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.