Sunday, February 03, 2008

The pitfalls of outsourcing ....

A couple of months ago, a friend of mine from "a galaxy far, far away" mentioned how the policy of outsourcing that they were following was causing all sorts of problems. The promised benefits and cost savings were much less than expected and they felt they had not only lost significant amounts of talent but were dependent upon the vendor.

What had gone wrong? I can't talk about the details but I'll try and explain.

If you take an snapshot of a company at any time, you will find that it consists of a mass of different activities (where each activity is either a process, or part of a process, or related to the result of a process such as a product or service). Each of these activities is on their own pathway from innovation (some new and relatively unknown) to commodity (something common and well defined).

In figure 1 - I've provided a very simplistic and hypothetical example of such activities in a profile form. The components are actually all connected but the profile helps to highlight that many are far more widespread (ubiquitous) and well defined (certain) than others.

Figure 1 - Hypothetical examples of organisational activity


Now, many companies organise themselves by type of activity such as marketing, finance, operations and IT. Each "function" of the business will therefore consist of a range of activities from innovation to commodity. Ideally when you outsource a "function", you want to outsource those activities which are well defined and common in your industry i.e. the commodities, see figure 2.

Figure 2 - Focus of outsourcing


Such activities are more likely to be suitable for economies of scale, standards and an ecosystem of providers. This is where outsourcing can work and for a business consumer this roughly translates to lower prices, reliability, increases in speed and potential for portability in a competitive market.

However if you outsource a function of the business, such as marketing or finance or IT, then along with the commodity like activities you will be outsourcing some innovative and transient activities - see figure 3. For such activities there will be no economies of scale, standards or an ecosystem of providers.

Figure 3 - Additional activities lost in outsourcing



The net result of such an outsourcing would be a loss of innovative activities, potential future profits, capability and talent. Furthermore such outsourced activities are unlikely to show any economies of scale and are more likely to result in lock-in and cost overruns.

Outsourcing is a sensible approach for commodity-like activities, for all others, buyer beware. If you are intending to outsource a function of the company, then ideally you should only be outsourcing those commodity activities, and ideally to multiple service providers.

I mention this because the same conversation came up again recently. I was a little bit harsh in my response by making numerous references to the Golgafrinchan B Ark and why management consultants were included.

In general though, if you are considering outsourcing, then :-
For goodness sake, make sure you are fully aware of ALL the activities you are outsourcing and whether those activities are suitable for outsourcing. Not everything is.

Look before you leap!

22 comments:

Anonymous said...

Interesting concept. Would you say that's the reason why the outsourcing partner is not able to innovate on behalf of the client? They are left to handle stuff from which the innovation potential has been squeezed out.
Outsourcing providers argue that they do innovate a lot but most of the time the impact is not explicitly seen in the end result which is often a stringent metric.

swardley said...

Good points.

Even when you outsource an activity which is common and well defined to a 3rd party provider, there is still plenty of opportunity for the provider to innovate (whether incremental or radical or disruptive) in the operational details of "how" that activity is provided. For example, the utility electricity industry didn't stop innovating just because we had standards and a competitive market. Whilst they innovate in the operational detail, what they provide to most of their customers (e.g. it is common) is the same standard service (e.g. for A/C, specific frequency, voltage etc).

These are the innovations which are "not seen" as they do not change the service you receive. However they are part of a competitive market, as each provider tries to gain advantage over another.

As a consumer of these services, you generally desire reliability, low prices and patration (freedom to move between providers). Lower prices are achievable because of economies of scale.

However, economies of scale require that the activities that you outsource are well defined and common i.e. commodity - like. An innovation which is relatively undefined & unknown and undertaken by a few companies will not achieve economies of scale.

If you are a large Pharma company, you would not expect that outsourcing a new programme to "create an anti-aging process based upon XYZ" to a 3rd party is going to achieve economies of scale. Outsourcing the manufacture of a well defined drug might do, but not the initial creative process.

Now there is an argument in circulation that invention, ideas and innovation can be "outsourced" to open innovation markets. However, though these markets are a useful tool particularly for dealing with post-event innovations (i.e. those that have already happened) there would seem to be a significant problem with treating a non commodity (such as innovation) as a commodity, which is what an OIM does. I'll blog more on this particular point in detail over the next week or so.

The basic principle is that when you are considering outsourcing, focus on those activities which can be described as common and well defined.

Michael Allen said...

I agree with Anonymous that your original (and very interesting) article underestimates the outsource provider’s commercial and strategic imperative to innovate, namely to improve processes which makes them more effective (and therefore more profitable), and to improve customer outcomes, which strengthens the relationship.

