Ashley Bailey provides some useful tips on how companies can reduce the failure rate of outsourcing contracts and outlines the potential rewards from successful outsourcing relationships
In today's global business environment, the outsourcing of non-core business processes is now well established as a best practice strategy in many sectors. However, not all attempts at outsourcing are successful.
A Dunn and Bradstreet report on outsourcing found that between 20% and 25% of outsource contracts fail in the first 18 months. According to Gartner, the outlook is even more pessimistic. It puts the chance of strategic sourcing deals succeeding at 50/50. So what processes do you need to apply be successful? Firstly, consider a couple of fundamental questions on outsourcing.
What is outsourcing?
Outsourcing is the process of buying in services from third parties, that were previously provided by in-house resources. The day-to-day delivery and management of the outsourced activity is delegated to third party service providers. It is this delegation of management that differentiates outsourcing from mere sub-contracting.
What are the benefits?
The benefits achieved depend on the operational functions outsourced, the current costs and benefits from those functions and the effectiveness with which the new solution is implemented and managed. Organisations typically outsource when they recognise a need to:
An organisation's non-core activities can often be more effectively run by businesses that are specialists in service delivery, have in-depth expertise in those areas and may benefit from economies of scale. The organisation can then concentrate on its core operations, while retaining responsibility for the strategic direction and performance measurement and control in the outsourced service area.
Globalisation, increased competition, declining margins and the constant search for product differentiation have forced most businesses to concentrate on core business competencies. The need to reduce costs and improve operational effectiveness has also led many to seek to divest themselves of the time and capital cost involved in the provision of non-core support functions. Finally, mergers often lead to consolidation, with the obvious need to streamline back office functions.
Unfortunately there seems to be a gap between expectation and reality. A study by Cap Gemini Ernst & Young shows that only 54% of companies are satisfied with outsourcing, down from more than 80% a decade ago. To get the most from it, writes Martha Craumer in How to Think Strategically About Outsourcing, you must look beyond cost cutting, to long-term outcomes. The real opportunity of outsourcing is 'to use it as a tool to drive strategic value, transform businesses, and even fundamentally change industry dynamics.'
In order to identify the most frequent problems in outsourcing relationships, you must first understand how to structure a good relationship. Partnership is the key. The basis of a successful relationship is when both provider and buyer have clearly-defined, shared objectives. These could be cost saving, bringing more efficiency and effectiveness to the outsourced services, or providing access to a new technology. Whatever the objectives are, it is vital that both sides focus on them and share the desire to achieve the outcome.
If both sides do not share the same objective, they may prioritise differently. For example, a supplier may believe that driving down costs is the most important goal, while the client is looking to harness new technologies to increase competitive advantage. The opposite situation would see a client wanting to keep the relationship as lean as possible, while the vendor was trying to provide value added services. In either case, the two parties will be moving in different directions.
According to the Global Top Decision-Makers study on Business Process Outsourcing, companies which felt that their outsourcing strategy was not delivering identified the the top three barriers to success as:
It is therefore critical for managers responsible for outsourcing projects to follow best practice processes to minimise disruption and maximise business benefit.
The steps to success
We recommend six key steps to ensure success.
Step 1. Identify needs and opportunities
Make a list of the operational problems your company faces, together with the solutions to them. Ask, 'Why are these solutions not being implemented today?' If the answer is lack of management time, lack of organisational expertise, lack of capital investment or the potential ongoing operational cost, then outsourcing is a possible solution.
Step 2. Evaluate external services and suppliers
Start discussing your problems with reputable outsource service providers.
Step 3. Specify service levels and supplier requirements
Determine the areas to be outsourced and detail the current situation, such as locations, people, technology and costs. Examine the objectives that must be met in the future, such as time, quality and costs, and consider your expectations of future service levels and the qualities you want in an outsource partner.
Step 4. Choosing a partner
If uncertain of the market or potential partners, undertake a formal tender process and be systematic in the measurement of each supplier's proposal and performance. Insist on access to current customers to seek direct feedback on consistency of performance and strength of relationship.
Step 5. Change management
The transition to a partner must be managed carefully. Think about how the change will affect employees and assist them in the transition. Be sure to explain what the business is doing and why, and how the change will enable it to offer better service in the future.
