Outsourcing holds significant promise but has serious legacy problems. The chief economic rationale of traditional outsourcing has been efficiency and cost savings. It has often been used to fix non-performing companies by off-loading risk and undesirable processes to vendors. Vendors have too often been pitted against their clients to make money while retaining huge contracts. When the calculations of all parties have proven wrong, vendor profitability and unrequited buyer returns have been the casualties. Despite this, companies have steadily increased their use of the practice because returns, while sometimes below projections, have been significant.
The wrong rabbit
The most critical issue with traditional outsourcing is less obvious, however. Fundamentally, firms are trying to create economic value, and today they must try much harder to cut costs because customers no longer value low prices and limited choice as they once did. Companies are chasing the wrong rabbit: vast swaths of the Industrial Economy are facing commoditization due to chronic overcapacity. Traditional outsourcing can provide near-term value through process innovation and labor cost arbitrage, but upside will be limited as companies hit the point of diminishing returns. Innovation and new offerings are where the value is in the emerging Knowledge Economy.
The client-provider relationship
Traditional outsourcing uses Industrial Economy methods to create value: highly complex conditions and definitions, tight process control, punitive SLAs and aggressive contracts. These practices often assume stable business conditions against which vendors and clients must perform and be penalized if they don't measure up, yet stability is down and volatility up. Too often the relationship between provider and client is not one of collaboration and openness but of tolerance and suspicion. There is extensive up-front analysis and negotiation to get the deal done, but interaction falls off afterwards. This style of relationship is not at all suitable when the goal is sustainable innovation.
Since innovation involves an inventive, relatively abstract process whose output is something fundamentally new, it requires a high degree of trust and information sharing to manage risk and results. The relationship must be flexible, and the parties acknowledge that there will be factors that arise that change the proposition. Most important, trust enables the parties to accommodate unplanned events and volatility because they understand that all parties must find the venture rewarding.
A new look at upside
Innovation and new offerings have the potential to produce significantly more value for shareholders than cost savings, especially considering imminent changes in global demand for the majority of products and services. The cornerstone of innovation process in the Knowledge Economy is helping customers to have rewarding experiences. Companies will create the most value by gathering and analyzing information about customer experience, packaging that information to create knowledge and applying that knowledge to innovate new offerings. Their knowledge of customer experience itself will enable them to constantly offer novelty and value. "Customer intimacy" used to be a hollow tagline, but it is rapidly becoming actionable due to IT-enabled information- and knowledge-gathering tools.
However, "customer experience" is a relatively abstract, complex and fast-moving target. To succeed, enterprises will work with a network of specialist providers that have insight into various aspects of experience. Orchestrating knowledge sharing among their network will be a high art practicable by firms that learn to excel at collaboration in a networked environment, which is characterized by voluntary participation.
Results confirm early stage adoption of a new phase of outsourcing
The world is changing around outsourcing, and reputable analyses of outsourcing results show that companies are in the early part of the learning curve of a new phase. Because outsourcing reflects a wide array of business activity, many reports are specialized by industry or function; however, the trend is that results are varied and unpredictable when compared to mature business practices. It is also important to recall that outsourcing became a sensation during the economic downturn of 2000-2004 in the U.S., which is one of the leading countries in outsourcing contract value. In the rush to save money quickly, companies were too light on due diligence, and many contracts underperformed. In addition, many new vendors were stress testing themselves under new conditions, and some didn't measure up.
- 70% of the most experienced outsourcers had negative experiences and have revised their outsourcing strategies; they will continue to outsource but with much more dilligence.1
- 75% of U.S. and European multinationals use outsourcing or shared services to support financial functions, although less than half consider outsourcing to be cost effective. "Many companies enter outsourcing arrangements without conducting a proper cost-benefit analysis."2
- Offshore IT outsourcing providers are achieving better results than onshore in 2005, perhaps reflecting increased flexibility, lower costs and ongoing maturity/experience (47% of offshore clients had all their expectations met v. 29% onshore).3
- Predictably, companies are significantly better at achieving results when the outsourcing goal is cost savings than when it is revenue enhancement: roughly one-third of goals for access to new markets, quality improvement and increasing responsiveness fell short of expectation.4
Transformation for outsourcing
The practice of outsourcing must be redesigned for the Knowledge Economy. Such a redesign must explicitly address outsourcing's legacy issues, value chain player roles and cultural challenges. It must foster open collaboration, increased information sharing and trust. Tomorrow's leaders will recognize that the greatest risk today lies in acting too slowly rather than in having competitors steal their ideas. In the Knowledge Economy, life cycles are short, so having high innovation velocity is a critical success factor.
|Outsourcing must be transformed to enable enterprises to create innovation-focused partner networks.
1. Calling a Change in the Outsourcing Market, Deloitte Consulting, 2005
2. PricewaterhouseCoopers Barometer Survey, 2004
3. DiamondCluster 2006 Global IT Outsourcing Study, 2006
4. Outsourcing Strategically for Competitive Advantage, AT Kearney, 2005