ERP Outsourcing

Why buy when you can rent? Peter Drucker gave his blessing in a 1995 interview when he predicted that "in 10 to 15 years organizations may be outsourcing all work that is 'support' rather than revenue producing, and all activities that do not offer career opportunities into senior management." Drucker's prediction reached early fruition in the corporate information-technology (IT) function. Consider the success of such IT outsourcing firms as Electronic Data Systems Corp. (EDS), Computer Sciences Corp., and IBM's Global Services in the U.S. and Origin Nederland BV and Siemens Nixdorf Informationssysteme AG in Europe. Starting in the days of mainframes, such organizations built their reputations on upscale IT handholding that could -- and did -- take over entire data centers including staff. For example, in the early 1990s IBM Corp. built a data processing facility in Rochester that consolidated five Eastman Kodak Co. facilities, but was owned and operated by IBM. Estimated savings through the 1990s: $1 billion. And others followed. Now outsourcing is taking a new turn -- toward specific applications for the midmarket instead of the big-ticket, end-to-end IT operation model. In the last 18 months as the Y2K-driven market for enterprise-resource-planning (ERP) software sagged, vendors and a variety of new application service providers (ASPs) scrambled to partner in outsourcing as a way for ERP to expand down-market. Their reasoning: Make the software more appealing to midsized companies by letting them rent, instead of buying, installing, customizing, and maintaining applications themselves. Don't think, however, that outsourcing solutions are limited to new ERP projects. For example, three months after implementation a SAP R/3 system was outsourced at Sebastian International Inc., Woodland Hills, Calif. "Confronted by unacceptable system performance and the loss of key IT personnel, we made the decision to outsource," says Dianne King, director of information technology. "We probably would have saved quite a bit if we had outsourced right at the beginning." (The outsourcer is Syntacom IT-Services Inc., Waltham, Mass.) The rationale offered by the providers is compelling. With a predictable monthly payment, a company can solve all of the problems of running an application. Outsourcing's new wave targets high software ownership and maintenance costs; simplifies and/or eliminates the traditional difficulties in implementation; and avoids the problems of hiring and retaining IT staff to run the applications. But potential exists beyond a mere cost-cutting measure. Outsourcing can be a strategic, competitive move. For example, outsourcing the ERP function offers a faster time to solution and removes a major distraction from a company's core competence. "A key factor is the technical assistance the vendor-ASP partnerships can bring to bear," says Darren Waddell, applications-outsourcing analyst at Dataquest, San Jose. "Services providers like IBM typically have put together alliances with key ERP players like SAP, which puts them in the loop of the newest and latest changes in the application." "That improves the chances for obtaining predictable, assured results," adds Tom Melchiore, director of outsourcing at SAP America Inc., Newtown Square, Pa. He says the hosted model brings lower risk in the implementation cycle and better knowledge transfer from integrators to users of systems. "When the implementation partner leaves, the implementing hosting vendor is still there managing the solution. So the knowledge transfer happens seamlessly, automatically, for no additional cost, no impact on schedule, and, of course, lowering risk. With conventional implementations the opportunity exists for disconnects that could hamper the knowledge-transfer process to the customer's support staff." Some analysts link the value of outsourcing to the question of where the strategic value or significance of a technological solution -- such as ERP-really resides. "When it is available to everyone, then any competitive advantage must come from the quality of implementation" adds Sam Amore, vice president of marketing at Resource Partner Inc., a Columbus, Ohio-based ASP partner of PeopleSoft Inc., Pleasanton, Calif., and SAP. Although providers readily dramatize the way outsourcing alleviates IT staffing problems, few allude to the impact on the chief information officer. "Our expectation coming into this business was that internal CIOs would tend to be competitive with us," notes Michael S. Harper, vice president and general manager of USinternetworking Inc., Annapolis, Md. (USi is an ASP that delivers software solutions via the Internet, such as HR and financials from PeopleSoft and sales-force automation from Siebel Systems Inc., San Mateo, Calif.) "But what we've found is that they're often more of a proponent than the CFO or CEO that originally brought us in. We solve problems and bring CIOs capabilities they didn't have before. The value we bring to CIOs is not in head-count reduction, but in opening up the possibility of greater management participation. With the application outsourced, the CIO is able to pursue a leadership position to better leverage the IT investment for the business purpose." Market predictions are exuberant. For example, a forecast by Forrester Research Inc., Cambridge, Mass., has ERP rental reaching $6.4 billion by 2001. In five years half of all ERP implementations will be outsourced, adds Paul Shaughnessy, senior vice president and general manager of Syntacom IT-Services Inc., Waltham, Mass. Another estimate predicts that by 2003 three-fourths of all companies will outsource some or all of their transaction-based processes, says Farrell Griswold, manager of outsourcing strategy at PeopleSoft. PeopleSoft's application-outsourcing focus is broader than the midmarket. "The model can be beneficial for any size company," says Griswold. "And frankly we're seeing a lot of interest, not just in the middle market, where I think most of the ERP players are focusing, but upstream as well. The largest companies in the world are taking a good look at [application] outsourcing and sometimes for very different reasons than the smallest companies might." PeopleSoft's delivery model includes ASPs USi, and Corio Inc., Redwood City, Calif. Most software vendors deliver their applications through business partners that tend to have market specialties. For example, World Technology Services, one of the four partners of J.D. Edwards & Co., began delivering ERP solutions to the construction industry in 1997. An example is Redmond, Wash.