Cloud, 3rd generation outsourcing and what it means

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Virtual Ark Executive CEO & President Marty Gauvin recently described Cloud Computing as the 3rd Generation of outsourcing, and it’s a useful way of looking at it.

Marty called the 1st generation “your mess for less” which is an apt description and pinpoints how service providers made their money.

The 2nd generation was “selective sourcing”, sometimes called “strategic sourcing” although it was anything but – more on this below.

And “cloud” is the 3rd generation, and it’s potential, in part, will be shaped by the previous generations of outsourcing and the previous generations of people on both sides of the deals.



Here’s my take on the big picture evolution of outsourcing.


1st Generation – Your mess for less

This is the period 1970 to 1990. Marty’s description exactly fits the perfect qualified opportunity for a service provider seeking a 1st generation outsourcing contract. The more complexity and the more mess the more the service provider can truly save, and hence better margins, and hence the desire for as long a contract as possible.

This was a golden era for both EDS and IBM in particular. IBM had a huge amount of government business and the Space Program, and EDS led in large-scale outsourcing for the commercial sector. Both had fabulous methodologies and top gun project directors and managers. In the US CSC was strong and DIGITAL had a strong core SI group with sound methodologies (later destroyed by Compaq), Accenture built a global presence around BPO, and ICL had some general outsourcing business in the UK (which formed the nucleus of Fujitsu’s later move into the sector), while current day players such as HP, Fujitsu, DiData had no material presence nor capability.

The successes were many, although the failures attracted the media attention because it has to be remembered that the Outsourcers were the enemy of the techos at all levels, from CIO down. The IT media wrote for the IT folk and stories about outsourcing failures caused a lot of glee in the IT sewing circles. The reality was that companies that had a mess got less of a mess for a lower price, they got better service levels, and in most cases benefited from economies of scale.

The failures were legend and well known, if not over-reported. The tenure of these reports was universally “IBM / EDS / CSC screwed up” whereas the truth is that the headlines should have universally read “Company managers fail to manage – again”, with one major exception which I will discuss. The fundamental issue in the failures was that companies abrogated their management responsibilities, they threw out the baby with the bathwater. Through poor judgement, lack of understanding, and an obsession with cost-reduction as the principle goal they willingly destroyed their own abilities in IT strategy, architecture, performance management and didn’t enhance their contracting and commercial skills.

Some outsourcing firms played up to this, to their discredit, with the full knowledge that the customer was destroying their ability to manage the contract and wanting to take advantage of this. I think that it is an unfortunate fact that EDS was worst in this regard, the UK Internal Revenue Service contract being their ultimate Waterloo.

Customers also often complained about lack of innovation from the outsourcers, but hey suck it up! If you understand anything about commercial reality then you can’t back people into a financial corner and expect spontaneous investment during the tail end of a contract cycle. It’s easy to build in an intelligent business innovation contract component, but you have to have an intelligent customer!


2nd Generation – Revenge of the geeks

This is the period 1990 to 2010, and here’s the setting of the time around 1990 – firstly bad news is bigger than good news and 1st generation outsourcing had a groundswell of bad news, and I won’t argue that there were lots of candidates, even though I assert it was overall a generally successful era for those clients that had competent management skills.

Secondly, outsourcing wasn’t going away, which in itself became even more threatening to the geek IT managers, and public service IT managers, and who then fueled the fire of the horror stories. Thirdly, the fatal flaw that many of the 1st generation deals were led by the clients’ CFOs or accountants who took an uninformed cost-cutting approach provided the platform for the revenge of the geeks.

That revenge was so-called “selective sourcing”. The geek CIOs and IT managers got control back, the 1st generation Fear Uncertainly and Doubt worked, without doubt! The financial guys lost their role in outsourcing precisely because most were out of their depth.

Having wrested control back the geek teams announced “selective sourcing”. Selective sourcing was simply bundling up slices of technology and getting bids from small guys as well as the large outsourcers and parceling things out in technical packages which the geeks understood. I’m talking about “the help desk” or “the servers” or “the network” etc. It has little bad press, because why would the IT press promote bad things about the geeks being in control?

It’s certainly generated huge growth for the smaller and mid-tier outsourcing firms – the reason being that it’s all commodity stuff and while the big guys should have been able to compete on scale often the geek terms and control conditions meant that the big guys just had too much overhead and high costs to be able to win the small commodity chunks of work. Smaller players were “more flexible” which was really just a feint for “I’ll replace your people with my cheaper people”.



