How to Calculate IT Outsourcing Cost


The comparison of prices is the foremost thing on any business’s agenda while selecting the best-outsourced service. But when we speak of IT outsourcing and its cost, there is a range of factors that can significantly alter the quality and terms of a provider’s offering.

To mention the old adage: you only get what you actually pay for! This couldn’t be truer when it’s about outsourcing IT services.

But contrary to this quite popular belief, the outsourcing of IT or such services are not actually a commodity, thus, the price continues to vary from market to market. In other words, one size doesn’t fit all and that is exactly why we have different models to calculate the cost of IT outsourcing decision.

The cost significantly depends upon both the level and breadth of services offered by the IT service provider and as you must know, not every provider offer the same cost model.

The outsourcing of IT for the improvement and development of the information system is now the most widely popular practice. It is all about hiring a new IT crew to work in favor of your business specifications and needs. Today there are thousands of companies which are outsourcing different departments to get the best expertise on hand and much of it involves the IT sector.

What is IT Outsourcing?

If you run a small business, you might not have considered this idea. One reason could be the cost of hiring an outsourced IT team and another could be the lack of awareness.

The outsourcing of IT involves farming out or subcontracting a few or all information technology functions to a more independent and well-equipped 3rd party company or even individuals, rather than keeping such functions in-house. This overseas hired assistance is often referred to as virtual, as in a virtual staff or virtual worker.

For instance, Google is one of the top organizations that take pride in themselves on taking care of their employees and in-house culture. This tech giant has been taking advantage of expert outsourced staff for years now. Regardless, if it was the matter of developers or IT specialists, Google has been a strong implementer of outsourcing or outsourced work. That is exactly how it takes care of the several projects that continue to work on and deploy.

The same goes for many other giants as well including Opera, American Express, Skype, Whatsapp, and many others.

Outsourcing Works Great for Any Kind of Business

Not a business owner is a strong supporter of outsourcing. There are many companies which don’t feel comfortable about the word – outsourcing.

IT Outsourcing Team
But if we look at the term in a broader perspective, not every business prefers to involve 3rd parties in their business operations or authorize them to use their business information. Not everyone is comfortable with the delegation of work to a 3rd party. For some, it is nothing but a deep feeling of distress or discomfort.

This is a normal experience if you are outsourcing your IT for the first time, but what is scarier than this is to compromise business results and to work at average efficiency. Most of the times, these concerns are raised out of inexperience and uncertainty with the term outsourcing.

Also if you have a small business, you might not be able to afford a complete in-house IT department. This is particularly true for a business that is still in the early stages.

As per the IBM research:

“Almost 27% of organizations outsource to reduce cost, only 36% are basically innovators and around 37% are actual growth-seekers who use outsourcing as their one of the best tools to optimize the business operations”

For most business, the main reason to outsource IT is to save money. This is the sole reason why businesses used to incorporate outsourcing into their overall business strategy. But there are some businesses that outsource IT for the following reasons:

  • Staffing and hiring in a world of Gig Economy
  • To increase competitiveness and productivity by almost 100 fold
  • To get the key advantages and growth over their competitors.

Leveraging outsourcing depending on your business needs and preferences truly create a positive impact on the business operations and productivity.

Kinds of IT Outsourcing

There are many types of outsourcing IT. It depends on where this outsourced work occurs. These types include:

  • Moving services/business overseas: To take advantage of the more favorable economic climate and lower cost
  • Nearshoring: The transfer of services/business to some other closely country, often sharing your own country’s border.
  • Onshoring/Home shoring: Allowing your employees to work at home rather than coming to an office, a physical workplace or factory.

Examples of Commonly Outsourced IT Services

Here are some of the most commonly outsourced IT services by many organizations all over the world.

  • Web development/hosting
  • Software/application development
  • Helpdesk/technical support
  • Management or application support
  • Infrastructure
  • Telecommunications
  • Database management/development

With ITO – Information technology outsourcing contributing to almost half of the market growth, it is expected that the industry will react around $1.1 trillion by the end of this year.  

The fundamental reasons for the growing trend of outsourcing IT  are a shortage of IT skills along CIOs are pressurized to execute better and new digital demands by following the limitations of their tight budgets. This has solidified the role of outsourcing even more.

Nowadays, it is quite rare for established businesses to not outsource at least one segment or aspect of their overall IT organization.

So how do you measure the IT outsourcing cost? Or, if you have already outsourced IT, do you wonder if you are paying too much cost for your IT outsourcing service?

Following the best practices, and IT outsourced service provider must work with the client business to cut down all the unexpected IT costs while providing the top-notch service for the entailed fee. So if an IT service provider fails to deliver the necessary advisory services in order to strategize the future IT expenses, fail to offer business reviews to fully assess their services’ performance along with the IT environment then most probably you are paying more than needed for too little service.

