Outsourcing and the network effect

Outsourcing and the network effect

Summary: Some people say outsourcing is a sign of incompetence. But what could be more incompetent in the era of the network than to cut yourself off from the network?

TOPICS: Outsourcing

Over the past few days, several ZDNet bloggers and Talkback posters have been postulating that organizations who outsource do so because they are incompetent. In this day and age, that's just inane! The reverse is closer to the truth: organizations that refuse to outsource are neglecting their full potential.

I guess I shouldn't be surprised that so many readers and writersThere's bad, industrial-era outsourcing, and there's good, collaborative-era outsourcing here on ZDNet haven't seen the light yet. It's the classic engineer's fallacy: "If only I/my systems were good enough, I wouldn't have to rely on all those others." But surely the one lesson we all ought to have learnt from the open source movement by now is that you get a better result by pooling resources than you do when you act alone.

Perhaps the bias against outsourcing is also a hangover from the tail-end of the industrial era, when people believed that the pinnacle of success was to build and own the biggest, most monolithic closed system of them all. Much of our experience of outsourcing has been with companies equally steeped in that mindset. EDS-style outsourcing simply substitutes someone else's huge, monolithic closed system for your own. No way is that going to deliver any of the network effects of outsourcing in the Web 2.0 era. There's bad, industrial-era outsourcing, and there's good, collaborative-era outsourcing. 

Another problem is that outsourcing is really the wrong word to convey what actually happens when you connect to a service provider in a Web 2.0 context. It implies you're just sourcing from outside something you could equally well choose to do in-house. Whereas what you're really doing is connecting into the wider resources of the network.

Employease, one of the hidden giants of software as a service, illustrates this well. Founded in 1996, the company provides HR management as a service to more than 1,000 US customers with a combined total of over 700,000 employee records. Its big differentiation from an on-premises solution is that it doesn't simply provide an application toolkit that the customer still has to connect into payroll systems and insurance providers and 401k schemes and compliance systems. All of those connections — to 3,000 partners —come already packaged as part of the service. Once a customer's employee information is uploaded into the system, the third-party services are immediately available to select.

"It goes beyond software," co-founder Mike Seckler told me in a call earlier this week. "It's all about these network effects ... With our one-to-many model, we provide a great platform for outsourcing."

An HR provider like Employease is a superb example because so many of the services that an HR system connects to are external by their nature (no one is going to argue that healthcare for its workers is a core competence for an automobile manufacturer or a software company — are they?). But in an increasingly connected, collaborative world, how many systems and processes will stay competitive if they remain insular and monolithic?

The broad benefits of being able to connect into a rich, collaborative network of varied resources will, in almost every case, massively outweigh the narrow advantages of having every single aspect of the system under your own control. That's why organizations today don't run their banking or their raw materials production in-house and it's why in the Web 2.0 era fewer and fewer of them will run their information systems infrastructure wholly in-house. What could be more incompetent in the era of the network than to cut yourself off from the network? Doh!

Topic: Outsourcing

Phil Wainewright

About Phil Wainewright

Since 1998, Phil Wainewright has been a thought leader in cloud computing as a blogger, analyst and consultant.

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  • Jump in the Pool!

    Yes, pooling resources is the best answer for almost all small and mid-sized business. These are points that a few of us (erik.engbrecht, pkstephens) have been making on the original post by Paul Murphy.

    We do for our 160+ clients something they could not do on their own: combine phone/fax/Web/database into one solution and set of tools. We are responsible to find the best solutions and put them together. In addition, we find and manage the right talent to make it all happen.

    Without an outsourced solution like ours, those 160 organizations would not have the resources to do business well. It's a fact.

    The count of times that outsourcing makes sense outnumbers those that don't by more than 3 times.
    Paul C.
    • Small, Midsize, and Large

      I think the percentage of IT that should be outsourced is roughly inversely proportional to the size of the business.

      IT is subject to both extreme economies of scale and diseconomies of scale. Small(er) businesses need to outsource in order to make reliable IT affordable. That doesn't just mean "well my Linux server has been running for 5 years straight" type of reliability. If you're on vacation, and it dies, and you're the only person who can run the system, then the business is screwed.

      But Fortune 1000 companies should probably all do a significant portion of their IT inhouse. Fortune 100 ones should do almost all of it. However, in either case there's nothing wrong with contracting companies for special services or workload leveling.

