Top 10 reasons of outsourcing

According to surveys completed by the Outsourcing Institute, the following are the top ten reasons for outsourcing.

Improve company focus
Access to world-class capabilities
Accelerate reengineering benefits
Share risks
Free resources for other purposes
Make capital funds available
Cash infusion
Reduce and control operating costs
Resources not available internally
Function difficult to manage or out of control.

This paper will discuss each of these reasons.

1. Better focus

Outsourcing can help an organization to reduce its view of and concern with functions other than the core business. At the same time, the view of that core business can become broader, allowing closer analysis of competitive and innovative issues.

This is an important point to consider when looking at other reasons for outsourcing:

World-class capability should be achieved by an organization within its core business. It should not need to develop this capability within other parts of its business.
People should focus on the organization's core business, and should be freed from involvement with other business issues as much as possible. This should enable them to provide an in-depth focus across a broader range of issues affecting the core business.
Capital should be invested in supporting and enhancing the organization's capability to continue its core business.

2. World-class capability

Just as an organization attempts to concentrate on its core business, so outsourcers concentrate on theirs. As a result, outsourcers must continue to demonstrate continuous innovation, sound methods, specialist skills and competitive price performance.

There is also a warning in this for customers of outsourcers. They must be satisfied that their outsourcers will continue to

remain committed to outsourcing as their core business
implement new, effective methods, tools and technologies
stay up to date with developments in their industry
provide competitive pricing.

3. Reengineering benefits

Business reengineering can enable an organization to identify the processes that will provide dramatic gains in performance. In adopting those processes, an organization may also decide that some of the performance gains can best be achieved through outsourcing.

There is, of course, a question of scale to be considered when linking outsourcing to business reengineering. The following questions should be asked.

How many outsourcing opportunities are there? Can we do them all together or should they be incremental?
Should outsourcing follow completion of the reengineering? How long will the reengineering take? Can we afford to delay outsourcing until the reengineering is complete?
Can the organization handle more change? Will the outsourcing exercise put further pressure on people committed to the reengineering project? Will more change cause greater resistance?

4. Risks

It is necessary to distinguish between "risk sharing" and "risk reduction". It is highly unlikely that outsourcing will actually reduce the risk that an organization faces. What outsourcing can do is to make risk more easily measurable, so that it can be more easily managed. The organization can decide to share some of its risks with the outsourcer and with the outsourcer's other customers.

It should also be realized that outsourcers are not insurance companies. Using an outsourcer to manage those risks will not reduce the costs of risk management.

What outsourcers can do is to measure and assess the risks, decide how to share those risks between its customers, and offer a solution for managing those risks.

5. People

Any organization will want to use its people effectively. The costs of employment, accommodation, taxes and levies, welfare and other services can make people the most expensive resource within an organization.

Also, because organizations are moving to become "lean and mean", there is a constant pressure to reduce the number of people employed on non-core activities.

Progressive outsourcing of an organization's non-core processes and services is often seen as a means of increasing the proportion of staff engaged directly on the organization's core business, processes and services.

6. Capital

We shall see, when we come to the next reason for outsourcing, that a cash infusion into the organization may be desirable. This reason concentrates on the organization being able to concentrate its capital budgets on its core business, with the outsourced services being financed from the operating budget.

Often, within a manufacturing organization, the business units have to compete with each other for a share of the capital budget, with the cases for new or enhanced computer systems and for new or replacement vehicles vying with the cases for new production plant.

Outsourcing may be seen as an answer to this problem, by reducing the competition for capital budgets.

In the manufacturer, the outsourcing of computer systems and vehicle management could reduce the competition for capital budgets. The requirement for production plant would be able to make a better case for a larger proportion of the total capital budget.

In addition, the problems caused by expansion of the core business to the detriment of the other demands upon the capital budget will be relieved.

In the manufacturer, the situation before outsourcing may have been that the computer systems and vehicles were becoming increasingly outdated or expensive to operate because capital investment was always allocated to the production processes. Outsourcing could allow the organization to replace computers and vehicles and to better maintain its buildings.

