How to Understand The Effect of SaaS on IT Outsourcing

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Executive Summary

IT outsourcing will be dramatically impacted and reduced by SaaS/cloud/IaaS.
Present outsourcing companies were developed primarily for the on-premises implementation model when many labor resources promoted the concept.

Introduction

This is a topic on which I was able to find very little written, and I think some critical changes are occurring, which will strongly negatively impact IT outsourcing. It seems that many areas of SaaS are fertile areas of coverage, but many others have fallen below people’s radars. In this article, you will learn about the current state of IT outsourcing and then move towards how SaaS fits into the support design, and in fact, it has such a high potential to improve it.

How Outsourcing Works

Outsourcing IT fundamentally about reducing costs while pretending that the quality stays the same. The cost of outsourced IT is lower than internal support. However, the outsourced IT support margins are vast as the companies that provide outsourced services engage in what is known as arbitrage.

The Labor Arbitrage of Outsourcing

That is buying something from a lower-cost area and reselling it at a higher-cost area. Yet, while margins made on Indian based resources by major outsourced companies like HP, IBM, CSC, and Accenture are substantial. The ultimate goal is to charge the highest rates in the world while paying the absolute lowest. So imagine charging Switzerland rates but paying out at Bangladesh wages. The difference goes into the pockets of executives. This is what is often referred to as “globalization.” It has a very modern feel to it, but it is most appreciated by those who make the most money.

Now outsourced support means that the client uses IT support from an outside party. No rule states that the outside party needs to use offshore resources — yet in practice, they pretty much always do. Therefore, in this article, I will not distinguish between outsourced and offshore support.

The Inefficiency Outsourcing

Outsourcing is quite inefficient because outsourced IT provides a low level of service versus internal IT.

Here are some of the reasons why:

Major Language Issues: The outsourced workers don’t speak the supported company’s users’ language as a first language. This is paramount since it’s one thing to express themselves and write a particular language at a basic level versus doing so at a higher standard — and solving more moderate to difficult IT issues and understanding broader issues means having like language facilities. The miscommunications on the outsourced support are rampant and well documented.
Real Support or The Illusion of Support?: Support becomes more about maintaining the illusion of support than providing actual support.
Change Management Support: Support drops away from explaining more sophisticated parts of using the application to be about ticket closing. That is how to do the bare minimum to get tickets closed to maximize this KPI.

There is little coverage of these issues in the regular IT media as they would be alienating to advertisers. And the IT media entities have moved to be almost entirely industry sourced in funding.

What Happens During Outsourced Support?

The outsourced support that I have witnessed numerous times tends to undermine the investment made into the implementation and the software purchase. When outsourced support is used, the following things will most often occur:

The use of the software swiftly declines to a lower level.
The business begins to take on more of the support burden.
IT support typically recedes to only fixing the most foundational problems with the application.
Their ability to help improve the usage of the application is minimal.

Maintenance Costs and Outsourced IT Support

The maintenance costs are the most expensive part of using enterprise software. In estimating 53 applications, we calculated an average estimate of 65% of the TCO of an application (see the calculators at Brightwork TCO Calculators). That is over the application’s entire life; on average, 65% of an application’s costs are attributed to lifelong maintenance costs.

This varies significantly per the actual application. These are by no means perfect figures; they are estimates and require more tuning for a specific company. As for other sources:

A Forrester study where they state that 55% of the total IT budget is maintenance.
Accenture’s study showed that maintenance was roughly 55% to 65% of a typical IT budget.
InformationWeek had one article that estimated maintenance is 61% of the IT budget.

All of these seem reasonable or “within the ballpark.”

So with maintenance costs being a high percentage of the yearly IT budget, it is natural that companies would want to get this number down. Accenture’s outsourcing document focuses on this cost reduction.

“Our project data show that clients can reduce software maintenance costs by 20 to 25 percent. When companies are struggling to maintain or expand operating margins despite tepid top-line growth, optimizing software support presents a meaningful opportunity to impact overall margins.”

Accenture’s statement may be correct. However, IT outsourcing is a way to get the number down, but not an excellent way to maintain applications and databases. And this has repeatedly been demonstrated.

That is, it does not leverage any technology; it simply degrades the service provided at a lower cost.

Outsourced IT Support Leads to Nothing but Tears…and Increased Blood Pressure…for the Users

In my consulting life, I have yet to see an effective outsourced IT department. The story is always nearly the same; the service declines; the outsourced company’s management is often absent (they tend to spread account managers over many accounts). The users say things like

What happened to our support? What are we paying CSC for?

Look don’t bother asking support because they won’t know, figure it out yourself, it will be faster.

and

A lot of times we cannot understand what support is saying.

“Who is Working on This Support Issue Over There Again?”

Often it is a question as to whether individuals in India are assigned to the account full time, as different people flow in and out of the support organization.

Secondly, the margins made on the offshore workers are so large that most of the money ends up in the outsourced company’s management, far more than if that money were spent hiring internal IT support personnel.

In this way, outsourcing is highly elitist…

Offshore Margins and a Feeling of Eminent Coronation

I have seen proposals with margins of offshore labor included within them. And with that type of margin, it can feel like you have just been crowned.

And this has to lead to the following…in outsourcing companies, the word “margin” is now pronounced “MAAAARGIN.” This is done quite loudly and on occasion with a vigorous fist pump into the air.

Adding Big Value?

It should be remembered that these profits are not based on hard work, thought leadership, or innovation — but instead based upon what is known as arbitrage. That is buying something from a lower-cost area and reselling it at a higher-cost area.

Making the CIO Look Good

Outsourced IT has shown the significant dysfunctionality of many IT departments. There are scenarios where they will accept a lower capability provided to the business as long as they look good.

A big part of IT outsourcing is improving the KPIs of the CIO. The way support is measured does not show the decline is supported. This is because the focus becomes on how many tickets were opened and how many were closed. There are ways of gaming this system so that tickets are closed and then quietly re-opened.

Therefore one cannot measure IT support performance by ticket closure.

The Future of IT Outsourcing?

At one time, it seemed that SaaS had the potential to put the kibosh on outsourcing, as application support will naturally move to the SaaS providers. Now, there is nothing to stop SaaS providers from outsourcing their support. And that is a different topic, however currently, SaaS providers are not major outsourcers of their support, and there is a problem with them doing it due to their goal of subscription renewal. However, SaaS growth has been relatively slow versus predictions.

That is the type of wholesale outsourcing where a CSC takes the support from an IT department and then plays games by pretending it is closing tickets, has less of a place with SaaS vendors. Remember that an outsourced IT firm can deliver poor service because their customers are locked into on-premises software, have purchased the hardware, and “bought the cow,” so to speak.

The same cannot be said once customers move to a subscription-based model. I cover this topic in the article The Effect of SaaS on Software Selection.

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Conclusion

SaaS means a reduction in outsourced IT, which is entirely good as outsourced IT has been a problem since it was first rolled out. Those with outsourcing contracts can be stuck in contracts for years, but as SaaS continues to grow, this will mean a decline in outsourced IT revenues. This extends to IaaS and PaaS.