Still a Loser's Game

Computerworld - More than six years ago in this column ["Outsourcing: A Game for Losers," Aug. 21, 1995], I demonstrated that the real reason corporations were awarding massive IT outsourcing contracts was simple: Just about every firm that was outsourcing IT was in financial trouble.
That column continues to be cited in books and reports that have addressed the viability of IT outsourcing. Meanwhile, I continue to field inquiries from CIOs and a few chief financial officers on whether the original findings remain valid. My curiosity led me to check on some of the largest recent multiyear contracts for firms that outsourced more than half their computing resources.
Detailed financial information for 1996 through 2000 was available for eight such firms: AT&T, Aventis, Du Pont, Nortel, Rolls-Royce, Sainsbury, Textron and Xerox. Outsourcing deals of troubled firms such as Enron, which had a huge IT outsourcing contract, were excluded.
Each of the eight corporations that have outsourced most of their IT also delivered declining returns on shareholder equity (ROE).
The average ROE for the entire group declined from 18.2% in 1996 to 2.5% in 2000. That 2.5% is below the prime lending rate, suggesting that many shareholders would have been better off since 1996 investing in U.S. Treasury bonds rather than holding onto their shares. Such dismal performance is generally considered a reliable indicator of an organization in trouble.
It's also remarkable that three of the firms that were reasonably profitable in 1996 subsequently showed rapidly declining ROEs that turned negative in 2000 - a sign of financial failure.
The Importance of Successful Outsourcing
According to IDC, global IT outsourcing (which doesn't include application services, consulting services, business process management, network management and desktop outsourcing) will grow from a $56 billion industry in 2000 to an estimated $100 billion in 2005.
The compound growth rate for such services will exceed 12%, which is far greater than the maximum projected growth rate of total corporate IT budgets of 5% per year.
Since the U.S. accounts for about half of global IT spending and tends to favor outsourcing more than the rest of the world, the projected growth rate of outsourcing contracts by U.S. companies exceeds 12%. This rapid increase suggests that the IT scene is likely to be plagued by two new perils:
• Outsourcing services firms are likely to suffer unforeseen losses, quite possibly from contract disputes, after taking over damaged IT departments from troubled firms.
• Corporations with poor ROEs could be exposed to unwelcome risks if a major IT support fa