During a tough economy, outsourcing can seem like the perfect way for a business to cut costs and improve the balance sheet. But, Sue Copeman warns, the devil is int he detail

Cheaper, faster, better (sometimes) are all adjectives that companies use to justify their outsourcing decisions. But there’s no pain without gain – or in this case risk. And will decisions prompted by the recession hold true in the next decade when economic circumstances improve?

There’s no doubt that the recession has given a boost to outsourcing. Says Adrian Polley, CEO of Plan-Net: “In tight economic circumstances companies think that they need to focus on things that they are particularly good at and outsource others to business that are better at them. Basically, the aim is to get a better service or product at a better price – which is why off shoring to India has become so popular.”

There are other considerations too, explains Polley. In a recession particularly, companies are looking for ways that they can demonstrate better value. When analysts look at companies they often consider profit per employee. “Outsourcing gets employees off the books and generally means that profit per employee goes up so the company looks better compared to its peers.

While the recession may have concentrated companies’ attention on the cost benefits of outsourcing, Dr Grant Foster, associate director of Aon’s enterprise risk management team, has misgivings. “Some companies that before were looking at investment in the future have become much more focused on short term profitability. My personal view is that sometimes decisions have been made quite quickly and without necessarily thinking about longer term effects. But these fast short term cash-oriented decisions could store up problems for them later.”

Foster says that such companies may be giving away “a small part of the crown jewels” which could be difficult to claw back if things go wrong. The bad news is that there are quite a few things that can potentially go wrong with an outsourcing contract. The good news is that risk management, if involved at an early stage, can substantially improve the chances of a company attaining its outsourcing objectives.

Polley sees one of the main risks residing at the contractual stage. “Companies need to define precisely what they expect their outsource provider to do and how performance will be measured,” he says. He warns that otherwise companies can face unexpected additional charges for services that they thought were included in the contract or having to pay for services that are not up scratch.

Foster views this as a particular risk when companies resort to outsourcing because of economic circumstances. “Service level agreements and measures are quite well established. But in the recession with the need to get the deal done quickly, some companies may have agreed to sub standard conditions and compromised on time, cost or quality.”

For many risk managers, checking out contracts for potential liabilities and problems is nothing new. It’s an essential process as far as outsourcing is concerned. And within the outsourcing contract, if they want to score some points with their board, they’ll also check flexibility.

The last 18 months or so have shown that the trading environment can change rapidly. Companies have had no choice but to change rapidly themselves in order to survive.

Polley says that one of the big problems in the past with outsourcing has been rigid contractual terms which don’t allow for business changes. “You can sign up for a long term outsourcing service and then find that it doesn’t meet your requirements. Getting out is usually expensive.”

However, in view of several high profile cases in Europe, security of information and intellectual proiperty tends to be the greatest concern when outsourcing. Don’t make assumptions here is the message from Polley.

“Outsourcing can give a third party access to your company data, trade secrets and intellectual property. Do not assume that the outsourcing provider meets your own standards of best practice and risk management, that information will be kept secret and there are the right controls on recruiting honest employees,” he says.

Issues around intellectual property can also cause disputes. A service provider may contend that it’s not just providing people to do the job but has specialist expertise, processes, software and systems. Customers argue that they have paid for specific systems to be developed which the provider then uses at no cost to get other clients. Once again, this IP ownership issue needs to be negotiated up front. Says Polley: “The contract needs to make it clear who owns what. It’s like a prenuptial agreement!”

The loss of control that inevitably comes from entrusting a third party to undertake key services for your organisation is one of the key drawbacks to outsourcing. It can affect both the time and quality of delivery. As Foster says, “The provider’s objectives are unlikely to be aligned precisely with your own; it won’t feel the pain of mistakes in the same way.”

He points out that it’s unlikely that you are going to outsource to someone who only works for you – and your business might not have priority. So if your provider’s business is disrupted or it loses a more important client, “you might find that you’ve opened your company up to risks that were not on your radar at all.”

What’s likely to happen when the recession lifts? Polley believes that outsourcing will continue but that companies will go about it better, for example looking for flexibility in contracts. “Companies are now focusing on their bottom line and reducing costs and I don’t think that the lessons learnt in last 18 months will be forgotten. It is possible that recovery might encourage some companies to take some operations back in house with a larger employee base because they feel more comfortable with being able to exercise a greater level of control.”

Foster agrees that the recession may have taught some salutary lessons. “It’s forced businesses to be extremely lean and cost effective - focusing on what they do and what makes them money. They are going to be used to working with better control of costs. It may have sharpened up business practice.”