There is a lot of talk these days about the rationale for outsourcing migrating from cost to quality. But ask the CEO or board of most large companies for their primary motivation in signing an outsourcing deal, and cost savings will not be far from the top of the list.
The fact is, people do not outsource without a business case for doing so. And whatever other elements go in to making up a business case, cost has to be one of them – even if it is not necessarily the foremost driver.
However, the cost equation itself can vary widely between different deals, reflecting the wide variety of reasons why it might cost less to have someone else handle your IT or operations than doing it in-house. Economies of scale and standardisation can dramatically reduce the cost base. And there is the option of going offshore to a lower-cost environment – a cost play that can also be a political and industrial hot potato.
In this context, it is important to remember that outsourcing and offshoring are different decisions. Companies are not obligated to rely on a third-party supplier to tap into the wage arbitrage and cost benefits of going offshore. But confusion over this whole area has created a widespread public perception that outsourcing and offshoring are the same thing – when of course they are separate strategies, but are sometimes used in combination in what some call a best-shore outsourcing model.
Beyond the cost motivation for outsourcing, a second driver that we are seeing increasingly in deals is reshaping of the business for strategic reasons. A lot of major businesses have improved their performance by using outsourcing to focus more tightly on the areas where they add most value, and using third-party specialists to handle non-core areas.
Here again, the picture is not as simple as it might seem. People used to say you should keep core activities in-house and outsource the rest. But some capabilities that are core and absolutely critical to your business – IT being a prime example – might still be handled more effectively and efficiently by someone else.
For other instances, look at the motor industry, where the manufacturing of vital components is contracted out, or at the trend in financial services towards outsourcing customer contact and distribution in order to focus on branding and product “manufacturing”.
A further increasing driver for outsourcing IT and other functions is the need to meet increasingly stringent and costly regulatory requirements. Once again, financial services emerges as a prime example. In areas such as payments, many financial institutions lack the specialist skills in-house to comply quickly and cost-effectively with regulations such as the Single Euro Payments Area (SEPA) – and outsourcing is a logical way to access the necessary capabilities.
Finally and very significantly, as major European cross-border merger activity is at its highest in a decade, mergers and acquisitions are becoming an increasingly prominent driver of outsourcing decisions. Post-merger integrations present a unique opportunity to decompose and recompose processes across the merged entity, as well as allowing those processes to be redesigned and reengineered to deliver higher efficiency and/or service quality.
Increasingly, the solutions considered for this purpose include outsourcing of enterprise-wide functions to an “industrialised” provider of services ranging from IT, to HR and credit services. The benefits can go beyond better and cheaper operations, since an outsourced supplier can bring the added benefit in a post-merger situation of being politically independent of each merger partner.
Looking forward, with businesses’ primary focus shifting from controlling costs to generating more revenue, we believe the motivations for outsourcing will continue to evolve. Specifically, outsourcing techniques are being used as a way of driving revenues upwards and speeding up “time-to-value”.
Recently, we have seen cases where outsourcing has demonstrably shortened the time it takes a company to achieve the business objectives it has set itself. In doing so, outsourcing has actually enabled these businesses to reduce the level of risk in their operations – a far cry from the traditional view of outsourcing as being all about cost reduction but with an increase in risk.
Having said that, the need for a robust business case means cost considerations will always play a part in any outsourcing decision. But boards need to look well beyond the costs trigger – and more and more are now doing so.
Jean-Louis Bravard and Robert Morgan are authors of “Smarter Outsourcing”. Robert Morgan is a founder director of sourcing advisory firm Morgan Chambers. Jean Louis Bravard is managing director at EDS Global Financial Services Industry.