When outsourcing goes wrong

Outsourcing sounds great in theory, but often falls short in execution. Here are some pithy insights on what goes wrong . . . and why.

By Ralph Welborn

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Once upon a time it sounded so simple. Just send part of your operations to someone else to deal with and sit back and enjoy your new, streamlined, ever-more-profitable organization. But those companies that have taken the outsourcing plunge have found that reality is more complicated than theory. A lot more complicated. If you’re one of them, take comfort in knowing you aren’t alone. If you’re considering joining them, you can benefit from studying the challenges that have blindsided your intrepid colleagues.

I have gotten a firsthand look at the problems outsourcers face. If you haven’t experienced them firsthand, you probably will soon since the reality is outsourcing is a huge issue (as well as opportunity) for companies everywhere.

Consider the statistics:

  • Today, only 19 percent of US businesses have an outsourcing strategy.  However, the percentage skyrockets to 95 percent if only Fortune 1000 companies are considered.
  • Outsourcing grew 30 percent a year between 1995 and 2003. Worldwide business process outsourcing (BPO) services—which include finance and accounting activities like accounts payable and accounts receivable—are expected to grow from $110 billion in 2002 to $173 billion in 2007, an annual 9.5 percent growth rate.
  • By 2008, the outsourcing market is expected to grow to over $500 billion, of which nearly $380 billion will be information technology outsourcing (ITO), with the balance being BPO. This is up from $335 billion in 2005.
  • Approximately 36 percent of the overall outsourcing activities are occurring in the manufacturing (manufacturing, transportation, retail, and communications) industries.

Outsourcing continues to experience double-digit growth. Yet outsourcing providers are facing lower profits, shorter contracts, and unhappy customers.  And few of the $100 million deals signed will generate the expected revenues. Why? Because, at its core, the outsourcing industry rests upon an old business model based on inflexibility and cost reduction that doesn’t account either for the predictable patterns of technology adoption or for the demands customers face for providing more “value” and “service” rather than simply reducing costs for their customers. Times have changed; customers have changed; markets have changed. But the underlying logic of outsourcing contracts, and relationships, has yet to change.

Here’s the gist of the problem: Once the work leaves your organizational walls, you lose visibility—and some say control—over what gets done how and by whom. In other words, you run, immediately, into the “execution gap”—the difference between what needs to get done and what actually does get done.
Consider the 10 lessons the co-author of my new book, Vince Klasten, and I learned about the challenges and difficulties of global outsourcing:

  1. If it looks too good to be real . . . it probably is.  At least 50 percent of outsourcing deals “fail” (don’t return the results promised to customers) and 80 percent don’t produce any savings at all, according to the Gartner Group, an industry analyst. Forrester Research, another industry analyst group, recently reported that more than 25 percent of North American customers are dissatisfied with their outsourcer’s ability to hit cost and service level agreement (SLA) targets, while 69 percent of European customers reported failure to meet expectations for innovation. The key reason? Lack of contract flexibility and the one-size-fits-all approach. The world changes; customer needs change; technologies change. What doesn’t? Too frequently, the answer to that is outsourcing contract terms. Outsourcers (understandably) try to lock customers into long-term deals based on contract terms and pricing that will be out of date six months after the contract is signed. The result? Frustration, irritation, and a sense of impotence regarding lack of understanding and insight into why the sales promises of outsourcing aren’t meeting up with its delivery realities.
  2. Too many outsourcing deals suffer “death by change order.” Here’s what happens: Outsourcing firms don’t always do their homework up front in regard to understanding their clients’ processes. Thus they underestimate the amount of work it will take to meet their promises. Often this is an honest mistake, but other times outsourcers may underquote on purpose, just to get the business. Then, when they get further into the contract, they say in essence: “Circumstances have changed and we’re going to need more money.” Naturally, customers aren’t happy about it, but because they have so much invested in the outsourcer they have little choice but to pony up. When change orders occur several times over the course of the relationship, irreparable damage may occur. Companies lose profits, yes, but they also lose faith in their outsourcing firm . . . and what is supposed to be a fruitful partnership goes sour and possibly even comes to a bitter end.  

  3. The prevalent “core vs. context” approach—outsourcing what’s not important to let us focus on what is important—is becoming outdated.  The “core vs. context” argument states that companies should focus on what is “core” to them—things that directly impact shareholder value or that the customer cares about—and outsource everything else. Examples of “core” things would be R&D—or any type of new product or service innovation—and “context” things would be customer service (call centers) or accounts payable (A/P) and accounts receivable (A/R). This distinction may have worked in the past, but today? We don’t think so. Underlying the “outsource context” chant has been that you had to know only that the service was being provided to you and your customers, but not necessarily how it was being done; after all, if customer service calls were meeting their targets in terms of number of calls taken and number of complaints resolved, then all is good, right? Wrong. Dell Computer had to take back (“insource”) its outsourced customer service centers because of the huge number of customer complaints they were receiving about it—and the drop-off in number of additional sales that usually accompanied customer service calls. And, on the “core” side, Procter & Gamble, one the world’s leading companies known for its innovative product design, has now “outsourced” or more appropriately “co-sourced” its product innovation process—for a simple reason. Procter & Gamble has 1,500 “product designers”—those people who come up with new product ideas that consumers globally clamor for and Wal-Mart sells to us all—but the world has 15,000 of them. So, P&G, realizing 15,000 people developing product ideas would far out-innovate/out-create product ideas than could 1,500, created a co-sourced innovation model with product designers around the world—harnessing the brainpower of people well outside their organizational walls.  Recognizing that such new models of innovation and strategic value are occurring, quickly and all over the place, forces all of us to re-consider the role, impact, and type of “outsourcing” relationship that makes sense—and that far too often is ill- or not-at-all considered because of the tired old outsourcing model underlying and offered by most service providers.

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