Or for heroes, for that matter. When it comes tooutsourcing, its simply for those smart enough to know how to do itright.

BY MAREK JAKUBIK

The outsourcing debate and, especially, its offshoring aspectcontinue to invoke elements of passion, fear, misinformation, andthe occasional hostility. It already has brought a strong politicalresponse from Congress, which has been to include in the fiscal2004 spending bill a provision prohibiting federal agencies fromoutsourcing certain kinds of work to private companies that useworkers in foreign countries. Similar restrictions are underconsideration in 23 states, and four states already have passedthem.

Deliberations have been particularly animated within the ITfield. Recently a fresh twist has been introduced to an alreadyoverheated debate: Only incompetent wimps do outsourcing.
An argument, presented in a column, which contains the subheadlineOutsourcing Is for the Lazy, in the June 1st issue of CIO magazine,goes something like this: IT managers outsource because they findrecruiting and retaining good employees too hard. In other words,it is a clear sign of laziness and incompetence. Judging from theresponses the article provoked, the argument found a soft spot inmany IT professionals hearts. A new sharp turn has been added tothe emotional outsourcing roller coaster.

When talking to CIOs from the insurance industry, I see signsthe volatility of the outsourcing debate has made many of themuncertain as to what to think and do about outsourcing. Politics ofthe election year, a slowly recovering economy, andpseudo-arguments such as the one above all contribute to aconfusing and emotionally overcharged scene.

Outsourcing: A Tool for Business

Is outsourcing for wimps or heroes? Let it be known my answer isneitheroutsourcing simply is an important tool for smart businesspeople. I say business, not IT, very intentionally. Unless anduntil an IT manager learns to think and act like a businessmanager, he or she will not be able to select, negotiate, andexecute an outsourcing deal properly. Such a manager can indeed becalled incompetent.

Although white-collar service outsourcing is a relatively newphenomenon, outsourcing of products and services has a long andgrowing economic foundation and tradition built on twin factors:specialization and core competencies.

At the highest level of abstraction, the outsourcing formulasays: Keep your core competencies; allow the specialists to do therest (which happens to be their core competence). If you do itright, the reward always will be the same: Your company(department) will deliver more value at lower cost.

Large and predominantly multinational companies understand thisvery well. A majority of them have been using outsourcing in itsmany forms for many years. Still, midsize companies seem quiteunsure.

Why Do Midsize Companies Hesitate?

While some of the CIOs fears are quite rational, others arebased on misconceptions. Here are reality checks for severalcommonly held fallacies.

Outsourcing is not just about offshoring. While in someinstances offshoring may offer the best financial leverage, it alsobrings high risks and relatively high management overheads. Otherways to structure an outsourcing contract include near-shoring,co-sourcing, in-sourcing, joint venturing, traditional consultingmodels, and their hybrids.

Outsourcing in the insurance industry is not new. The industryhas a long tradition of outsourcing in areas such as marketing,advertising, and most often, claims. How many of your companiesstill handle glass claims themselves?

Opportunities offered by outsourcing never should be limited toa one-time expense-reduction exercise or simply looked upon as alabor arbitrage. Turning work over to specialists should result inongoing, long-term process improvements. In properly structureddeals, companies business targets should include ability to growwhile flat-lining the cost or ability to turn their fixed costs(internal resources) into variable ones (paying pertransaction).

Outsourcing of anything to do with data is not prohibited by thePATRIOT Act or Sarbanes-Oxley. Yes, these acts bring certainrestrictions, but at the same time they offer carriersopportunities to offload noncore aspects of specialized analysisfor which insurers are not particularly well equipped (e.g.,anti-money laundering).

Outsourcing is not about giving up talent. On the contrary, itallows tapping into a large pool of otherwise unavailable talent.Many midmarket companies simply fool themselves when they talkabout having the best IT talent. The reality of the IT market isunless a company is located near one of a handful of majoracademic/commercial centers, it rarely will have a shot at eithertier-one or tier-two IT professionals.

On the other hand, there are certain rational aspects that helpexplain slow adoption of outsourcing among the mid-marketcompanies.

Size Matters

Three issues stand out in examining differentiators betweenglobal and midsize (which most often means regional) carriers:culture, capabilities, and competitive landscape.
The culture of most midsize carriers tends to be strongly tied tothe community in which they operate. That, in turn, means placing apremium value on loyalty, relationships, and community in-volvementrather than simply focusing on costs.
Capabilities of midmarket companies often limit their ability todeploy resources to address outsourcingan endeavor for which theyusually have no internal expertise.

