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article | 10 Mar 2022
IT outsourcing models: selection and assessment
Przemysław Pala
Outsourcing the development and support of information systems has recently been of concern to more and more global companies. For the vast majority, IT is a non-core asset, so the opportunity to outsource them to a professional external partner and free up resources for priority business areas looks very attractive.


How to choose the most effective form of outsourcing for the company? Furthermore, how to assess whether this approach is more profitable from a financial point of view than investments in the development of own IT specialists?

As practice shows, IT outsourcing is suitable primarily for two groups of customers. The first one are medium and large companies operating in highly competitive market segments: banks, finance, insurance, and investment companies, representatives of travel and airline industry, for which a quick reaction to changes in the external environment is critical. This can be achieved only with the stable operation of IT solutions that support key business processes.

The second group are companies whose business is characterized by low margins: cost reduction is the most important when every ruble is essential for increasing profitability. Such a situation is especially typical for organizations with geographically distributed structures, such as retail networks and telecommunication companies.


IT Outsourcing models globally

Today, there are three best-known models of outsourcing the development and evolution of information systems on the global market. We can distinguish: the "fixed cost", the "actual labor costs" (time&materials), and the "dedicated development center" (Dedicated Development Center - DDC, Offshore Development Center - ODC). The latter model in which the outsourcing almost entirely outsources the development processes or system support implies a long-term partnership between the contractor and the customer.

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  1. The fixed cost model implies that before the start of the project. The scope of work to be performed by the service provider and the customer's cost are clearly defined. Supposedly in the course of the project it becomes clear that it is necessary to solve much more tasks than initially planned. In that case, the outsourcing company covers the difference in project costs from its resources or agrees to change the project budget with the client.

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  2. The peculiarity of the second model - the actual labor costs - is the absence of precisely defined project costs: the customer pays for the actual volume of work performed by the outsourcer following the time spent on it and the hourly rates of the contractor's specialists. Therefore, both parties have a flexible approach to changing requirements, conditions, and priorities of the project, and as a result, they can re-schedule their work.

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  3. The fundamental difference between the third model - a detached development center (DDC, ODC) - from the other two is in its long-term nature: the partnership between the client and the provider is long-term, may involve the implementation of not just one, but a complex of projects, or the complete outsourcing of the entire process (for example, maintenance of information systems). Within the model of the allocated development center (or competence center), the outsourcer selects a team of IT specialists, taking into account the client company's needs and creating the necessary infrastructure for its work based on one of its branches. The formed team focuses exclusively on assignments for this customer. The client chooses the set and scope of services provided by the center: it may be the development of new solutions, functional development of existing information systems, migration to other platforms, testing, software support, etc.

The moment of truth - Choosing the right IT outsourcing model

The criteria for choosing the form of outsourcing appropriate for a particular company can be illustrated by two examples. Suppose that a company uses a small number of information systems that do not strongly influence the success of its activities. At the same time, there are tasks associated with a slight modification of their functionality or support for their use. In this case, it makes sense to turn to suppliers offering development outsourcing on "actual labor costs" or "fixed cost" models. Project outsourcing is also optimal in the case of a one-time project (e.g., the creation of a new business application).

Another situation is when a company uses a large number of systems, including those developed in-house in different periods and operating on other platforms. Often the documentation for these systems is outdated or missing, which further complicates the maintenance and support processes. For further functionality development, it is necessary to know not only the technology but also the architecture and the nuances of building these systems and the competence specific to the customer's business. In this case, a practical option is the model of a dedicated development center, whose specialists will study the customer's systems and speak to him in the same language and understand his tasks precisely.

When choosing an outsourcing model, the financial factor is also important: the cost of using a particular form of services is evaluated in combination with possible risks and compared with the variant when the same amount of work is performed using your resources.

Financial pros and cons of IT outsourcing models

At first glance, the preferable option for the company is a fixed cost model: it is immediately clear how many resources will be needed to implement the project. It seems that there is the confidence you will not have to pay anything above the defined amount. However, there are several pitfalls here. All IT projects involve different risks: from the human factor to technological issues. It often happens that the tasks for the project and their requirements are defined very roughly. Sometimes it's due to the contractor's lack of experience and knowledge in solving the customer's task, sometimes - because of the lack of time and money allocated to the pre-project survey. 

Implementing a fixed-cost project, an outsourcing company seeks to insure itself against risks and includes additional amounts in the cost of its services to cover possible risks. The customer finds himself at a disadvantage. If the extra work within the project is not necessary, he overpays. If it is essential to do something beyond the agreed scope of work, the task becomes unprofitable for the contractor. Therefore, he will strive to negotiate with the customer to expand the budget or change the scope and priorities of the project, reducing the quality requirements for the solution being created: only then will it be possible to cut costs and meet the original plans. But for the company, this means they need new charges to refine the system in the near future.

Thus, the fixed cost model is effective only when the customer and the contractor have a very precise and detailed understanding of what needs to be done within the project and how it should be done. This can be achieved by increasing funding for the analytical phase of the project and allocating a sufficient amount of time for its implementation.

