Calling a change in the outsourcing mart

Executive Summary

Organizations have now begun to recognize the real costs and inherent risks of outsourcing. Instead of simplifying operations, outsourcing often introduces complexity, increased cost, and friction into the value chain, requiring more senior management attention and deeper management skills than anticipated.

In addition, outsourcing has allowed organizations to transfer financial and operational risk to vendors, but organizations are discovering that their contracts will never fully protect them against customer damage and business losses caused by service disruption. Many have responded by bringing operations back in-house and by exploring alternatives to traditional outsourcing, such as the Transform-Operate-Transfer model.

Forced to globalize and meet client demands for closer working relationships, vendors face significant challenges, including the prospect of diminishing profit margins. Based on the evidence from our research, Deloitte Consulting is calling a change in the outsourcing market.

The world’s largest companies have engaged in outsourcing for a variety of reasons: to reduce costs, expand capabilities, and increase flexibility. However, contrary to the optimistic portrayal of outsourcing by vendors and the marketplace, outsourcing is an extraordinarily complex process and the anticipated benefits often fail to materialize.

The outsourcing of services requires a complex series of tradeoffs: cost savings versus growth, speed versus quality of service delivery, and maintaining organizational cohesion versus knowledge and innovation.

Vendors and organizations have inherently conflicting objectives, putting the latter’s objective for innovation, cost savings, and quality at risk.

Moreover, the vendors’ structural advantages do not always translate into cheaper, better, or faster services. The world’s largest companies should be able to replicate the vendors’ structural advantages in-house and rely on vendors only under specific circumstances, such as fixing deep-seated structural problems or maintaining infrastructure operations.

Outsourcing originated and became popular as a cost-saving strategy during a recessionary environment. The world’s largest organizations in this study are calling into question its efficacy in today’s economy.

“In the near future, with structural risks that cannot be fully mitigated, uncertain cost savings, and a multitude of components to manage, outsourcing will likely lose lustre for large organizations.”

In today’s economy and labour market, organizations looking for differentiated growth solutions should avoid outsourcing when based solely on cost savings. Many organizations have been compelled to adopt outsourcing to improve their technical, operational, and process management skills.

However, companies should outsource only commodity functions to guard against a loss of knowledge and should plan for short-term outsourcing to prevent vendor dependency.

Demanding transparency to costs, negotiating for simplicity to eliminate hidden charges, and actively managing against service disruptions may improve the outsourcing experience for large companies…but in turn they also will increase the time needed to manage the complexity and costs of these arrangements.

In the near future, with structural risks that cannot be fully mitigated, uncertain cost savings, and a multitude of components to manage (people, process, and knowledge), outsourcing will likely lose luster for large organizations.

An unfavorable mix of rising costs and increased demand will drive up the cost of outsourcing for organizations and vendors. Weaknesses in operational management will result in more deal failures, prompting organizations to bring more operations back in-house.

In the long run, organizations that continue to outsource will experience a loss of bargaining power to vendors as the supply side consolidates.

Those that apply strong skills in deal structuring and risk management and strong management skills to oversee deals from inception to execution will be best positioned to reap the benefits of outsourcing.

Deloitte Consulting’s point of view is that outsourcing will remain a useful solution within the conservative context of five models: Centralize-Standardize-Outsource, Transform-Operate-Transfer, Commodities Outsourcing, Risk Transfer (“Insurance”), and Shifting Fixed Costs to Variable Costs.

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Jim Love, Chief Content Officer, IT World Canada

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