Defining the term
In its simplest term, outsourcing is the contracting out of a business function to an external supplier, involving the transfer of people, processes and assets. This contracting out can be undertaken at either an on- shore or off-shore location, and to one (single-sourced) or more (multi-sourced) outsourcing partners.
Outsourcing is most mature in the Information Technology sector (Information Technology Outsourcing – ITO) although it is increasingly developing to include a wide range of business processes (Business Process Outsourcing – BPO) such as HR, Finance, Procurement, Customer Service, and the wider back office function.
From small beginnings in the 1980s, IT Outsourcing has evolved into a sophisticated global market and most companies, no matter how traditional their business model, have outsourced one or more layers of their IT function. Outsourcing IT has always been a complex exercise, in part due to the requirement to bundle IT into ‘services’ combining hardware, software, people and processes. These services (‘towers’) often contain data centre, end-user computing, service desk, application development and maintenance, and voice and data network packages.
For traditional IT outsourcing there are intricacies in transferring staff, novating contracts and assessing the financial impact of selling physical assets. These complications have been recently compounded by on-demand IT offerings, the evolution of off-shore centres, and the advent of cloud-based offerings.
Business process outsourcing
The outsourcing of business processes that were typically performed in-house began in the early 1990s, and has since grown dramatically with the drive for reducing costs and improving performance.
There are two broad sub categories of BPO:
- Horizontal BPO: Which focuses on the delivery of classic, back office business support functions such as Finance and Accounting (F&A) and Human Resources;
- Industry specific BPO: A rapidly emerging sector which includes services such as claims processing in the insurance industry, and mortgage processing for banks.
Sometimes perceived as a simpler proposition given its focus on transactional processes when compared to ITO, BPO faces its own unique challenges. These are primarily driven by the relative immaturity of BPO, particularly in the industry-specific arena, and the consequential risks of the first generation outsourcing for both the supplier and customer.
Whilst the offering mix is widening, deals are becoming shorter with five years now the prevailing contract term. This aligns to a more rapid technology refresh cycle and provides a client with further control over the deal.
Drivers and evolution
Traditionally, the key driver for outsourcing activity has been cost reduction. Cost is still key factor, but we have yet to see anyone adopt outsourcing when it is more expensive than in-house delivery.
Nevertheless, there are other drivers that are important:
- Speed of development: Following a start up or carve out, a new business entity can use outsourcing to put in place key functions much more quickly and cheaply than developing an in-house capability from scratch;
- Flexibility: Outsourcing can provide the flexible capacity that a rapidly growing – or declining – business may need to keep pace with changing demand;
- Specialist skills: In specialist areas such as IT, attracting, developing and retaining skilled staff can be a real challenge: outsourced providers can often offer access to these scarce skills;
- Political manoeuvring: Off-shoring can be a sensitive topic – outsourcing to a provider that can then draw on its own near-shore and off-shore capability can be politically acceptable way of achieving the same end.
Outsourcing: A dynamic market
Outsourcing has become a major market activity, with Gartner forecasting the IT Outsourcing market alone to reach $287 billion in 2013. With an annual growth rate of 6.5% until 2017, average annual IT Outsourcing investment has reached almost 25% of total IT spend.As this shows, the outsourcing market is growing in complexity as well as size – IT’s impact on the business is growing and with continuing economic uncertainty, there is an ever stronger focus on innovation. In recent years, offshore providers have entered the global market, providing increasingly sophisticated alternatives to the established US and European providers. Outsourcing can also bring regulatory and financial complexity, with legislation around services frequently changing and the tax implications of shifting sourcing strategies providing considerable complexity. Throw in issues such as risk, and rapid, game-changing technological advances such as cloud computing, and you have a market increasing in both sophistication and significance.
A challenging relationship?
“Outsourcing Failure Stories” is its own Google keyword. The potential to achieve significant savings through outsourcing is well known. However, there are a number of examples where companies hit obstacles, get entangled in complexities and simply get it wrong. Without adequate advice, planning and management, outsourcing projects can and do fail. The consequences of a messy public divorce can be disastrous.
In our experience, organisations will almost certainly fail to realise the benefits of outsourcing unless they stick rigorously to the following steps:
- Adequately plan, manage and retain the right level of control/direction in the outsourcing relationship;
- Establish and manage an effective governance process;
- Effectively manage the commercial, legal and financial risks of outsourcing;
- Effectively manage any transition and transformation phases (these being the highest risk, and most failed upon phases along the life-cycle).
With so many opportunities for failure, and to get the very best from suppliers, a ‘tough love’ approach to outsourcing is required.
Each section of the handbook begins with an overview of the key concepts, guiding principles and a summary of the main activities being undertaken. The exact structure of each section varies according to the exact detail being described, but a consistent format for these pages has been followed, as set out below.