Backsourcing: Can you do it right?

Is 'backsourcing' the right strategy? Let's consider, to start, some recent decisions. The list is long, so just to name a few:

American Airlines brought back its IT infrastructure from IBM in 2007. JPMorgan Chase terminated a $5B contract with IBM in 2002. Mutual of New York ended a 7-year contract with CSC in 1997. Sainsbury terminated an outsourcing contract with Accenture after 5 years of service. McDermott International Inc. dropped what was supposed to be a 10-year global IT outsourcing deal with AT&T’s professional services and took back responsibility for design, implementation and management of its IT services. More recently, both Santander and General Motors announced that they are bringing back offshored work from India to onshore. While there are high profile client firms and vendors involved in backsourcing, there is still too little known about the phenomenon – often simply because client firms avoid publicising backsourcing in order to not upset their outsourcing vendors. While we know a little about the reasons for backsourcing, I can safely say that we know nothing about the success of this trend .

Backsourcing (also known as re-shoring or insourcing) is the act of bringing back in-house previously outsourced services as outsourcing contracts expire or have been terminated. This view of backsourcing implies an informed decision-making to backsource, in which firms evaluate a set of factors and arrive at a decision that is based on higher value or better control. Indeed, in the vast majority of cases, firms backsource because they want to improve control over services or escalating costs.

In reality, firms do not always achieve these objectives through backsourcing, simply because the act of backsourcing is often pursued as a remedy to a problem rather than a calculated sourcing model. I believe firms should consider backsourcing once they’ve introduced improvement to their internal sourcing and retained organisation, while other firms should re-consider the decision to backsource as their in-house service support function may not be sufficiently improved since they outsourced. In other words: Success in backsourcing really depends on what you are trying to achieve with backsourcing – whether it’s a reaction to bad planning, or a healthy evolution of the internal sourcing capabilities.

3 Reasons to Backsource: The Drivers and Success There are three main reasons for backsourcing:

contract problems opportunities from organizational changes, and opportunities from external environmental changes. Lets examine each driver and its success criteria.

Contract Problems Why are we still facing contract problems? There are a few reasons: The costs involved in outsourcing tend to be substantially higher than planned because of what has been coined as ‘hidden costs’. Cost savings are not always as promised and tend to erode rather quickly, in particular when the parties face challenges. There is also a sense of losing control on the part of the client firm, which may affect the client’s strategic view of the outsourcing realtionship.

These factors may cause a client to feel that they are locked-in to these outsourcing relationships, and the only way out is backsourcing. For example, in 1996, Continental Airlines ended collaboration with its outsourcing partner EDS, after four years of successful work together. Continental wanted to improve their reservation system to enable more efficient fleet capacity usage and better ticket pricing. Since EDS was not familiar with the air flight industry, nor with Continental’s customers, Continental decided it was preferable to run these IT developments in-house.

The success criteria of this kind of backsourcing depends on the client’s ability to resolve conflicts with the vendor in order to ensure an effective reverse knowledge transfer from the vendor to the client firm. The success of backsourcing also depends on the absorption capacity of the client firm, to take back knowledge and practices and re-integrate them rather rapidly at service levels on par or better than the vendor’s. Considering these fairly major challenges, my advice to the client firm is to rethink their backsourcing intentions. In particular, if the key driver is concern over losing control and running costs, I suspect that the ‘retained’ organisation may lack the capabilities to effectively absorb knowledge and smoothly re-integrate the service.

Internally Generated Opportunities Changes in executive management within the outsourcing company are generally combined with shifts in power distribution. When companies introduce new executives, these new members are three times more likely to provoke changes. In particular, new CFOs and sometimes CIOs reconsider the value gained from the IT outsourcing contract. At JP Morgan Chase, for example, a new management team, including a new CIO, clearly influenced the decision to backsource services.

The key challenge for an organisation that is considering backsourcing following a change in leadership is to understand whether the new leadership can align their sourcing vision with the breadth and depth of the internal sourcing capabilities. New vision, which often means change in direction, can be a changing point for the organisation; however, it can only materialize if the internal sourcing capabilities support such a new path. In addition to a strong retained organisation that can absorb knowledge and smoothly integrate new service, the success of this scenario depends on the alignment of the business and technical vision, and actual operations.

Externally Generated Opportunities Some firms pursue backsourcing following external changes, such as mergers, divestures and acquisitions. The Halifax Building Society’s merger with Bank of Scotland is an example of externally induced structural changes that led to Halifax Building Society cancelling a ten-year outsourcing contract with IBM. In such a scenario, the focus of the firm is on assessing threats following rapid changes in the environment and safeguarding its competitiveness by securing access and ownership of critical resources – one of which is the repatriation of an outsourced function.

The success of this kind of backsourcing depends on the strategic value of the outsourced function to business operations and organisational competitiveness, and the strength of the retained organisation. Most firms fail to realize the strategic value of the outsourced function to business operations , and therefore may improperly interpret signals from the external environment as competition intensifies; however, the remedy for this strategic shift is not necessarily backsourcing a function, but possibly extending the partner networks to tap into innovation and value adding services.

Backsourcing: What should you do?

Based on the list of drivers above, nearly any firm can be a candidate for backsourcing. However, what determines the success or failure of this decision is the strength of the retained organisation, and its ability to absorb knowledge, and re-integrate new services. Further, each backsourcing scenario is different. Therefore, it is important that you carefully analyse drivers (contract issues, internal change, external change) and seek advice regarding the factors affecting backsourcing success.