Outsourcing – have you weighed all the options?

Add bookmark

The conference attendee sitting next to me mentioned they were offshoring parts of their finance shared services. Here’s part of the conversation:

"How's offshoring working for you?"
"Ok, we think, but alot more difficult than expected."
"Are you saving lots of money?"
"Maybe, but we're not exactly sure."
"Did you have a good understanding of all your baseline costs prior to outsourcing so that you compared 'apples-to-apples'?"
"We tried, but probably didn’t include everything."
"Did you consider some of the added costs associated with outsourcing - for example, how outsourced AP might add work to purchasing, receiving & warehousing, management time, etc.?"
"Some, but probably not enough."
"So why'd you do it?"
"Well, the original business case from our consultants looked great."

This and similar conversations have spurred my thinking about shared services outsourcing in general.These days, outsourcing is all the rage, and as a consultant, I’ve seen much done right – and much done wrong. The latter category includes many who consider outsourcing as thenext logical step, or rather, the only option for competing in today’s marketplace. Decisions thus made can be flawed and come back to haunt the company.

The unrelenting push for outsourcing, in spite of the inconsistent results we constantly hear about, makes me wonder if we’re all drinking the same outsourcing Kool-Aid – one spiked with irrational exuberance (and we know how that turned out for dot-coms and real estate!).

The race is on

Few would argue that there’s an ongoing push to outsource as much as possible. Interested in saving costs? Outsource. Want to improve quality or capacity? Outsource. Have a problem area or group of people? Outsource. And these days, most outsourcing typically means offshoring.

But ask a few questions and you’ll mostly hear how difficult it can be, how time-consuming, and how many aren’t even sure of the payoffs.

One consultancy says to expect as much as 35% savings when offshoring. Others show much less, or even cost increases. The best we can say is that results are variable and savings appear to be shrinking.

The worrying shift from transactional

The outsourcing/offshoring rationale has shifted a bit over the past several years. Originally focused primarily on transactional services, more and more outsourcing is moving towards higher end decision and analysis functions.

What’s the problem with this? Many say the future of shared services lies in moving ‘up the value chain’ by offering more analytics and decision-making, thus improving benefits to the business. However, if you outsource most of your people, who’s left to perform these value-added functions? Without people who understand billing processes, receivables, customer habits, and the intricacies of your business – where will innovations and value-added analysis come from? Your future business process improvements are at the mercy of your outsourcer.

If you want innovation and continuous improvement in business practices, then you need people who understand and are closely linked to your business. Your employees are typically more committed and loyal than outsourcers who may be multiple time zones and continents away. Lest you think this is just an issue for shared services, manufacturing companies have been learning a painful lesson for a number of years – that is, innovation and new ideas often come from those with ‘hands-on’ experience in processes and production lines.

Outsourcing the future?

Many companies consider employees as "a cost of doing business". Yet, it's this "cost" that is responsible for producing products and services, developing innovations, making customers happy and making our businesses run. Employees are the source of a business’s intellectual capital.

One presentation I heard recently was particularly disturbing, yet it was not so different from many others. In the first few slides, this company touted their consistent ranking as a Top 100 "best company to work for" in the US. They then proceeded to summarize plans for offshoring most all of their back-office functions, beginning with transactional and then moving up the value chain (but, of course, they softened the blow with a good communications plan for the affected employees). Does anyone else notice the contradiction?

If you outsource most of your transactional jobs (which is often closely followed by outsourcing more value added decision and analysis functions), where are the entry points for your future analysts, controllers, CFOs, CIOs, etc.?In the near term, you can hire from others who are also outsourcing jobs, but soon, the supply chain of expertise dries up. In essence, you’ve outsourced your future, as you lose knowledge and the opportunity to learn internally and instead rely mostly on external sources.

Now couple this with the results of more and more studies that show the often limited savings from offshoring, the increased geo-political risks, and the loss of flexibility – and you start to scratch your head.

What are the alternatives?

Lest anyone think I'm an outsourcing/offshoring Luddite, I realize the payoffs of outsourcing and the economic benefits of world-wide business and trade. However, it seems the decision-making processes surrounding outsourcing could be dramatically improved. Specifically, consider these two options.

First, improve the job of total cost analysis. I was recently involved in a series of LinkedIn discussions with a number of cost accountants on this subject. As one well-known participant lamented, "I believe half the outsourcing decisions I've seen were mistakes, due in part to lousy cost analysis which ignored the significant changes in overhead costs which outsourcing can cause."

Many outsourcing business cases fail to include the full picture of costs and risks, both current and in the future. These costs then get buried in overhead and G&A burdens. In addition, most don't know the true cost of their current processes - or of the cost and performance impacts on other processes throughout the service delivery supply chain. Thus it becomes difficult to compare "apples-to-apples" in many outsourcing decisions.

