Outsourcing

Outsourcing, is it for you?

As a rough guide:

If you have not adopted a shared services model then the benefits from outsourcing are probably greater
If you have adopted a shared service model then you will probably know more about what you have to outsource, will be more specific in your requirements, with the move to outsourcing being easier

Why outsource?
There are many factors in the current business environment that are making businesses turn their attention to outsourcing:

Markets are increasingly becoming global. This is forcing many companies to reorganise and consolidate activities to compete on a global basis.
Technology is rapidly advancing, making today’s costly investment potentially redundant tomorrow. The desire to invest ones own capital is being replaced by the wish for someone else to make this investment. Someone who can spread the cost across many and who is motivated to maintain and improve the investment.
The acceptance that when it comes to the back-office nothing is truly unique. Over two-thirds of the activities undertaken are common, are not dependent on location and benefit from economies of scale.
The realisation that it is the core activities of a business which generate its wealth and that anything which is non core risks been done poorly, becoming a distraction and a burden for the business.

Choosing an outsourcer
Remember this is a partnership you are getting into, not a business as usual vendor-customer relationship. The outsourcer will become an integral part of your business so be careful who you choose. Some things to look out for are:

Look for knowledge and experience

Putting it simply – do they know what they are doing? Are they currently performing the processes/functions you wish to outsource? Are their volumes at least comparable to your own? Are they doing things smarter than you are?

Look for substance

How long has the Outsourcer been around, who is backing them, are they here for the long haul?

Look for a one-stop-shop

Do they provide a full-suite of services? You may only want to outsource one process now, but what about later? Do they do their own application hosting? Can they support themselves and your organisation?

Look for scalability

Think of the future – not now. Can they accommodate your growth plans?

Look for a cultural fit

Corporates have their own culture. You want your outsourcer’s culture to be in-line with your own. It will never be exactly the same, but make sure that there are no big differences. Remember, some of your employees may end up working for the outsourcer as part of the contract. If they are not happy your service will suffer.

The Benefits
The benefits of outsourcing could fill pages, but in the end they all fall under six major headings. These are:

Focus on core business

Outsourcing allows you to focus you business on what it does best – its core activities that actually generate your income. In a rapidly evolving competitive environment it allows you to be more agile in responding to the market. Also it is not possible to be an expert at everything, outsourcing gives you access to expertise in areas you lack.

Improved service quality

The outsourcer is in the business of providing service. Its systems, processes and people will be aligned to provide high levels of service. Their business survival depends on it.

Access to improved technology & processes

Expect the outsourcer’s systems to be better than your own. They will have the scale to afford the investment, and as your non-core activity is core to them, they will have the focus to develop their systems and processes to the maximum. You should expect year-on-year process improvements.

Gain flexibility

If you business is either in acquisition or divestment mode then outsourcing provides flexibility. You can scale your operations up or down knowing that you have instant access to more, or that you will immediately save money by buying less.

Reduce costs

Yes you can (should) expect cost reductions. Anywhere from the 10% to the 30%+ mark depending on how efficient your own systems are. You can save on the up-front capital investment required for new systems by adopting what is already developed, and you can save on on-going operational costs through the outsourcer’s economies of scale. Achieving cost savings year-on-year should be expected. However, cost should not be the prime driver for outsourcing. It is important but should be one of many benefits you are targeting. Be sure of the distinction between true cash savings and opportunity costs. Also, it is important to understand the true cost of your own process when comparing with the price from the outsourcer.

Improved shareholder value

The end product of the all of the benefits mentioned above. The maxim of any business – improving shareholder value – is a key benefit from outsourcing.

How is it priced?
There are many options for pricing an outsourcing contract. These are some of them:

Cost Plus

Common practice throughout many industries it is a simple matter of taking actual costs and adding a predetermined profit percentage. Simple but not necessarily very flexible if circumstances change. Nor does it provide the outsourcer with an incentive to do things more efficiently unless it is combined with some form of savings incentive.

Unit Pricing

A usage based approach when applied to business process outsourcing. The customer pays $X per transaction, $X being agreed between the parties by negotiation. A similar problem with the incentive for the outsourcer to improve unless combined with some form of savings incentive.

Fixed Price

A service is scoped and the customer agrees to pay $X regardless of the volume. Good if you want to know how much you are going to spend. Bad if you have not defined the scope of services well enough and find that you need additional services. The outsourcer has an incentive to be efficient but the rewards are all theirs.

Variable Pricing

Basically like fixed pricing except that the price will usually vary either depending on volume or the service quality desired. Defining the scope of a service can be a problem, but a popular method none-the-less.

Incentive-based pricing

The customer gives the outsourcer an incentive to perform efficiently and effectively. The better the service or lower the cost, equating to increased benefits for the customer, the higher the income for the outsourcer. Often includes penalties associated with poor performance by the outsourcer.

Risk & reward sharing

With this method the customer and the outsourcer are truly in partnership. Jointly they develop a model which shares the risks and the rewards relative to the input from each party, each having an incentive to maximise the benefits of the outsourcing relationship.

There is no right or wrong method of pricing. Each has its good and bad points and is relevant in a given set of circumstances. If asked to choose the most appropriate method BP Consulting would recommend the last two. They both encompass the partnership aspect of the outsourcing relationship. For outsourcing to work all parties must work together and have an incentive.

The Contract
The contract can play a critical in the success of an outsourcing relationship. If the relationship really works then the contract will seldom, if ever, be referred too. But it does set the ground for everything that comes afterwards and facilitates the learning and bonding process between customer and outsourcer.

Some things to consider are:

Clearly define who is responsible for what
Assess the risks associated with the activities outsourced and agree upon the authority given to the outsourcer and retained by the customer
Negotiate the liability for potential damages either with respect to third parties or through service failure to the customer, whether it results from actions/non-action by the customer or outsourcer
Be fair and reasonable, this is a partnership. There needs to be a fair balance of risk and reward between all parties, and the expectations, for all parties, need to be reasonable.
Do not expect to use an “off-the-shelf” contract. This is not an off-the-shelf arrangement. Negotiating the contract is part of the learning process.
Ensure there is a Service Level Agreement either included or agreed separately, but viewed as been equal to, the main contract.
Once the contract is agreed and signed do not try to micromanage your outsourcer. You have partnered with them because they have expertise you do not. Let them use it.
Plan for the termination of the relationship at the beginning. Everyone wants things to go well, but this is a time to be realistic. Circumstances change and things can go wrong. Include at the outset planning for how the contract will be terminated and the outsourcing arrangement either unwound or passed to another outsourcer.

Negotiating the contract for an outsourcing relationship will not be quick, but it can tell you a lot about the parties involved and is a precursor for what may occur in the future.

Remember, an outsourcing relationship is similar to a marriage - to make it work you need to work at it. Outsourcing works but it needs two to tango and will work at its best when all parties buy into it and work together.

Conclusion
Whether outsourcing is for you depends on these main factors:

Where is your organisation / shared service in its life cycle
How efficient are your processes, what is the potential benefit
Where is your business in its thinking

These factors play a role in determining whether outsourcing is for you and can only be determined by you. But outsourcing is worth a peek – if only to see what might be coming – and face it – better to know your options and in the end what have you got to loose.