7. Cash infusion

It is difficult to visualize this reason being the sole reason for an organization choosing to outsource, but I have known this to be so.

Often, outsourcing means transferring some of the organization's assets to the outsourcer. These assets can be buildings, machinery, computers, vehicles and other "solid" assets. They can also include contracts and licences capable of being assigned to the outsourcer. In some cases they can involve staff.

The assets for which the organization will receive a cash infusion are likely to be the "solid" assets. The outsourcer will buy them and then use them to provide services back to the organization.

When assets are sold in this way, they are normally sold at their present book value, which is often higher than their market value.

An outsourcer buying a three-year-old mainframe from a customer will be doing so at a price that far exceeds the current market value of that mainframe. In the case of PCs, the market value is likely to be zero within a few months, although they may continue to have a book value for some years.

It would make commercial sense for an outsourcer to make up the difference between the market value and book value through its charges to the customer, and this is what often happens. The result is that the customer receives the required cash infusion, but will then be paying an additional cost throughout the period of the outsourcing agreement.

Any organization considering using outsourcing to gain a one-off cash infusion would be well advised to examine the ongoing price that they will pay for it.

8. Operating costs

This is the reason most often given for outsourcing.

The logic for using outsourcing to manage and reduce costs is clear.

An outsourcer will provide the same service to a number of customers, and should be able to do this at a cost to itself that will be less than the total cost of the individual customers all doing it themselves. The major area for this will be in the overheads such as accommodation, administration, finance and other services. It may apply also to staff costs, as the number of staff needed to perform the outsourced service could be less than the total number required if all the customers employed staff themselves. An example of this is in computer operations.

In addition, an organization needs to invest in research and development and in training so that it can continue to grow and develop. An outsourcer can be more cost effective than in-house departments for some of these functions.

This logic depends, however, on the organization making these investments; too often, in my experience, there tends to be little investment in R&D and staff development within a customer organization, while an outsourcer will have to make these investments to stay in business. It can be argued, although costs may increase as a result of the outsourcer's need to invest, that these costs are actually better managed than before. The customer's lack of investment would eventually have led to further, unforeseen and uncontrolled costs later on.

9. Additional resources

There are several reasons why resources may not be available internally:

The organization may be expanding into new areas of business
The organization may be expanding into new geographic areas
The resources may have been removed as part of a major reorganization or divestment.

This last possibility is not necessarily caused by short-sightedness or bad management.

A group of companies may have a centralized information systems function, and selling off a company from that group will cut that company off from IS expertise.

Usually, organizations in this situation will be looking either at building an entire function from scratch or at expanding an existing function to several times its current size.

In either of these situations, outsourcing is a viable option. Indeed, in many cases, it is the best option.

As well as these reasons why resources may not be available internally now, there are also some reasons for not making the resources available internally in the future. These include

the scale of internal demand for those resources
the cost of acquiring and retaining the resources.

In some instances, these two factors may both be at work at the same time.

In an organization that has downsized so that it no longer employs specialists in a particular area, there may be a requirement for such a specialist for 10 hours each week. In addition, the specialist's area of expertise may be in demand such that the market price of employing the specialist has risen by 25% since the downsizing exercise. The result could be re-employing someone for 25% of the time at 125% of the previous cost.

10. Control

When a function is difficult to manage or is out of control, outsourcing can appear as a final 'fall-back position'. It implies that the organization has given up on all other ways of bringing a function under control and has decided to sell the problem on to someone else.

There is clearly a problem with any organization that believes that it can sell its problems on in this way, because the problem usually lies with the management of the organization rather than with the manageability of the function.

I have often found that the reason that an organization finds a function difficult to manage is that it does not really understand that function. In outsourcing, it is essential that the organization's management do understand any function that they plan to outsource, so that they can communicate that understanding to the outsourcer.

Choosing to outsource a function (or, more appropriately, to outsource the problem) will probably only lead to the scale of the problem increasing.