Standards such as ITIL has succeeded in levelling the playing field when it comes to operational processes and outcomes, but now that the market has mostly all adopted ITIL standards, it has meant that the ability innovate on behalf of the customer has become the key battle ground in defining a competitive advantage.

But I also agree with your reply that the service provider will be increasingly likely to provide “incremental” rather than “radical or disruptive” innovation.

The key is to ensure innovation is a collaborative process between the provider and outsourcer. That’s certainly the case with our clients (www.talkinnovation.com) in the Managed Service and Outsourced sector. Ideas are raised, discussed and rated by all stakeholders. This way, you are more likely to get the right mix of innovation that can benefit both parties.

swardley said...

Hi Michael,

Fantastic comment, much appreciated.

As I mentioned earlier, "even when you outsource an activity which is common and well defined to a 3rd party provider, there is still plenty of opportunity for the provider to innovate (whether incremental or radical or disruptive) in the operational details".

Now in this instance I'm talking about an activity (either a process, sub-process or result thereof) which is well defined and ubiquitous within an industry. Such an activity would be considered a cost of doing business, and of little strategic value due to its ubiquity. A business consumer would be expected to focus on price, quality of service and portability between providers. This doesn't mean that the providers won't innovate - of course they will.

However, in my opinion, it does means that they will tend to innovate in the "how" rather than the "what".

As you point out, "Standards such as ITIL has succeeded in levelling the playing field when it comes to operational processes and outcomes". I completely agree with this, however I also believe it has much further to go.

Many of the activities undertaken are so ubiquitous, that we really should be asking why they aren't provided as utility services with a choice in providers. This is slowly starting to happen in the SaaS (software as a service) world but it has taken almost seven years for the conversation to really get started.

Where an activity is in a transitional stage between innovation and a ubiquitous, well defined standard, then I would agree with you that "a collaborative process between the provider and outsourcer" is essential.

Good comment, much appreciated.

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KPO Services said...

Outsourcing has rapidly become an effective management tool to reduce costs, control outcomes, and focus on core business practices. However, because your success is often dependent on foreign cultures, laws, and business customs, it can be replete with pitfalls. A well-drafted outsourcing agreement can help minimize those pitfalls and soften the blow when unavoidable ones arise.

Julienne

BPO Manila said...

Thanks for sharing. While I agree with your points on the pitfalls of outsourcing. I still think that outsourcing has a lot of benefits to offer. It's really all about choosing the right outsource partner. I think, essentially, the first year of outsourcing should be spent building a good relationship with the outsource partner so that you will learn to be in tune with each other and trust each other.

Michael Renton said...

I think it is like anything in life, if you ask enough people, you will hear views from both ends of the spectrum.

Outsourcing is far from the magic bullet, but if done right, can be very valauble to a business.

Nice article!!

Knowledge Process Outsourcing said...

Outsourcing has rapidly become an effective management tool to reduce costs, control outcomes, and focus on core business practices. However, because your success is often dependent on foreign cultures, laws, and business customs, it can be replete with pitfalls. A well-drafted outsourcing agreement can help minimize those pitfalls and soften the blow when unavoidable ones arise.

Outsource seo said...

There will always be companies wanting to outsource if you want my opinion.

Telemarketing Companies said...

Companies just have to be careful in choosing their supplier. Always do a background check on the company, the team and each agent who will be working for them. Clients should work hand in hand with the BPO company and not let them do all the work.

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Anonymous said...

Great post! Outsourcing has become more useful these days and a lot of innovations has been made to improve what it can do. Best of Luck!

Natasha Lauren said...

Great post! Outsourcing has become more useful these days and a lot of innovations has been made to improve what it can do. Best of Luck!

mohanraj said...
This comment has been removed by the author.
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Daniel Hedstrom said...

That's very interesting. You pointed out a lot of important stuff about outsourcing. I heard that in the U.S., they're proposing an Anti-outsourcing Law. I don't know why but I think this would affect a lot of industry.
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bethany said...

A nice article. Maybe anything in this world has its ups and downs we just have to deal with it. Most seo reseller wont tell their negative side but they will tell your convincing outcome.

Thomas Woodall said...

Outsourcing is the most convenient way of getting the needed hands for a company that does not want to bother with the hiring and selection process. For them, it is too time consuming and in consideration of the training and development expenses, they find it too much. As such, it is but practical for them to get contact centre (sales outsourcing) especially on product sales and upgrades.

Cyrus Gilmore said...

An outsourcing company is not complete without the customer care representatives, but that has been the big issue for quite some time now. Agents can always undergo a call centre training, but it's always the communication skill that matters the most. Anyone can communicate, but it takes a good skill to do it effectively.

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I think they should know better and just adapt to the current marketing strategies such as SEO if they really want to be cost-efficient.

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