Total cost analysis should not only include standard comparison data (and consulting fees), but also extra costs associated with such factors as: risk of business interruption, extra inventory, added management/travel time in babysitting the vendor, decreased ability to be respond to your customers, and a decreased ability to improve business processes/supply chains/product designs. So now you’re not just looking at the "sticker price" of that shiny new vehicle, but rather the total cost of ownership for operating something over the next five to ten years.

Because of uncontrolled variables in outsourcing, how do you know if you've included enough cost in the equation? Consider this analogy .Most of you have probably remodeled part of yourhouse or worked on a home improvement project? Did you ever come in at your original projected cost? I haven't - every project seems to cost 50-100% higher than my first estimate.

Same idea with outsourcing analysis. Do the best job you can of adding up the total costs – and then bump that number up by half or more.

Second, look to process improvements first. Another attendee I met at this same shared service conference mentioned they had offshored their AP department. He didn’t know their exact savings, but felt costs were lower since they were paying their offshorer about half of what it had originally cost for the dozen FTEs in their AP department, i.e., a 50% savings. But again, he had no real knowledge of any impacts and added costs to the rest of the company. He also mentioned that the original AP group had been somewhat difficult to manage and so it was just easier to outsource in total.

I questioned him as to whether they could have performed internal process improvement and achieved the same or similar savings. He said "yes", but wasn’t sure management wanted to put in the time, energy and costs it would have required.

As he walked away, I couldn’t help shake my head. Here was a company that could have achieved similar savings without outsourcing, but "swung and missed." In the process, they lost the added benefits of retained intellectual capital, the ability to conduct future value-added analysis in-house and improved morale from saving jobs. Yes, it would have taken management effort and investment, but isn’t that what the management profession is all about?

Bottom Line

In the end, an external outsourcer has three primary approaches for being lower cost than an in-house team.

First, the work is transactional and added to an ongoing system or there are large economies of scale such that the outsourcer primarily charges based on variable costs.

Second, the outsourcer is in a lower wage country. However, we’ve seen labor arbitrage benefits decrease dramatically as wages have risen.

Third, the outsourcer can perform the processes better than the in-house team.

For many, the third approach often ends up to be the deciding factor. Basically, if your in-house team’s processes are done well and you have a good understanding of total costs(including cost & risk impacts on the entire delivery chain)an outsourcer, who must also make a profit margin, has a difficult time beating the in-house team in a well-developed business case.

If, after doing all this, you do end up showing savings from outsourcing, and if the results come in at less than 10 or 20%, then you have to ask yourself if the potential business impacts and risks, both current and future, are really worth it.

So the next time someone hands you a cup of that outsourcing Kool-Aid – just pause a bit and reconsider before taking that sip.

And here’s some more to think about:

Financial Director magazine identified that most CFO's are unable to quantify the ROI from outsourcing arrangements.
"CFO’s struggle to measure outsourcing ROI"

CIO magazine reported earlier this year that offshoring savings are declining - under 30% these days as an average.
"IT Offshoring Savings Declined for Past 5 Years"

Moving up the value chain in AP:

Managed cash discount program: capturing all discounts from vendors and suppliers
Vendor fraud detection & prevention
Overpayment prevention (continuous monitoring)
Pricing compliance (often no single group has this role), including various contract discovery tools from emails and other historical data
Supplier portals

Source: apexanalytix

Those interested in the impacts of outsourcing on manufacturing and process innovation might be interested in a recent series in Forbes magazine:

www.forbes.com/sites/stevedenning/2011/08/17/why-amazon-cant-make-a-kindle-in-the-usa/

Recent summary from ITFMA conference publication:

Outsourcing/offshoring net cost savings for major deals is typically 10-20%
Norm is large upfront investment and long ramp-ups, with up to 5+ years for paybacks
Transition costs are often underestimated
Offshoring/outsourcing may increase risk, reduce flexibility to adapt to change and impair business alignment

One CPA on LinkedIn related a story of working with an auto supplier who had offshored to realize a $3M reduction. A couple of years later they were instead experiencing a net cost increase of $0.5M, all buried in overhead. These cost increases helped contribute to the company going bankrupt a couple of years later.

Additional reading: "Using Lean in Wholesale Financial Services" – see Exhibit 2 (Offshoring alone no longer seems to create a competitive advantage.)

Andrew Muras is Sr. Manager of BAE Systems Support Solutions and is responsible for developing and implementing performance management and business solutions for both industry and government organizations. He gives talks and workshops in performance measurement, knowledge management and process analysis techniques across North America. His professional experience includes both back office/shared services functions and front-line/manufacturing operations. Mr. Muras has recently published a book, Process Improvement and Performance Management Made Simple (www.simpleprocessmgmt.com) and has dozens of articles in such publications as the Journal of Corporate Accounting and Finance, the Petroleum Accounting and Financial Management Journal, Performance Management Institute's Measured Quarterly and Shared Services News.

www.linkedin.com/pub/andrew-muras/2/8b5/a7b