Is Outsourcing Reaching Its Limits Or Simply Pausing For Breath?

Outsourcing is a management tool that is taking the business world by storm, or so it would seem from reading much of the dedicated coverage of outsourcing topics featured in business and IT publications and websites. Thus it was very surprising to me to come across two recently released studies on outsourcing published by leading consulting firms – Deloitte Consulting and DiamondCluster - that accentuate the negative aspects of this management practice. Both of these studies inject a welcome dose of reality into the hype-saturated subject of outsourcing. They present insightful perspectives on the advantages and disadvantages of outsourcing that counterbalance some of the biased treatment of this topic emanating from those media, research and consulting firms with a vested interested in seeing the outsourcing trend grow.

Deloitte Consulting’s study, “Calling a Change in the Outsourcing Market” (http://www.deloitte.com/dtt/research/0,1015,sid%253D45635%2526cid%253D80376,00.html) was released at the end of April 2005. It presents data collected from twenty five of the world’s largest and most sophisticated companies and draws valuable insights from their substantial experience with outsourcing – both the good and the bad.

The report asserts that outsourcing is not delivering its expected value to large organizations. For example:

• Seventy percent of participants have had significant negative experiences with outsourcing projects and are now exercising greater caution in approaching outsourcing.
  
• One in four participants have brought functions back in-house after realizing they could be addressed more successfully and/or at a lower cost internally.
• Forty-four percent of participants did not see cost savings materialize as a result of outsourcing.

In addition to these attention-grabbing findings, the study uncovers several hidden truths about outsourcing:

Outsourcing relationships add complexity to the business. “Instead of simplifying operations, outsourcing often introduces complexity, increased cost, and friction into the value chain, requiring more senior management attention and deeper management skills than anticipated.” Many companies outsource because they think they can manage vendors more easily and effectively than they can employees. Indeed, managing anything for excellence whether internally or through a third party is not a trivial challenge. Outsourcing adds complexity to any process simply by increasing the number of players involved and by introducing a third party to the frequently strained user-support group relationship of many organizations.

Outsourcing does not insulate buyers from operational and financial risks. Often buyers of outsourcing services think that they are transferring risk to the outsourcing supplier. In truth, they are transferring responsibility for managing the risk associated with the outsourced process to the vendor but they are not insulating themselves from the downside of poor management and decisions of their outsourcing providers. “Outsourcing has allowed organizations to transfer financial and operational risk to vendors, but organizations are discovering that their contracts will never fully protect them against customer damage and business losses caused by service disruption.”

The outsourcing of services requires a complex series of trade-offs. This finding will really get the goat of sales and marketing executives in outsourcing services vendors. It suggests that “cheaper, faster, better” actually should read, “cheaper, faster, better – pick one”. According to the report, “The outsourcing of services requires a complex series of trade-offs: cost versus growth; speed versus quality of service delivery; and maintaining organizational cohesion versus knowledge and innovation.”

The structural advantages of vendors do not always translate into a better deal for buyers. The Deloitte study points out that really big companies like those it surveyed often have greater economies of scale opportunities than most of their vendors. Indeed the notion of outsourcing as an effective tactic for reducing costs takes a pounding in this report. Very few respondents indicated that outsourcing saved them any substantial costs. Instead, the main benefit was allowing companies to refocus their internal resources on more productive activities.

Before we get too carried away by these negative findings, it is important to point out that the report showed significant positive experiences with outsourcing as well. It must be noted that less than 50% of the companies surveyed were unhappy with or experienced significant problems outsourcing. Despite the problems it reports, most participants in the study indicated that they intended to continue outsourcing and will simply apply the lessons they’ve learned from any disappointing experiences and failures.

The report concludes by recommending that large organizations pursue outsourcing only in these cases: when substantial additional efficiency gains can be squeezed out from already centralized and standardized processes; to transform and stabilize processes before transferring them back in-house; to offload true commodity functions such as mailroom and web hosting services; to provide back up facilities and infrastructure; and to shift fixed costs to variable costs in areas where demand for resources is highly volatile.

So, is outsourcing reaching its limits or merely taking a digestive pause before devouring more corporate activities and processes? The Deloitte report suggests that there are indeed clear limits to outsourcing. The sheer volume of problems it identifies should give serious pause to any manager currently engaged in outsourcing or considering it. However, don’t bet on the growth of outsourcing to slow anytime soon. There are simply too many companies with inefficient processes and ineffective managers that are under constant and intense pressures to improve their performance. For these organizations, the perceived benefits of outsourcing, and particularly offshore outsourcing, will likely be too hard to resist.

