Printer Friendly

Outsource or insource? Making the right decision.

Last year, as part of a corporate restructuring, Occidental Petroleum's top management said information services cost too much and ordered a cost reduction. The result: a full-fledged outsourcing review. Now, 10 months into the project, the program is reducing Occidental's IS computing costs by half. In an informal roundable discussion at Financial Executives Institute's recent information management issues conference, executives gathered to learn more about outsourcing and about Occidental's experience. Here is how Edward A. Barrows, Director of Occidental's Corporate Data Center, answered their questions.

Q. What's happening with information systems an Occidental?

BARROWS: Occidental is in the midst of a corporate restructuring, and as a result, everything in IS is being rationalized--data centers, applications programming, telecommunications. It is basically an exercise in rethinking the entire business down to some of our core strategies. "Oxy" is a commodities producer--we don't have any retail gas stations or refining--so cost drives everything.

We formed an internal team that competed for the business the same way the external people did. In all, we sent out four requests for proposals, including one to our own internal processing operation.

Evaluating the response to the RFP was a team of executive representing each of the main line industries--coal, chemical, oil and gas, and gas transmission. They formed a kind of board of directors for the entire project.

Our internal people had no advance warning that the RFP was coming, and they had no inside knowledge other than that they knew our business very well. The process was, of course, highly charged emotionally. But because each major business was represented on the task force, the project--from the time the RFP went out to the time the proposal was presented to management--took about four months.

Q. Was this approach used just in the systems area or in all services areas, such as project and maintenance?

BARROWS: This was the first time for data centers. Telecommunications has now been through a similar process. Occidental has always looked at outside providers for services. As an example, in an area outside of IS, a large number of our gulf coast plants use contractors for plant maintenance.

Q. Did you find that certain IS activities lend themselves to outsourcing better than others?

BARROWS: Outsourcing is theoretically cheaper than doing it internally because outsources have broader expertise. They're very good at running large data centers and large projects, and they have buying power, but they're also in business to make a profit. I think there's a trade-off there, and an internal group can compete effectively.

Another thing. Many outsourcers arrange fixed-price deals, and they are betting you don't stay within the band you signed up for. In my experience, very few people in data centers are able to stay within those limits. If your capacity grows as ours has--30 to 40 percent a year--you can't stay within those bands. Once that happens, the sky's the limit as far as fees are concerned, and the outsourcers tend toward long-term deals. They don't want to talk to you for less than 10 years. You may get them down to five years, but it's absolutely nothing less than that.

Q. What happens when you're outside the band? Do you reevaluate at some point to see if you would have made the decision to outsource?

BARROWS: With outsourcing, in essence you sell your business to the provider, and it seems to me that it would be nearly impossible to revert back after you lose your infrastructure. They'll say it is a partnership, but in fact they want to do it all. If you give them pieces of the operation--the networks, or the data center, or applications programming--they're going to tell you that you're not going to get the best bang for your buck unless you've given them the whole thing. It makes sense.

Our project was like a rubber band. We started with the idea of outsourcing the data center, expanded it to include everything, and then pulled applications development back in. All of the outsources more or less wanted to buy our applications portfolio for a buck and take it anywhere they pleased. We said, wait a minute, this is like selling a business. Our applications may not be on the balance sheet, but they've got value and you're going to pay us what they're worth if you want to take them somewhere else. So we had a parting of the ways.

And some basically told us we are large enough to get all of the savings they could get in operate the data center. Anything that has more than 150 mips probably can do almost as well as an outsourcer, especially when you consider that the outsourcer is out to make a profit.

Q. Is 150 mips a good guide to use?

BARROWS: I'm convinced that with anything above 150 mips you ought to be able to do as well as, if not better than, an outsourcer. We took the total contract period, which was five years in the RFP with a five-year option, and amassed all of the equipment that was going to be bought during that time. The internal team put that our for bid as our underlying structure. As a result, we actually have a fixed-price hardware contract for mips and gigabytes. It's a supply contract, not a lease, and it's recorded on the books as an operating expense. It's literally year-by-year mips and gigabytes.

