Today, I’m going to tackle two topics from the Deloitte Consulting report on outsourcing (since I was supposed to do one yesterday and never got around to it): costs and organizational challenges.
According to the report, 83% of respondents said cost savings were an expected benefit of outsourcing. Seventy percent said cost savings were an important driver in choosing outsourcing. The expectation is that service providers can achieve economies of scale that individual organizations can’t. As the report explains, “vendors’ scale advantages may be illusory.”
Standardization, which is inherent in the idea of “economy of scale,” is tough to come by because so many companies need customization to some extent. Also, if the client is large enough, it may already be enjoying the same kinds of economy of scale promised by service providers.
Companies are also having a tough time getting a full picture of the cost structure, because vendors resist full transparency to their pricing. Only 19% of respondents said they have transparency to their vendors’ pricing and cost structure. It gets even worse the more the outsourcing contracts get bundled into other service offerings. “Bundling,” as the report says, “makes it difficult for organizations to discern unit costs and complicates business cases.”
Also, service providers lowball their pricing to get the deal. Then, after a period, in order to recoup their margins, they begin to reprice their offerings or start hitting hard with hidden costs. As one respondent was quoted, “After two years of contracts, the costs go ballistic…”
Likewise, management overhead tends to be higher than planned. Fifty-seven percent of respondents said they couldn’t free up internal resources for other projects — which leads to larger than expected internal expenses.
Nearly half of respondents said they don’t have any kind of standardized methodology in place to evaluate the business case for outsourcing. The methods cited include:
- NPV/ROI cost payback (52%)
- Case by case analysis (28%)
- Competitive bidding (10%)
- No formal methodology (10%)
Insufficient due diligence, in turn, leads companies to underestimate how much management oversight will be required in the new structure. Likewise, a quarter said they needed a new skill set among involved personnel that emphasized negotiation, relationship development and maintenance.
Adding to the complexity of the situation are contracts that can range up to 10,000 pages.
Also, service providers aren’t immune to the same challenges as the client organization in terms of having mediocre or complacent staff, employee turnover and unsatisfactory deliverables. The report states, “While sales and marketing representatives perform well, the operations teams often perform at par or slightly above the level at which the organization previously performed the function.”
About 15% of respondents said service level agreements are tough to monitor as well and that “vendors can ‘twist the numbers’ to protect themselves.
The report concludes that while about a third of respondents have simply encountered “normal outsourcing growing pains,” 70% have had significant negative experiences — including unexpectedly complex governance management and problems with change management, quality/delivery issues, limited transparency, loss of knowledge, less-than-expected cost savings, and so on — and are outsourcing with “increased caution and in a conservative manner.”
Tomorrow, I’ll spend some time discussing the five situations in which Deloitte Consulting researchers see outsourcing as a “useful solution.”
You can obtain your copy of the report here.
