Source: theHRDIRECTOR
Date: Summer 2006

Nearly two-thirds of outsourcing deals have had to be renegotiated and almost one in four have been brought back in house, according to a new study of the outsourcing experiences of major UK companies produced by outsourcing consultants orbys in conjunction with Henley Management College. It is clear that whilst outsourcing can still be extremely effective in achieving organisational goals, it needs to be managed correctly…

Outsourcing is an important feature of today’s business landscape. According to estimates, the global revenues from IT & BPO outsourcing for 2005 were $200 billion and $133.7 billion respectively. A high profile aspect of this growth is the move to offshore locations, estimated by the McKinsey Global Institute to involve 4.1 million service jobs by 2008.

Outsourcing has come a long way from the initial focus on the traditional ‘make-or-buy’ decision. Perhaps most noticeable has been the move towards outsourcing more complex activities such as Knowledge Process Outsourcing (KPO), which may be non-routine and have a high knowledge content such as research and development. The growing capability and maturity in outsourcing is underlined by the emergence of suppliers offering the complex services demanded in areas as diverse as contract manufacturing, third-party logistics and customer-service call centres. Firms looking to outsource can turn for advice and support to the specialised consultancies that have developed considerable expertise in this field.

"Unfortunately, experience shows that many outsourcing deals fail to deliver the benefits expected. One estimate suggests that four out of five business process outsourcing deals being signed today will need renegotiation within two years"

Firms seek a range of benefits from outsourcing. Cost reduction is key for many. This can include savings in both operating and capital costs. Such cost savings are possible as the result of the vendor’s exploitation of economies of scale as well as superior expertise. Aside from cost, outsourcing also offers the potential for improving other areas of performance. Underpinning this is the idea that firms should focus on their core competencies. Thus companies that outsource may seek to gain access to process technology and know-how that they themselves lack but that represent a core competence for the vendor. Moving a process out of house can also provide the opportunity to reevaluate and re-engineer, free of constraints imposed by legacy systems and ways of working. Outsourcers can also look to gain both better service and reduced costs over the lifetime of the relationship by leveraging the improvement capabilities of the vendor.

All these remain only potential benefits unless they can be realised in practice. Unfortunately, experience shows that many outsourcing deals fail to deliver the benefits expected. One estimate suggests that four out of five business process outsourcing deals being signed today will need renegotiation within two years. What is more, outsourcing in both the private and public sector is often controversial – especially when jobs migrate overseas. Whilst not all forecasts are as pessimistic, success in outsourcing is not a foregone conclusion. Recently there has been much talk of ‘in-sourcing’ as a solution to problem agreements and there have been several high profile examples in the press. Until now, what has been unclear is how widely insourcing and other alternative actions have been used in practice, and how successful such actions have been.

Neither has there been a clear overall picture of what other management approaches are being used to meet the challenge of successful outsourcing. In short, what is the real picture and what are the lessons to be learned to ensure outsourcing agreements deliver maximum value across the life cycle of the contract?

INVESTIGATING OUTSOURCING
To answer this question Orbys, in conjunction with Henley Management College, undertook a detailed study into the UK outsourcing market by investigating the experiences of 82 large private sector companies, each with outsourcing contracts worth in excess of £5million annually. The research aimed to identify how far expectations of outsourcing are being met, how the performance of the vendor and the outsourcing relationship are being managed, what problems are being experienced, and how these are being addressed.

KEY FINDINGS
Cost reduction and service improvement were key objectives for over 90% of outsourcing deals and almost all companies included these in their upfront planning. An equally important objective was the ability to work with vendors to find new ways to improve products and services and to add value. In this case, however, as many as one in four firms only started thinking about this opportunity later in the outsourcing process, with the risk that they may have followed unsuitable sourcing approaches without the most appropriate vendor shortlist. Reported overall satisfaction levels with the values achieved from outsourcing were positive with 55% being quite satisfied and a further 27% very satisfied. Nevertheless, a significant number of deals failed to meet initial expectations. Over 40% of firms reported that the supplier failed to perform as expected and 35% that the deal failed to meet their needs. More than a third of respondents indicated that there was a mismatch between vendor and client expectations, emphasising the importance of upfront research and planning.

THE RETAINED ORGANISATION
This importance was underlined by the findings regarding the organisation retained in house to manage the outsourced contract. Although the majority of firms addressed this during the planning stage, nearly 40% left it until later. The research showed that there was a significant relationship between failure to plan for the retained organisation upfront and dissatisfaction with the subsequent value of the outsourcing contract.

