Outsourcing is Wonderful Part 1

As I said in my last post, outsourcing does make sense in some situations. The problem comes when it is used in major corporations which have significant complexity and have the scale to manage operations themselves. What I want to do now is set out the major arguments in favour of outsourcing and show why they are flawed in these circumstances. I’ll talk about cost issues this week, with more to follow next week.

Reducing Costs

Straight away you have to deal with the outsourcer’s margin. They are legitimately in business to make money, so you’re behind from the start. Next, you have to look at how the outsourcer is going to reduce costs compared to your current organisation. They must either use people more efficiently, or pay them less. So, in accepting the case for outsourcing, you are admitting that your organisation is inefficient, overpaid or both. Either or both may well be the case, but it is a failure of management to use outsourcing to fix this rather than addressing it internally. Why not fire the managers who advocate outsourcing instead

Next, consider the considerable increase in complexity that comes with outsourcing and I will go into in much more detail. Monitoring and managing the contract, people to act as interface to the outsource company, duplication of roles (twinning). This increases costs and generally isn’t factored into the cost comparison when victory is declared.

One key driver for big outsourcing deals is to realise off-shore rates, but we should not confuse outsourcing with offshoring. It is possible to employ people in lower cost locations under direct company management. This achieves the savings from offshore rates while avoiding the complexities of outsourcing.

Control over costs

This is certainly a very compelling argument. Sign the contract for say 5 years and you know your costs, right? Of course, it doesn’t work out that way; an outsourcer may well accept a contract that at the base level is not profitable, knowing that over time the client will require work not covered by the contract that will prove considerably more profitable. This is a key issue with outsourcing where the contract can never cover every eventuality.

Every time I’ve been involved in the renewal of an outsourcing agreement, I hear someone say something like this:

“The last deal didn’t work out quite how expected. We understand it better now though, so we’re going to structure the new deal in a way that avoids those problems.”

But next time round, I hear the same thing all over again.

You have no doubt heard the phrase “The Law is an Ass”. What is behind this phrase is that life is so complex that you can never define a set of rules (the law) that applies to every possible situation, so applying the rules inevitably leads to anomalies occurring and very stupid judgements being made in some cases. The law becomes ever more complex in attempting to deal with these anomalies and in reacting to high-profile cases.

The situation with outsourcing is the same; in place of the law there is a contract, which is just another set of rules. If the nature of the outsourcing is not very simple, then the contract rapidly becomes complex and even then it cannot cater for every situation. Suppliers are naturally driven by their own commercial interest and will operate the contract in support of that. So even if you take a simple ‘body-shop’ arrangement, there can be problems with the rate card. It’s very hard to pin down the definition of each level in the rate card, so the levels tend to inflate and increase the actual day rates paid.

For more complex contracts that attempt to define requirements based on deliverables or support services, it becomes pretty much impossible for the contract to specify the requirements in sufficient detail to fully align the objectives of the outsource partner with the client’s objectives. I saw a recent example of this where a vendor was paid a great deal of money for a contract they were operating on a break/fix basis where very little actually broke.

Freeing up capital

Particularly in the context of replatforming or reengineering, an outsourcer may take on the capital cost of the work, charging a ‘rental’ fee to the client and recovering the cost over several years. Perfectly reasonable, but this is just a hidden form of borrowing.

Next week I’ll look at allowing management to focus on the core business, gaining access to scarce skills and knowledge and dealing with problematic projects or operations.

What do you think? What’s your outsourcing experience?