CHAPTER 1
THE DECISION TO OUTSOURCE
Introduction
The ever growing pressure on governments throughout the 1980s
and 1990s to control public expenditure has focussed attention on outsourcing.[1]
Much of the evidence to the committee tended to argue for or against outsourcing
almost as a matter of principle. The committee observes that such an approach
is not helpful. In practice, outsourcing is just one option available
to managers to pursue their agencies' objectives.
Outsourcing of IT as a service wide policy had its origins
in the then government's March 1991 Industry Statement. This was fleshed
out in a Department of Finance circular in September 1991 requiring all
Commonwealth agencies to examine new and existing services with a view
to outsourcing if that represented better value. The circular noted that
the intention of the policy was to 'achieve maximum outsourcing subject
to value for money, agency efficiency and public policy considerations'
and reminded departments that outsourcing should be consistent with two
other principles of government purchasing, 'open and effective competition
and support for local industry.' [2]
In late 1993 the then government established the Information
Technology Review Group (ITRG) to,
examine Commonwealth acquisition and use of information technology
[and make recommendations] ... directed at making information technology
a more efficient and effective means of achieving the objectives of government.[3]
The ITRG report, Clients First, presented to the then
Minister for Finance in March 1995 has provided the basis for much of
the current thinking on the future of Commonwealth IT. The report is particularly
concerned with the reform of the Commonwealth's use of IT to 'transform
the quality, range and relevance of Government client service delivery'.[4]
In general terms the report focuses on the need for a whole of government
policy framework to facilitate interoperability and cross agency use of
IT to improve efficiency and service delivery. With regard to contracting
out, Clients First commented that,
Most submissions to the Review agree that outsourcing has
a place and can be beneficial for some activities but argue against a
whole of government approach. Major concerns are with the ability to promote
local industry growth, restricting government's flexibility to re-engineer
itself and the transfer of core competencies outside agency control.[5]
The change of government in March 1996 both accelerated the
adoption of, and significantly changed, the approach to outsourcing. As
the then Minister for Administrative Services stated, 'We came to Government
with a very strong philosophical commitment to outsourcing. We believed
it was time to question whether many of the services currently being provided
by Government would be better delivered by the private sector.'[6]
The current government's approach to outsourcing of IT is that all aspects
of IT services with the exception of applications development are required
to be market tested. Applications development is essentially the 'policy'
area of IT - the decisions about how IT can be applied to an agency's
operations.
In the specific area of IT the Commonwealth already sources
a significant proportion of goods and services from the private sector.
Virtually all hardware and a large proportion of software is purchased
from the private sector and a proportion of other services - applications
development, maintenance, training, help desk services - are also provided
by private contractors.[7] Thus,
particularly with regard to the supply of hardware, the government's IT
outsourcing initiatives represent a change of process from a decentralised
agency focussed model to a consolidated, integrated, service wide approach
rather than a dramatic shift from public to private provision. This is
not to suggest that the changes underway are not significant. The scale
of outsourcing is greater than anything previously undertaken in the Australian
IT market. The provision of services to agencies by private contractors
where they were previously provided internally by the agencies' own employees
represents a major change in the way the public sector works.
Considering Outsourcing
The potential benefits of outsourcing flow from identifying
activities which are not considered to be part of the core business of
an agency, rigorously defining and costing the services to be provided,
making explicit all the components of those services and all the related
effects which might flow from outsourcing, for example with regard to
privacy or employment. Only then should market testing be undertaken and,
if appropriate, the provision of that service be put out to competitive
tender. The Industry Commission identified 'increased flexibility in service
delivery, greater focus on outputs and outcomes rather than inputs, allowing
public sector managers to focus on strategic priorities, encouragement
of suppliers to provide innovative solutions and cost savings in providing
services'[8] as the benefits. Proponents
argue that by going to a specialist supplier of IT services, agencies
can gain access to the best available technology and skills as they require
them. Keeping up with technological developments can be difficult for
in-house units while retaining skills can be both difficult and costly.
The decision to outsource should be pragmatic and must be
based on a clear statement of the objectives being pursued and a rigorous
appraisal of all the factors relevant to the delivery of the service in
question. It must also draw on the experience of others so that the process,
objectives, costings, performance targets and assessment of risk are realistic.
