The Trouble with Outsourcing: Five Flaws to Remember

In a recent IPG webinar, Benchmarking: A Crucial Tool for In-plants, Consultant Howie Fenton made reference to a Booz, Allen, Hamilton white paper that included some interesting data on why outsourcing often fails. Though the paper (Profits or Perils? The Bottom Line on Outsourcing) is a few years old, it offers some useful observations for in-plants concerned about outsourcing threats.

"There is strong reason to believe that most studies conducted to date have overestimated the benefits generated from outsourcing," reports the Booz, Allen, Hamilton paper, a sentiment sure to cause many an in-plant manager's head to nod. "Many simply ask respondents to estimate the savings they have achieved rather than requiring a more rigorous economic analysis. In coming up with these estimates, many companies fail to consider the full economic impact of their outsourcing decisions. Plus they ignore the administrative costs incurred in managing a new supplier relationship."

The paper highlights several flaws in the way organizations apply and manage outsourcing, which often lead to the failure of these outsourcing relationships and rising costs:

1. Non-core activities are outsourced too automatically. The decisions about which functions to outsource should be made only after thoroughly evaluating whether the activity can be performed most effectively, cheaply, and reliably in-house or by an external provider. The analysis may well suggest keeping non-core functions in-house.
2. Insufficient consideration is given to the full economic impact of outsourcing. An external supplier may initially appear to offer cost advantages given its lower labor costs or higher utilization rates, but when total costs are taken into account including remaining fixed overhead, new supplier management expenses, and transition costs outsourcing is revealed to be the more expensive option. A full cost-benefit analysis should also include an assessment of productivity impacts.
3. A lack of appropriate attention is paid to supplier selection. An effective evaluation process thoroughly reviews a supplier’s qualifications, track record, and cost structure.
4. Ongoing supplier relationships are poorly managed. Sometimes problems can be traced to a flawed or poorly defined original agreement that fails to clearly set service levels or establish appropriate incentives. More often, the problems arise later because the in-house liaison function has not been adequately trained or resourced to manage these new, more complex sourcing relationships.
5. The organization is unable to transform itself to manage new processes and relationships. Outsourcing draws on a brand-new set of capabilities and skills and generally requires a brand-new set of people in key supply management positions.

Read the full Booz, Allen, Hamilton white paper here.