Preparing for utility computing: the role of IT architecture and relationship management.

In recent years, outsourcing has become an important consideration in every organization's information technology (IT) strategy-making process. Economic uncertainties and rapidly changing market conditions are driving firms to assess bow they apply knowledge, assets, and resources to create strategic opportunities and respond to competitive threats. (1) Executives are being urged to combine internal and external competencies to deliver new and improved services to customers. (2) They are being told that outsourcing, particularly offshore outsourcing, can reduce their costs significantly. (3) Recently, new technologies such as utility computing and its close relative, Web services, promise to reduce costs further, while simultaneously increasing each firm's IT agility. (4)

Consequently, most experts anticipate that increasing numbers of firms will outsource increasing numbers of services in the coming years. (2,5,6) Although the outcomes of most early IT outsourcing initiatives were disappointing, (7,8) recent research suggests that firms are improving their capabilities related to managing outsourcing relationships. (9) Despite the fact that firms continue to report difficulties with their outsourcing arrangements, (10) outsourcing has emerged as an important IT tool, with its own set of specialized management practices.

As outsourcing is becoming more mainstream, new outsourcing models are emerging. For example, IT professionals in countries such as India and China are offering high quality, low cost IT outsourcing services. (3) Web services are promising to breathe new life into business process outsourcing. (11) Enterprise resource planning (ERP) vendors have Web-enabled their software and started to offer application outsourcing services. (5) Furthermore, traditional computing vendors are touting the virtues of self-healing computing environments and processing capacity on demand. (12)

As capacity on demand, grid computing, Web services, and other service provisioning models win favor, enterprise computing may take on the characteristics of a utility. We define utility computing as a collection of technologies and business practices that enables computing to be delivered seamlessly and reliably across multiple computers. Moreover, computing capacity is available as needed and billed according to usage, much like water and electricity are today.

In the promised utility computing model, firms will be able to purchase as much IT service as they need, whenever they need it. In time, they may even be able to access over the network components of business processes, such as billing or claims processing, and integrate them seamlessly with other processes inside and outside the firm. If this occurs, it could profoundly change the nature of IT. (2,11) But, the future is, as yet, unclear.

Will utility computing entice growing numbers of companies to "hand over" their IT infrastructures to specialist firms? Will enterprises increasingly outsource not only IT but IT-enabled business processes? Will visions of rapidly reconfigurable IT service and business process components become a reality? Will utility computing lead to ubiquitous outsourcing?

In this paper we review the outsourcing literature and examine the outsourcing experiences of eleven firms, in order to explore the potential impact of utility computing on firms' outsourcing practices. We focus primarily on managerial implications of outsourcing and utility computing for large corporations, as opposed to a detailed discussion of utility computing and its component technologies. We examine how a firm can position itself to take advantage of utility computing and new types of outsourcing in whatever forms they eventually assume.

The paper is organized as follows. The first two sections examine the traditional benefits and risks of IT outsourcing. We then describe how the firms in our study addressed outsourcing risks using two different approaches to outsourcing--selective outsourcing and large-scale exclusive partnerships. We find that IT architecture--namely the componentization and standardization of key IT assets--has a key role in enabling firms to effectively utilize outsourcing arrangements. The fourth section explores the implications of IT architecture on outsourcing management and outcomes. We then examine the benefits and risks of utility computing, in light of traditional outsourcing benefits and risks and the implications of IT architecture. We close with recommendations for how managers can position their firms to take advantage of utility computing in the future.

Outsourcing benefits

Most outsourcing arrangements deliver one or more of three capabilities: infrastructure services and data center operations, application development and maintenance, and business processes. The literature has cited a number of different potential and actual benefits from outsourcing these capabilities. The most frequently cited benefit is cost savings. (3,8) Other benefits include increased strategic focus, access to new technologies and technical skills, and variable (rather than fixed) computing capacity and pricing. (13,14)

Cost savings in infrastructure services result primarily from the vendor's ability to leverage economies of scale and scope in IT operations or application maintenance. (15) Because vendors have large numbers of projects and systems to support, they can justify an up-front investment in IT management competencies. Typically, cost savings result from the discipline the vendor brings to a firm's IT management and use. (16) In contrast, application development outsourcing garners cost savings from significantly lower wage rates in countries such as India and China. (3)

Cost savings from lower wage rates are equally available to all firms. However, in infrastructure services, large firms taking a disciplined approach to IT operations may not be able to realize cost savings from outsourced vendor economies of scale and scope. (15) Indeed, large well-run IT units often cannot elicit promises of lower IT operations costs from outsourcers. (17)

The potential for outsourcing to increase strategic focus has received heightened attention as firms have emphasized their core competencies. (18,19) If IT and business process outsourcing enables greater focus on strategic priorities, outsourcing may become increasingly important to building more agile firms capable of competing in the global economy. (20,21) IT outsourcing vendors develop a core competency in IT management and can build and leverage best practices because, unlike the client firm, IT management is the vendor's core business. (15) By delivering their core competency to clients, vendors free client firms to focus management attention on their unique core business.

Outsourcing may allow firms access to state of the art technologies and technical skills that would otherwise be unavailable. (8) Firms have tended to tap vendors for unique skills as they implemented packaged software (22) or developed new capabilities, such as e-business. (23) The desire to introduce strategic capabilities dependent upon new technologies encourages firms to partner with vendors specializing in relevant technologies. (24)

Client firms' need to increase the return on IT investment generates enthusiasm for replacing fixed IT costs with costs that vary according to IT usage. Outsourcing arrangements that transfer computing assets to a vendor can convert fixed amortization and operating expenses to variable usage charges. On the application side, outsourcing can reduce the commitment to fixed-cost, full-time human resource expenses through contracts that provide development skills on an as-needed basis.

Researchers have suggested that firms need the benefits of outsourcing--particularly strategic focus and variable capacity--to build strategic agility. (1,2) Outsourcing, however, introduces risks as well as benefits. In the next section we summarize the literature on outsourcing risks.

Outsourcing risks

When firms transfer an internal capability to an outside party, they lose some control over that capability. (25) Concerns about loss of control of foregone strategic capabilities have countered the enthusiasm for outsourcing. The risks of IT outsourcing highlight the need to both outsource the right things and to outsource them the right way. (26) Prior literature has highlighted four major types of risks:

* Relationship risks: Regardless of the length of an outsourcing contract, both clients and vendors know that the client's market will change and new technologies will create new opportunities. These constant changes lead to new expectations, new costs, and eventually, new metrics for service. A contract cannot fully specify these changes or define requirements for vendor adaptation. Thus, clients and vendors sign contracts that do not necessarily meet their future needs. The relationship risk encompasses the uncertainty about the long-term viability of contractual arrangements.