On Management: Outsourcing slowdown

Uncompetitive costs and dissatisfaction with the business impact - have companies had enough of outsourcing?

by Simon Caulkin, World Business
Last Updated: 23 Jul 2013

Tom Peters once exhorted companies to outsource everything except their soul. Given that outsourcing then meant manufacturing and a bit of payroll, that seemed like a typical piece of provocation. But now the idea of a virtual company is a very real one: manufacturing has already decamped to the 21st century workshop of the world, China. Now the extraordinarily dynamic and inventive Indian IT firms have their sights trained on the even bigger prize of services, which today makes up two-thirds of global GDP. Even if some services are unexportable and others, such as financial, are held back by trade barriers, the Indians reckon that virtualising the services value chain - disassembling the parts, exporting them for processing and seamlessly recombining them for final delivery - could be a $3 trillion market.

Some of this is already happening. IT still represents the bulk of the market, with firms offering to take on not just helpdesk, software development and business processes, but the remote management of a company's entire IT infrastructure. Beyond that, though, organisations are increasingly laying off tasks and functions that would previously have been thought of as core.

Financial services firms and information providers are carrying out high-powered analytics in Bangalore; R&D and architectural and other design services are routinely outsourced, as is film animation. In medicine, it is perfectly possible to carry out a scan in one country, send it to a second for processing and a third for another opinion, before delivery back to the country of origin for consultation with the patient. Optimistic providers note that even SME manufacturers routinely globalise their production; why shouldn't modest-sized professional services firms reap similar benefits?

The caveat, however, may be that the next episode in the outsourcing story is not so much a continuation of the present stage as the start of a new one. While the range of 'solutions' on offer continues to grow by the day, second-round customers have learned through experience that just because something is technically possible doesn't mean it necessarily ought to be done. In fact, one UK sourcing specialist goes so far as to say that the industry has hit a mid-life crisis.

According to Compass Management Consulting: "A combination of high-profile outsourcing deals being taken back in-house and dissatisfaction with the business impact of sourcing decisions - such as uncompetitive costs and the negative customer services impact of offshoring - is creating a new mood of mistrust in many outsourcing relationships."

Up to 65% of large contracts are unravelling before their full term, claims Compass. In particular, it found that the much-touted cost savings of outsourcing were largely illusory. Contractors would have to be at least 20% more efficient than the in-house operation just to cover the bid costs and to break even, it estimates - without allowing for a profit margin, overhead costs and a margin for risk. As a result, in many cases, the company would have been better off keeping the operation in-house.

Another issue is the pace of change, both of the technology itself and in the overall business environment. In long-term deals, the benefits of sharply falling hardware and software prices are gobbled up by the outsourcer; in other cases, a company may find itself unable to change strategic tack - for example, an established airline wanting to set up an internet-based no-frills service - because it is locked into a different kind of provision or service level. What's more, once experience has been lost, it is hard to bring work back in-house even if managers want to.

Don't be surprised if such experiences herald something of a slowdown in outsourcing as companies reflect on the relative merits of the 'solutions-driven' and 'problem-solving' approaches to the more ambitious stages of virtualisation. It is true that service virtualisation offers a more tantalising prospect than simply outsourcing a department or function - the opportunity to rearrange parts of the value chain into an entirely new business model.

That's what the outsourcers are now trying to sell, switching the emphasis from 'labour arbitrage' - providing cheap programming grunt work - to 'innovation' and 'transformation', a very different proposition.

Models include the downloads and software that have changed music from primarily manufacturing to a service business and thereby altered its competitive landscape forever; or the blogs and social networks that are usurping roles played by traditional media, although with a less certain outcome.

So to outsource or not to outsource? The question is more complex than ever before - and as ever, the hardest part is deciding on the boundary between body and soul.

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