Outsourcing also known as contracting out is a strategic business decision to hand-over some or all of an organization’s non-core production operations/business activities to a third-party provider that specializes in that operation/business activity. It is a concept based on the principles of comparative advantage and division of labor initially expounded by Adam Smith in his book “The Wealth of Nations”.
Smith suggested that individuals, businesses and nations are better off if they concentrate on producing goods and services they are relatively better at than over those they are not. It is this idea that has overtime become the genesis behind current developments in modern management theory; in particular the concept that each company has a few “core competencies” that it is specialized in, and is much better of focusing on those instead of the non-core competencies.
There is a fine but subtle line between Outsourcing and offshore outsourcing. The latter is the correct term to use when the home location of the provider of the services is abroad. Aided by the new instantaneous communications capacity and information technologies, more and more companies are now increasingly embracing the concept of offshore outsourcing to lower costs and increase efficiency. Unfortunately, all too often the promises of lower costs and efficiency gains fail to match the reality.
The debate over the benefits, long term implications and challenges of offshore outsourcing is still ongoing. Yet, offshore outsourcing still continues to be a valid corporate business strategy. So, it is worthwhile to study ways it will live up to its promise than to wish it go away.
Fundamental Framework for outsourcing
Preferably, the decision to use outsourcing should be made as part of a company’s strategic vision to create a new business paradigm of increased innovation and productivity, while reducing costs. Hence, any decision to outsource must begin by asking and addressing such fundamental questions as:
- Why do we need to outsource and conversely why shouldn’t we?
- What do we need to outsource and conversely what should we not outsource?
- If outsource, what do we need to do to be successful?
Discussing the fundamental framework of outsourcing is clearly beyond the purview of this article’s main topic. However, it suffices to say that if the decision to outsource is made, then it would be critical at a minimum to undertake the following:
Increase the rigor of due diligence: The accounting scandal of the recent past such as the Satyam case, though it might not be seen as a symptomatic of the outsourcing industry, clearly underscores the need for buyers to increase the rigor of their due diligence when it comes to their potential suppliers’ financial stability and viability.
Strive to find a better deal structure: The present global economic environment that causes capital constraint and increased vendor flexibility would offer companies the possibility to structure offshore arrangements in new ways, thereby limiting the significant up-front investments of traditional agreements.
Why standard offshore outsourcing is not working?
Whole portfolio of outsourcing agreements
Having a whole portfolio of outsourcing deals for the different areas – different agreements for helpdesk, different contracts for customer care apps, different agreements for application support, and different agreements for new projects – is a recipe for failure.
A slew of outsourcing deals lack simplicity, coherence, and clear accountability which are a sine quo non for getting the best out of outsourcing agreements and ensuring they are delivering long-term value. Moreover, managing and monitoring these multiple agreements not only is cumbersome but would prove costly as well.
What makes rather a lot of business sense is to enter into outsourcing agreement with a single or two outsourcers. That way, you will be evaluating your outsourcing activity on a more strategic level instead of on a mere tactical level. And, this strategic partnership can bring a much needed flexibility and innovation to the company. After all, the large part of the savings from outsourcing deals is derived from the economies of scale of the outsourcer.
Culture Clashes and Communication Pitfalls
It is no secret that there always will be cultural differences between a client and its offshore outsourcer. In fact, the common stereotype of offshore outsourcing is but to blame national cultural differences for things that go wrong with offshore outsourcing. Indeed, there is a certain degree of truth to this fact. Do the offshore teams respond quickly? Do they ask for help when they didn’t understand the tasks? Or do they make ‘big assumptions’ and attempt to perform the tasks? Is the business culture such that no one but the boss could make a decision on changing priorities? Most of the issues surrounding the above questions could be traced to the general difficulties of working with an offshore firm that operate in an entirely different way with a different business culture. So, a bigger barrier to overcome is not mere difference in national culture but difference in business culture.
Embedded within this is also the issue of miscommunication. It may not a pleasant fact but at any stage of a development project, it can mean that the target completion date slips. Just this year (in January 2011), Boeing announced – for the seventh time – a delay in the delivery schedule for its first 787 Dreamliner, pushing its initial delivery back at least three years later than originally planned. These delays beginning to raise important questions for the management practice of outsourcing.
So, what we are underscoring here is this: With offshore outsourcing, miscommunication and cultural differences, even basic ones like “I just assumed that they understood that was one of the requirements” misunderstandings can potentially undermine a project every step of the way.”
High Staff attrition and turn over rate
Staff attrition (or turnover) is like a double edged sword that cuts both ways in that it represents a huge problem for the outsourcing company in terms of training costs, and increase human resources, recruiting, and productivity costs while at the same time it create substantial continuity problems for longer-lived projects, and thus significant delays for the customer company.
