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:
- 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.
- 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.
- 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.
- The contractual crunch and win-lose contracts have unintended consequences. Early on in outsourcing, it was easy to take out costs from redundant processes and locations and bloated technology areas. But lately, it has become harder to deliver the savings promised for a few reasons: 1) the easy fat was cut because of the wrenching margin and competitive pressures just about all industries have been under the past five years; 2) customers learned lots about what to do and how to do it—before they handed over their processes to outsourcers; and 3) customers learned about service level agreements (SLAs) and the use of “change orders” that “put the squeeze on their customers” for more money as a means to cover up their poor scoping capabilities of bidding and running the jobs in the first place. With what result? Outsourcing has become more difficult to support because the processes are leaner than before, leading to more contentious contract negotiation and focus on tight SLAs, resulting in an inherent “I’ve-gotta-win-and-you’ve-gotta-lose” approach to contract negotiation. In the short term, one party “wins” and the other party “loses.” But in the long term, everybody loses. The animosity, frustration, and badmouthing that result are incompatible with what was supposed to be a mutually beneficial partnership.
- What you don’t know will bite you. It sounds simple: Outsource all of your business processes and applications so you can focus on other things. But reality is always more complex than it appears on the surface. There are many “invisible” factors—and activities—that outsourcers don’t, indeed can’t, know about when they’re taking over your processes. For instance:
- The “exceptions” that have to be handled by, let’s say “Betty” and “Michael,” because the computer application can’t understand them: a signature is illegible, or the check bounced and has to be tracked down, or the oil heating cost doesn’t match what the invoice said it should, so it has to be reconciled for this particular customer that Betty and Michael have dealt with before
- The “workarounds” added or new features that were never documented but are now part of the computer application
- The “we’ve-always-done-it-this-way-because-it-works-better” activities that only Betty and Michael know about because they’ve been here for 20 years. It’s these “invisible” things that keep the processes and applications running. And being invisible, these workarounds—both manual and automated—are hard (and nearly impossible) to identify when the outsourcing firm takes them. Companies discover these unseen factors after it’s too late—after customers complain, after frustration has exploded on both sides, after the outsourcing partnership is damaged.
- Outsourcing providers build in a lack of transparency—the “black box” of costs and margins. Watch my lips, not my hands—says the magician as she moves quickly to hide what she’s really doing. Not so different, really, for outsourcers as they try to hide their overall margins and give themselves more flexibility to be profitable over the life of the contract. Understandably, outsourcers are worried about being commoditized; the pressures and number of competitors are always increasing. So, what do they do? They provide a vast range of consulting services, application development, solution deployment, and project management—all grounded by lots of “change orders”—into the complex contract. Since different services have different costs—and different margins—the outsourcer can use (or just say he used) the ones that benefit him the most. After all, when you have lots of people in your business (from the outsourcing firm) or they say they have lots of people elsewhere doing your business activities, how do you know what they are doing—and how much they charge? Can you know what you don’t see?
- It’s easy to underestimate the Bull’s Eye Effect. Lots of stuff has to get done to outsource a business process. This “stuff” ranges from simple things (moving equipment) to hard things (consolidating computer applications) to really difficult things (moving and retraining people). What’s more, it all has to come together just right to create “the perfect storm.” Or as Trevor Davis, the chief implementation officer of one of the world’s largest business processing utilities, puts it, “It’s like hitting the bull’s eye with parallel darts thrown with both hands.” And if that’s not troublesome enough, if one thing goes wrong, it has a “cascading effect” on other things. If you don’t get people trained, then customer service calls don’t get made. If the calls don’t get made, the service level goes down. If the service level goes down, customers defect. And so on, and so on, and so on. It’s like the children’s book If You Give a Mouse a Cookie…—but with far less charming results.
