A Google search on the word outsourcing produces more than 33 million results. After reading the story about the Nortel/IBM contract, it got me thinking about what outsourcing is all about and where it is headed. The aim of this short story is to offer a perspective on the past, present, and future of outsourcing.
Outsourcing used to be simple. Rather than hire employees to clean the office building, many companies decided to hire a cleaning company to do it. The cleaning company specialized in cleaning ,had experienced people, and could manage the cleaning operations better than a company could do themselves. The concept spread to the mailroom, overall building maintenance, and other functions of business. One of the largest targets of opportunity became information technology — hiring someone else to manage the computers and people.
In the sixties, IBM thought IT outsourcing was a really bad idea. However, some large customers concluded that if they outsourced their computer operations to a "datacenter company" they could save money. The theory was that the outsourcing company had a larger number of mainframe computers and therefore a lower unit cost for computing. IBM did not like this because it was perceived at the time that it would result in selling less computers. One of the outsourcing companies was Shared Medical Systems in Philadelphia (now part of Siemens Medical Systems) when I was the IBM branch manager there. SMS was buying a lot of new IBM computers but hospitals around the country were returning computers they had been renting from IBM to use SMS instead. At the time companies like SMS were considered by IBM to be competitors.
As time went on, things changed. The "data services" business flourished and IBM saw an opportunity to become data servicer itself. In the early stages it was a somewhat defensive move but it took on more significance as some very large customers began to outsource to IBM. IBM made offers to take over the datacenter operations and it’s assets and also hire the customers employees. Some of the deals were huge in scope involving many millions of dollars and thousands of people. That was the first major phase of IT outsourcing. During the next phase, IBM began to increase the value proposition to a higher level and significant partnerships began to form. I remember Lou Gerstner once telling a group of CEO’s to not outsource for the wrong reason. What he meant was that if you just wanted to move your assets and people to IBM you would be missing a big chunk of value. By forming a partnership where you jointly developed goals, carefully segmented who would do which functions, opened up wide communications channels, and even shared in certain risks and rewards you could have a very strategic and mutually profitable relationship. That was what I think of as the second phase of outsourcing.
The next phase of outsourcing is being spearheaded by IBM — and it goes well beyond IT. A major consumer products company uses IBM to handle all of their human resources functions including the hiring process, payroll, and pension administration. A major defense contractor uses IBM to handle their accounts payable process whereby IBM uses it’s own buying power combined with the customer’s buying power to negotiate better terms from suppliers. They have a cost savings sharing arrangement that motivates IBM to do a really good job for the customer. These types of arrangements go beyond outsourcing. In addition to handling various business functions for the customer, IBM also helps them redefine, streamline, and improve the business processes. IBM calls it Business Performance Transformation Services. I call it outflanking.
A glimpse of the future of outsourcing can be seen in a deal announced last week between IBM and Nortel. Nortel is a recognized leader in the communications industry. They produce technology for Voice over IP, multimedia, and wireless broadband. The network equipment marketplace is intensely competitive and Nortel was looking for a unique way to accelerate their growth. The two companies have established a Nortel-IBM Joint Development Center in Research Triangle Park, North Carolina where they will collaborate on the design and development of new products and services. In other words, IBM is going to become a key part of Nortel’s research and development arm. In addition to Nortel’s own strengths, they will be leveraging the tens of thousands of patents, in depth research and development engineering skills of IBM. The unprecedented R&D collaboration will help Nortel reduce their R&D costs and introduce products at a faster pace. They have already announced plans to develop new specialized servers which will combine IBM’s hardware and software technology with Nortel’s telecommunications expertise. As telecommunications and computing continue to converge, it is a natural for two leaders to collaborate on the innovation that is needed to meet the demanding data flow, reliability and security needs required by the telecommunications companies.
The bottom line is that this looks like a very smart move for both companies. Nortel isn’t outsourcing their R&D. They are outflanking their competitors. By leveraging the collaborative innovation capability of IBM, they are outflanking their competitors too.
