Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 1

Outsourcing Information Technology

In a recent survey of CFOs, 57 percent reported that their firms were outsourcing a portion or all of their information technology (IT) needs. The motivation for outsourcing IT is twofold. First, it can help to dramatically reduce the firm’s overall cost of IT. Second, and perhaps most important, it helps the firm to keep up with advancing technology by partnering with an application service provider or consulting firm with a high level of expertise.

How does IT make the firm more competitive? Consultants and analysts disagree on this point. Some argue that IT is a strategic resource in most industries and should be supported within the firm to achieve the desired integration of IT and business strategy. They point to Wal-Mart that has used IT to improve its strategic goal of low cost and low price. Similarly, ADP, Inc., and Levi Strauss have used IT to improve their competitive position through enhancements in customer service.

Others argue that the question is not whether to outsource but which of the IT activities to choose to outsource and where to outsource. For example, Xerox has an outsourcing arrangement with Electronic Data Systems (EDS) to handle its operational IT tasks while it maintains a partnership with the software developer Oracle to develop Xerox’s strategic goals for IT. Also, IT outsourcing has gone global. Software engineers and database managers in India and the Philippines are less costly than in other areas of the world.

N. Venkatraman, a leading author on IT outsourcing, argues that IT should be viewed as a strategic SBU in either a cost, profit, investment, or service form (for Venkatraman, a “service” SBU puts customer service as top priority). Venkatraman proposes a simple formula for choosing the type of SBU based on two factors: (1) the degree to which the firm needs either operational efficiency or business capability from IT and (2) the degree of risk the firm is willing to bear. A low-risk firm that requires operational efficiency should choose the cost center; a low-risk firm that requires business capability should use a service provider. In contrast, a firm willing to accept risk and requiring business capability should choose an investment center because it will provide the desired long-term perspective for IT.

Sources: Based on “Outsourcing Comes of Age: The Rise of Collaborative Partnering,” PricewaterhouseCoopers, 2007; Pete Engardio and Arlene Weintraub, “Outsourcing the Drug Industry,” BusinessWeek, September 15, 2008, pp. 49–50; “In a Pinch: How the Financial Crisis Will Affect the Outsourcing Industry,” The Economist, October 11, 2008, p. 86; Sarah Johnson, “Nobody Doesn’t Like Outsourcing,” CFO.com, December 11, 2008. N. Venkatraman, “Beyond Outsourcing: Managing IT Resources as a Value Center,” Sloan Management Review, Spring 1997, pp. 51–64; Pete Engardio, Aaron Bernstein, and Manjeet Kripalani, “Is Your Job Next,” BusinessWeek, February 3, 2003, pp. 48–60; “Beyond Blue,” BusinessWeek, April 18, 2005, pp. 68–76. For further information view the Outsourcing Institute’s Web site at http://outsourcing.com/.

Step 1 of 3

Make-or-buy strategy is the strategy of the firms which helps management decide that whether they should make the parts used in production in-house or they should go for buying the part form outside supplier. They decide it with respect to costing, quality. resource management, opportunity cost, etc.