Georgia Institute of Technology
Executive Master of Science of Management and Technology (MSMoT)
MOT6107-IT Strategies
Case # 3
Cathay Pacific
EMSMOT 11
(a) What factors contributed to Cathay Pacific’s decision to outsource parts of their IT function?
The implementation of IT outsourcing at Cathay was a slow process, but with rapid growth, competitive pressures, and turbulent economic conditions, it became crucial for the survival of the company. Initially, Cathay was handling virtually all of its IT needs internally.
Cathay’s Data Center was separated into three locations, and IM Operations Manager cautioned that their rapid growth would require a fourth or even a fifth data center facility to meet the company’s IT needs. This rapid growth was a definite factor leading up to their outsourcing endeavors. They had two separate centers in Hong Kong, which was second only to Tokyo as the most expensive international location for office real estate. As cutting costs became a higher priority, it became evident that the extremely high cost of maintaining data centers in such areas would impair their ability to remain competitive.
“Operation Better Shape” was the name of the strategic initiative that formally prescribed a company wide effort to reduce costs within Cathay in 1992. According to one Hong Kong-based analyst: “The company is highly, perhaps too highly, vertically integrated. It does too many things in-house which it should have outsourced.” This initiative identified outsourcing as a critical approach to cutting costs. Outsourcing would allow Cathay to focus on its core aviation competencies. IT outsourcing was identified as a target for outsourcing along with other business processes.
Anthony Yeung, GM of Information Management (IM), realizing that Cathay could not develop all their solutions internally, had already begun to purchase software packages that were available on market in the late 80’s. He even changed his unit’s name from “Systems Development and Support” to “Systems Delivery” to reflect the fact that his team’s role would be shifting from writing coded and developing applications to delivering IT systems to Cathay business units.
In the mid-1980’s, Cathay outsourced its networks to SITA. This was an important step in Cathay’s transition from a regional carrier to an international carrier. SITA offered application, desktop, network, and infrastructure services, systems integration, outsourcing, and consulting.
Early on, outsourcing was identified as a means to bridge the gap between the IM department and the business side, and overcome vast learning curves associated with rapid growth and moving into new arenas. It had become impossible for IM to fulfill the ever-growing needs of all of Cathay’s business units. Further, the cost of maintaining internal legacy systems was continually increasing and also not necessary to develop custom systems.
Along with a new GM of Information Management came a new IT ideology at Cathay in mid-1994. It had become clear that whether or not outsourcing was necessary was no longer questioned; it was necessary in order for Cathay to remain competitive.
Cathay’s new IT ideology would be industry driven and quick to respond to industry practices in adopting new technology. Whereas before Cathay’s programmers spent years writing code for Cathay applications, acquisition and outsourcing various IT needs was necessary in order for Cathay to remain competitive.
In 1997-1998 economic difficulties onset by the handover of Hong Kong from British rule to Chinese rule. The economic crisis that ensued made it even more imperative for Cathay to find additional ways of cutting costs. One significant blow to Cathay’s business was that tourism for the entire area from their major market dropped approximately 70%. They had also made a commitment during more prosperous times to purchase 13 new aircraft that they were obligated to take. This further contributed to Cathay’s financial woes and contributed to their decision to outsource.
Along with various other cost-cutting measures, outsourcing nonstrategic business functions may have been Cathay’s saving grace. Cathay posted a $281 million profit in 1999 despite continued decline in the airline market. Early on, outsourcing at Cathay was a matter of convenience. With rapid growth, competitive pressures, and economic turbulence, outsourcing became a matter of survival. Cathay utilized outsourcing very effectively as those factors (e.g. rapid growth, competitive pressures, and economic turbulence) demanded well-executed responses.
(b) Evaluate Cathay’s overall approach to outsourcing.
The overall approach was cautious, well researched, and implemented well. They began with the areas that were not directly associated with the core business, but were necessary in the support roles. These were the “low hanging fruit” and easy to implement.
They were smart in the approach that they did not get locked into a sole source for supplying the needed solutions for the IT needs. This enabled them to compare the product offerings in the market and get the best mix to address their specific needs. They also negotiated for the needs of the employees whose jobs were being out sourced, as in the case of the data centers. This helped to make additional future outsourcing initiatives go smoothly.
The concept of Benchmarking is another good trait for outsourced contracts to ensure that the charges remain competitive on an ongoing basis.
The method of employing outsourcing at CP was very good when compared to some US companies. They did not seem to announce a close to an office or data center and have the employees shocked, but worked to take care of them as well as set well researched contracts. They also did not move jobs outside of the region, but maintained them where they were already located. In the case of the Data center, CP had already relocated the center when they decided to do the outsourcing.
What are the strengths of their approach?
Cathay’s approach to outsourcing is strong on the following aspects:
Identifying business process areas that are non-core to Cathay’s aviation competencies. The company realized that it could cut costs by eliminating the non-essential functions that were adding unnecessary fixed costs.
