What's Missing from Outsourcing

By Sourabh Hajela

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First, everyone jumped on the bandwagon. Then came the backlash. Then we were led to believe that not only could America not compete with third-world countries, but that we were a bunch of whiners.

Now, however, after years of offshore outsourcing results are pouring in and they do not look good for the proponents of outsourcing.

In a recent survey by Deloitte Consulting titled "Calling a Change in the Outsourcing Market," 70% of respondents had significant negative experience with outsourcing; 57% absorbed costs they thought were covered under the agreement with vendors; and, 44% did not see the promised cost savings materialize.

The proof, as they say, is in the pudding!

Cost savings is perhaps the most widely used reason for outsourcing. However, as this and other studies reveal, companies are really not reaping these benefits.

One of the most common reasons why outsourcing does not produce the desired results is because cost model has flaws. The underlying assumptions are incorrect and miss key variables. It also does not help that, for the most part, quantifying costs and benefits is very difficult, if not impossible.

Take for example, the outsourcing of call centers. The underlying premise is that this will save costs on personnel and infrastructure. Personnel costs are reduced because of the lower compensation and benefits paid by the outsourcer. Infrastructure costs are reduced because of economies of the scale and "knowledge payoff" that comes from specialization in a particular business function.

And these are valid points (for the most part). However, what's missing are some key elements from the big picture that can and do affect both cost and benefits:

Loss of Knowledge: Over time, the client company looses its edge in the outsourced function to its outsourcing partner. This will result in it being dependent on the outsourcer who can take advantage and raise prices.

Also, what seems expensive today gets incrementally cheaper, over time, because of the "knowledge payoff." Typically, outsourcing cost models do not include this in the cost calculations.

Loss of Owners' Touch: Customer retention is less costly than customer acquisition. Therefore, repeat sales are critical to revenues. Customer service can make all the difference in this area. The question here is are your employees better at delivering this "quality of service" than the contractors? Probably.

Loss of Incremental Revenues: Cross-selling and up-selling are critical components of company revenues. Also, incentives drive behavior. A "sales person" who is paid by the hour is really not motivated to cross- or up-sell. This will result in loss of revenues to the client company, i.e. you.

One of the ways to alleviate this problem is to structure outsourcing deals, not on a client/vendor model with a pay-for-service basis, but on a partnership model with underlying value-sharing model.

The simplest form of value sharing is base-plus commissions -- a certain base payment for service plus incentives based on, say, increased sales -- both direct and indirect. The latter recognizes the fact that the partner is contributing to brand building that is resulting in sales.

Since customer service indirectly impact sales, a satisfied customer is a repeat customer and customer service is critical to customer satisfaction. Hence, customer service personnel should be rewarded even if they were not directly taking the order.

The problem with this model is that it is very difficult to assign numbers to indirect sales. Sales happen because of multiple reasons and service is one of them. However, careful analysis and collection of data can help solve this problem over time.

Outsourcing is not, inherently, a bad thing. However, it must be based on realistic assumptions supported by business models that factor in all the key drivers of cost and benefit.

Sourabh Hajela is a management consultant and trainer with over 17 years of experience creating shareholder value for his Fortune 50 clients. His consulting practice is focused on IT strategy, alignment and ROI. For more information, please visit www.StartSmartS.com. Or feel free to contact Sourabh at Sourabh.Hajela@StartSmartS.com or post your questions at www.StartSmartS.com/forums/index.asp.