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!