THE PERILS OF PIECEMEAL OPTIMIZATION

by Peter O'Farrell, Cutter Consortium Senior Consultant

Much discussion about IT outsourcing focuses on activity considered for external procurement as well as the benefits and challenges associated with moving an inhouse activity to a vendor. Typically, the framework for choice of projects involves a review of the corporation's important functions that, for various reasons, cannot conceivably be duplicated by a vendor. Whether the defining rationale addresses core competencies or resources or derives from a transaction cost framework, there is an implicit assumption that the remaining corpus of the business will continue to be healthy and even benefit from having fewer critical activities delegated to vendors. Once proponents choose the function to be shifted out of house, determine the nature of the requisite relationship, and select a vendor to provide the function, the decision itself rarely requires revisiting the original reasons for addressing it. Many developments in the outsourcing effort itself, of course, may require attention, but the analysis that prompted the procurement isn't likely to be revisited.

But just as IT outsourcing wasn't as popular even a few years ago as it is now, within only a few years, the firm's environment might have changed so significantly that the decision to outsource may not, in retrospect, have been wise. Similar situations arise with almost any of the firm's major decisions. Hindsight provides perfect clarity on the current value of past decisions but has no instrumental ability to turn back the hands of time. Might other approaches to the outsourcing decision result in fewer possibilities of regret? It depends what the firm's goals were when the outsourcing decision was made. Was there a pressing interest in taking action that would produce cost savings over the short term? Given the pressure on firms in this recession, it's understandable that many management teams would embrace a ready cost reduction. Perhaps less likely would be a decision to enhance the longer-term profitability of the firm given current expectations for the environment that the firm might see over the term of the outsourcing arrangement. Still less likely but perhaps of more enduring importance would be actions that promote the firm's longevity and contribute to its ability to adapt to ever-changing business conditions.

A common framework for the outsourcing decision treats candidate projects as largely separable, both among themselves as well as from the firm. Observing each opportunity in turn, then, provides a list of new ventures with potential value to the firm. There's an implicit assumption that the projects are independent and, therefore, may be added to the firm's current portfolio of "investments" without any adverse consequences for other current activities. In the cases in which this might be true (e.g., payroll), the genuinely separable activities have long ago been turned over to vendors with little adverse consequences for the company. But for the current array of purely IT efforts under consideration by most firms and prospective business process outsourcing opportunities entertained by the very brave, the separability is questionable.

In the future, what will be the impact on the company? First of all, from portfolio theory, we know that none of the analysis leading to maximizing benefits is valid if the distinct opportunities in the portfolio are more than mildly coupled. And distributed "optimization" of each outsourcing candidate won't lead to maximizing overall firm performance because, as general systems theory tells us, the serial optimization of subsystems will not lead to optimal behavior of the entire system. For many of these decisions, the prospect of doing some sort of analysis that would encompass all of the firm's activities as well as its many opportunities seems overwhelming given the likely cost and the time the analysis might take. So from a practical standpoint, the decisions often turn on an analysis of the project as a largely isolated undertaking.

For a firm, relying on a somewhat simplistic analysis of an outsourcing opportunity may well be the most prudent activity if it hopes to learn more about the relevance of outsourcing to the organization. Some of these ventures need to be experienced before their true relevance to the company can be fully appreciated. And if the company's management fails to take some risks in business decisions, then it will surely learn little about the ventures it might be capable of undertaking. But with this in mind, the outsourcing decision still must be viewed in some respects as part of a discovery process rather than a demonstrable path to revenue enhancement or cost reductions.

-- Peter O'Farrell, Cutter Consortium Senior Consultant