Nailing the Outsourcing Deal

Handing off key business processes to a third-party provider calls for considerable thought and planning. These best practices can help you capture the full value of an outsourcing effort.

Companies that have undertaken outsourcing initiatives are generally happy with the results -- more than 80 percent attain ROI above 25 percent -- but they struggle to maintain a productive relationship with their outsourcing service providers, according to new research findings from Deloitte Consulting LLP. The study surveyed 300 senior executives who were involved with outsourcing projects at midsize and large organizations in the United States, Canada, the United Kingdom, and Germany.

Nearly 40 percent of survey participants reported that they had terminated at least one outsourcing contract in their careers, and 61 percent said that they had escalated problems to senior management in the first year of a contract. Dissatisfied respondents' complaints included higher-than-expected costs and poor quality communication and service from providers. And fully 50 percent of participants who reported that they were dissatisfied or very dissatisfied with their largest project said that they had brought the function back in-house.

A large part of the problem is companies' "lift and shift" mentality, which sees an outsourcing project as a simple cost-driven move designed to realize the benefits of economies of scale and labor arbitrage. That's aiming much too low, according to Deloitte. Instead, businesses should be looking for benefits of process transformation and enhanced competitiveness. And those can be impressive; the study cites a global media company that used outsourcing as a way to reengineer its finance and accounting processes, slashing financial management costs by 50 percent and reducing internal trading volumes by 75 percent.

The study recommends the following actions for companies that want to capture the full value of an outsourcing project:

• Rightsize the deal. In addition to taking a more transformational approach, companies should ensure that the outsourcing initiative matches their overall business needs. When asked what they would do differently if they had to do their outsourcing effort over again, nearly half of the executives surveyed said that they would do a better job of defining service levels aligned with business goals.

Alignment of business strategy and outsourcing objectives is one of the most challenging aspects of an outsourcing project and should encompass operational strategy, including metrics such as productivity and time to market; competitive strategy; and financial strategy, including the effects on risk management and working capital.

• Build a solid foundation. Defining the business case for the project is a crucial step, but, surprisingly, it's one that often gets short shrift. Only 37 percent of the executives Deloitte surveyed said that their company had used a business case/strategy assessment during the outsourcing initiative. Companies often think that they don't have the resources to produce a formal business case, or that they already know the issues and don't need to bother. But they sometimes have only a vague idea of the total cost of ownership of the solution they're purchasing. Hidden costs such as more complex reporting and the impact of language and cultural differences on productivity can quickly sink ROI.

• Choose the right service provider. This is another area where companies tend to shortcut the process and, as a result, end up leaving money on the table. The selection process calls for a clear, well-designed RFP that encourages innovative responses from vendors, for example by describing both the operation's current state and its desired end state. Don't let existing relationships with providers short-circuit the selection process. And don't give midlevel managers too much decision-making power in this area; they may be tempted to stick with what they know, rather than exploring the possibilities for fundamentally rethinking process design.

• Strike the deal. Senior executives should continue to be involved at the contract negotiation stage to ensure that strategic objectives don't get buried in legalese or marginalized by a procurement department that's overly focused on costs. It's important to build into the contract enough flexibility to respond to future business requirements, for example by requiring periodic technology reviews to ensure that systems remain current, and regular benchmarking of service quality and cost against industry standards.

• Follow through after the deal is signed. Active management of the outsourcing initiative is critical, and it calls for close monitoring of performance on an ongoing, daily basis as well as a commitment to managing the provider relationship. The cost of those functions can add up to as much as 7 percent of the annual contract cost. While most outsourcing contracts include provisions for penalties if required service levels are not met, it's important to avoid "managing by penalties." Instead, companies should work with the provider to identify and remedy the causes of a problem.

Read the full study, "Why Settle for Less? The Deloitte Consulting 2008 Outsourcing Report."