In this report the committee is concerned with the factors
that need to be taken into account when considering the provision of IT
services to ensure that decisions are soundly based and that the subsequent
process is properly managed. The literature on IT outsourcing presents
a broad range of findings.[9] It
is clear that there are examples where some of the objectives sought have
been achieved: costs have been cut; services improved; agencies freed
to concentrate on their core business; more flexible and responsive IT
services put in place; employment stimulated and industry development
encouraged. Equally one can point to examples where outsourcing has not
delivered the predicted outcomes, presenting agencies with significant
problems and costs in finding an alternative supplier or re-establishing
an in-house service. A balanced review of the published analyses of outsourcing
supports a cautious approach to this issue and a recognition that it is
only one of a number of alternatives which agencies may wish to pursue
in seeking to reduce costs or improve efficiency. Support for in-house
bidders or retention of IT within an agency coupled with rigorous benchmarking
of the service may achieve the desired outcomes without incurring many
of the risks.
The Commonwealth Treasury emphasised a cautious approach to
the initial decision:
Outsourcing poses major business and management risks without,
in all cases, certain financial gains. A policy of adopting outsourcing
across-the-board is therefore likely to be less than satisfactory. Treasury
supports the option of outsourcing of IT services to the extent that it
can be demonstrated, on a case by case basis, that it is financially worthwhile.[10]
The then Department of Finance noted that agency efficiency
and public policy considerations also had to be factored into the equation.[11]
Public policy matters include accountability for the expenditure of public
funds and the provision of public services, privacy, security, equity,
employment implications and the impact on industry.
The Industry Commission, while emphasising the potential benefits,
noted the importance of getting the process right. Competitive tendering
and contracting may assist,
public sector managers to get best value for money by ensuring
that the best provider is chosen for the task at hand. When done well,
[emphasis added] CTC can lead to significant improvements in accountability,
quality, and cost-effectiveness, providing benefits to clients, taxpayers,
and the broader community.[12]
The Australian Bureau of Statistics (ABS), for whom information
technology is absolutely integral to its responsibilities, noted that
'world wide experience of major outsourcing initiatives in both public
and private sectors has been very mixed. (An unbiased examination of the
UK experience show this all too clearly)'. It also referred to its own
experience with the trial outsourcing the support of the desktop environment
of one of its offices. ABS concluded from this study that 'there would
be no significant benefits ... in proceeding with an outsourcing solution;
a conclusion shared at the time by the contractor'.
What Should be Outsourced
What constitutes the core business of an agency? The difficulty
of providing a simple definition of core and non-core business is exemplified
by the recent statement of the Secretary of the Department of Immigration
and Multicultural Affairs (DIMA) when announcing a partnership between
the department and CSC Australia to undertake applications development;
'Information Technology is becoming a core and essential part of any business
and this alliance recognises this'.[13]
At the committee's hearing of 4 July 1997 some agency responses
to this issue were superficial. To rely on the mission statement of an
agency as an adequate guide to the relationship between IT and the agency's
other functions does not seem adequate. However the representative of
the Defence Department offered a useful definition:
Core activities [are] those that are so integral to the operational
effectiveness of Defence that performance by other than Defence personnel
would diminish or put their effectiveness at unacceptable risk.[14]
The Australian Taxation Office (ATO) representative, while
defining the ATO's core function as administering the tax laws, acknowledged
the heavy reliance on IT to discharge its functions. Rather than relying
on a narrow definition of core business it would be more useful to use
idea of 'strategic activity' which has been defined as activities 'integral
to an organisation's achievement of goals and critical to its existing
and future business direction'.[15]
Professor Peter Weill expanded on the idea of a strategic
activity in his evidence to the committee:
IT outsourcing decisions are strategic ... in organisations
where information assets are important and there is a lot of transaction
processing ... for example [in] Customs, Tax [and] Health. Information
is the essence of all those departments.[16]
In addition certain management skills must be retained in-house:
[the] ability to help and specify and manage "rightsourcing"
(the right mixture of contracting in, contracting out and in-house activities);
ability to work with business management and specify IT requirements over
time; and ability to track, assess and interpret changing IT capabilities
and relate these to the needs of the organisation.[17]
To these factors the authors added the concept of technical
maturity as important to making the decision on how a service is to be
provided. Technical maturity refers to 'the degree to which the technology
is stable/unstable ... in situations of low maturity an "insourcing"
approach is preferable'.[18]
Getting the Process Right
The Industry Commission's cautionary qualification, 'when
done well', should be a constant warning to ministers and agency heads
contemplating outsourcing. To do it well will be time consuming and costly.