Suppose you work with the time&materials model. In that case, such risks are eliminated because the project's cost is calculated depending on the amount of actually performed work and the rates of engaged specialists. On the one hand, this protects the customer from the contractor's desire to save on everything, including the quality of services; on the other hand, there is a particular danger of the contractor's desire to drag out the project and "inflate" the billable person-hours, which would lead to unlimited growth of costs. To prevent this situation, it is possible to break up the project into separate, smaller size and timing sub-projects, gradually creating the necessary functionality of the system without losing control of the contractor.

Whereas in the first case, the risks would formally fall on the shoulders of the contractor, in the second case - on the client's shoulders. The use of the model of a separate development center, or competence center, implies equal responsibility. The company depends on the outsourcer because it has transferred to him the main functions of designing and developing its information systems. In turn, the outsourcer is connected to the customer because, in the case of rupture of relations, the company has a formed team of specialists and infrastructure of the center, which cannot always be quickly connected to another project. Mutual dependence opens up opportunities to create a transparent and mutually beneficial partnership. 

In addition, there are virtually no communication risks in this case (with properly structured interaction processes). This helps avoid additional financial expenses to eliminate problems in the project, which appear if the client and executor do not know each other and have not found a common language yet. However, the creation of a dedicated competence center for the sake of implementation of just one or two small projects does not make sense: it may lead to the fact that the center's specialists will be unemployed between projects, and the customer will have to pay for their services according to the contract.

Cost of services - IT outsourcing models elements

To determine whether outsourcing software development and support are profitable for the company financially, it is necessary to calculate the cost of own IT specialists. There are two groups of expenses to be taken into account - personal costs, associated with the salary of a particular specialist (the amount of wages is only one component here), and organizational costs, caused by the need to provide the conditions for the employee's work.

Personal costs include wages (personal income tax, insurance contributions, and social payments), to which the number of bonuses or premiums may be added. Also the cost of the social package (like voluntary medical insurance)), if it exists. Then you must add the cost of vacations (in fact, one month a year a specialist does not work but receives a salary), payment for sick leave (at least once a year most of the employees gets sick), and travel expenses. There is often a confirmation of the well-known rule: an employee costs his company about twice as much as his salary. But the calculation does not end there. 

It is necessary to consider the share of the company's organizational costs, which fall on each employee. These are primarily overhead costs (for example, organization of workplaces, rental of premises, utilities, repair costs, etc.). These costs are associated with supporting the activities of other non-profit departments of the company: financial and human resources services, marketing, and administrative structures. A separate item of expenditure, which also applies to all employees, is IT costs: using licensed software and information systems, computer infrastructure, networks, telecommunications, etc. Finally, the calculation should also take into account those resources that the company allocates to ensure standard technologies and methodologies of work support the compliance of internal processes with various kinds of standards and rules.

Indeed, each company in such calculation can have its components, some expenses may cover all personnel, and some - only some groups, but generally the methodology remains the same: it is necessary to take into account all items of expenses connected with the labor remuneration of the employee and the organization as a whole. As a result, the final figure is three to four times higher than the salary, which is the company's actual cost of IT specialists. This figure should be compared with the offers of outsourcing companies: then it will be possible to understand to what extent IT outsourcing is more or less costly compared to the use of own resources.

An important factor - the productivity of the work

There is another crucial point - the existing difference between the productivity of the organization's specialists and the employees of the external service provider, which directly affects the level of the company IT costs. As an explanation, you can compare the work of a dedicated competence center to the company's IT service (this comparison is the most obvious, as it allows you to compare the two similar structures with an already established infrastructure).

The IT services provider carefully approaches the organization of a dedicated center and allocates a significant amount of resources (time and financial) to create a structure that will help the center teamwork as productively as possible. This is justified, as the investment is directed to developing the outsourcer's core business. On the contrary, companies from non-IT industries often finance the development of their own IT division on the leftover principle because IT is just one of the areas that support the business. The difference in approaches determines the effectiveness of the center and its unit.

Availability of financial and time resources allows the outsourcer to build a methodology of functioning of the center, technologies of management of development processes, testing, and maintenance of information systems according to international standards (GOST, ISO, CMMI). For practical project and resource management, specialized internal information systems are introduced and used to track key points of the project (compliance with deadlines and financial parameters, the quality of specialists and issued solutions, etc.). This creates all the necessary conditions for effective and highly productive work of specialists, rapid identification of the most challenging moments in the career of the project team, and their elimination.

Who is in the winning position regarding IT outsourcing models?

Only a handful of companies outside the IT industry can "boast" of such an infrastructure. This is quite understandable: to create it, you need to attract qualified and experienced IT managers and specialists, give them time to develop a methodology, build internal processes, implement supporting information systems, staff recruitment, and training. All this translates into serious capital expenditures, which do not bring quick and measurable business.

Banking, investment, insurance structures, software manufacturers, global corporations consider turning to an external partner as a way to control IT costs and ensure their predictability, to get reliable support for core activities, to bring new ideas and technologies to their business. Their experience proves that cooperation with an outsourcer (especially if it is a long-term partnership) helps companies increase efficiency and improve the quality of services for their end clients.

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