IT outsourcing service provider
A good IT outsourcing service provider charges consistent fees and with that, delivers only the best and consistent results. They fulfill the promised level of services within the scope of work as well as service level agreement – SLA.

Remember the consequences of not receiving the adequate and proper outsourced IT services can be detrimental both in terms of business finance as well as reputation.

Here is an example of poor outsourced IT services and its impact on the business:

Nothing could be worse than leaving your customers stranded on the airport i.e. keeping travelers from accessing their money. This is an ordeal faced by the clients of Royal Bank of Scotland. It was the biggest IT outsourcing disaster happened at the RBS.

Back in 2012, this failed software functionality affected millions of RBS customers and enable them to check or withdraw balance from their bank accounts. The bank also suffered the same fate and could perform any transaction at all. Almost 30000 recipients of social welfare fail to receive payments even after the transfer of funds from the accounts of government. This also affected the clients of Ireland’s Ulster Bank and British Bank NatWest.

The failure of the system resulted in the paralysis of crucial banking systems. Local businesses also faced the ripple effect due to customers’ inability to process transactions. The blockage took many days before clearing up. This clearly indicates that the outsourcing service was not equipped with a contingency plan and their provided expensive services were not sufficient or didn’t exist at all.

That is why outsourcing your IT to the right and only the reputable service is as much important as outsourcing IT in the first place.

Determine the Cost of IT Outsourcing

While there are many approaches to calculate the cost of IT outsourcing, the fundamental approach is known as Differential Cost Analysis.

It is one of the key concepts for the accurate evaluation of the outsourcing decision. This method clearly shows the impact of outsourcing on the cost of your company. Thus, make sure that you always analyze the differential cost rather than comparing the status quo complete cost to the outsourcing to the outsourcing partner total cost.

If you are still wondering why you should consider the differential cost only: this is because the comparison of the total cost will also include all the fixed costs. This cost is unavoidable by means of outsourcing and this might create a false impression of lesser cost.

Differential Cost Analysis: The 4 Steps Process

Here are the four steps to accurately determine the cost of IT outsourcing.

Understand All the Aspects of IT Function before Outsourcing

The foremost step is to specify the quantity and quality of your IT function to receive the expected outcomes. This will help in providing a good comparison as to the services or functions that can be realized in-house and the ones that must be outsourced to an outsourcing partner.

Any business that fails to realize the outsourcing business function or wrongly define the business preferences, the in-house cost will either be higher or lower in comparison to the outsourcing cost. This happens because the in-house service may be more or less than the services documented in the request for proposal to the outsourcing partner.

Determine the Avoidable In-House Cost

Once you have understood the functions of the business area to be outsourced i.e. IT in this case, the next step is to recognize and ascertain the cost that your organization can easily avoid in case it outsources the IT.

First, itemize the complete cost of your IT function including the cost of salaries, equipment, software, supplies etc, in addition to, indirect costs like internal services or administration. Don’t include the already incurred cost as this is unrecoverable, known as a Sunk cost.

If your outsourcing decision is based on a cost analysis that you must focus on avoidable future cost. In this case, it is the case that you can easily eliminate by outsourcing IT to an external contractor.

Next is to determine every in-house cost that can be avoided in case the business function is outsourced.

Measure the Total Outsourcing Cost

The 3rd step involves calculation of the total cost of outsourcing the IT function. This outsourcing cost may include administration cost of contact, contractor’s bid price, the transition cost, less the revenue from sales of unneeded equipment, supplies, and furniture.

The contract administration cost includes every cost necessary to manage and select an outsourcing service over the contract life. This may include wage of the virtual agent to evaluate bid, subscription fee, and others.  However, larger unit’s outsourcing may also include the cost of evaluating or reviewing proposal request, negotiating or writing a contract, processing amendments and change orders of the contract, evaluating and monitoring contractor performance etc.

The transitional cost is the overall cost of shifting the IT function to the outsourcing service. This cost may involve laying off employees, severance pay including unemployment compensation.

Derive Saving By Deducing the Outsourcing Cost from In-House Costs

In the last step, measure the difference between the saved cost of outsourcing and the incurred cost from outsourcing. If the result is indicative of a significant reduction in your cost, then your decision of outsourcing IT is beneficial in the long run and justified.

The Final Words

Any who choose to outsource IT is able to redirect resources and develop software solutions. Outsourcing brings new opportunities to implement better and new processes. You can avoid chasing down your IT issues and focus on creating value for your clients.

Outsourcing helps in utilizing the in-house professional expertise to add value to your business by being relieved of duties that can be handled by a dedicated team of experts. In today’s competitive business industry, farming out a business function makes perfect sense. But it is also necessary to ensure effective communication, detailed contracts along with careful vetting of service providers to prevent any contingency.  

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