For example, the Department of Veterans Affairs process for outsourcing
of its datacentre in February 1992 commenced in December 1989. The Defence
Department in evidence saw the origins of the outsourcing of its IT in
the development of the Commercial Support Program in 1991 leading to the
calling for expressions of interest in 1994 and then a two year process
leading to the letting of a contract.[19]
The Attorney-General's Department in its submission to this committee
notes that 'there is usually an inverse relation between the effort spent
in relation to [contract preparation] and [contract disputes and litigation]'.[20]
In announcing the policy in April of this year the Minister of Finance
anticipated the tendering process being completed within two years.
Unless an agency has an efficient in-house system operating
it will not have the necessary grasp of the services it requires and the
costs involved. Without this information the agency will not be in a position
to initiate a responsible market testing or tendering process. Mr Robert
Jackson, a computer industry executive, commented on the Defence IT market
testing during the Committee's hearings, stressing the extent of pre-planning
and consultation that went into the process:
[Defence] actually streamlined their in-house organisation
first, made it a very attractive marketable product and then they spent
a long time consulting with industry at all levels including Australian
industry involvement.[21]
In discussing the Australian Customs Service outsourcing process
Mr Mick Roche noted that:
We have a good handle on our costs because we have an activity
based costing system in place and we will be using that as a test against
which tenderers for our outsourcing are evaluated. If they cannot meet
that and provide a better service or alternatively provide a similar service
at reduced cost then we simply will not do it.[22]
Mr Roche went on to comment that if a 'department does not
have a good handle on its costs ... that is an indicator for not going
to an outsourcing proposition until you [do]'.[23]
Mike McNamara of the Department of Defence summarised the
gains made by Defence through this process of rationalisation prior to
going to the market:
The number of staff involved in the delivery of the service
has probably more than halved ... The intensity of the use of the available
technical infrastructure has increased ... we started this process without
defined service levels. We are now able to say that one does not need
a Rolls Royce when a Holden will do.[24]
As Mr McNamara acknowledged these gains can be made independently
of putting the services out to tender.
The APS has built up extensive experience and expertise in
purchasing and contracting over many years. Governments have used the
Commonwealth's purchasing power to achieve competitively priced products
and have ensured that agencies have had access to reliable and appropriate
IT via the common use arrangements managed by the former Department of
Administrative Services. The most recent common use arrangement is the
PE68-IT Services Panel, which commenced on 1 July 1996. Six categories
of services are offered - systems integration, networking integration,
systems management, business consulting, applications development and
IT specialist services - and all suppliers on the Panel were endorsed
by the then Department of Administrative Services.
For major IT purchases, that is, ones costing AUD$10m or more,
all agencies governed by the Audit Act 1901 were obliged to submit
the proposal to an IT acquisition council for consideration and report.
Councils comprised the agency head or deputy, representatives of the Departments
of Industry, Science and Tourism, Finance and Administrative Services
and an independent member. In an independent review of the work of such
councils, the ANAO concluded that 'councils added value to the IT acquisition
process and gave a measure of assurance that cost effective decisions
were taken in an accountable environment'.[25]
Councils have, however, been largely superseded by the government's new
arrangements.
Nor is the Australian Public Service short of good advice
on outsourcing. In addition to the academic and other literature to which
the committee has already referred, particularly the Industry Commission
report, the APS has built up an extensive body of experience and knowledge
in this area. The former Department of Administrative Services developed
considerable expertise in the areas of tendering and contracting and managing
the acquisition process. The former Department of Finance, through its
Performance Improvement Group, has also produced guides for managers contemplating
outsourcing, particularly Competitive Tendering and Contracting, which
provides a guide to key principles and issues. The Management Advisory
Board and Management Improvement Advisory Committee (MAB/MIAC) have also
produced a series of guides to the benchmarking and contracting out processes,
notably Before you sign on the dotted line, which 'is intended
to provide public managers at all levels with practical information to
help them to select, prepare and manage contracts'.[26]
The Auditor General has produced two reports on the original IT contract
of the Department of Veterans' Affairs, a report on the use of IT Acquisition
Councils and a general study on measuring performance.
