Risks and Advantages Of Outsourcing Information Systems. In today’s fast-paced and changeable business world, information systems are becoming more sophisticated and complex, and managing them is becoming more and more difficult.
So, companies need to optimize their management processes in building and deploying information systems to ensure the success of their business and minimize risks.
Outsourcing information systems to external vendors is a helpful solution that involves taking over computer central operations, telecommunication networks, and the application development.
What is Outsourcing Information Systems in 2024
Back to the Roots of Information System Outsourcing
To get to know what outsourcing information systems are, let’s clarify the outsourcing term first.
Outsourcing can be considered as a purchase of goods or services that were provided within internal resources previously. Outsourcing information systems have existed since data processing has emerged. Back in 1963, Electronic Data Systems provided services of data processing for Frito-Lay and Blue Cross & Blue Shield.
Other outsourcing options, such as the use of contract programmers, timesharing, and purchase of packaged software, have been exercised for two decades.
Information systems outsourcing stands behind entrusting data storage and handling information systems by external providers. Businesses may consider information systems outsourcing to reduce expenditures on data storage, and ensure that the data are secure.
Located in outsourcing destinations, data storage centers charge lower fees for actual storage, configuration and management, and thus make information systems outsourcing one of the popular methods in the technology sector.
Information System Outsourcing Now
The huge change in scope is what renewed the interest in information system outsourcing and draws attention to it today.
Early forms of information system outsourcing handled contracts in a single system: payroll, credit cards, insurance processing, and mailing lists that accounted for only a small portion of the information system budget. Outsourcing recently evolved and it covers multiple systems.
Now, it represents a major transfer of assets, leases, and personnel to the vendor that takes responsibility for profit and loss. The 10-year contract signed by Enron and EDS, valued at $ 750 million, is a typical example of this expanded outsourcing model.
The provider received the management levers, actually operating, managing and controlling the functions of the information system.
Why Information System Outsourcing Works Today?
Information systems play a vital role in modern companies, and today information technology accounts for about half of the capital expenditures of most large companies.
In companies where the cost of information system functions is rapidly rising, managers seek ways to control these costs and treat information technology as a capital investment rather than the operating costs of a business. Outsourcing is the option to control these costs.
A typical outsourcing model is as follows: the vendor charges a fixed fee for a predetermined number of services (called “benchmark”). Assure clients that within the contract period (usually five to ten years), the cost of SI for the benchmark will be fixed.
During the contract period, you can buy services not included in the provider’s baseline, but you will have to pay more.
Transactions are generally enhanced through financial incentives such as stock purchases, low-interest loans, and deferred payments. From the beginning, these transactions have been extremely attractive, especially to a financially distressed organization.
Which of the Following Is a Risk of Outsourcing Information Systems?
Not all organizations benefit from outsourcing information systems. Putting information system functions outside the organization is dangerous. Information system outsourcing can cause serious problems, such as inexperienced staff, loss of control, risk of leaking strategic information, hidden costs, and dependence on vendor solvency. So, let’s look at the risks of outsourcing information systems.
Inexperienced Staff
One of the risks of outsourcing information systems is hiring inexperienced employees to manage the processes involved.
By hiring an internal team, you can conduct interviews and get references from all members, but this method is only effective if you can verify the experience of the new hire.
Information system outsourcing means that you don’t have much knowledge (if any) about the members of the management information system. Instead, it is important to verify the knowledge and experience of the outsourcing provider.
Loss of Control
When a company transfers responsibility for the development and running its information system to another organization, it may lose control of the functions of this information system.
When a vendor accepts the outsourcing information system, it puts him in a good position as the customer has to accept everything the vendor does, and also accept the vendor’s charges. If the vendor becomes the only option for the company to run and develop its information system, it must accept any technology provided by the vendor.
This dependency can lead to higher costs or loss of control over the direction of technology.
Hidden Costs
When the cost reduction is behind the outsourcing information system, generally and long-term cost savings and early cash flow benefits are promised. Of course, current costs can be compared to vendor costs and learning curves can be built in future cost plans.
On the contrary, one may not know how much can be saved in the future, nor to foresee technical discontinuities. Still, two trends deserve attention.
First, the company underestimated installation costs, including redeployment costs, relocation costs, and handover or parallel operation costs more than expected. Second, a company can underestimate the management costs.
Vulnerability of Strategic Information
Trade secrets or proprietary information may be leaked to competitors in the course of information system outsourcing.
If a company allows a vendor to develop or operate applications with a certain competitive advantage, information leakage can be particularly damaging.
First, determine the service provider that stores or transmits confidential information. Next, consider the extent of sensitive data processed by third parties and the frequency of its processing.
The greater the amount of sensitive data managed by a third party and the higher the frequency of processing, the greater the risk that the confidentiality of the data will be compromised.
