Hidden costs prompt companies to rethink outsourcing strategies

Paul Boughton

Many of the world’s largest process organisations that were quick to participate in information technology and business process outsourcing are bringing operations back in-house and exploring alternatives, according to a new study released by US company Deloitte Consulting.

Ironically, dissatisfaction in areas that traditional outsourcing was expected to improve, such as costs and complexity, was found to be the primary reason behind participants’ negative responses.

The study, Calling a change in the outsourcing market, reveals that 70 per cent of participants have had significant negative experiences with outsourcing projects and are now exercising greater caution in approaching outsourcing. One in four have brought functions back in-house after realising that they could be addressed more successfully and/or at a lower cost internally, while 44 per cent did not see cost savings materialising as a result of outsourcing.

Moreover, 57 per cent of participants absorbed costs for services they believed were included in the contracts with vendors.

And nearly half of the study participants identified hidden costs as the most common problem encountered when managing outsourcing projects.

“There are fundamental differences between product outsourcing and the outsourcing of service functions, differences that were overlooked but have now come to the fore,” says Ken Landis, a senior strategy principal at Deloitte. “Outsourcing vendors and companies may have conflicting objectives, putting at risk clients’ desire for innovation, cost savings and quality. Moreover, the structural advantages envisioned do not always translate into cheaper, better or faster services. As a result, larger companies are scrutinising new outsourcing deals more closely, re-negotiating existing agreements, and bringing functions back in-house with increasing frequency.”

According to the study, participants originally engaged in outsourcing activities for a variety of reasons: cost savings, ease of execution, flexibility, and lack of in-house capability. However, instead of simplifying operations, many companies have found that outsourcing activities can introduce unexpected complexity, add cost and friction into the value chain, and require more senior management attention and deeper management skills than anticipated.

Pitfalls

Additional findings that illustrate pitfalls encountered include:

  • 62percent of participants realised that they require more management efforts in comparison to the original estimates.
  • 81percent of participants have limited or no transparency to a vendor’s pricing and cost structure, resulting in increased chances of paying additional costs.
  • 48percent of participants indicated that they do not have a standardised methodology to evaluate the business case for outsourcing.
  • 53percent of participants have moved from long-term contracts (6–10 years) to shorter contracts (up to five years) to increase flexibility and bargaining power.
  • 73percent of the participants are working with multiple vendors to reduce vendor dependency. Participants that had exclusive deals in the past warn that they are very risky, and they will not enter into them again.
  • 45percent of participants are forced to include gain-sharing clauses in vendor contracts as motivation for innovation, highlighting continuing concern about vendor complacency.

“In the near term, outsourcing will become less appealing for large companies because it is not delivering the value as promised, and its appeal as a cost-savings strategy will also diminish as the economy recovers from recession and companies look for differentiated solutions to support their growth,” says Landis. “However, outsourcing can still deliver value to companies that enter into outsourcing for the right reasons using a right model such as centralise-standardise-outsource, transform-operate-transfer, commodities outsourcing, risk transfer, and shifting fixed costs to variable, and have superb talent in-house to manage these deals from inception to execution,” he concluded. 

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