Finally, the competitive pressures within the midmarketinsurance industry are not as intense as experienced among thelarge, global players.

However, if after balancing various pros and cons a CIO decidesoutsourcing may indeed improve ITs performance, his or her nextstep would be to analyze where the best options lie.

The Best Opportunities

First, lets talk about what not to outsource. For guidance, Imgoing to quote one midwestern carrier CEO recently featured in thisvery magazine: Im not against outsourcing, but Im againstoutsourcing the brain. So, whats the brain of an IT unit in atypical midsize P&C insurance carrier?

Generally, it means those IT jobs where the core expertise ofthe insurance business resides. The best examples of such functionsare business analysts and data analysts. In other words, the peoplewho have the best knowledge of core insurance business pro-cessesand the underlying informational content flowing through thesystems. To this rather short list Id also add functions thatprovide glue between the business-level design and its system-levelimplementations: architects, designers, and project managers. Foryouan insurance CIOthese are your core assets. Develop, nurture,and protect them at all cost.

Look for Specialty and Commodities

Conversely, functions that are technology oriented butnon-insurance related are likely available from multiple sourcesand quite often their quality will exceed what your company candevelop internally. Think about it this way: Who can attract betterprogramming talentMidwestern Mutual Insurance Co. or Microsoft?Furthermore, while your shop is hard at work to retool for J2EE or.Net, how much focus can you dedicate to keep your legacymaintenance team that still grinds COBOL/CICS code?
As IT matures, many of its functions commoditize and, in manyinstances, already have become a relatively low-tech game. Helpdesks, technical support, or various infrastructure services thatprovide processing, security, e-mail, collaboration, and officesupport have become relative no-brainers.

A more complex assessment needs to be applied to outsourcing ofapplication or entire business processes. CIOs must look at them ina holistic way and with their strategic hat firmly on.

Test for Fit

Business process outsourcing (BPO) or application outsourcing mustbe subjected to a stringent analysis in at least three dimensions:suitability, readiness, and risk.
Suitability must test both strategic value and technical cohesion.Functions that can yield new, high-value business capabilities,those with high numbers of complex interfaces, or those dependenton difficult-to-find functional skills are best kept in-house.

Readiness assessment tests the current state of functional,organizational, and technical preparedness. Factors such as poortechnical quality of application, complex interfaces, substandarddocumentation, or dependence on key resources inevitably willdiminish the effectiveness of any outsourcing arrangement. Theseand similar conditions serve as red flags, raising questions as towhether cost-savings benefits indeed can be realized.

Risk assessment concerns all other tangible and intangibleareas. For example, the highest risk categories include processesand applications that have direct impact on a companys reputationor those having a clear need for a frequent, dynamic interactionbetween business users and IT developers.
At the same time, as the quality of outsourcing services grows, therisks associated with processes that touch companies customers areperceived as more and more acceptable. A good example is billing,outsourcing of which has been gaining steadily in popularity.

The analysis of suitability, readiness, and risk vs. thepotential value leads to the consideration of specific alternativesourcing options. C-level discussion of these options always entersinto sensitive areas and includes such issues as control,organizational pride, vulnerability to vendor- or platform-specificdevelopments, and effects on the broadly meant community ofstakeholders.

Regardless of the method and function that are the subject ofoutsourcing analysis, the CIO must rigorously test the plannedfinancial outcomes from short-, mid-, and long-term perspectives.Also, it is worth remembering that to be a win-win, the savingsshould exceed a rather steep initial threshold defined by overheadplus vendors profit margin. Experience shows a typical overhead(i.e., resources that must be retained by the organization tomanage outsourced services at the right level) is between 5 and 15percent. Adding a net profit margin of, say, 10 to 15 percent givesan idea of a reasonable cost-savings threshold that must bemaintained.

Only 70 years ago, Ford Corporation used to go as far as to runits own rubber plantations to control the supply of natural rubberfor tires. Today, General Motors, a $190 billion corporation, runsits entire IT operation with only 1,700 people. You can guess howthey do it.

, a former CIO of Zurich Financial and Pitney Bowes, is aco-founder and managing director of the Insurance Technology Group(www.insurancetg.com). Hecan be reached at 416-214-3445 or [email protected].

CIO Chronicles is a regular feature in Tech Decisions andfocuses on issues of concern to midmarket insurers. Its content isthe responsibility of the author. Views and opinions in thisarticle are those of the author and do not necessarily representthose of Tech Decisions.