-based E. Kent Halvorson Inc., a $60 million general contractor that is using J.D. Edwards accounting and financial software. "We wanted a package that we could access at multiple sites without housing a full internal IT staff," says CFO Brian Laurence. "By specializing, our partners can leverage their knowledge of an industry and its technology with their expertise in the application," says Marc Duame, national sales and marketing manger at J.D. Edwards. "Thus far our partners have signed up 24 midsized companies ranging in revenue from $50 million to $500 million." One partner focuses exclusively on high-tech start-ups that want the benefits of the software solution, but can't afford the high upfront cost of conventional in-house implementations. In the Great Plains Software Inc.-IBM Global Services outsourcing plan, announced this year, for $350 to $450 per user, IBM will host and maintain users' Great Plains financial software. In February an application-outsourcing alliance teamed SAP America with EDS, Plano, Tex. "This alliance changes the economic and logistic model for companies considering ERP," says Eric Rubino, senior vice president at SAP. "Access to these services also can help companies initiate electronic-business strategies in a shorter time frame with less capital expense," adds Ed Deenihan, unit president at EDS. The service already is up and running at Sebastiani Vineyards Inc., Sonoma, Calif. "By outsourcing our ERP technical environment through EDS and benefiting from the use of SAP R/3, we can direct our time and energy toward improving our core business processes," says Jeff Perkins, director of information services. Software vendors aren't the only market drivers. For example, service provider Syntacom is a new, wholly owned subsidiary of Plaut Consulting Inc., Waltham, Mass., a management- and technology-consulting firm. "Basically we found our customers wanted someone to be with them after the implementation," Shaughnessy explains, "and they preferred not to be switching firms." In addition to outsourcing, Syntacom offers midmarket companies solutions in SAP R/3 outsourcing, workflow management, data warehousing, data archiving, IT networks, Web hosting, Internet, and ABAP/4 and Basis services. Together, Plaut and Syntacom help companies develop the right strategies, implement them on both business and systems levels, and provide the IT infrastructure. So what's not to like? The concept is so new that confusion and misunderstandings are likely if the midmarket doesn't grasp the implications that outsourcing an application can have, says Amsterdam-based Greg Grosh, executive vice president at Origin Nederland. "A lot of expectations may not be met if the midmarket participants don't understand how outsourcing is different from the earlier model where entire IT operations were involved." Analyst David Caruso, vice president of enterprise-application strategies at AMR Research Inc., Boston, explains: "The outsourcing model that began in the 1980s was simply taking the data-center operations and having someone else run them, either on-site or at a remote data center. . . . In contrast, the new outsourcing model targets an application such as ERP and attempts to treat it like a utility." Caruso cautions that while the concept of application outsourcing is attractive, he sees issues that need to be thought through before the phenomena will grow as rapidly as predicted. First, outsourcing an application in a medium-sized organization can be in conflict with software-integration issues. What if the outsourcing model does not accommodate extensions such as advanced planning and scheduling, bar-code data collection, warehouse management, and e-commerce? asks Caruso. "A company planning an internal e-commerce implementation while seeking to outsource ERP might discover little or no cost benefit in terms of IT staffing." On the other hand Resource Partner's Amore advises that outsourcing applications should be a matter of setting the right objectives -- make it a strategic issue, not a cost issue. "Evaluate the concept from the standpoint of what the value-added is as opposed to what the reduction in cost is going to be," he advises. "It's not to say that it may not be cheaper or that it can't be. But don't let cost be an over-riding factor. You may find that even though the cost is the same, the added value more than compensates. The most significant contribution of outsourcing is in making management more strategic in their thinking." Other integration issues to consider involve the ever-evolving list of third-party products, legacy systems, the design and maintenance of data warehouses, and customization of the ERP application. Dataquest's Waddell notes that to gain the attractive pricing of some outsourcing models, customers will have to accept a lower degree of customization. Caruso predicts that, for the next few years, point solutions will grow faster than mission-critical ERP applications. The ultimate issue for outsourcing in any business sector is not how to do it, but whether to do it. A survey of 37 categories of outsourcing activities by the American Management Assn. (AMA) revealed that 94% of the 619 respondents participate in at least one category with 40% of them naming some aspect of their information systems operation. However the practice is growing most rapidly in accounting and finance, doubling in the last two years. The study targeted managers in the purchasing, administrative, and financial functions in AMA member firms.Once considered evidence of a quick-fix response to some sort of internal technical or performance lag, the practice has gained respectability because top-performing companies outsource to perform even better. Yet consultants remind companies to consider whether the practice is at least in pursuit of the right objectives. If a case for outsourcing does pass scrutiny, then consider outsourcing providers as suppliers and judge them on the basis of value-added.