Employees leave their jobs for a number of reasons but the major factor seems to be the high wage inflation existing in the outsourcing world. In India, the Mecca Medina of outsourcing companies, the employee turnover rate is estimated around to 24-30%. And that undoubtedly has a significant impact on costs and quality.
Rising offshore Costs/Offshore ‘labor arbitrage’advantage Decline
The early promises of lower pricing and higher profit margins made many customers salivate. “Go east” was the rallying cry, and many followed that cry–only to find out the savings weren’t as great as expected and were only a short-term solution. The relative cost advantage of the leading offshore destinations declined almost universally, while their scores for people skills and business environment rose significantly. These findings reinforce the message that corporations making global location decisions should focus less on short- term cost considerations, and more on long-term projections of talent supply and operating conditions
A Better Way
Unless a company developed a paradigm shift in its approach to its outsourcing endeavor, the ROI on outsourcing will surely be disappointing. Studies that detail all the things that go wrong in outsourcing relationships are plenty. The question you then might be asking yourself is “Is there a better way?” Indeed, there is.
1. “Vested Outsourcing “
“Vested Outsourcing “which is also dubbed as the “next-generation” outsourcing model, might just be the one that you need to achieve greater ROI on its outsourcing investment.
Vested Outsourcing agreement is based on the concept of desired outcomes. The agreement must clearly define financial penalties or rewards for not meeting or exceeding agreed upon desired outcomes. In such an agreement, regardless of what is being outsourced, the outsourcing partner has the ability to earn additional financial value (e.g., more profit) by contractually committing to achieve the desired outcomes. Simply stated, if the outsource provider achieves the desired outcomes (achieves results), they receive a bonus.
Companies too often make the mistake of assuming they have a Vested Outsourcing agreement because they have taken their existing contract and simply added a clause stating that if a service provider achieves the metrics they are paid a bonus. At its core, Vested Outsourcing is fundamental business model paradigm shift in how the outsourcing company and its service providers do business.
Outsourcing should not mean abdication. Rather it must be a close collaboration with regular, frequent communication to manage the expectations as well as the work. As the Boeing’s recent outsourcing debacle demonstrates, a huge problem ensues when a company hands over a process completely to the outsource provider, washes their hands and walks away. By outsourcing both the design and the manufacturing, Boeing lost control of the development process and stuck with the seventh delay in the delivery of the new jet.
By outsourcing both the design and the manufacturing, Boeing lost control of the development process and stuck with the seventh delay in the delivery of the new jet.
Companies that successfully adopt the Vested Outsourcing model would have internalized the following fundamental rules:
- Focus not on activities/tasks but on results/outcomes
- Collaborate in performance partnerships with the outsource vendor and thereby reduce risk
- Establish mutually agreed upon goals – this arrangement will disincentive with lower profit when goals are not met and conversely will incentives with more profit when goals are met
- Achieve optimal service levels and thereby reduce costs
- Drives accountability towards desired results with the outsource providers
Adherence to the rules is crucial to the success of the outsourcing endeavor.
2. ‘Manage’ the offshore Global Resources
The tendency and the accepted practice in offshoring favor leaving the management of the offshore resources with the contracted consulting firm’s onshore staff. Your employees will work closely with the onshore staff of the consulting firm on requirements, design and other activities. The onshore staff will then communicate the work to the offshore resources. In such situations, it is certain you will lose the needed visibility into the work and performance of the offshore team except from the status report you
might receive from the onshore staff. To the extent you lack visibility; the success of your offshore outsourcing will be impacted.
So, putting in place structures to ‘manage’ the offshore resources as you would the onshore resources is critical. Put another way, if as an organization, you employ a large amount of onshore and offshore resources, you would be much better off to treat your organization as a global organization and act accordingly. Some of the structures you could put in place are:
- Establish weekly or bi-weekly video conference calls
You should be willing to work flexible hours and schedule such calls or meetings by accommodating varied time zones. In such calls or meetings, you will have first-hand information on the progress of the work as well as on any issues that need to be resolved. In addition, it provides you an opportunity to communicate clearly, and to make sure all aspects of the work are fully understood. The more time spent upfront in discussion will more than pay off in the long run. Experience attests that in dealing with Far East resources, for example, no is not in their vocabulary and that yes has varied reasons and doesn’t necessarily mean yes I understand.
- Travel and build “face to face” personal relationships
A lot of global leadership of virtual teams has to be done via conference calls, webex and video conference. However, you cannot be successful without “in person” leadership and relationship building. You need to be visible. You have to be physically present as often as practical to develop relationships. There’s just simply no substitute to creating trust and alignment.
3. Establish workable repeatable processes
Building repeatable, scalable, and documented processes is another critical structure you could use to foster success to your global outsourcing endeavor.