Why Corporate Culture Counts

Researchers and consultants often point out that real change in how things are done inside a corporation cannot happen unless its culture is changed first. But corporate culture is a difficult thing to pin down and even harder to change because it reflects the implicit values, norms and behaviors of an organization.

When culture drives positive and value creating behavior it can give a company a distinct leg up on the competition. Just ask anybody working for an organization like Southwest Airlines or eBay. This can be a virtuous cycle – positive values and productive behaviors continuously drive and reinforce how employees act. But when the culture has significant negative aspects, it can create a reverse, destructive cycle driven by conflicted values and dysfunctional behaviors.

While both the media and the courtroom seem to be full of stories these days about the most egregious examples of corporate cultures and executives gone astray, there is little in-depth treatment of the causes of this phenomenon. It is for this reason that I found a working paper produced by the MIT Workplace Center entitled, “From Here to Flexibility in Law Firms: Can It Be Done?”, available at http://web.mit.edu/workplacecenter/, a fascinating read. Written by Laura Rikleen, head of a Boston Bar Association task force that studied the legal industry’s disappointing attempts to implement flexible working practices, it provides an eye-opening inside look at the culture of the legal profession and the high cost that its predominant behaviors and values wreak on the industry.

According to Rikleen, “Law firms provide the perfect vantage point for a study of the overworked American. What we have in law firms, essentially, is an increased demand for billable hours and decreasing partnership opportunities. This combination leads to high attrition, poor morale and a variety of other problems.”

Her task force points a finger directly at the profession’s emphasis on ‘total commitment’ as a basis to enter the partner ranks as the key debilitating factor affecting the work environment, attraction and retention of talent and work-family balance within the industry. It found that the profession’s concept of total commitment translates to pushing all non-work obligations aside on a regular basis as a symbol of one’s commitment. The task force concluded that this predominant ethos triggers a series of ‘vicious circles’ in the industry - where solving one difficulty leads to another problem which in turn creates new difficulties.

In the legal profession, revenue growth is the key performance imperative and billable hours is the most important metric of performance. Attracting top talent to drive growth is a priority and salaries and bonuses go up every year in the competition for the best and brightest. Higher starting salaries necessitate revising the rest of the salary structure upward. As salaries rise, growth targets are increased. There is greater pressure to bill more and thus work longer hours. Stress levels increase, morale plunges, people leave. The greater the attrition, the greater the number of new associates needed each year to replace the attorneys that leave. And so, a vicious circle spins on and on.

But that’s not all. The task force also identified what it terms the ‘myth of meritocracy’. While law firms promote the idea that they provide environments in which “excellent lawyers will excel”, the reality is frequently different. Not surprisingly, the small number of people who survive this marathon of work and progress up the ranks tend to be the most ambitious, money-driven, workaholics. This simply perpetuates the negative working environment.

And even if the cream rises to the top, the rest of milk seems to get spoiled. The level of attrition resulting from this system is both high and costly. The task force cites a research study involving more than 10,000 associates in 154 law firms. The findings revealed that 43% of associates leave their firm within 3 years, two thirds leave within 5 years and three quarters are gone by their 7^th year. This study pointed out that it generally takes at least 3-4 years before associates even begin to return the firm’s financial investment in them. An associate’s primary return on the firm’s investment occurs in years 5-10, but by then, over half have left.

The task force believes that the current system not only makes work-life balance unachievable, but will in the long run hurt law firms because it alienates large numbers of employees and potential employees while requiring unsustainable levels of growth in billable hours. They describe the situation bluntly, “We are in danger of seeing law firms evolve into institutions where only those who have no family responsibilities — or, worse, who are willing to abandon those responsibilities— can thrive. This is not an exaggerated perspective; it is a description of where many think we are heading and where others think we have already arrived.”

Do you believe vicious circles and meritocracy myths exist only in the legal profession? Think again. Many of the same debilitating characteristics of the legal profession’s culture and working environment can be found throughout corporate America today, particularly in the upper echelons of the organization.

This is one key reason why work-life balance is largely not yet a reality for most workers and isn’t likely to become so until more companies begin the difficult work of changing their culture in ways that create circles of virtuous behavior and make merit the actual basis of reward and advancement.