Outsourcingand Financial Decisions
Outsourcingand Financial Decisions
Inthe past twenty years, CFO’s in multinational corporations havesought to outsource transactional elements relative to their financefunctions. IT outsourcing relates to the subcontracting ofresponsibilities for a part or in some cases the entire IT functionto third party organizations on a contractual basis (IBM, 2008). Mostorganizations favor IT outsourcing as a means to realize acompetitive advantage as this reduces operating costs and optimizesefficiency in the finance functions, which has traditionallyattracted high operational costs, as it is skill intensive.
Competitionamong industry players compels organizations to seek ways with whichthey can maximize shareholder value through wealth creation byreducing operating costs (Thoppil, 2011). To achieve this end,organizations address issues such as policies towards productquality, product pricing and the ability to keep up with theproduction of innovative goods and services. To achieve this,policies adopted seek to exploit internal resources fully while atthe same time cutting back on unnecessary expenditures. This paperseeks to address outsourcing as a means with which organizations canachieve this end by agreeing to the fact that standard financialinvestment information and criteria are vital towards effectivelyevaluate IT outsourcing decisions.
Outsourcingpresents a number of advantages to organization. Outsourcing the ITfunction to a credible service provider with a premium quality ITskill pool and resources not only reduces cost but presents anorganization with the opportunity to harness new and innovative ITrelated products (IBM, 2008). The IT functions in many organizationsboth big and small has in the past considered the IT function asbeing a non-core business function in their organization objectives.However, this is rapidly changing, building a comprehensive andsustainable IT function is both expensive and complex and more soriddled with uncertainty due to the rate at which the IT sector isincorporating new technologies. As such, the future of IT spendingleads many companies to view an internal outsourcing function asdetrimental towards shareholder wealth creation (Thoppil, 2011).
Itis important to note that even the major IT companies have in thepast outsourced their IT function to offshore companies in an effortto cut on operating expenditures (IBM, 2008). To the shareholder, IToutsourcing translates to a larger financial resources pool due tothe elimination of unnecessarily expensive internal IT operatingcosts, which can be invested into an organization’s core businessfunctions towards better wealth creation.
Whenan organization is considering whether to outsource the IT function,investors require that there be a thorough analysis on all standardfinancial investment information (Cresswell, 2004). One thing thatorganizations have to bear in mind is the fact that by outsourcing,they are facilitating the creation of other organizations eitherlocally or in some other part of the world. For organizations with alarge equity base, the question as to whether to invest internally onan IT function or outsource this function to other organizations maybe subject to a host of other considerations other than the standardfinancial investment information (Graham & Campbell, 2002). Onthe other hand, for an organization that is in debt, financing aninternal IT function presents a complex affair as it may lead tofurther borrowing and may thus be forced to outsource the IT functionto reduce risks associated with further borrowing.
Fororganization with good financial status of accounts, decisions onwhether to outsource the IT function or not revolve around thequestions would an investment in technology and IT raise the value ofthe shares and increase the wealth the shareholders? Would anoutsourcing be more beneficial? Should the company lease (oroutsource) these technologies or should it invest in developing newtechnologies? What impact would these decisions have on shareholders’value?
Toanswer the first question, financial planning, analysis processes,and related technologies tend to differ with regard to organizationalgoals and the geography involved in outsourcing (Cresswell, 2004).Many large organizations favor outsourcing the IT function to thirdparty organizations operating in offshore economies. Thestandardization of all aspects related to such business processes areboth complex and demanding on the time function. This translates tothe financial managers in such organization debating on the long-termbenefits versus short-term benefits (Graham & Campbell, 2002).Outsourcing definitely results in short term benefits accruing fromhigher profits within a shorter operating period. For an organizationwith debt, outsourcing the IT function can enable it to realizeorganizational objectives as financial resources can be used inpaying up the debt or investing to other organizational processesthat can realize profitability in a shorter period.
Outsourcingthe IT function requires an organization to have a comprehensive riskmanagement process to be able to supervise relationships with thirdparty service providers (Cresswell, 2004). Issues such as servicingstrategies and requirements, selection process for an external ITfunction provider, contract negotiation, monitoring service provisionand the process of discontinuing third party relationships have to befactored. This translates to increased expenditure in either the longterm or short term.
Onthe other hand, investing in an internal IT function can lead to morecapital investment and stronger long-term benefits. Investing in aninternal IT function can lead to better shareholder wealth creationoutcomes as this function can be made in a manner that encompassesall the organizations core business functions (Graham & Campbell,2002). This can enable an organization to employ the internal ITfunction in a way that enables it to be highly competitive incomparison with its competitors thus highly favoring shareholdervalue. Leasing the IT function can also translate to improved wealthcreation as the IT function may incorporate core organizationstrategies towards improving profitability.
Leasingor investing in an internal IT function can therefore enables anorganization to further invest in the integration of new technologiestowards maximizing shareholder wealth creation (Cresswell, 2004). TheIT industry is a rapidly evolving through the introduction of new andinnovative products. With a strong internal IT function, anorganization can be in a position to employ these new developmentspro-actively in leveraging itself in a highly competitive marketplace. Many organizations have been able to rapidly rise to be themost appreciated brands in the world through such strategies. The ITfunction has come to be an integral function with which otherfunctions in an organization heavily rely on, from marketing, toresearch and development as well as in logistics. Organizations cantherefore realize many significant benefits from an internal ITfunction as compared to IT outsourcing.
Thoppil,D. A. (2011). ITFirms Split on Outsourcing Demand for 2011.IndiaRealTime. Retrieved June 18, 2014 fromhttp://blogs.wsj.com/indiarealtime/2011/02/17/on-outsourcing-demand-for-2011-indian-it-is-split/
Cresswell,A. M. (2004). Returnon Investment in Information Technology: A Guide for Managers.Retrieved June 18, 2014 fromhttp://www.ctg.albany.edu/publications/guides/roi
Graham,.J & Campbell, H. (2002). How Do CFOs Make Capital Budgeting AndCapital Structure Decisions? Journalof Applied Corporate Finance.Retrieved June 18, 2014 fromhttp://faculty.fuqua.duke.edu/~jgraham/website/SurveyJACF.pdf
IBM.(2008). Theoutsourcing decision for a globally integrated enterprise: fromcommodity outsourcing to value creation.RetrievedJune 18, 2014 fromhttp://www.inkoopportal.com/inkoopportal/download/common/outsourcing-decision-white-paper.pdf