Wednesday, June 13, 2007

The perils of outsourcing


Outsourcing of information technology — and to a lesser extent business processes such as finance, administration or human resources — is now so prevalent that it has become the default: companies, and particularly the public sector, have to explain themselves if they don’t outsource, the underlying assumptions being that they are:

(a) missing out on automatic cost reductions attendant on shedding routine operations to specialists

(b) by the same token, handing competitive advantage to those who do.
Yet outsourcing is going through ‘a mid-life crisis’, according to Compass, a management consultancy.

When Compass analysed 240 large outsourcing contracts in Europe and the US, it found that fully two-thirds were unravelling before the contract’s full term. Far from cutting costs, in many cases outsourcing ended up costing more than keeping the services in-house.

Ironically, the inflexibilities are often negotiated into the contract by buyers, whose faith in the existence of large cost advantages is akin to a belief in alchemy, according to Scott Scarrott, Compass’s head of business development.

“There’s no magic,” he says. An outsourcer has to be 20% better than the in-house operation just to cover set-up costs and break even. Factor in a margin for risk, overhead and profit and that rises to 40%.
That’s a handicap that can’t be offset by simple ‘labour arbitrage’ even in low-wage countries such as India, where high labour turnover and low productivity compound the disadvantages.

“For every bad vendor there are at least five bad buyers,” he says. The mistakes are all the bad old management habits, speeded up and updated for an IT-enabled world: short-termism, wrong yardsticks (speed and labour costs rather than anything connected with the business), failure to retain know-how to manage the new relationship, inadequate attention to governance, and an unappealing combination of greed, laziness and cowardice that is manifested in the all-too- common practice of ‘lift and shift’ — simply taking an inefficient operation and handing it over to someone else to deal with, often, in the medium term, by sacking people.

In short, outsourcing has become a classic management fad. Depressingly, the public sector is a serial offender, adding to poor procurement a dogged failure to learn: a contract’s true value can only be evaluated after two or three years, but since those who do the deals are only concerned with procurement, that rarely happens.

Given that IT outsourcing is three generations old, you might expect the lessons to have been learnt by now. A few companies, having found out the hard way, are indeed beginning to take a more selective attitude to the practice: lowering cost-saving expectations, bringing back some operations and retaining much more expertise even in those they outsource.

None of the hi-tech trappings or jargon can disguise the fact that ‘lift and shift’ represents the management equivalent of football’s ‘route one’ — heads down, hack the ball upfield and chase. No wonder customers are unhappy. If they are cynical about customer service with a foreign accent, it’s because they know it’s an accurate reflection of suppliers’ reliance on low-cost and mass- production methods for dealing with them.