Outsourcing has ancient origins. It has been the basis for all trade since the birth of organized society over 10,000 years ago. Civilization can progress only by making the best use of resources, wherever they may be available. That makes it necessary to purchase goods and services you'd otherwise have to produce yourself.

Why has outsourcing suddenly become one of the most controversial topics among IT professionals? As far as IT staffs are concerned, outsourcing breaks up the traditional budget patterns wherein a company had direct control over 80% of IT spending. IT outsourcing is seen as a threat to the status quo and to the custodianship of custom-made systems. IT staffs now have to compete with outsiders. Systems designs that locked in costly corporate-specific solutions now have to become open to standard and even commodity solutions. If your job is at stake, you won't favor something that alters a hitherto protected situation.

Nevertheless, IT outsourcing is here to stay and will continue to grow with the rise in global commerce. Therefore, it may be useful to gain a better perspective of what outsourcing could do for your organization. In doing so, you'll be better able to rationally cope with outsourcing proposals whenever an economic justification for such a move is presented at your company. To illustrate, I use the economics of a $40 (retail price) Logitech computer mouse.

Logitech Inc. is a Fremont, Calif.-based multinational company. The mouse is assembled in China. According to The Wall Street Journal, the assembly costs $3, about $1 of which is spent on information overhead. Globally produced parts costing $14 account for most of the mouse's manufactured costs. I estimate that the logistics support to get the components to the assembly plant consumes about $3.50. This leaves the company with $8 for sales, marketing, and research and development, plus profit, with an estimated $6 of that going toward information management. The mouse is then sent through a distribution and retailing chain costing $15, an estimated $10 of which is for information costs. From Logitech's standpoint, it has outsourced 80%, all but corporate costs and profit, of the value chain (see "Economics of IT Outsourcing" below).

ECONOMICS OF IT OUTSOURCING

Value chain element Costs in value chain Estimated information costs Estimated IT costs Assembly in China $3 $1 $0.02 Parts from suppliers for China $14 $3.50 $0.18 Corporate costs + profit $8 $6 $0.66 Global distributors and retailers $15 $10 $0.30 Total costs $40 $20.50 $1.16 Percentage of retail price 100% 51% 3%

If the CIO of Logitech had oversight of every penny of corporate IT spending, this would account for only 66 cents. In a typical outsourcing contract that produces 10% in operating savings, the deal could shave as much as 6.6 cents from total costs. From a purely technical standpoint, such a move could be worthwhile. However, this still begs the question of what the role of a CIO ought to be in a multinational organization. Does the scope of the job just cover the 66 cents for corporate IT; does it include $6 for corporate information management and $10.50 for the logistics pipeline stretching from China to Logitech's warehouses; or is the CIO responsible for the $20.50 in total information costs that matter when competing against aggressive suppliers?

Depending on whether outsourcing is considered from the standpoint of the factory, management or the competitor, the outsourcing ratios (calculated as purchased goods and services/cost inputs) would be 467%, 213% or 95%, respectively (see box below). The competitor could then have an advantage in outsourcing less, because that company could make product improvements more rapidly. My take is that before you chase 6.6 cents' worth of IT cost reductions, you'd better make sure that this won't jeopardize the capacity to improve on the $20.50 that a competitor is striving to take over.

IT OUTSOURCING RATIOS

Outsourcing perspective Cost input Value output Outsourcing ratio As seen by factory $3 $17 467% As seen by management $8 $25 213% As seen by competitor $20.50 $40 95%

The most frequently encountered IT management disease is micromyopia — the vision defect that appears when the manager is pressured for immediate cost cuts. Beware of outsourcing decisions when you can't see the value chain from the competitor's point of view.

Paul A. Strassmann (paul@strassmann.com) views IT as a competitive weapon in a game where only the total value-chain optimizers will end up as winners.

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