delivery model.

For vendors, Yankee recommended re-evaluating their business models and delivery strategies in light of this trend. In particular, professional services firms working with the financial services industry seeking large projects or legacy (COBOL mainframe) projects need to aggressively build offshore capabilities. Most industries outside financial services have little willingness and a low adoption rate for offshore outsourcing. Pricing for small projects, Web technology projects, fixed price contracts and process management projects is less subject to pricing pressure, and therefore the need for offshore capabilities is lower.

In addition, professional services firms need to focus on business processes, Yankee believes. By focusing on business outcomes, cost becomes less of an issue for enterprises.

And finally, the consultancy calls on traditional outsourcing firms to move support and maintenance functions offshore and develop business process outsourcing capabilities to mitigate the effects of offshoring. Support and maintenance — the low capital intensity and higher margin components of traditional outsourcing contracts — are moving offshore. As the high-margin components of outsourcing move offshore, outsourcers' margins will erode. Business process outsourcing — particularly vertical processes — will face a lower threat of margin erosion.