Dividing the Information Technology function between the two competency areas of infrastructure and applications and finding the best suppliers to meet needs in each of these areas. Many organizations may have looked at this and seen that there was no single solution provided by one supply. This may have deterred many organizations from outsourcing both of these functions. However, Cathay realized that the extra effort put into tripartite relationship could provide long-term benefits if established and carried-through successfully.
Identifying key strategic partners that could deliver solutions that in turn could cut Cathay costs. With the Smartsourcing strategy Cathay did not cut corners when it came to what organizations would be supplying them their IT solutions. They went with proven organizations that had established a history of delivering quality products and services.
Employing an appropriate mix of outsourcing and insourcing. Cathay realized that they had a great deal of internal knowledge about their IT systems and supplier management. In the early stages of outsourcing this was a key to their smooth transition to outsourced services. This knowledge served as a key liaison between in-house and outsourced suppliers. In addition, Cathay still maintained many legacy systems, and servicing theses systems requires internal expertise. Eventually these systems could be phased out, but for the time being it was essential that they were not simply replaced. In essence, Cathay did not abruptly change their business model, which could send operations into shock, but rather they gradually and strategically chose areas to outsource, providing a transition for the IT functions.
Cathay continually managed and maintained contract relationships. They made sure that they employed periodic benchmarking and continually monitored the progress and success of contracts. This helped smooth relationships with suppliers. Even though there were issues when it came down to knowledge about the relative benefits of the contract for all parties, it was important that Cathay make sure that suppliers were aware and living up to expectations. This avoided any potential disasters.
What are the risks and disadvantages?
The risks and disadvantages of Cathay Pacific’s approach to IT outsourcing and “smartsourcing” are as follows:
In contract negotiations for outsourcing the Data Center, Cathay Pacific did not issue RFP’s, nor did they elicit bids from other vendors. In addition, they did not share financial data with IBM during the decision making process; therefore, neither side was able to determine if the other was getting a good deal. Instead, it was hoped that benchmarking, now into its’ third study, along with pricing parameters established from material collected at IT conferences would serve as a surrogate in establishing competitive pricing pressure. However, several managers believed that smartsourcing eliminated commercial tension and competition from the purchasing process, thereby exposing Cathay Pacific to unnecessarily excessive expenditures.
By outsourcing the Data Center to IBM along with the vast expanse of Cathay Pacific human IT capital that transferred to IBM as part of the deal, Cathay Pacific has essentially foregone the opportunity of providing data services to other industries. As Anthony Yeung is now realizing in his review of the transaction, IBM was able to transform the Data Center, with assistance of highly trained former Cathay Pacific employees, into a very successful operation serving over 50 customers in both Australia and in Asia. Now, with Cathay Pacific’s desires to establish air routes into mainland China and possibly to offer Chinese and other airlines IT services, their ability to do so is minimized by the opportunity cost of outsourcing the data center and its’ highly valuable employees in the name of cost reduction, when they more than likely could have benefited more by utilizing internal strengths to diversify the operation.
What should Cathay have done differently?
First, Cathay should have trained the procurement staff on how to bid and manage an outsourcing contract or have hired new procurement staff that had extensive experience with outsourcing. The article mentioned that the procurement staff and legal staff were not trained well enough to write a good outsourcing contract. Since an outsourcing contract can make or break the deal, Cathay should have put more emphasis on aligning the appropriate skill-sets and resources to develop and implement a strong contract.
Second, Cathay should have setup a core outsourcing team responsible for the following:
• Managing the smart sourcing vendors - IBM, Sabre, and SITA;
• Develop amendments to the contract and Service Level Agreement (SLA) as needed;
• Develop vendor scorecards to track the financial success of each smart sourcing contract. For example, Cathay was promised a 10-15% cost reduction with the same level of quality and service. This core outsourcing team would be responsible for ensuring the vendors were meeting these goals monthly.
Cathay should also manage and develop a competitive pricing process to price the same services with other vendors to ensure Cathay was getting market rates or better. In this process they could also develop cost reduction strategies with the current smart sourcing vendors to ensure that contractual arrangements remain mutually beneficial. Based on the case Cathay had never pressured their vendors about pricing and could potentially benefit significantly by engaging their vendors in discussions regarding reducing rates. As previously mentioned, Cathay did not issue RFP’s, nor did they elicit bids from other vendors. By engaging in this sort of process they would be able to ensure that what they are paying for these services is competitive with the prices available from other vendors.
Finally, by 2007, legacy custom Cathay-built systems should be phased out. Thus, Cathay should get rid of the Infrastructure delivery manager and group. In addition, they should reduce head count in the system delivery group by outsourcing some of the responsibility of this group. For example, the support and maintenance of their business systems should be easy to outsource, especially when Cathay has phased out all of their custom legacy systems.