Many submissions to the committee have dwelt at length on
the potential risks involved in contracting out. These include a decline
in service quality in the lead up to outsourcing as staff join the outsourcer
and morale suffers because of uncertainty; the 'deskilling' of the agency
in the relevant area as it passes services to the contractor leading to
the risk of 'capture' by the contractor; the problem of transition at
the end of a contract; restrictions on the ability of the agency and government
to adapt to changing circumstances or make policy changes because of the
limits imposed by the contract; and the increased opportunity for sweetheart
deals or outright corruption. The potential risks lend weight to the view
that agencies should be given ample time and resources and a supportive
policy environment to ensure that they can manage the process well. However
it is important to understand that these and other potential problems
are not inherent in the process of outsourcing and should be dealt with
in reaching the decision whether to outsource and, subsequently, in the
management of the process.
The committee does not doubt that the APS has the ability
to manage its IT effectively and efficiently if given the opportunity.
However, as is discussed in more detail in chapter 3 the committee is
concerned that several features of the process indicate that the APS is
being pressed to pursue wide ranging outsourcing of its IT requirements
as the preferred option. This may militate against successful outcomes.
Footnotes:
[1] The then Department
of Finance offered the following definition of outsourcing: 'Outsourcing,
in the IT context, is a contractual arrangement where an external organisation
takes responsibility for performing all or any part of an agency's IT
functions. This can involve a partial or complete transfer of staff and/or
resources.'
Department of Finance, Guidelines for the Operation of
Information Technology Acquisition Councils, Canberra , 1994, p. 43.
[2] Department of Finance,
Finance Circular 1991/23, Canberra.
[3] Information Technology
Review Group, Clients First, Canberra, 1995, p. iii.
[4] ibid, p. iii.
[5] ibid, p. 57.
[6] The Hon David Jull
MP, Minister for Administrative Services, Press release, 4 August 1997.
[7] Clients First
included some of the results of an extensive ITRG survey of IT in the
Commonwealth public sector; see Appendix 5. In 1993/4 hardware acquisition
comprised 41.5% of IT expenditure (Table 1) and IT contract staff represented
14.3% of total staffing costs.
[8] Industry Commission,
op. cit., p. 4.
[9] For example this
committee has received submissions and evidence from the Community and
Public Sector Union, the Public Sector Research Centre of the University
of New South Wales and Mr Graeme Hodge of the Graduate School of Government
at Monash University which has tended to focus on the negative impacts
of outsourcing and from the Industry Commission and Professor Simon Domberger
and his colleagues at the Graduate School of Business at the University
of Sydney which has presented very positive views of the results of outsourcing.
[10] Cabinet submission
on Information Technology infrastructure, April 1997, attachment B, paras
17 -18. (Herein after referred to as Cabsub). Note discussion on the use
of this document in the Preface.
[11] Department of
Finance, Guidelines for the Operation of Information Technology Acquisition
Councils, Canberra , 1994, p. 44.
[12] Industry Commission,
Competitive Tendering and Contracting by Public Sector Agencies, Report
No. 48, Melbourne, 1996, p. 1.
[13] Department of
Immigration and Multicultural Affairs, Media Release, 19 August
1997.
[14] Committee Hansard,
4 July 1997, p. F&PA 509.
[15] Willcocks L and
Fitzgerald G, Market as opportunity? Case studies in outsourcing information
technology and services, Journal of Strategic Information Systems,
1997, p. 227.
[16] Committee
Hansard, 5 September 1997, p. F&PA 696.
[17] Willcocks and
Fitzgerald, op. cit., p. 230.
[18] ibid., p. 230.
[19] Committee Hansard,
4 July 1997, p. F&PA 512.
[20] Finance and Public
Addministration References Committee, Submissions, vol. 2, p. 372.
[21] Committee Hansard,
p. F&PA 632.
[22] Committee Hansard,
4 July 1997, p. F&PA 535.
[23] ibid.
[24] Committee Hansard,
p. F&PA 514.
[25] ANAO, IT Acquisition
Councils, Audit Report no. 7, 1996-97, AGPS, Canberrra, 1996, p. x.
[26] MAB/MIAC, Before
you sign on the dotted line, 1997, Report no. 23, p. 13.
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