PERFORMANCE REVIEWS
Once the outsourcing deal is in place, performance review is critical. Whilst about three quarters of firms had formal review processes in place for ‘hard’ factors such as performance SLAs (Service Level Agreements) and pricing against contracted levels, ‘softer’ factors such as the client-supplier relationship and overall strategy were less likely to be monitored formally. In fact, only 55% had formal reviews covering the effectiveness of the relationship with the vendor. Importantly, the research showed that firms with formal, regular reviews of key factors such as delivery performance, commercial performance and risk were significantly more likely to be satisfied with the overall value of their outsourcing.

MANAGING THE RELATIONSHIP
As well as performance reviews, firms reported a range of techniques used to manage the ongoing relationship with vendors. These included jointly-sponsored improvement initiatives and continuity of engagement at executive-level by both parties. Various approaches were also employed to manage the relationship between suppliers and internal customers of the outsourced service, including support to implement internal changes required and ensuring that internal customers understood their roles in the new arrangement. ‘Softer’ dimensions such as internal customer satisfaction surveys and customer involvement were less widely used. As elsewhere, the adoption of good practice in this area was significantly related to overall satisfaction with the value of outsourcing.

PROBLEMS AND SOLUTIONS
But problems still happen in outsourcing. The three most common problems were loss of price competitiveness, declining or static levels of service, and supplier inertia, all of which had been experienced by about 40% of firms. Loss of price competitiveness was particularly linked to the failure to measure vendor performance against the market. Firms reported taking various forms of corrective action to resolve these problems, 71% having implemented remedial programmes with the supplier and 59% having renegotiated the contract. Whilst in almost all cases these actions were at least partially effective, only 29% found remedial programmes highly effective. Most successful was renegotiating with the stated intention to retender the contact, although this was an approach used by less than half of the respondents. Indeed, the evidence suggests that companies prefer to work with the current vendors rather than break off relations altogether, with only 11% of firms indicating that they had issued new tenders for the contract that excluded the current vendor. Nevertheless, in-sourcing remains an option that nearly one in four companies reported using.

COMPETENCE IN OUTSOURCING
The research also provides important insights into the competences firms need in order to manage outsourcing. In fact, only 17% of respondents indicated that they did not need new or enhanced skills to manage outsourced contracts. Most frequently cited (63%) were supplier relationship management skills but service management, contract management and demand management skills were needed by over half the firms. The primary way (85%) of obtaining these skills was by developing existing staff but nearly 40% made permanent hires, and over a quarter resorted to interim management. Consultants were used by nearly a third of the firms. These findings clearly reflect the fact that outsourcing management requires a different and specialist skill set to that existing within most organisations.

CONCLUSIONS
The research reveals a strong relationship between satisfaction with the value of outsourcing and the adoption of good practice in the following areas:

• Designing the retained organisation at the strategy and planning stage
• Adoption of formal comprehensive review processes
• Attention to the active management of the relationship with the vendor

Conversely, failure to meet expectations is related to weaknesses in these three areas. It underlines the need to manage an outsourcing contract actively throughout its life-cycle. High quality strategy and planning initially must be matched by close attention to performance levels and the relationship between buyer and supplier. This, in turn, requires an appropriately structured retained organisation whose members have the skill sets to manage high value, complex outsourcing deals.

"The research suggests that companies expect there to be difficulties, but by and large they do overcome them"

To help ensure flexibility in any contract there can be break clauses and regular performance reviews, but it is always difficult to change supplier once a relationship has started, so the best approach is to work together to overcome problems. The research suggests that companies expect there to be difficulties, but by and large they do overcome them. People managing these relationships should seek to overcome problems as they arise, and should do this as quickly as possible, rather than have them fester on. Any scheme for measurement should be made clear at the contracting stage, and should be designed to ensure accountability.

It clearly has to include the degree to which aspects of any service level agreement are being achieved. To derive value from outsourcing, organisations need to focus on effective prevention of problems – via effective strategy and planning and proactive and systematic management – rather than resorting to only partially effective corrective action programmes. It is in the interests of both clients and vendors to support this process. Such improved management will ensure that expectations are better defined, managed against, and delivered. Organisations should not have to accept less than good performance from their outsourcing arrangements.