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The future of outsourcing

September 3, 2014

“Outsourcing is moving backwards; it is tired and outdated”.

“I see no future for the major outsource providers: they have become trapped in out-tasking.”

These are just two of the comments I have recently heard during conversations with experts in the outsourcing field. There is no doubt that many client organizations are questioning the value of outsourcing and that many providers are struggling to make a decent margin. Add to this on-going questions about the integrity of the provider community and there appears to be a volatile mix of negative sentiment.

Managing internal relationships is hard; managing external relationships is even harder. And few organizations have yet grasped what it takes to build productive and sustainable relationships with an external partner. Providers are often caught in the dilemma of customization versus standardization; the former appears responsive, but actually adds dramatically to costs and to risk of poor performance.

So is outsourcing in decline? Will its use become more selective and more limited?

I believe that outsourcing offers many potential benefits, but realising these will take a continued shift in attitudes and behaviors. A few things that need to be addressed are:

  • Establishing requirements: clients must know what they want and express it clearly. This requires engagement with the market to establish and evaluate capabilities. Needs must be properly documented to avoid regular disagreements over scope and goals. Current measurement and motivation systems do not help; they should be altered to rewards based on results, not on getting a contract signed.
  • Executive sponsorship: client organizations must appoint a sponsor with experience of developing or managing contracts and supplier relationships. Too often, those in charge may be technically proficient and understand the subject area, but they often fail to test the commercial issues or capabilities of either organization and thus end up with the wrong supplier, or inadequate internal competencies.
  • Use of third parties: if a third party is really needed, they should be very carefully controlled. In my view, third party involvement has been one of the major causes of value erosion in outsourcing. If they act as an expert mediator or facilitator, there can be major benefit. If they act as a partisan representative, they distort negotiations and performance, often creating an adversarial environment.
  • Outcomes: if the only goal is cost reduction, then out-tasking existing activities may be fine. But if the aim is continuous improvement or innovation, it will be achieved only through focus on outcomes and continued discussion as these evolve. That means the parties must focus on what is to be done, not on how to do it. If the supplier is not expert in the field, why are they being hired?
  • Governance and performance management: good relationships need the right structure – and this needs to be provided through an appropriate form of contract. The adversarial, risk-consequence focus on many contracts and contracting processes means that the parties lose their fundamental business management tool. After so many years, it is remarkable that there are so few examples of good performance based / outcome based contracts which integrate ‘the contract’ with ‘the relationship’. Yet given the factors above, perhaps this is not surprising ….

So can the industry survive and prosper? This depends on significant shifts in the way that outsourcing is approached and handled. Meanwhile, Shared Services will increasingly represent a dynamic alternative.

  1. Eugene P. Grace permalink

    Outsourcing like other issues seems to be like a pendulum swinging in the direction of acceptance and then in the opposite direction. Outsourcing can provide business improvement in the quality of work performed and/or cost savings. I have served as attorney for outsourcers of IT and investment accounting services. I have also been a user of outsourced solutions. Paradoxically, a key element of the outsourcing contract from the very inception is its termination. The acceptance of outsourcing should be greatest when termination can occur promptly. This is a critical issue so that users are not held hostage to the outsourcer. However, users need to be realistic regarding the time required to replace the outsourcer either internally or with another outsourced solution. The outsourcing company should be provide significant comfort to the user on this issue and should be contractually bound to provide termination assistance. Prompt termination rights have a beneficial impact on discussions regarding ongoing service levels. Termination rights may not be symmetrical for both parties. Users of outsourced services have to be attentive to the relationship. There is a substantial amount of vendor management involved with these relationships; the more complex the service the greater the need for vendor management. Users need to be attentive to how the outsourcer might be embedding itself into the operational flow of the user. The deeper that penetration the harder it will be to terminate them. Outsourced relationships are most beneficial when there is frequent and meaningful communication between the two parties, including home-and-away site visits as appropriate. The two parties should agree upon broad-ranging performance metrics and always be attentive to how difficult it might be to terminate the outsourcer. After all, the user wants to maintain its flexibility to retain or discharge the outsourcer. On another issue, the issue of “outcome” or” results” type agreement was raised again. I have previously commented on this issue. These agreements take a lot of work by the contracting team but there is nothing particularly extraordinary relating these contracts. It take teamwork between the business units, finance, risk management and legal. In another post, I mentioned how the structure of the agreement might be a contracting tool or impediment for these and other contracts.

  2. I agree wholeheartedly with your thoughtful analysis of the future of outsourcing and what needs to be addressed, because many of your points are best practices that we have highlighted in our research at the University of Tennessee on the Vested Outsourcing business model for strategic relationships. The Vested methodology offers a step-by-step approach for parties who want a strategic, long-term outsourcing relationship. Parties become vested in each other’s success, which encourages trust, investment and innovation. Your point about the use of third parties is well taken and I agree: the key is that they be neutral and committed to achieving a successful deal, not to any one party. The Vested model does this in conjunction with the University of Tennessee’s Vested Centers of Excellence – which play this role.

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