When outsourcing fails: How to avoid driving off a cliff?
September 27, 2009
Over the last decade, outsourcing has evolved into a standard global business practice that is considered by some to be a silver bullet that allows an organization to become more efficient and to lower overall operating costs. However, while the benefits of outsourcing along with numerous successful outsourcing case studies are often cited, there are very few specific examples reported of outsourcing failures and even fewer studies that report actual statistics about such failures.
1. How Often Does Outsourcing Fail?
Nevertheless, outsourcing and offshore outsourcing in particular does fail and the few studies and surveys that have been completed about the subject shows that it fails surprisingly often. In fact, an article appearing in an April 2003 issue of Computing Canada cites a whitepaper from management consulting firm Compass that states that more than one quarter of all outsourcing deals will fail during the first year while half of all companies with outsourcing initiatives will seek to renegotiate their service agreements – often with new service providers. Moreover, a 2005 press release from the same consultancy cites an analysis of 8,000 customers in 32 countries from their Compass FactBase database to conclude that 58% of all outsourcing service agreements fail. Meanwhile, in a September 2004 interview for the ABA Banking Journal, David Forte of Forte Partners who has profiled approximately 90 offshore outsourcing initiatives since 2001 along with almost 800 outsourcing programs in general since 1993, states that he has uncovered a 50% plus failure rate for offshore outsourcing initiatives.
2. Why Outsourcing Fails?
Despite the grim statistics, Forte for one is quick to point out that these failures were not absolute failures in a sense that the entire outsourcing project or initiative sank but rather the cost savings and performance targets that were outlined in the service agreements were not achieved due to quality control problems, timeliness issues, hidden costs and/or other “surprises.”
His findings along with those of Compass combined with anecdotal evidence suggest that outsourcing failures can be categorized into several broad categories:
2.1. Trying to Outsource a Problem or the Wrong Activity
Outsourcing can not only solve specific problems or challenges but it can also act as a catalyst for change. However, expecting an outsourcing vendor to solve all of your problems or to straighten out all of your messes will likely doom the initiative to failure. Furthermore, if you don’t know how well your organization or a functional area of it is performing right now, you certainly won’t have a basis to measure how well any outsourcing initiative is performing. In other words, you need to have a clear understanding of where your organization is right now and have a clear map of objectives outlying where you want the outsourcing initiative to take your organization.
Moreover, there are some projects or functions that are simply not meant to be outsourced or are not meant to be outsourced in their entirety. For example, projects that require languages other than English may prove to be difficult to offshore in their entirety and hence, the work may be better off remaining in-house under your control or a tailored solution (such as setting up specific processes that manually or automatically translate the relevant materials) will need to be created so that any lack of linguistic skills on the side of the vendor does not doom the whole initiative in the future.
2.2. Failing to Seek Outside Advice
Outsourcing and entering into an outsourcing relationship is a complex initiative and as Patrick Garrett of global advisory firm Alsbridge pointed out in a brief whitepaper, it is not something that most companies do on a regular basis. In fact, he describes entering an outsourcing relationship using the analogy of buying a car i.e. you may enter into a transaction to purchase a car every few years whereas the car dealer does the same transaction several times a day. In other words, you need to seek outside advice and counsel to help level the playing field as such expert advice, which may cost only a small percentage of the deal or the targeted savings to be achieved, will avoid significant additional costs and/or problems later on.
2.3. Selecting the Wrong Vendor
Vendor capabilities will vary across the spectrum and as David Mitchell of Alsbridge pointed out in an issue of their Outsourcing Leadership News, there are at least six things that even a good outsourcing vendor won’t tell you. These six things include their sales people not talking to their delivery guys, not knowing how to measure their client satisfaction rates, cost models not reflecting all of the commitments entered into in their service agreements, not being able to figure out their own organization (in other words, not being able to find the right resource who is not already allocated on another project when needed for your project), having their own employee turnover issues (especially in the account manager role for your project) and having their own vendor relationship issues.
Thus, and to protect your organization, you must demand to talk to both the vendor sales and delivery personnel early in the discussion process, insist on quantifiable measures to measure quality, ensure that there are procedures or processes outlined in the contract for when more resources are needed to be taped, take into account that your account manager may not be with your vendor forever (in other words, get everything in writing), and have your vendor take responsibility for any problems they may experience with their own vendors.
2.4. Using the Wrong Negotiation Tactics
Adversarial negotiations have long been a hallmark of negotiating outsourcing deals. Even worst, such negotiating tactics are often carried out by the outside advisors or by lawyers who increase their own legal fees by haggling over every contract clause. Hence, you and the vendor fail to establish a strong working relationship and everything begins to breakdown as soon as the project or initiative runs into a roadblock or faces a serious problem.
Moreover, negotiating an outsourcing service agreement is not the same as buying a car or a house where the buyer wants the lowest price and the seller wants the highest price. In other words, an outsourcing deal is not a one-time transaction but rather a long term partnership that needs to work for both parties in order to be effective. Hence, negotiating a deal strictly on price alone will likely lead to cost cutting on the side of the vendor or other methods to recoup lost revenue and hence, end up costing you even more in the long run.