To minimize these risks, you can ask the CIO to occasionally make on-site visits to high-risk vendors to assess their security and data protection controls. Your CIO may also consider increasing the frequency of these visits.
Dependency on the Business of Vendor
When outsourcing information systems, companies become dependent on the viability of vendors. A vendor with financial problems or deteriorating services may create severe problems for its clients.
Customers cannot predict the service providers’ business continuity plans and whether they continue their operations if their core infrastructure or business is impacted by a natural disaster, a threat to the electrical grid, geo-political upheaval, or other crisis.
To address the risk of outsourcing information systems, it is recommended to simulate the crisis with the vendor so they can see how the vendor responds quickly.
For example, simulate a data center outage to understand the time it takes for the vendor to set up a backup data center at another location.
Communicate with the vendor on the importance of key business processes, transactions, and functions, as well as the time threshold that can be lowered before these processes, transactions, or functions start to lose money and customers may encounter compliance issues.
If the service provider goes out of business, exit the outsourcing strategy.
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What are the Advantages of Outsourcing Information System?
Not only outsourcing information systems has its risks, but it can also offer advantages that can make you opt for it. Please see the advantages of outsourcing you can get in the review below.
Economy
The providers of outsourcing services are the experts in servicing the information systems services and technologies they provide. They can offer the same service and value for less money than the cost of an internal organization through specialization and economies of scale.
Quality of Service
If customers are not happy about outsourcing services, the vendors will lose them. So the company may have more control over the external providers than over its employees. The companies that outsource their processes can obtain higher levels of service from providers at the same or lower cost.
Predictability
A fixed-price outsourcing contract for the provision of specified services minimizes uncertainty of the expenditures for outsourcing.
Flexibility
You do not need to make major changes to your organization’s information system infrastructure to accommodate business growth. As information technology penetrates the entire value chain of a company, outsourcing can provide excellent control over the company because its costs and functions can be adjusted to meet changing needs.
Variability of Fixed Costs
Some outsourcing arrangements (for example, running payroll) are based on the price of the unit work performed (for example, the cost of processing each check).
Many outsourcing companies will take into account possible changes in transaction processing volume over a year or throughout the outsourcing contract. Customers only have to pay for the services they use instead of paying a flat fee to maintain underused internal systems.
Allocation of resources for other projects and financial capital
Scarce and expensive talents in the organization can be focused on activities with higher value and returns, and the returns from these activities are higher than when operating a technology factory.
Some outsourcing arrangements include the sale of the outsourcing company’s technology capital assets to the seller for cash.
How much does Outsourcing Information Systems cost?
The cost of outsourcing varies depending on the specific region. The biggest outsourcing destinations are the Wesern Europe, Eastern Europe, and Central Asia. We have analyzed the hourly rates and spotted the top countries for outsourcing information systems by region.
Western Europe
The high living standards and highly professional software engineers make the Western Europe the most expensive software outsourcing regions.
The top countries are the Netherlands, UK, Germany, Belgium, France, and Norway. A team of developers can be hired in these countries at the cost varying anywhere from $110 to $300 per hour.
Eastern Europe
Despite a close geographic location, Western and Eastern Europe have a considerable difference in software outsourcing rates.
The region includes such countries as Ukraine, Poland, Romania, Bulgaria, Moldova, Estonia, Hungary, Lithuania, etc.
These countries have developing economies and have a high education level, and also have made significant contributions to the information technology industry. However, their wages are still relatively low. Outsourcing to these countries is about $ 25-50 per hour.
Currently, Ukraine, Russian, and Belarus are the leaders in outsourcing locations of the region, leaving Poland, Czech Republic, Hungary, Romania, and Baltic countries far behind based on quality to price ratio.
Ukrainian software development companies follow the global trends and lean towards science-based technology advancements, showing a lot of interest in mobile development, big data and AI projects, and also blockchain and cryptocurrency projects.
Another special feature of the destination is that the number of senior developers exceeds the number of intermediate and junior software experts. The level of expertise of the experts enables outsourcing companies to contribute to the project success of leading fintech companies.
Central Asia
The countries such as India, Philippines, and Indonesia are the top players for information system outsourcing in this area.
This region used to be the heart of outsourcing for a long time, but the situation changed drastically in 2017 due to threatening to the industry from the US.
Having lost their rich clients, local IT engineers decreased their prices by being lower than $25 per hour, and some companies even work for $15.
Wrapping Up
As it can be seen, information systems outsourcing has some disadvantages, but also the benefits.
Not all factors affect businesses in the same way as each one of them has specific needs and requirements. Understanding the risks of outsourcing is essential in making a business decision to outsource.
However, a wisely planned outsourcing strategy can provide numerous benefits and ensure the business profitability and efficiency. IT outsourcing still has many advantages that can bring benefits to business owners as long as it is used successfully.
