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Deciding What to Outsource

Careful Choices and an Advocate Increase Chances of Success

One of the crucial decisions companies have to make is what to outsource.

Companies can selectively outsource for services such as data center operations, applications development and maintenance, or payroll. Or they can outsource entire business processes such as IT, finance, accounting, legal services, and human resources. Total outsourcing transfers most (usually defined as more than 80%) of the equipment, staff and responsibility for delivery of services to an external provider, while selective outsourcing is the sourcing of one or a few selected functions.

Total outsourcing is usually more complex because of the scope of the endeavor and the consequences of failure. The stakes are high, since total outsourcing is a major undertaking often structured to last for long periods — more than five and sometimes 10 years. The provider must make profit margins from economies of scale and from replacing hardware in the future at costs that are substantially below current levels. Therefore, total outsourcing usually yields acceptable margins only over longer periods of time.

Customer companies who enter into total outsourcing arrangements should spend considerable time, effort and money analyzing the deal and negotiating a win-win contract. Remember, it is difficult to predict the future, so set contract provisions that allow for large changes in scope.

Failure can be a costly consequence of total outsourcing. If the outsourcing relationship with the provider does not succeed, there are two difficult options– repeat the entire process and negotiate a contract with another vendor usually with substantial costs and difficulty, or bring the functions back inside the organization with the attendant costs and problems.

Outsourcing Relationships Follow a Continuum

Outsourcing relationships vary along a continuum. At one extreme are market-like relationships in which your organization has a choice of many vendors capable of performing the work with relatively short contract duration. These relationships allow the buyer to switch to another vendor at the end of a contract for future work of the same type with little or no cost or inconvenience.

At the other extreme are long-term partnership arrangements in which your organization contracts repeatedly with the same vendor and develops a mutually beneficial relationship that lasts. The middle of the continuum is occupied by relationships that must endure and remain reasonably harmonious until a major piece of work is completed; these are termed “intermediate” relationships.

Market relationships cost the least to set up and administer and are relevant for work that is fairly simple and straightforward. Intermediate relationships cost more and are relevant for work that is complex. Partnerships cost the most and are only relevant when the benefits of a close relationship with a vendor are substantial.

Choosing the wrong relationship can result in either excess cost or failure. The typical outsourcing relationship is an “intermediate” relationship that includes the best of a market relationship (e.g., specific service levels) and a strategic relationship (e.g., building trust and a close working relationship).

Taking Leadership Responsibility

Outsourcing relationships have a better chance for success if they have an internal champion who believes in the cause. Early in the evaluation identify who will take leadership responsibility, perform the analysis, and make the decision recommendations. The persons who should be involved depend on the scope of the outsourcing engagement and the circumstances surrounding the outsourcing decision.

An executive sponsor or champion is critical, and in cases that involve organizational politics, absolutely critical. For larger outsourcing initiatives, top management must play a major role. For smaller initiatives, middle-level managers might do the heavy lifting with the support of senior management.

It helps tremendously to have persons experienced in outsourcing on the team for the insight they bring to the issues and the realism they add to cost and benefit estimates. I also recommend outside consultants highly.

The team usually needs a mix of managerial and technical talent and representatives from user areas whose services will be directly impacted by outsourcing. User perspectives and objectives are essential for setting scope, assessing risks, and gaining ownership of the final decision.

The size of the team depends on the scope and size of the project, but smaller teams are generally more effective. The team can be quite small in the planning phase and expanded when analysis begins. Teams with full-time members are often more focused and effective than teams composed of people who work part-time, although full-time allocation may only make sense for big outsourcing projects.

Identify as soon as possible who will be given responsibility for oversight and management of the outsourcing arrangement and vendor relations after the contract is signed. These people should be part of the team that crafts the contract. Their inclusion is critical for several reasons. First, there is no better way to understand the issues involved in outsourcing than to be involved in all aspects leading up to the deal. Second, relationships start at the moment discussions begins. Being on the ground floor and having continuity in the relationship with people in the vendor organization contributes to success.

The Importance of Outsiders

When outsourcing threatens to upset the status quo in an organization – especially when outsourcing is motivated by perceived poor performance-it is usually impossible to rely on internal sources for accurate estimates of internal costs or effectiveness. Under these circumstances, bring in objective outsiders for the assessment work as well.

Although the information that these vendors provide is often useful for establishing the types and general prices of services that might be outsourced, the actual price an organization will pay is a competitive process, set in actual negotiations related to specific requirements. Do not to be misled by what other organizations say they are paying or what a vendor might casually offer as a possible pricing scheme. After narrowing potential vendors to a manageable handful, a buyer can obtain better pricing and service agreements can by negotiating with the best-fit two or three vendors and then striking a final deal based on the best final offer.

Services such as Outsourcing Center, Gartner Dataquest, Giga, Yankee, and others are sources of information about which service providers offer various services. Companies who have previously outsourced can provide useful comparative information as well.

The path to outsourcing is not an easy journey, so it is important to get outside assistance from advisors/consultants such as the Everest Group, who can help coach and assist during the evaluation, negotiation and relationship management processes. Bear in mind that outsourcing vendors have fine-tuned their approach and are usually armed with seasoned staff. Using unbiased advice to guide through the process from the beginning helps level the playing field.

Dr. Wendell Jones is an executive analyst with the Outsourcing Center and a senior executive with thirty years of IT and general management experience in the securities, aerospace and computer industries. He was awarded the 2000 World Outsourcing Achievement Award by PricewaterhouseCoopers in recognition of his contributions to outsourcing. He is the co-author of Outsourcing Information Technology Systems and Services, a book recently published by Prentice Hall.

His education includes an MBA and Ph.D. in general management and information systems from the University of Georgia, a bachelor’s degree from the University of Arkansas, and a postdoctoral fellowship in computer science at Cornell University. He can be contacted at [email protected].

Lessons from the Outsourcing Primer:

  • Companies can outsource services or entire business processes.
  • If an outsourcing relationship fails, the buyer has two expensive options: find another vendor or bring the process back in-house.
  • An executive champion is critical.
  • Seek outside professional help because they help level the playing field.

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