Step 6. Contract management
As the relationship between the companies moves forward, it is not possible to over communicate. Insist on open dialogue. Outside providers should become a constant source of innovation.
Following these steps will help reduce risk to a minimum, but companies may also reap a number of additional rewards on the back of a successful outsourcing relationship. The importance of these should not be underestimated or overlooked:
The service provider is typically committed to delivering to agreed service levels, often with financial incentives and penalties tied in. As the focus is on delivery, the partner will arrange easy access to contingency arrangements.
At any time in its life, there are competing demands for an organisation's resources. However, an outsourcing agreement, when structured appropriately, can allow scarce resources to be focused on revenue-generating core business projects rather than on cost-generating support systems. This will result in an improved return on investment. Furthermore, the balance sheet and financial ratios, such as earnings per employee, are improved as companies transfer out employees who do not provide a direct contribution to positive changes in revenue.
Outsourcing also has the potential to reduce the costs associated with cash management, as regular and consistent payments to the supplier are substituted for irregular capital investment in support services and technology. This improves company cash flow and does away with unexpected cash demands resulting from non-core capital outlays.
Management information, typically provided more effectively by an outsource supplier, allows an organisation to scrutinise and benchmark cost and service quality. This provides organisations with the ability to identify areas for cost reduction.
Through outsourcing, companies can often access procurement economies of scale, which are generated by specialised global procurement. Furthermore, an outsourcing provider can bring the experience of running thousands of individual operations and apply proven process improvements to all support operations, as a matter of policy.
Outsourcing provides an opportunity to move some or all functions off site, to purpose-made facilities. This has the effect of releasing valuable office space, making it available for the organisation's primary functions. This can represent a significant saving.
Senior management time is released to focus on making the core business a success, removing the day-to-day distractions created by managing internal support systems. Support service staff allocation is optimised to fit the business requirements, and the problem of managing staffing levels to cover absence is removed.
Career opportunities for outsourced staff are expanded, as the tasks they perform shift from being peripheral ones to the core of their employer's business. Employees may also benefit from training and personal development coaching.
It is in the interest of your outsourcing partner to ensure that equipment utilisation is maximised. When equipment is managed by an internal function, it is frequently over-specified, to cope with one-off peak requirements. The result can be expensive and under-utilised equipment.
Outsourcing removes the risk of adopting technologies which subsequently become obsolete. As organisations buy access to technology on a 'per-use' basis, risk is transferred to the outsourcing partner. This allows you to switch to new ways of working with minimal risk.
Specialist services providers must constantly adopt the best technologies and processes available in order to remain competitive in their marketplace. By selecting an outsource partner that is independent of hardware suppliers your company is given access to future-proof, scalable solutions, which are not tied to single supplier legacy systems.
Success in outsourcing is about long-term partnership. Only together do the outsourcing industry and business customers stand the chance of realising the potential benefits of outsourcing and of creating a long-term and effective contract.
Ashley Bailey is managing director, PBMS (Pitney Bowes Management Services), Tel: 01442 416000,
Guidelines for financial services
Many firms involved in financial services are now turning to third party suppliers for IT services. As a result, regulators around the world are keen to ensure that firms have appropriate procedures in place to manage the associated risks.
The Futures and Options Association, working with PricewaterhouseCoopers, has developed guidelines on adopting a structured approach to sourcing projects and managing the attendant risks. The guidelines draw on good market practice and use the Financial Services Authority's regime for banks in setting a methodology for compliance with regulatory requirements. They also provide insight into how to address some of the issues and avoid some of the pitfalls that can prevent a firm from securing maximum benefit from sourcing projects.
For further information on the Procurement and Outsourcing of IT Services Guidelines, visit http://www.foa.co.uk/publications/guidelines/pogs/index.jsp
FSA working paper
A Financial Services Authority (FSA) working paper on business continuity management (BCM) provides some useful pointers on dealing with outsourcing risks.
The FSA's outsourcing policy requires firms to have written service level agreements (SLA) with their outsourcing providers where the contract is material.
The paper says that this fully applies to the outsourcing of BCM processes, but an FSA review of firms' BCM processes revealed that many firms have not established SLAs with their disaster recovery providers. It suggests a range of performance criteria that can be incorporated into a SLA with a disaster recovery company. For more information, go to http://tinyurl.com/c3nw