We figure that in today's dollars, we're in effect buying this capacity for about 60 percent of list price. That's brand new stuff at 40 percent off! It's true you have to have a pretty sizable volume to get those kinds of discounts. We also said we don't have to have a leading-edge technology, so our disk drives are one generation old throughout the whole five years. We'll try to figure a switching point, probably in about three years, when they'll go from what is currently a generation old to what is current today.

Q. How well do outsourcers really understand your business?

BARROWS: Probably not as well as our own employees. But remember that some of your own people know your business very well and some never really get it. The same is true with outsourcers. You'll get good ones and you'll get mediocre ones. You should also remember, by the way, that the outsourcer will try to retain your best employees.

Q. What effect did going through this process have on your costs?

BARROWS: We halved the cost of computing, and our costs before we got started were not exorbitant. We were in the lower quartile of some measurements we did with external sources, so we were reasonably comfortable that our costs weren't out of control. We're comfortable now that by cutting our cost of computing in half, we're in far better shape than the norms.

Q. How much do you save over the five years?

BARROWS: We were spending about $28 million a year on people, software, and hardware for all our data centers. When it's all over, we're going to be spending about $18 million a year. That's a 36-percent drop on a yearly basis.

Q. What did you do to cut the cost so dramatically?

BARROWS: We consolidated data centers, from three to one. That look us from 143 people down to 67. We saved a lot on licenses on software by having fewer machines in fewer locations, and in some cases we're able to use a site license to put software on multiple machines. That was probably the next biggest piece.

Hardware, I think, would be about the third piece. It's unfair to say what we were paying on hardware before the project, because if that equipment was at the tail end of a three-year lease we were at a high cost of computing until we rolled it over. It would be unfair just to say you are spending too much on processors. I had one processor that we literally put on a month-to-month basis because we didn't know what we were going to do and I didn't want to lock myself into a long-term arrangement. But it was a high cost.

Q. How do you compare with the 150 mips rule of thumb?

BARROWS: We're starting at about 180 mips and about 600 gigabytes, and we'll go out at about 275 and 900 in year five. We have between a 12- to 14-percent compounded growth rate built into the plan. The beauty is that the pressure is now on the demand side of the business. It's okay for the data center not to meet its budget if the businesses push it over the wall. They're the bad guys. They're the guys that have to go into the board of directors and ask for more iron. Before, it had always been the data center. So each business has signed up for a quantity for the five years and businesses are happy if they stay within what they've signed up for. Anything above that, they're the ones that have to go to the board.

Q. You help them do the modeling?

BARROWS: Absolutely.

Q. But it's still their contract?

BARROWS: Yes, I have a contract with each company.

Q. If the modeling is a joint venture, is it their responsibility if somebody goes over the wall?

BARROWS: Yes, because we're measuring and reporting on a daily basis.

Q. What is the nature of the contract?

BARROWS: Two things. As I've said earlier, we have a demand/supply agreement with each business and the data center employees have an implied contract with the parent. We keep our jobs if we do what we said we were going to do. If they don't demand any more than what they said, we've got to meet the numbers that we signed up for for five years. It's more or less an employment contract.

Q. So the recourse is you lose your job?

BARROWS: We'd be outsourced. We'd go through it a second time. We have an agreement. They're my landlord, you know, so they control my floor space and all the benefits and salaries. But I've got hardware and software and hiring and firing kinds of decisions.

Let's take our coal company, which is probably right now leading the rest of our organizations in the application of our tools. If that company's chief executive says he's willing to spend more money on IS because he's going to save it in engineering, he's going to save in operations, I'm going to save it somewhere else, that's his business decision. If he's got a good story to tell, let him tell it to the executive committee and he'll get the bucks.