2.5. Writing a Poorly Written Service Agreement
Everything needs to be in writing and having a strong and clearly written service agreement will lead to a strong partnership between you and your outsourcing vendor. At a minimum, the service agreement needs to clearly outline exactly what services are to be rendered, what are the responsibilities of each party, what are the target deadlines to be met, what happens if the deadlines are not met, what are the key measurements to determine service quality levels and success and what are the procedures either party must follow in order to terminate the agreement early.
Moreover, all prices for everything and anything that could possibly be needed throughout the life of the service agreement should be included as it is inevitable that changes will occur and additional services will be needed. Furthermore, some vendors may even price their services artificially low with the intention of making up for any losses when such a change occurs. Thus, having a contract where pricing is completely transparent will go a long way to avoid costly surprises later on.
2.6. Ignoring Potential Management, Personnel or Cultural Issues
Selecting the wrong vendor and having a poorly written contract in place are rarely the big culprits for outsourcing failures. Rather, it is the “soft” issues and the failure to address them that are often the real culprits. These issues include internal resistance to the outsourcing initiative due to poor internal communication on the part of senior management who fail to clearly outline the objectives and positive outcomes that are expected to be gained. Moreover, senior management may even attempt to hide possible negative outcomes such as job losses or changes in job responsibilities and provide no mechanism for employee feedback. This can lead to frustrated employees to disrupt or even sabotage the initiative – forcing management to go into damage control mode after it it’s already too late.
Moreover, management consulting firm Compass cites 80% of outsourcing failures as the result of poor governance due to the lack of initiative or a shortage of management skills on the part of the client and/or the vendor. In fact, Compass also concludes that poor governance can reduce anticipated returns by as much as 75%.
2.7. Losing Control over the Outsourced Activity
Many companies will choose to abdicate their management responsibilities and leave this in the hands of their outsourcing vendor and this can ultimately cut deeply into any cost savings that the outsourcing initiative was designed to achieve. Hence, having the ability to still maintain ultimate control over the project or initiative after it is outsourced and leverage the capabilities gained from unloading if off the balance sheet is critical. Furthermore, how much control and at what level the control will be must be decided in the very beginning and clearly articulated by including limits, deadlines and penalties in the service level agreement.
2.8. Overlooking Hidden Costs
Some of the biggest outsourcing horror stories inevitably involve unexpected and escalating costs that may start from the very beginning. After all, with so many vendors to choose from, selecting the right vendor and getting a service agreement negotiated and in place can easily turn into a lengthy process. Moreover, transitioning the work from doing it in-house over to a third party vendor will inevitably bring additional costs in the form of new IT and telco infrastructure, training and travel requirements, dealing with any employees who are made redundant and resource shuffling that lower costs in one department while raising costs in another.
2.9. Underlying Technological or Process Related Issues
Lacking technical expertise is often cited as a reason to outsource a project or a function to a third party vendor. However, some companies may also have complex systems or have non-standardized software, processes or procedures that may prove difficult to outsource to a third party vendor accustomed to using standardized systems. In other words, the more complex and non-standardized it is, the more it will cost and the greater the chance of failure.
2.10. Failing to Plan an Exit Strategy or do Contingency Planning
While the future cannot be controlled, it can be anticipated. Moreover, times will change and what makes sense today may not make sense five years from now. Hence, there may be a point in time where the outsourcing arrangement no longer works for you, the vendor or both of you and thus, there must be a clear exit strategy from any service agreement that was entered into. Likewise, there needs to be contingency plans in place in case a serious problem or failure happens during and immediately after the life of the service agreement.
3. Conclusion
Outsourcing is a powerful tool for both cost savings and improved efficiency but outsourcing failures happen and they happen often and for a number of reasons. However, with careful planning and awareness of the many speed bumps and pitfalls that exists throughout the outsourcing process – from the initial decision to outsource and continuing all the way through the life of the service agreement – many potential problems and risks can be foreseen and avoided. In the end though, there are never any guarantees that an outsourcing initiative will succeed and act as a silver bullet for bringing down costs or for acting as a key catalyst for change.
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4 Responses to “When outsourcing fails: How to avoid driving off a cliff?”
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Nice article, lot of good tips before you outsource the project. Though most of the issues are obvious, companies often miss these when outsourcing their projects.
Like any partnership, companies must pay close attention to all the details in the outsourcing partnership. Specifically if the vendor is located in offshore locations then companies must perform full due diligence before signing the contract
In my opinion, the failure of outsourcing is frequently because of bad service management. We are a leading provider of payroll services, trust outsourcing and accounting outsourcing solutions and we take these issues very seriously.
One of the most important for the failure of outsourced projects is poor planning and ineffective management. The result is that cost cutting from these initiatives falls far below the potential level. Most companies are not willing to invest time at the onset to satisfactorily plan and implement a project. They also incorrectly presume they have the in-house capabilities to oversee an offshore operation.