- Companies are starting to reject long-term contracts. In the beginning, long-term contracts seemed to make sense. After all, it takes a long time to get a new company up to speed and operating efficiently. Besides, such contracts appear to offer better rates. But customers are wising up. They’re realizing that getting locked into a five-year contract—complete with inflexibility, broken promises, and non-stop change orders—may come back to bite them. The proof is in the numbers. According to TPI, one of the outsourcing industry’s analysts, (September 2005), 38 percent of the total global outsourcing contract value in 2005 was from existing contracting restructuring; only 62 percent was new contract value. In other words, customers were so unhappy with their existing contracts that they went through the cost, the time, the frustration, and the disruption to change them, many of them with shorter timelines. Unfortunately, the smaller, shorter-term contracts companies have started to favor come with their own problems. Having to deal with more providers inevitably sucks up valuable (and already scarce) management time. Damned if you do; damned if you don’t.
- Outsourcing firms are suffering from the Botox Effect. There’s a reason Barry Manilow and Mary Tyler Moore can’t smile anymore without making it painful for us to watch. Botox takes out their wrinkles but inhibits normal facial expressions. This isn’t so different from challenges outsourcing firms face as they get into the “upgrading” portion of their contracts. Around year three to five, they were supposed to have taken out lots of the “easy” process-based costs and added in the simple automation they promised. The problem is, they discover lots of “gotcha stuff” they didn’t know about back when the contract was signed. Turns out, they oversold. The “technology refresh” is a lot more expensive than they thought—and they’ve got so many operational challenges and cost pressures just to keep going (“keep the smile on”) that they can’t afford to do the promised investments when they promised to do so. They’ve become inflexible. They push out the timeline for the technology refresh. They smile, but it’s an artificial one . . . and the change orders keep on coming.
- All customers want is a flexible, innovative partner—but they usually get the opposite. Customers are straight forward: They want a flexible outsourcing partner who will introduce innovation into their process, help them manage both costs and service, and use relevant and emerging technology. Oh! They also want someone who will truly understand their specific requirements and their business—with a level of confidence and transparency to know what to look for in the business so the “gotchas don’t get ’em.” After all, if the outsourcer loses money, it’s likely the customer will too; a win-lose contract doesn’t help anyone in a long-term relationship. But outsourcers tend to offer their standardized technology and processes—better suited to the “industry laggards” or “mature marketplace” rather than to those who want to use outsourcing creatively, the early adopters or fast-moving dynamic companies. Outsourcing firms tend not to meet many (and slowly the ones they do meet) of these requirements: 1) flexible infrastructure, 2) means to understand the business and the process exceptions, workarounds, and embedded business logic that drives them, 3) innovative in terms of business arrangements and using emerging technologies.
So . . . in the face of all these challenges, how can companies ever “get outsourcing done”? There are certain steps you can take to minimize the pitfalls and maximize the opportunities. Outsourcing is here to stay; it will change, evolve, mutate. And knowing that it will do so—helping “make sense” of these changes and the opportunities—is critical to helping companies “take action” on them. But the single most important thing you can do, the thing that underlies everything else, is just this: know thyself. Make sure you understand your own business inside and out before you do the outsource thing. After all, “making visible what is invisible”—your workarounds and exceptions, your modified technology applications and tools, your “organizational wisdom” that resides in the heads of Betty and Michael—is what is essential to run your business and to ensure effective outsourcing that juggles minimizing your costs with maximizing your value.
Blueprint your business processes to get visibility into what’s really going on. You need to know what connects with what, where, when, how and how much. There are far too many potential pitfalls and risks as well as real jewels and innovation opportunities for you to not have this type of visibility. After all, the outsourcing game is no longer just about reducing costs; it’s also about creating value. It’s no longer an “either-or” game. In fact, one of the most compelling and exciting opportunities around global outsourcing is precisely that new business models and forms, collaborations, and delivery options exist that can be, and need to be, understood to ensure that you’re outsourcing a) what you should, b) when you should, with a full understanding of c) how you should.