      Size is a very important distinction. I think Murph's incompetence is a combination of failing to handle diseconomies of scale (at the large end) and failing to achieve economies of scale due to insufficient specialization and cross-coverage at the low end.
  • Employease

    I wrote the business plan for Employease right after Netscape and Yahoo went public in the summer of 1995 and founded Employease 10 years ago with Mike,who you interviewed, and John Alberg.
    Thanks for your insightful comments.
    The power for Employease now is in its partners and the network they create and expand everyday. With huge partners like AON and ADP and many, many others they are becoming MORE dominant as a result of the network effect. Most importantly of all - they are delivering real solutions to real problems day and day out to their customers and partners. That is why we started the company in 1996. Through good and bad times of the Internet boom and bust the company has stayed the course and is now seeing the true fruits of a lot of dedicated people's hard work!
    Thanks for recognizing it and the underlying new business model - the network effect - that makes them a true pioneer and deserved leader.
    One other area to think about is that significance preceeds success. This is true for all software businesses. A long slow climb up the growth curve before the classic "hockey stick" spike.
    Welcome to the "hockey stick" Employease! Enjoy the ride! You deserve it.
  • Not necessarily

    Part of the issue here is trying to define "outsourcing" as it applies in this context. Small to mid-size companies pooling resources for certain infrastructure services is, generally, a good thing. When it makes sense. Every business is already dependent on a web of support services. Forinstance, I have an accountant. I pay him to provide a specialized service with near constantly changing rules and regulations. He handles the books, I can focus on my core business. It's easier to leave dry cleaning to the place down the street than understand the process. The classic outsource examples.

    Where outsourcing runs into trouble is the same place large "do all" data systems like Siebel run into trouble: Trying to be all things to all people. Over time, as the business owner, you start paying for more services, overhead and capacity you don't need. Going back to my accountant, let's suppose he was bought out by KPMG. I'm not going to hire KPMG to do my taxes because they're billing for so much overhead I don't need and more "network" than I can afford.

    So, outsourcing isn't automatically a good thing. Sometimes it's a good value and worth the extra money, but don't do it just because you don't want to bother understanding the underlying business processes enough to make a value judgement on what you're getting from the outsource provider. Whether that's software, web hosting, graphic design, taxes, HR, payroll or engineering. The network effect doesn't mean jack s*** if it doesn't directly contribute your cash position. Because cash is what makes business go round and round. Measure everything with that standard when evaluating outsourcing. What are my exact cash outlays going to be with this service and what don't I have to spend in exchange? If it doesn't balance on that simple forumla, then you're counting on intangibles. How much time it saves you. What are you doing with that extra time?

    And hearing someone declare that outsourcing works without applying it to any specific situation is a sure sign you're dealing with the marketing rep. It's not whether it works for the company down the street or next door, or every other SMB on the planet, it's whether it makes sense for your particular business case. The marketing rah-rah guy is the wrong person to ask.
  • Insightful

    Interesting take on the Network effect. The old ways of looking at outsourcing are obviously changing as more vendors and customers embrace the "on demand" model.
  • Synergy?

    "The broad benefits of being able to connect into a rich, collaborative network of varied resources will, in almost every case, massively outweigh the narrow advantages of having every single aspect of the system under your own control."

    Why do anything yourself? Outsource the lot then! Oh right, salesmen selling synergy!
    Nigel Johnstone
    • Wasn't that waht Enron did?

      There is a way of doing business where you don't actually do anything of value yourself. It's called a swindle, and it has made far more people rich than it has put in jail.
  • Ahh Free Trade results an Non-America America :)


    Its not directly related to outsourcing, but still relates very well to actually how bad the past 25 years have been for the U.S. economy. And before you start with short-sighted comebacks. Realize that at this rate it won't be long until almost all industries are dominated by foreign owned corporations that boost foreign economies.

    But hey atleast the current upper class already have theirs right?
    • Here's how I feel...

      Warning: the following site contains strong language.
      [url=http://www.illwillpress.com/tech.html]IllWillPress.com: Tech Support.[/url]

      Basic jist, "Why am I (the consumer) paying for first rate ... from a third world country?"
  • Employee Healthcare as a "Core Competency"

    Now, healthcare is generally considered a personal matter, so it's people who outsource their healthcare to doctors. But...

    Where I work, we have a nurse and frequently a doctor on site in an company run clinic. I'm pretty sure they are company employees, not contractors. Basic exams like blood pressure are available on a walk-in basis any time. New hires all get a complete physical along with drug tests.

    Free cholesterol screenings, flu shots, and a number of other health care services are provided on site. It's coordinated by a small department that also provides things like free yoga classes and health seminars.

    So does my employer completely take care of health care? No, employees wouldn't like that. But it certainly takes an active interest in providing employees with health resources.

