How Centralized Services Make Corporations Less Agile

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There are some solid financial benefits initially to centralizing resources, but as companies grow and these organizations become mature, they tend to be more of an anchor then a help. This is because they, in effect, become internal monopolies and, over time, become more focused on containing costs and don't have the "customer satisfaction" balance of an external entity. This is one of the reasons IT appears to be in trouble, and outsourcing has become so popular.


I was thinking about this while looking at HP's stunning financials from last week, how it has been able to pass IBM, and the particular success the PC organization has had, by going around the massive bureaucracy.


Let's chat about how these things come to pass and then conclude with some suggestions other than the obvious, but not often successful, outsourcing of the function to fix the problems.


The Birth of an Internal Monopoly


When a company first starts out, it outsources much of its legal and IT services. There is a clear break between the customer and the client. If the firm doesn't like the service it gets, it bids out to another law firm, accounting firm, or IT services firm until it is happy.


The advantage in this early phase is that the company can get access to some top talent and not have to take on more overhead; these services can be scaled up or back depending on the company's resources and needs. The disadvantages are a lack of control over these resources and concerns surrounding security, which can become a serious problem when working with outside firms.


As the company grows, to gain more control over both the resources and the costs, the firm will build up internal organizations that gradually replace most of these initial outside services. Accounting and finance move inside, IT moves inside, as do legal functions. The company seems to gain more control over costs and staffing by creating an internal monopoly that has one customer: the firm itself. Initially, this is a positive thing because everyone is focused on making the company successful.


How These Internal Monopolies Become Problems


When the firm was using external resources, and when these resources were first internalized, there was a huge focus on keeping the company happy. Call it a focus on customer satisfaction. If this is lost with an outside firm, that provider is replaced. If it drops off with an inside resource, the decision to bring the resource in-house can be reversed. But, over time, the inside resource becomes entrenched and very hard to extract, short of a catastrophic event. This doesn't make anyone, particularly top performers, happy.


In addition, the internal resources start competing with resources at an executive level, and the customer/client relationships become blurred. This is most pronounced, often, with the internal legal organization, which generally isn't funded to hire the best talent (and continues to outsource things like litigation). Unlike an external organization that isn't engaged until an opinion is needed, internal organizations make themselves part of the approval process and learn, over time, that saying no is the safest path. This is because there is no risk to saying no, they can't be replaced, and not doing something only has economic risks associated with it and those risks are generally owned by line organizations.


Saying yes has legal risks, and if a problem results, the legal organization can be held accountable. (It is impossible to anticipate all risks and, given that internal legal organizations are seldom active in litigation, they are often disconnected from the real world and increasingly are out of touch with what an acceptable risk actually is.)


For instance, HP, which has one of the most restrictive legal organizations, with the full approval of that legal organization, engaged in a practice called "pretexting," which resulted in a massive amount of corporate damage. While common in prior years, the current environment is overcharged on privacy concerns and the unacceptable nature of the risk should have been obvious. Even in this most restrictive of legal organizations, the one time they should have actually said no, they didn't. This undoubtedly made them more restrictive, but didn't actually address the core problem of being current.


On the IT side, IBM, which for years had the most advanced large systems, actually didn't use them. HP, by changing a similar policy, has turned its IT organization into a strategic advantage, contributing to HP's current growth spurt. If a technology company is having trouble justifying using its own technology at wholesale prices, it stands as evidence that the technology isn't that valuable. That alone will create a sales drag. On the other hand, if a firm like HP can demonstrate solid savings by using its own technology, that becomes one of the best examples that its promises are real and IT becomes a strategic strength rather than a strategic weakness.


The reason IT, even in tech companies, tends to be undervalued is because it is seen as a cost center and not a strategic part of the business. External hosting companies must constantly find ways to look for and sell against the needs of their clients, but they often aren't held accountable for the results. Internal organizations should be favored because they are held accountable, but they don't actively look for opportunities because they have no sales or marketing staff and tend to be more focused on containing costs rather than improving revenues.


Fixing This


If it is worthwhile having a function inside the corporation, the argument that you can afford to have less valuable resources who are themselves under-resourced is a stupid one. To be successful, you need quality at all levels, which means the people must be good and the resources adequate to the task.


In addition, there needs to be clear motivation to sell the internal function's services into the company by aggressively looking for unmet needs and constantly improving real (not artificial) customer satisfaction. Finally, there should be no major function in a corporation that doesn't have top- and bottom-line responsibility. Too much focus on cost is a company killer. You can't make a profit by exclusively focusing on costs at any level because the managers will make bad decisions that have a larger impact on profits and competitive success over time than costs.


I don't advocate outsourcing as an easy fix because you generally are just trading one set of problems for another. It is often easier to address problems you know than it is to address those you don't. However, the threat of outsourcing can be an effective way to wake up an internal organization and get them refocused on the needs of the business. But, if they are inadequately resourced, waking them up to the problem alone is just cruel.


In the end, the best path is to first realize you have a problem and then set up a structure where the incentives map back to the behavior you want. Legal, IT and other centralized departments should get credit for moving the business forward, otherwise they just become blame magnets and ever more powerful barriers to success.