Outsourcing: A Game for Losers

by Paul A. Strassmann

August 21, 1995

Strategy isn't driving outsourcing.
Statistics show the real reason companies outsource is simple:
They're in financial trouble.
Outsourcing most of a corporation's I.T. budget is more like an emetic than a miracle cure.

Despite all of the reasons offered in the press, so far there is only one good explanation that fits almost every case of large-scale outsourcing. The outsourcing corporations are trying to return to profitability by cutting employment. One way of achieving this objective is by ending their commitment to keeping up a home-grown capacity to master the introduction and maintenance of information technologies.

The Puzzle

I did not start out thinking that way. What I read in the magazines about letting professional firms manage the modernization of I.T. was entirely plausible. But, I was also personally acquainted with two huge outsourcing contracts which crippled information management for years and made the companies unable to respond to competitive encroachments.

Announcements about the dismissal or transfer of computer personnel feature imaginative stories about why a function that was previously seen as critical success factor can now be reassigned to outsiders. Some corporations claim their I.T. has ceased to be a "core competency." For others, the divestment of "commodity" functions make it possible to concentrate on "strategic" systems. One also hears that outsourcing is preferable because contractors offer technical expertise which the firm can't support.

Should top management view massive outsourcing of I.T. as a new and imaginative way of obtaining I.T. services, or, as an excuse for getting rid of responsibilities they have been unable to fulfill?

The Search

If outsourcing is indeed done for reasons of strategic fit, to realize lower costs, to take advantage of specialization of vendors or to overcome the unavailability of technical expertise, then one would expect outsourcing would be randomly distributed throughout the Fortune 1000 corporations. Outsourcing should be an equally good rationale to everyone for parting with their in-house I.T. function. Its incidence would be found in corporations without regard to size, industry, assets, profitability or growth, as each corporation finds that one or more of the many claimed benefits satisfies its needs.

Statistical analysis could show whether outsourcing is a random, evenly spread phenomenon, or, clustered around some causal connection. To examine that proposition

I asked a librarian to assemble a list of commercial companies which were most frequently mentioned in the trade press about their outsourcing actions. With this list, I searched in my productivity database which includes data about operating performance of U.S. corporations, as well as their I.T. budgets. With that I set out to determine if there were no discernible unique characteristics among corporations which chose to outsource most of their I.T. functions.

The Findings

I ran many statistical tests that all showed that the occurrence of outsourcing was not a random phenomenon. The most revealing analysis displayed the Economic Value-Added (EVA(TM)), which is profit-after-tax minus compensation to shareholders for equity capital. For each corporation that outsourced most of its I.T. budget I listed EVA values for one, two and three years prior to awarding their major outsourcing contract:
                     EVA Prior to Outsourcing in $Millions

Company           Contract  Prior Year  Prior 2 Yrs.    Prior 3 Yrs.   
Halliburton         1994        ($354)         ($170)          ($497)  
Delta Airlines      1994      ($1,147)       ($1,239)        ($1,075)  
CSX                 1994        ($693)         ($943)        ($1,159)  
USAir               1994        ($621)         ($954)        ($1,011)  
Unisys              1995        ($472)         ($818)        ($1,636)  
General Dynamics    1994         $398            $66           ($928)  
Polaroid            1995           $3            $44            ($22)  
Scott Paper         1994        ($481)         ($269)          ($520)  
Xerox               1994      ($1,267)       ($1,806)          ($725)  
McDonnell Douglas   1994        ($110)          $106           ($308)                                                                
Southern Pacific    1993        ($140)         ($456)          ($241)  
Eastman Kodak       1991        ($778)         ($572)            $57  
General Motors      1985        ($776)         ($442)         $1,368
------------------------      --------       --------        -------- 
  Total Negative EVA          ($6,438)       ($7,453)        ($6,697)  

Those corporations which outsourced heavily were economic losers heading into the outsourcing act. They were shedding I.T. along with other corporate functions because they were in financial trouble. I could not find any corporation with a consistently large Economic Value-Added and rising employment which outsourced, despite all of the claims about "synergy" or "advantages of getting rid of commodity work." The losers were casting off I.T. because they were already shrinking their firm, as illustrated in the following table:
                           Corporate Layoffs
Company Employees    1991      1992      1993       1994   Change 91-94  
Halliburton         73,400    69,200     64,700    57,200    -22.1%  
Delta Airlines      66,512    70,907     67,724    65,596     -1.4%  
CSX                 49,883    47,597     47,063    46,747     -6.3%  
USAir               48,700    48,900     48,500    43,600    -10.5%  
Unisys              60,300    54,300     49,000    46,300    -23.2%  
General Dynamics    80,600    56,800     30,500    25,600    -68.2%  
Polaroid            12,003    12,359     12,048    11,115     -7.4%  
Scott Paper         29,100    26,500     25,900    15,900    -45.4%  
Xerox              100,900    99,300     97,000    87,600    -13.2%  
McDonnell Douglas  109,123    87,377     70,016    65,760    -39.7%                                                            
Southern Pacific    23,396    22,793     18,982    18,010    -23.0%  
Eastman Kodak      133,200   132,600    110,400    96,300    -27.7%  
General Motors     756,300   750,000    710,800   692,800     -8.4% 
                 --------- ---------  --------- ---------    ------ 
                 1,543,417 1,478,633  1,352,633 1,272,528    -17.6%  

If outsourcing truly had all of the advertised advantages, economically prosperous and growing companies would use it because they were unable to absorb a sufficient number of computer people into their expanding businesses. The winners also would be the most anxious to secure ready-made technical expertise so that they could concentrate on their "core" competencies. I could not find any.

The Implications

Outsourcing is in reality only one aspect of a currently popular downsizing trend among troubled corporations. It is executed under another label, just as "re-engineering" is a euphemism for cut-backs in most cases. It just happens that the I.T. community has consistently ranked in surveys as one of the least admired corporate functions. I.T. therefore becomes an attractive target when there is a quota how many bodies must leave.

Cutting staff, divesting businesses and getting rid of hundreds of person-years of accumulated know-how seems to be a prevailing compulsion among large firms which are seeking to improve profitability by shrinking their size.

One could say that outsourcing has many of the attributes of a widely prevailing disorder known as "Anorexia nervosa." It is a psychological disturbance involving the refusal to eat to the point of starvation. People with anorexia have a distorted self-image which makes them feel "fat" even when emaciated. Preoccupation with food and low self-esteem, along with emphatic denial of the problem, characterize most anorexics. Similarly, executives in companies with poor financial performance seem to concentrate on downsizing as the preferred method for restoring competitiveness.

I am in favor of outsourcing for any of the good reasons that would take advantage of somebody else's capacity to accumulate know-how faster than if it remains home-grown. It should not be applied as an emetic. I will be especially encouraged about the prospects for outsourcing services when I get a large list of prosperous and growing organizations that have picked this option as a way of enhancing their mastery of information management.