    Business lose millions/billions of dollars to lost productivity due to illness. Things like heart attacks can knock out people with key knowledge unexectedly. I really doubt my employer is the only one that takes an active interest in the health of its employees.
    • In a bygone era wellness centers were common

      And in the present era, that sort of attention to employees is an extreme rarity. It is far easier to build a spreadsheet model on the savings of using contractors to replace employees, which then makes sick days look like a non-problem. When the detailed workplan is the only reality seen, and every 'resource' (what we once called a 'person') is seen as a fungible commodity, it is far easier to do the math when you pay by the hour for exactly how much you use.
  • About Time

    It's about time somebody starting taking the complexities out of integrating HR and Benefit systems with insurance carriers.

    Now if those carriers could start passing on those savings to my monthly premium ....
  • you can not control Outsourcing issue so just keep learning

    I think rather than complaining about outsourcing is good or bad - we the developers, should focus on improving our skills, come on face the fact - outsourcing is not going away and you have no control over it. Work to make yourself irreplaceable and save your job....
    • You are mostly right

      You cannot control outsourcing. Should not even bother to try.

      Instead concentrate on what works. Large corporations, which are doing most of the outsourcing, are dinosaurs. They cannot compete with smaller, more agile companies, and so sell off long-term viability for short term gain.

      Go to the smaller companies, or start your own if you can. It may mean less $, but it will benefit you more in the long term.
  • You're out to lunch

    Its not so simple as saying that the organizations are incompetent. Organizations are made up of individuals, working as a team, or most likely in large corporations, as individuals out for their own good.

    As a recent "victim" of offshore outsourcing, I can tell you that, in my case anyway, the organization IS incompetent. I had to go thru the whole song&dance: train my replacement, get outsourced and laid off, be offered a continuation of employment (my offshore replacement quit). Others were outsourced at the same time as me; they were also offered continuation of employment or contracts. Many of them accepted, and one or two are still there, earning more $ than before. I wonder how much $ was actually saved...

    So why was this done? Executive level managers basically ignored the well reasoned (and valid) objections of mid-level management (many of whom were also outsourced) and implemented the program. Many experienced employees were terminated, to be replaced with a greater number of ENTIRELY INEXPERIENCED offshore developers.

    Does this sound like the actions of a competent, properly managed corporation?

    My conclusions: every company has a certain amount of "corporate intertia" (can't think of a better term) associated with it. The larger the company, the more inertia. What this means is that it can withstand a certain amount of incompetence before the detrimental effects begin to manifest. Basically, the executives are translating corporate intertia into personal inertia, to benefit themselves instead of the corporation. In the case of my former employer, the executives who instituted this stupidity will be long gone up the corporate ladder before the effects are noticed.

    So, why outsource? Is it to gain access to a huge pool of talent? Doesn't this talent still have to be brought up to speed before being effective? What about the competitors who don't outsource? Do they get an instant headstart, or perhaps a chance to catch up?

    No, outsourcing is NOT necessarily about cost savings or access to untapped talent. Its about cost cutting, so that the bottom line will look good for a while, and when things start to collapse, those who are responsible will be long gone.

    Sorry, Phil, but you are out to lunch on this one.
  • Insightful, as always

    This is a really good article. I am not 100% outsourcing, and I think in many cases it makes sense, particularly for small and medium sized companies. The real trick is to figure out what can, and what should be outsourced.

    For example, the US Navy will never outsource the staffing of nuclear submarines, regardless of how much money could be saved.

    For some things, like running an email server, or basic file/print services, or web site hosting, the costs and experiences levels are so low to do it yourself, it is hard to understand why someone would outsource.

    Other things, such as HR, accounting, legal services, etc. are either too complex, or too expensive to do in house, unless there is a critical reason for it.

    And, as previous posters have mentioned, a major problem with outsourcing in general is that the companies doing the outsourcing are dinosaurs & 800 pound gorillas. SAP is a disaster, no matter who hosts it, let's get real here.

    At the end of the day, my reaction against outsourcing is really a reaction against the perception that internal IT is inherently bad or that outsourcing is inherently better. If your internal IT guys can't run a mail server, I would suggest you fire them, because mail servers are pretty simple. But if you have well-run internal systems, and still find that outsourcing can save significant amounts of money, without incurring other "hidden fees" such as lost productivity due to network speed, or data privacy problems, or whatever, then I am in total agreement that outsourcing makes sense in that situation.

    Justin James
    • Only part of the staffing

      Even the Navy hires contractors for some things. Are you certain that none of the staffing on a nuclear submarine isn't being provided by a contractor? If the operation of LANs and WANs on and between military bases can be outsourced, as it has been for many years, along with transportation, building and maintaining facilities, and Halliburton being paid to supply meals in combat zones (with or without actually doing so), it it so far fetched that some functions in a sub would also be contracted?