Debate over offshore outsourcing limits states and municipalities from hiring
outsourcers despite needs caused by aging workforce and legacy systems

State and local government saw a tiny uptick in money spent on IT outsourcing this year, reaching $11.3 billion. Public confusion over the terms outsourcing and offshore outsourcing, the latter receiving wide coverage in the media, fueled fierce political debate during the November election. The fear of significant job loss to businesses overseas caused more than 30 states to introduce legislation within the past year to restrict or prohibit state and local government contract work from being performed outside of U.S. borders. Although the elections are over and the economy continues to improve, industry foresees these political debates lasting another year or two.

Annualized growth rates in government IT outsourcing expenditures will be a mere 3% a year through 2009, when spending by state and local governments for outsourcing will hit $17.7 billion. Retiring government employees, as well as archaic government legacy systems, are undeniable factors in the state outsourcing market. The increasing demand for outsourcing in the coming years will be borne out of necessity, which politics will be unable to refute.

According to the report, outsourcing sectors such as IT platform operations, applications services, applications management, and desktop services will grow rapidly during the next five years, driving much of the total market growth. Business-process outsourcing won't experience the rate of growth originally forecasted because of the continued political debate about turning over complete operational control to outside contractors.

Outsourcing has long spurred political debates because of the fear of job loss and relinquishing control of internal systems. With the government facing a workforce shortage, there isn't as much of a stigma associated with it now. Optimism that government workforces could be repopulated by fiscal year 2008 is unrealistic. Students entering the workforce now are drawn to the high-tech advanced applications and pay scales that the private sector provides.

The risks of outsourcing

Strategic
  • The supplier may conduct activities on its own behalf which are inconsistent with the strategy of the user
  • Inadequate expertise to oversee the service provider.
Reputation
  • The supplier provides poor service.
  • Customer service does not meet the standards of the user.
Compliance
  • Privacy laws are not complied with.
Operational
  • Privacy and consumer laws are not adequately complied with
  • The outsourcing provider has inadequate compliance systems and controls.
Exit strategy
  • There is a lack of appropriate strategies to exit an outsourcing contract.
  • The contract reflects fraud or error.
Source: Basel Committee on Banking Supervision

The Joint Forum's guiding principles
  • A regulated firm considering outsourcing should have a comprehensive policy to assess whether the IT system or service is suitable to be outsourced. The board of directors should retain responsibility for outsourcing.
  • Establish a risk management program to oversee the outsourced services and relationship with the supplier. Consider the effect on the user of the failure of an outsourced service, the cost of the service, and the links between the service and other parts of the user's business.
  • Conduct appropriate due diligence in selecting third-party service providers.
  • Outsourcing contracts should be governed by written contracts that clearly describe all material aspects of the outsourcing relationship, including the rights, responsibilities, and expectations of all parties.
  • Regulated firms and service providers should establish and maintain contingency plans, including disaster recovery and periodic testing of back-up facilities.
  • Retain Delta Consulting to manage your outsourcing initiative.
Market consolidation, increased competition, and offshore outsourcing will drive down packaged software prices, according to the Meta Group.

Ongoing consolidation in the software industry—such as Oracle's mega-acquisition of rival PeopleSoft earlier this month—will drive down the cost of packaged software during the next three to five years, according to a study released Tuesday by the Meta Group.

The consulting firm says the traditional software market will condense by as much as 35% by 2008 and by another 15% by 2010. Intensified competition among new application providers building on top of existing services from IBM, Microsoft, Oracle, SAP, and other major vendors, along with increased availability of open-source technology, the growth of third-party providers, and continuous use of offshore labor, also will affect pricing. "In the past few years, software prices escalated dramatically and, as a result, users are upset with how much they have to pay for software," says Dale Kutnick, research director at Meta Group. "Vendors will reduce prices because they will see significant pressure from competition."

The Meta Group suggests in its report that users should try to isolate and maintain the basic ERP software in which they've already invested and build bridges to the new business applications that are more innovative and transformational.

But emerging server technologies could drive up the cost of software licenses by at least 50% by 2006, according to Gartner. Trends in hardware, such as the move toward multi-core chip architectures, virtualization, server capacity on demand, and increased interest in rapid-provisioning tools might threaten the pricing model of software companies such as Oracle, IBM, and Sybase, which are based on hardware capacity or central processing units. "New server technology is coming out with dual-chip CPUs and some software vendors such as Oracle are telling their customers that they now have to pay double for every one of these licenses," says Jane Disbrow, research director at Gartner. The research firm suggests businesses renegotiate software licensing contracts to accommodate the new technology.

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