Axeba has been publishing an IT KPI (Key Performance Indicator) under the heading “KPI of the month” for over five years. Axeba is repeatedly confronted with outsourcing projects and has supported many companies in the outsourcing of their IT infrastructure or in some cases has taken over the operational provider management for them. So today we are not talking about the KPI of the month or individual KPIs, but about the myths associated with outsourcing. Most of the claims about outsourcing are simply wrong.
We start with the myth: “Outsourcing is cheaper”
Some time ago, we assisted a major client with the outsourcing of its entire IT. Various providers presented themselves in advance. When asked about the costs, one of the providers said that the costs would fall by 20% if we chose him as our outsourcing partner. This provoked the following question from me: “What are the current costs of the IT that is to be outsourced?”. The answer came straight away: “Unfortunately, we don’t know”. Although they didn’t know the IT costs, they did know that they could be reduced by 20% thanks to outsourcing… This gave rise to the myth that outsourcing is cheaper.
Let’s take a look at the general cost blocks:
In principle, the outsourcer has exactly the same cost blocks as internal IT. However, there is also its overhead (sales, administration, etc.) and its profit (it ultimately wants or has to earn money from its customers). On the customer side, there is also the cost of managing the outsourcer. Our rule of thumb is that 5-10% of the personnel capacity that is transferred to the outsourcer is required for provider management.
If we summarize these cost blocks, the cost comparison is as follows:
A new addition is the “Transition project depreciation” block. This is amortized over the term of the contract (usually 5 years) and must be included in the cost analysis. A rough cost estimate thus results in the following cost blocks, which arise in the case of outsourcing and which do not arise in the case of internal IT:
- Profit (margin) of the outsourcer: 10%
- Management of the outsourcer: 5%
- Depreciation transition project: 5%
This adds up to around 20%, which the outsourcer must be cheaper than in-house IT.
But that’s not all:
At the beginning of an outsourcing project, I always ask the CFO how high the savings must be thanks to outsourcing. Spontaneously, they always say around 20%, sometimes even 30%. This would then mean that the outsourcer would have to produce at a total of 40%-50% lower costs than internal IT.
After I have made this clear to the CFO, he often replies “but it has to be at least 10%”. This is understandable, but it means that the provider has to produce 30% cheaper than internal IT.
No problem if we source the services from a low-wage country…
Personnel costs usually account for around 50%. The other 50% is hardware and software (where the licensor of the software allows outsourcing). Hardware and software cost roughly the same all over the world. This means that the total savings of 30% must be passed on in full to personnel costs, which may therefore amount to just 40% of the personnel costs of internal IT: If the total IT costs amount to CHF 100, then CHF 50 personnel costs of internal IT – CHF 30 (30%) savings = CHF 20 for the outsourcer’s personnel costs and therefore still 40% of the original personnel costs of CHF 50.
If outsourcing is to save 20% instead of 10%, the outsourcer’s personnel costs may only account for 20% of the original personnel costs. These simple considerations show that outsourcing can only (still) be cheaper than in-house IT in the rarest of cases.
But then why outsource at all?
There are some good reasons for outsourcing. For example, internal IT is not capable of providing certain services with the same professionalism and quality as a specialized company. Let’s look at a Security Operations Center (SOC): it is hardly possible for a small, medium or even large IT company to set up and operate a truly professional SOC. Not just during office hours, but 24/7.
Outsourcing is virtually predestined for such cases. Even if outsourcing is more expensive, it is generally not possible to develop and provide such services to the same level of quality and professionalism in-house. For some time now, we have seen a rather cautious attitude towards outsourcing and we have also supported one or two insourcing projects. In specific cases, however, outsourcing can make a lot of sense.