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New Study Details What Makes Outsourcing Relationships Work

Why do some outsourcing relationships shine (next month’s Outsourcing Journal will focus on eight relationships that won this year’s Outsourcing Excellence Awards) and others fail miserably? Like the ineffable search for the formula for the perfect marriage, that seems to be outsourcing’s million dollar question.

A new study by Capgemini and CFO Research Services produces a blueprint for successful outsourcing efforts. It dissected the relationships that fell apart and spotlighted those that produced stellar results. And then it listed nine action points if you want your outsourcing relationship to hit a home run.

Here’s the Cliff Notes version of the secret sauce: The May 2006 study, the duo’s fourth annual survey, found that outsourcing relationships failed when buyers did not follow best practice policies in either selecting or managing their suppliers. On the other hand, when buyers took “appropriate care” in these two areas, “real benefits followed.” Sixty-nine percent say their management of their suppliers determines the success of the relationship.

The Anatomy of a Failed Outsourcing Relationship

The study, entitled “Outsourcing the Back Office: The Path Toward Sustainable Benefits,” paints Technicolor pictures of failed relationships in the section entitled “A Painful Past: Why Outsourcing Sometimes Doesn’t Work.” How many are unhappy? The study discovered roughly 25 percent of the respondents were disappointed with both near-term and long-term cost savings and the speed with which suppliers handled their back-office processes.

Buyers who terminated their outsourcing relationships gave the following reasons for doing so:

  • Lack of cost savings
  • Dissatisfaction with the supplier’s processes
  • An unwillingness to meet the buyer’s changing needs
  • Lack of sustained innovation

Of course, the buyers pointed out when suppliers clearly were derelict in their duties. But these financial executives were also honest about their roles; many placed the blame on their own shoulders.

Here’s what they did wrong: Only one-third of the respondents said their companies use a structured selection process. Less than 20 percent bothered to “define, document, capture, and report operational and financial performance metrics.” The same number did not have a formal governance process to oversee their outsourcing relationships. Less than 10 percent always audited their suppliers. And 90 percent did not build incentives or penalties into their contracts.

Ingredients for a Successful Relationship

The picture is just as clear for those relationships where the supplier is helping the buyer achieve its strategic goals.

The buyers who had winning outsourcing relationships said outsourcing:

  • Enabled them to focus more attention on core business functions (74 percent)
  • Made it easier and less costly to comply with regulatory demands (70 percent)
  • Generated near-term cost savings (71 percent)

The study found the success formula was remarkably simple: “Financing executives say an outsourcing venture’s outcome depends to a large degree on the due diligence and oversight the customer puts into the relationship.”

Successful governance includes:

  • Metrics and performance standards
  • Incentives to reward great performance and penalties for less-than-acceptable performance

Based on these findings, the report listed nine practices to help companies enjoy better results. They include:

  1. Visit the supplier’s site. The study found 47 percent never or rarely visited a supplier’s headquarters before signing a contract. The study’s verdict: “Bad idea.” Some of the companies with good outsourcing relationships reported they even visited the sites of some of the supplier’s customers to assess the supplier’s true staffing capabilities.
  2. Define and document all performance metrics; then capture and report them. The study says “deciding what factors you’ll measure help both you and your outsourcer understand what’s important in your relationship.” If you neglect this chore, the study predicts you’re “probably going to fail before you start.”
  3. Capture and report qualitative reaction to supplier performance. “Stay in touch with users and make sure they are being satisfied,” says the report. This prevents the friction that develops when a supplier nails every metric but still manages to upset or anger employees with their delivery.
  4. Conduct formal audits of the supplier’s processes and performance. Section 404 of the Sarbanes-Oxley Act requires companies to document the effectiveness of their internal controls. When they outsource, they must do this themselves or obtain a Statement on Auditing Standards (SAS) No. 70 report. “You can’t miss a beat in today’s governance environment,” points out the report.
  5. Allow or encourage company managers to join the supplier’s team. The report found the closer the buyer’s personnel are to the supplier, the better their outsourcing experience.
  6. Include incentives for excellent performance and impose penalties for poor performance. “Like employees, suppliers who are given incentive to provide excellent service are more likely to provide it than those who aren’t given any inducements,” notes the report.
  7. Be willing to revise performance objectives during the contract term. “Companies willing to adapt to change?and adjust the performance objectives they’ve set for their outsourcing suppliers accordingly?generally are happier with their outsourced activities than those who lack such flexibility,” says the report.
  8. Consolidate work with a few strategic suppliers. Most of the executives surveyed “prefer the convenience of working with a single supplier where possible.”
  9. Use a formal governance process for outsourcing. “Crafting and overseeing a successful outsourcing contract is a formidable job. Creating a formal process for governance is the only way to be sure all the pieces are being addressed,” states the report.

Other Interesting Findings

Using these suggestions should help the 73 percent of respondents who told interviewers they are interested in outsourcing more, not fewer business processes. The study found “a determined six percent” who announced they would like to outsource everything that’s not core to their business.

The study also addressed why companies outsource. It found finance executives “increasingly look to outsourcing not only as a source of cost savings–long one of its most highly touted benefits–but also as a source of process improvement and innovation.” Some respondents found outsourcing back-office processes “a competitive imperative.” Others chose outsourcing to help them manage their growth. “Whether they have expanded organically or by acquisition, their new girth is making the old do-it-yourself approach to back-office business look increasingly less attractive,” it says.

What about offshoring? The study found 30 percent of respondents had a negative view of outsourcing to India, China, and other countries in Asia. They worried about data security, supplier stability, and cultural differences. Instead, 71 percent preferred outsourcing their work to American suppliers, while 49 percent said Canada was acceptable.

Not surprisingly, respondents who have worked with offshore suppliers had a more favorable view of offshoring than their peers who have no experience with these countries.

Who’s the happiest? Answer: HR buyers. The study found 80 percent who outsource HR benefits administration, compensation, or payroll activities are satisfied with their suppliers’ performance.

Who performed the worst? Answer: Call center, IT infrastructure, and IT applications management suppliers. Only 65 percent of their buyers reported their performance met or exceeded their expectations. However, the satisfaction levels also reflect a larger base of customers. More companies have outsourcing using a variety of suppliers. Satisfaction was highest when outsourcing simpler tasks like payroll and fell as the engagement grew in complexity.

What does this all mean? “Outsourcing is not just a vehicle to help cut costs. It can help companies invest in their businesses or IT systems, improve their margins, or focus on strategy,” says Mark LaNeve, CFO of Americas Outsourcing for Capgemini.

How the study was done: CFO Research Institute sent out a printed questionnaire with over 100 questions to senior finance executives with a title of VP and above; 288 took at least an hour to complete it. The minimum annual revenue of the respondents was $500 million; two-thirds of the responses came from companies with more than $1 billion in annual revenue. They represented a broad cross-section of industries. The Institute mailed the questionnaires in late 2005.

Capgemini funded the research.

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