Outsourcing Falling from Favor

Many of the world’s largest organizations that were quick to participate in IT and business process outsourcing (BPO) are bringing operations back in-house and exploring alternatives.

According to a new study released today by Deloitte Consulting, dissatisfaction in areas that traditional outsourcing was expected to improve, such as costs and complexity, was found to be the primary reason behind participants’ negative responses.

The study, Calling a Change in the Outsourcing Market, revealed that 70% of participants have had significant negative experiences with outsourcing projects and are now exercising greater caution in approaching outsourcing.

One in four (25%) participants have brought functions back in-house after realizing that they could be addressed more successfully and/or at a lower cost internally, while 44% did not see cost savings materializing as a result of outsourcing.

Moreover, 57% of participants absorbed costs for services they believed were included in the contracts with vendors.

Nearly half of the study participants identified hidden costs as the most common problem when managing outsourcing projects.

“There are fundamental differences between product outsourcing and the outsourcing of service functions, differences that were overlooked but have now come to the fore,” said Ken Landis, a senior strategy principal at Deloitte. “Outsourcing vendors and companies may have conflicting objectives, putting at risk clients’ desire for innovation, cost savings, and quality.

“Moreover, the structural advantages envisioned do not always translate into cheaper, better, or faster services. As a result, larger companies are scrutinizing new outsourcing deals more closely, re-negotiating existing agreements, and bringing functions back in-house with increasing frequency.”

According to the study, participants originally engaged in outsourcing activities for a variety of reasons: cost savings, ease of execution, flexibility, and lack of in-house capability.

However, instead of simplifying operations, many companies have found that outsourcing activities can introduce unexpected complexity, add cost and friction into the value chain, and require more senior management attention and deeper management skills than anticipated.

Additional study findings discovered that:

The anticipated level of value is not always realized:

  • Many participants (62%) realized that they require more management efforts in comparison to the original estimates.
  • Over half (57%) said they could not free up internal resources for other projects, leading to larger than anticipated deal management overhead.
  • About half (52%) ranked cost-related issues as the main risks of outsourcing.
  • Most (81%) participants have limited or no transparency to a vendor’s pricing and cost structure, resulting in increased chances of paying additional costs.
  • Just under half (48%) indicated that they do not have a standardized methodology to evaluate the business case for outsourcing.
  • For outsourcing vendors, the paradigm is shifting:

  • Most (83%) participants said they have re-negotiated outsourcing deals due to pricing and to business, technology, and regulatory environment changes.
  • Just over half (53%) have moved from long-term contracts (six to ten years) to shorter contracts (up to five years) to increase flexibility and bargaining power.
  • Many (73%) participants are working with multiple vendors to reduce vendor dependency. Participants that had exclusive deals in the past warn that they are very risky, and they will not enter into them again.
  • Just under half (45%) are forced to include gain-sharing clauses in vendor contracts as motivation for innovation, highlighting continuing concern about vendor complacency.
  • “In the near term, outsourcing will become less appealing for large companies because it is not delivering the value as promised, and its appeal as a cost-savings strategy will also diminish as the economy recovers from recession and companies look for differentiated solutions to support their growth, said Landis.

    “However, outsourcing can still deliver value to companies that enter into outsourcing for the right reasons using a right model such as centralize-standardize-outsource, transform-operate-transfer, commodities outsourcing, risk transfer, and shifting fixed costs to variable, and have superb talent in-house to manage these deals from inception to execution.”

    Survey Methodology

    Conducted in person during October through December 2004, the study included responses from senior executives who have both decision-making and operational authority in outsourcing in their organizations.

    The participants represent 25 world-class organizations in manufacturing, transportation, consumer business, energy, financial services, technology/media/telecommunications, health care and the public sector.

    Nearly half of the participants are part of the Fortune 500. One quarter are privately held or public sector entities and four are headquartered outside United States. Six are part of the Fortune 50, and three are ranked in Fortune Global 100.

    The average participant has annual revenues of nearly $50 billion USD. Two notable academics, Dr. N. Venkatraman or Boston University and Dr. Eric Clemons of the University of Pennsylvania’s Wharton School of Business, also participated in the study.