The Hidden Costs of IT Outsourcing

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The cost of information-technology outsourcing involves more than vendor fees, but how much of that additional cost is really necessary? A survey of 50 outsourcing efforts shows that companies are largely unaware of costs associated with such activities as transitioning to a new vendor and so tend not to take measures to reduce them.

Jérôme Barthélemy of Audencia Nantes graduate school of management in France looks at four kinds of hidden costs that can erode the benefits a company anticipates from outsourcing. Drawing on lessons from company interviews, he provides anecdotes that show how the choices that a company makes can lead to high hidden costs.

When searching for a vendor, for example, companies often try to spend as little as possible. However, spending more at the search stage reduces hidden costs throughout the outsourcing effort and saves considerable expense later. Companies should include certain clauses in the contract, select a trustworthy vendor and be certain about the vendor's role.

Another hidden cost is the expense of transitioning activities to the vendor. This cost is elusive, because it is incurred as long as the vendor has not completely taken over from the internal IT department — something that is often hard to judge. The nature of the outsourced activities determines much of this cost.

The cost to manage the outsourcing effort can be considerable, but companies tend to overlook it. Experience is the best way to avoid high management costs. Even spending money to hire consultants with IT-outsourcing experience can be cheaper than enduring the high cost of contract renegotiation and dogging the vendor to get the desired performance.

The last hidden cost category is the expense to switch vendors or reintegrate the outsourced activities. Many managers view the end of an outsourcing agreement that involves strategic activities as a failure and are uncomfortable preparing for that cost. Simple precautions such as including a reversibility clause in the contract can help reduce problems.

Jérôme Barthélemy is assistant professor of strategic management at Audencia Nantes' graduate school of management, where he teaches strategic management and industrial-organization economics. Contact him at jbarthelemy@audencia.com or jbarthelemy@escna.fr.

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