Hidden costs of outsourcing; what can third party providers do?
August 5, 2009
When the margins are squeezed, third-party service providers are the worst hit. They often have to deal with what can best be described as the “hidden costs” of an outsourcing deal. This is already happening in the case of the Indian semiconductor industry.
Typically, where cost estimates can go for a toss —- sometimes by as much as 20%-40% — include the costs of layoffs, vendor selection, abrupt transition or winding up of a deal. Another major area for cost overruns could, particularly for the third party service provider could be contract management (6-10%). While most such causes of cost variations are erratic and difficult to predict or control, a significant portion can still be avoided by documenting all the intermediary processes of an outsourcing deal to the nth degree. Process management is often the key to vendor or deal management.
Another way to cut costs, as most third party service providers are already doing, is to move their operations to Tier II and III cities, where they can effectively leverage economies of scale and where wages and attrition are lower. The only constrain in this case would be quality management, but even this can be monitored with careful documentation and transparent, well thought-out processes.
Experts contend that the 40%-50% cost saving guaranteed through an outsourcing deal is grossly exaggerated. A realistic target could be 15-20%, especially in today’s market. People who have walked down this route know that unforeseen costs can undercut anticipated benefits.
The only change is that while earlier these costs were largely or almost entirely borne by the outsourcer and happily, so, these days, a big proportion also gets transferred to the brokers, i.e., third party service providers, who are expected to cushion the blow by treating it as a contingency cost and building it into their SLCs.
In the end, a strong communication plan between the offshore and onsite team, besides cultural compatibility, strong structure for governance, and having a offshore risk mitigation strategies are the only ways of mitigating some of these inherent risks of outsourcing.
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