Over the past four decades, outsourcing has evolved and it now offers businesses many options and alternatives. Companies can look to on or offshore providers, and they can outsource an activity, function or process. Jagdish Dalal, president of JDalal Associates, examines where the industry has been, how it is evolving, and how firms make, or need to make, the decision to outsource.
An analysis of outsourcing over the past four decades reveals the practice can be broken down into distinct models:
- Tactical outsourcing is when outsourcing is driven by factors such as short-term cost savings. Most of these engagements end up as instant gratification followed by disappointment. In various surveys, cost savings are identified as a primary reason for outsourcing.
- Businesses have effectively used transitional/transformational models to improve their processes, and have taken advantage of the provider's expertise in that particular area. For example, Xerox outsourced its legacy IT systems and invested in systems for the future. Companies have also used transformational outsourcing to improve processes or technology they would not have been able to update using their own investment and resources.
- There has also been an evolution in the type of functions businesses outsource. Initially, the focus was on departments such as the call centre and accounts payable. However, businesses soon discovered outsourcing these activites had limited benefits, so they started to look at outsourcing entire functions and/or business processes such as human resources, and customer order and fulfillment. The larger the scope, the greater the benefit from outsourcing, and this idea has led some businesses to consider bundling several related processes, such as production and MRO management, and outsourcing them to a single provider.
Setting the stage for creating strategy
History has shown that strategic planning has led to successful outsourcing engagements. This means the drivers for outsourcing are based on a desire to transform the way a business operates, which can be called 'changing the shape of business'.
Ironically, outsourcing changes the shape of business, since there is a critical provider inserted into the business and success depends on a new relationship. Figure 2 (see page 18) shows how environmental disruptive changes drive a course of action for the business. This creates a change agenda that may include implementing various strategies, and one of those strategies can be the use of outsourcing to either transition, or transform the operation. When a business develops an outsourcing strategy based on change drivers, the outsourcing relationship has a far deeper set of objectives and these help to select the right service provider and model for outsourcing engagement.
This type of strategic thinking is also based on the theory that businesses get evaluated (think of market value) based on their contribution to increasing business-shareholder value and reducing business-shareholder value destruction. Shareholder value destruction has many aspects ranging from products to performance. Often, value observers notice that the business is not maximising value through the lack of good business processes. This can be because of a lack of management focus, necessary investments or skilled resources. These are often cited as the benefits of outsourcing.
This value destruction can be a result of a short-sighted outsourcing decision. We have seen examples of how companies have reversed their decision to outsource (see 'GM brings in IT', opposite), and in these cases, leaders have identified changed business drivers as a reason for shifting to insourcing.
Value and risks
Like any business decision, outsourcing is based on balancing benefits and risks. Figure 3 (below) shows the 'risk-value continuum', where the buyer's first concern is the risks followed by the belief in benefits-value.
Until the buyer is satisfied that risks are adequately addressed, no statement of value will have an impact on the decision. It is the tipping point - the 'consideration point' - where the buyer is satisfied there is adequate coverage of the risk and is 'open' to considering value from the product or service. When the buyer believes that risk is addressed, they will have reached the 'decision point', where the value statement will have an impact on the decision to buy. Finally, value must be significantly high and cover all or most of the risk before the buyer will have reached the decision 'compelling point'.
Like any business decisions, there are risks associated with outsourcing. There are also non-action risks and these are often understated or overlooked.
Since any business action creates risks, it is easy to assume that the status quo means the avoidance of risk. This creates a 'doom loop' of increasing risk and worsening performance. At some point, this leads to a catastrophic failure adversely affecting business results and the destruction of shareholder value. Several factors create risks:
- Lack of management focus: typical supporting functions do not get adequate management focus, so the function is staffed with stagnant management that results in inaction. Continued lack of management focus reduces the capabilities and skills required to improve the function.
- Lack of adequate investment: tied to management focus is the lack of investment. Most businesses do not provide adequate investment for supporting functions such as technology, process improvement, and higher-calibre management. Over time, the supporting function continues to underperform and further adds to the doom loop.
- Lack of implementing functional 'best practices': If operations are not improved and there's no foucus on management and investment, a function that is not delivering value to the business is created.
Clearly, there are risks associated with outsourcing. Generally, outsourcing risks are categorised in one of the following broad categories, which can be identified as financial risks since the impact will result in not achieving financial objectives, loss of revenue, reduced profit and eventually lower credit rating:
- Strategic risks: may adversely impact business/product strategy, such as late product introduction, adverse customer reaction. This can occur if the outsourcing scope and agreement are not well thought out, or the provider selection process is not managed with discipline.
- Operational risks: may disrupt the supply chain, or product/service unavailability. This risk occurs when the integration of the outsourced function/process is not handled well with other in-house processes. For example, if the overall supply chain planning is not robust or integrated with outsourced MRO planning.
- Transactional risks: make outsourcing transaction difficult to manage and impact on one of the other risks. Good governance is a requirement for managing transactional risks.
There are many different ways benefits from outsourcing can be presented to businesses - cost savings, efficient capital management, resource maximisation and improved management focus on core activities. Figure 4 (below) breaks this down into three simple ways to measure and categorise these benefits: improving finances, increasing quality of performance, and reduction of cycle time to affect change.
In the past four decades, we have learned about managing outsourcing process effectively and efficiently. Unfortunately, there have been examples where outsourcing engagements have not met the expectations of customers and providers.
A typical outsourcing engagement process includes three steps: strategy, implementation and governance. Implementation of outsourcing - often referred to as the sourcing process - has been well defined and generally yields good results. However, governance is the 'secret sauce of success' in outsourcing. In the past, a lot of focus was placed on governing operational performance. We have learned that relationship and risk management are additional key ingredients of governance and need to be well defined prior to the relationship, and managed with discipline throughout the engagement period.
Trends and changes in delivery models
After four decades, outsourcing is changing the way businesses expect their providers to deliver service. Many changes are a result of technological advances - cloud computing, greater prevalence of social media, use of mobile devices and analytics. Technological evolution has also changed how the service is delivered. There are also changes resulting from various regulations in managing information.
The introduction of cloud computing has spawned a form of outsourcing, known as the 'as-a-service' model. Salesforce.com was one of the early adopters of this model. Access to and the proliferation of cloud computing has accelerated outsourcing service delivery options. Yet, we have only scratched the surface, so the outsourcing model of the next decade will look quite different.
Use of mobile devices and the proliferation of social media has altered how businesses expect their products and services to be made available to their customers. So far, outsourcing has been slow to provide platforms for these services because providers have too big an investment in legacy infrastructure environment, but this will change.
Outsourcing is also being impacted significantly by privacy of information and security of data regulations. US regulations around personal information privacy in the healthcare industry (HIPPA regulations) as well as personal data protection (Privacy Act) have created challenges on how providers manage information. The EU/US Safe Harbour arrangement has also created challenges as to what information is kept and how it is managed on a trans-border basis. Although still evolving, it is expected that regulations will only get stricter and will force providers to adopt their delivery models to be compliant.
Outsourcing is a global multi-trillion dollar industry. It has launched economic and social changes in many parts of the world and has made some of the previously developing nations - India, Costa Rica and Malaysia - into global commercial heavyweights. After four decades, the evolution of technology is changing what businesses expect from their providers
Businesses have also dramatically improved how they view outsourcing and are recognising that outsourcing is just one of the tools to help transform the shape of their business and react to the disruptive changes they face.