Reasons for outsourcing: why would you do it in the first place?
So the question is “why would you outsource part of your business?” Reducing costs, getting a third-party supplier to handle a part of your business you don’t want to be that involved in, getting access to experts and emerging technology without the risk and expense of developing that technology in-house, are some of the more popular reasons you hear. However the factors behind outsourcing are numerous and in this article I will attempt to identify them, and give some background on them. This isn’t an attempt to give a yes/no or good/bad evaluation of the reasons but is aimed at raising the factors behind outsourcing to provoke some thought into your outsourcing strategy and the reasons behind it.
I like to categorise the factors in outsourcing into four main headings: Technological; Human; Strategic; and Financial. It is important to note that these aren’t all pluses and reasons for you to outsource. Some of them need to be considered as possible reasons for not outsourcing.
Under the heading of technology there is the ability to access new technology. The ability to access this technology, that has been developed and tested by someone else, avoids much of the cost and risk. Outsourcing also helps to mitigate the risk of obsolescence. It is difficult to keep technology up to date and outsourcing to specialist suppliers helps reduce the risk of obsolescence for the client, especially if the contracts are short-term. The supplier can mitigate their own risk across a number of clients so the full cost is not passed on to individual clients.
Outsourcing also offers better disaster recovery and business continuity capability. For example outsourced hosting providers, due to their scale, can operate across multiple data centres and can also invest in high-end resilience solutions. Again the cost is spread across many clients so you are getting the benefit without the full cost.
The specialist skills you can gain access to are also a factor in outsourcing. There are niche areas (for example app development) that you can tap into without hiring your own staff.
Outsourcing also helps in the implementation and transition of technology. Third-party suppliers are likely to have done the transition of their technology before so the cost and risk to the client should be lower.
Dear old TUPE (or the EU equivalent Acquired Rights Directive) is an important factor in outsourcing decisions. The transferring of services can often involve the transfer of staff and in this case the transfer rights of those staff are covered by legislation.
Outsourcing to a specialist organisation can help the quality of staff and the motivation of those staff. If, as an employee, you are a specialist in a certain area, an outsourcing supplier may be able to offer you better career progression and better training than the client who may not have significant investment in your particular specialist area.
One of the human factors, and one that comes up in many discussions on the pros and cons, is control. If you outsource the staff no longer work directly for you and you may lose some of the expertise leaving you more reliant on the supplier and reducing your direct control. In this the client has to see the reality of the loss of control rather than just the emotional reaction. The degree to which this can have a negative impact is very much down to the service being outsourced, the terms and controls in the outsourcing agreement and the relationship between the client and supplier.
In the implementation and transition of a service the human factors are very important. This is true both for the staff immediately affected and for the relationship between the client and supplier staff involved in the transition and future running of the service. This is also true of other stakeholders and it is important to make sure there is buy-in across the board.
I believe outsourcing is all about strategy. You should ensure you have a clear idea of your business strategy and then make sure that your outsourcing strategy and model fits with and continues to fit with that business strategy. Part of ensuring that fit requires an understanding of how outsourcing can impact on your business at a strategic level.
There is research that shows outsourcing improves time to market. Best-in-class multisourcing, when done well, gives direct access to the experts in different areas and helps get new services live quicker and helps speed up, and de-risk, the change management process. This was one of the key reasons for National Rail Enquiries adopting a multisourcing approach.
It is also true that the process of outsourcing encourages companies to understand their business better. The act of having to define requirements, and explain those to third parties, makes the client look at what is being done and gets them to consider where things can be done better or where they are not required to be done at all.
Outsourcing, and in particular multisourcing, can increase flexibility. The ability to change quickly and increase or decrease effort in different areas can be easier with an outsourced strategy.
The benefits of time to market, cost reduction and access to new technology can give clients a competitive advantage. However, it also gives away some control and increases third-party dependency.
The strategic alignment of outsourcing is a little of a “chicken and egg” situation. Your outsourcing strategy should be based on your business strategy but a thorough look at outsourcing may lead to a change in business strategy. As with many significant business decisions it can be an iterative process to get the ideal outcome.
This is usually at the top of most views of outsourcing. Cutting costs is always a key driver but it isn’t the only one and an understanding of the financial factors, and how they come about, is important for any decision on whether to outsource and if so what and how.
Taking the cost reduction factors first of all, it is possible that a supplier can reduce costs through purchasing power and economies of scale. A supplier buying on behalf of a number of clients will benefit from volume discounts but will also have other economies of scale. If you take as an example a company that needs an expensive piece of equipment but only for a third of the time. The equipment can’t be split up so it has to buy one unit. However a supplier with three similar clients only needs one for all three realising a cost saving for the three clients. In a similar vein economies of scale can help spread overheads and help them afford higher quality staff and other resources.
Cost arbitrage – taking a service and delivering it from a country or region with a lower cost – is another cost saving for outsourcing. This happens all the time with companies moving services from London to regional UK and from the UK to countries such as India. Obviously you can do this yourself but it is often much lower cost and lower risk to outsource the work to an organisation that is already operating in the low-cost country or region.
One of the cost factors that can be overlooked is the governance on the client side. Outsourcing can be great but it is still your business and the client needs to resource up to manage the outsourcing arrangements. How much you need to do this depends on the situation but you do need to manage your suppliers.
Sometimes outsourcing can deliver a financial benefit by converting fixed costs to variable. Specialist suppliers have a greater ability to do this as their costs can be shared across clients but matching cost to activity can be a benefit to clients.
Outsourcing can also benefit the balance sheet and cash flow. Having assets provided by third parties can take away the upfront cash outflow and gets assets off the balance sheet to help with ROI ratios. There is a cost to this but the size of the benefit depends on how important this is to the client.
An outsourced operation can also help with transparency of costs. Trying to see the cost of something that is supplied in-house can get muddled with allocation methods and internal politics as well as defining where the boundaries of the service are. With an outsourced operation there is an invoice for the cost of the service. This is not a perfect way of seeing the true cost, but is much easier than an in-house operation.
Outsourcing can also have a financial benefit (and a possible downside) in the allocation of risk and the ability to mitigate risk. In risk mitigation a simple example would be a call centre supplier with two clients. One client has high call volumes before 9am, and the other high call volumes after 9am. By working out resource levels across the two the costs can be lowered but also the risk of calls not being answered can be reduced. In risk sharing the supplier may have the size to be able to take on more of the risk and mitigate that risk better than the client could. However this can be overdone. Risk has a cost and trying to load all the risk on to the supplier rarely works.
As I said at the beginning this gives no definite yes/no answers and gives no good/bad decisions. However understanding the underlying factors that drive the move to outsourcing will help you pick the right sourcing strategy and sourcing model and may help you to implement them with more success.
About the Author
Derek Parlour is an independent outsourcing consultant at www.djabusinesssolutions.co.uk and author of Successful Outsourcing and Multi-Sourcing, available now through Gower Publishing.