This period is sometimes called “strategic sourcing” which is only a sick joke as it is anything but strategic. It is completely tactical, and mostly lacking in accountability and almost always lacking in any connection to business KPIs. The Pharmaceutical industry is an industry where outsourcing is widely practiced across many activities. They have global benchmarks which show that the top performing companies incur management costs of about 5% of an outsourcing contract’s value, and the poor performers about 25%. An IT group with multiple sourcing contracts incurs these overheads but in the IT world they are almost universally hidden, just one of the hidden secrets of the geeks revenge!

The post-2000 boom in commodity hosting services has been a positive outcome of the long journey of outsourcing, however overall I’d characterise this 2nd Generation as the lost generation for business in gaining the business benefits of outsourcing.

Note: there was a version of this 2nd Generation called “Out-Tasking” a term coined by John Chambers CEO of Cisco in about 2001. That was really a very business-based selective approach to a kind of BPO, and it had a lot of merit, and still has a lot of merit as an outsourcing option. Unfortunately in the big scheme of things it is rarely adopted.


3rd Generation – Cloud

This is the period 2010 to potentially 2030! Without going into what cloud is and isn’t and whether it is the same old thing relabeled (which it isn’t!) this generation of outsourcing varies from the past in a few key ways. Before I note them I’ll just say that I am not talking about “private cloud” here, which besides being an oxymoron is just a sales ploy to capture the last retreat of the geek CIOs of 2nd generation outsourcing. That’s the subject of another post. I’m talking about cloud as access to resources that a customer does not own – what is sometimes called public cloud.

The three differentiators which I see, in contrast to previous models, are:

  1. Technical and service agility – more rapid provisioning and less commitment to infrastructure;
  2. Business agility – less constrained by contracts, by IT, and by capital;
  3. Logistics agility – one manifestation being instant geographic coverage.

So in a nutshell cloud is much less in terms of contracts, constraints and capital, and much more in terms of speed, scale and service levels.

How does the past effect the future?

The 3rd Generation is going to ride on the back of a collapsing 2nd Generation, and in fact be propelled by it. In one of the great ironies the fact that the geek CIOs won control of the 2nd Generation will accelerate their undoing by the 3rd Generation.

There will be a last gasp Fear Uncertainty and Doubt FUD campaign, aided and abetted by the “private cloud” sales teams who will be desperate to make their last sales and will back the geek CIOs to the corporate hilt. However I predict that over the first 5 years of this potential 20 year 3rd Generation phase we will see a general collapse of these efforts. There are a number of reasons:

  • Cloud economics are undeniable and unobtainable by 98% of inhouse operations;
  • 2nd Generation “selective sourcing” has sliced and diced outsourcing into commodities which are easily compared to cloud pricing and service levels on that basis alone 2nd Generation cannot win;
  • As cloud moves up the platform stack and interoperability, integration and migration options open up then it becomes even harder to resist;
  • The competitive edge of firms who adopt cloud will expose those CIOs who are resisting, and in particular the fallacy of the “private cloud”.

What’s the greatest constraint to all this – the FUD of privacy and security. Always the first question and the greatest friend of the geek CIOs. It’s the same question that’s been around since the 1st Generation, and will take the same time, pain, and frustration to move through the issues with those customers who are worth the effort.

On our side are people, and the fact that the line between consumer and corporate IT is blurring, perhaps with lightening speed due to social media, but with perhaps a 5 year lag generally in terms of reshaping expectations of IT and IT management within firms. The private experience is universally dominated by cloud, take out Outlook, which means that in the end the FUD won’t work! The result will be that IT Governance will continue to evolve in a natural way to embrace specific cloud issues – it’s no drama!!



My conclusion is that while the 1st Generation captured a small business base, and the second a wider base albeit with fewer business benefits, the 3rd Generation is set to capture a massive business base and in the process will rewrite the IT Management/CIO world not to mention the channels and distribution world.

Gartner projected in March 2009 that sales of cloud computing services would almost triple over five years, from $56 billion in revenues in 2009 to $150 billion in revenues in 2013.

Those business which get there first, and those ISVs and service providers which adopt the quickest will be the winners. This IS the biggest revolution in 20 years.

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