What's Missing From Outsourcing

The story of outsourcing is still unfolding. However, much has already happened that should give us reason to pause and think.

First, there was a wave. Everyone jumped on the bandwagon as if there was no tomorrow. Then, there was a “backlash” – noise about job losses and the “widespread” resentment. We were led to believe that not only could America not compete with third world countries, we are also a bunch of whiners. Now, results are pouring in and they do not look good for the proponents of outsourcing.

In a recent survey by Deloitte Consulting titled “Calling a Change in the Outsourcing Market”, 70% of respondents had significant negative experience with outsourcing, 57% absorbed costs they thought were covered under the agreement with vendors and, 44% did not see the promised cost savings materialize.

The proof, as they say, is in the pudding!

Cost savings is perhaps the most widely used reason for outsourcing. However, as this and other studies reveal, companies are really not reaping these benefits.

One of the most common reasons why outsourcing does not produce the desired results is because cost model has flaws – the underlying assumptions are incorrect and it misses key variables. It also does not help that, for the most part, quantifying costs and benefits is very difficult, if not impossible.

Take for example, the outsourcing of call centers. The underlying premise is that this will save costs – personnel and infrastructure related. Personnel costs are reduced because of lower compensation and benefits at the provider. Infrastructure costs are reduced because of economies of scale and “knowledge payoff” that comes from specialization in a business function such as call centers.

These are valid points for the most part. However, we missing some key elements from the big picture that can and do affect both cost and benefits:

- Loss of “knowledge”: Over time, the outsourcing organization loses its edge in the outsourced function. This will result in it being dependent on the outsourcer who can take advantage and raise prices. Also, what seems expensive today gets incrementally cheaper, over time, because of the “knowledge payoff”. Typically, outsourcing cost models do not include this in the cost calculations.

- Loss of “owners’ touch”: Customer retention is less costly than customer acquisition. Also, repeat sales are critical to revenues. Customer service can make all the difference in this area. Are employees better at “quality of service” than “contractors”?

- Loss of “incremental revenues”: Cross selling and up selling are critical components of company revenues. Also, incentives drive behavior. A “sales person” who is paid by the hour is really not motivated to cross or up sell. This will result in loss of revenues to the outsourcing organization.

One of the ways to alleviate this problem is to structure outsourcing deals, not on a client-vendor model with “pay for service” basis, but on a partnership model with “value sharing” basis.

The simplest form of value sharing is “base plus commissions” – a certain base payment for service plus incentives based on, say, increased sales – both direct and indirect. The latter recognizes the fact that the “partner” is contributing to brand building that is resulting in sales.

For example, customer service indirectly impact sales. A satisfied customer is a repeat customer and customer service is critical to customer satisfaction. Hence, customer service personnel should be rewarded even if they were not directly taking the order.

The problem with this model is that it is very difficult to assign numbers to indirect sales. Sales happen because of multiple reasons and service is one of them. However, careful analysis and collection of data can help solve this problem over time.

Outsourcing is not a bad thing. However, it must be based on realistic assumptions supported by business models that factor in all the key drivers of cost and benefit.

About the Author:

Sourabh Hajela is a management consultant and trainer with over 20 years of experience creating shareholder value for his Fortune 50 clients. His consulting practice is focused on IT strategy, alignment and ROI. For more information, please visit http://www.startsmarts.com/. Or feel free to contact Sourabh at Sourabh.Hajela@StartSmartS.com

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