Q. Does their resource stand alone or are they buying a part of your operation?

BARROWS: They have their own applications development staff, and I am a utility supplying them mips and gigabytes.

Q. So they have in effect signed a five-year service level agreement?

BARROWS: Yes, absolutely.

Q. What if they wanted to get their own hardware? Are they allowed to do that?

BARROWS: We have said there will be one 370 architecture data center domestically. We have also said that we will never suboptimize on total. As an example, the coal company was in a very used image in their data center, and their cost of computing was very low. Their piece of the new total was actually more than what they were used to paying. But because it's cheapter to have their volume and put it into the whole pie and bring the total cost down, the corporation's keeping them whole at their historical rate until they exceed the capacity of that old machine.

Q. Do the prices they pay to you go down over the five-year period or are they flat?

BARROWS: They'll actually go down. Our hardware proposal is a fixed price at level payments for five years even though the capacity is increasing. That was part of the RFP. Because we wanted it to look like the outsourcers'.

We've done the same thing with maintenance. But for software, the sky's the limit. You don't have as much control on the software vendors. So the pieces that escalate are software and people. They only cost increases we see right now are for those two categories. But when you sell more units, the average cost will come down.

Q. Has the application developer for the coal company used your mips and gigabytes, or do they have their own resource?

BARROWS: They're a mixture. They're doing a fair amount on PC LAN platforms. But they buy all their host cycles from me, whether it's development or production. The fact that total costs are reduced by half helps take out some of the politics when two divisions lost their data centers.

Q. Have you always outsourced your people time?

BARROWS: Only in applications development and maintenance. Even there we have always had a mix. We have tried to have a reasonably steady staff load for applications development, but on occasion we've gone out to contractors.

Q. Do you have a stable of contractors that you work with on a regular basis?

BARROWS: In most locations, we'll get down to two or no more than three. Once of our strategies in the insourcing, if you will, was to contract the number of people we do business with. We have one hardware supplier even though we have a multivendor environment. We are probably going to have one maintenance vendor.

Software, the same thing. In the past we've looked for products that are the absolute best. But now we're considering buying a whole suit of tools so we can get a lower price. We have only one guy to talk to. The tools integrate better. They install easier. I have fewer people to maintain them.

It's too early to tell how well that's going to work. Ten months into the deal it's proving to be very worthwhile, at least from a cost standpoint. When you tell a collection of vendors that their competitors are bidding on the job, it's amazing what happens to the prices.

Q. What did you do with the people?

BARROWS: As I said, in our data center, we dropped from 143 to 67. We were very up-front during the outsourcing review. We wrote a weekly letter to all affected employees to tell them what was happening. It got to the point where a lot of the people said, I can't handle all of this information. Just tell me when it's all over and tell me wheter I, you know... That's all they really wanted to know.

I guess the bottom line for me was that the exercise is well worth the pain and trouble. Anybody who is not taking a hard look at outsourcing is leaving money on the table. Whether it's good or bad. For some businesses, outsourcing is a very astute business move, especially those that have internal problems. So I think that an IS function ought to do it even if management doesn't legislative it. I don't begrudge having management all over my back for the last 12 months, because I think that we radically changed the way we look at the whole function. And for a very defined period of time, we had some very senior executives absolutely in the bucket with us.
COPYRIGHT 1991 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:Special Report: Information Technology
Publication:Financial Executive
Article Type:interview
Date:Jul 1, 1991
Previous Article:Perform as smart as you are.
Next Article:The strategic potential of information technology.

Related Articles
Robbing Drug Dealers: Violence Beyond the Law. (Book Notes).
Think like buffett about how to value outsourcing.
On-time, on-budget project adds new business.
Outsourcing as strategy: associations are aligning outsourcing activities with overall association objectives to enhance mission and service to...
Outsourcing tool kit 2004.
Akebono Brake to Establish New Casting Foundry.
Thomson Tax & Accounting.

Terms of use | Copyright © 2016 Farlex, Inc. | Feedback | For webmasters