Seven Myths About Outsourcing

By PHANISH PURANAM AND KANNAN SRIKANTH
June 16, 2007

In recent years, there's been a seemingly endless boom in offshore outsourcing. But companies that think handing off an operation to an overseas provider is easy can get a rude awakening.

The transition often proves to be much more costly and complicated than expected. And companies often find that their high hopes about cost savings and greater efficiency don't pan out.

To get a better understanding of the problems and solutions, we conducted a survey of senior executives at 62 of the 100 largest financial-services firms in the U.S. and Europe. Arguably, this industry is the deepest repository of leading-edge practices in outsourcing and offshoring. We also conducted approximately 100 interviews with outsourcing clients and vendors from financial services as well as other sectors such as pharmaceuticals and the media.

We found seven common myths that vendors and clients cling to about offshore outsourcing -- false assumptions about how the process should work. They range from unrealistic expectations to poor ideas about how to structure contracts to mistaken views of risk. These ideas can prove deadly to the success of outsourcing projects and even to an organization's overall services-sourcing strategy.

Here's a look at those destructive myths, and how to overcome them.

1. We Can Have It All
In our survey, the executives told us their top criteria for judging the success of an outsourcing project were efficiency, or cost reductions; effectiveness, or improvement in service; and flexibility, or the ability to increase and decrease production rapidly.

Each in itself is a perfectly valid objective. The problem is that many clients expect -- and, indeed, many vendors promise -- all three in the same outsourcing project. The fact is, achieving one objective means making a trade-off in another area.

Let's say a company wants to boost effectiveness by adding more features to its outsourced products or services. Even under the most efficient conditions, costs will increase. For instance, a company with an outsourced call center might set a new goal for effectiveness -- answering 99% of calls within a minute rather than 95%. In most cases, that means the call center must have more employees on hand, especially at peak periods.

There's also a very prosaic reason why mixed motives are dangerous: If people inside the client company have different expectations about the outsourcing project, it's in political trouble before it begins. It is important to prioritize outsourcing objectives and communicate them widely within the organization.

2. Outsourcing Services is Like Buying Commodities
Many companies think outsourcing is a "frictionless market," with no transaction costs or other restraints. A senior operations manager at one of Europe's largest financial-services companies told us, "You'll be surprised at how many of our people thought that outsourcing back-office operations is fundamentally like procuring stationery!"

On the contrary, outsourcing carries significant transaction costs, starting with finding a vendor and negotiating a contract. Then there's the expense of moving the operation from one location to another and subsequently keeping it in sync with the rest of the company.

An offshoring manager from a large financial-services company said, "We still have a significant number of key people on our outsourcing partner's sites in India, but we are very reluctant to bring them home, as we still lack confidence in our partner's ability to deliver if they are not there. This was not envisioned at the start and has caused numerous issues and unexpected costs -- when we went into the deal to reduce cost."

3. We Need an Ironclad Contract
Outsourcing is not a one-time transaction, but an exchange that evolves over time, as competitive conditions and technology change. So, many executives try to write complex contracts that protect them in a host of possible circumstances.

But that's usually a waste of time, as many of our respondents discovered. It is impossible to take all contingencies into account. Instead, companies should write a contract that ensures that all parties understand their roles and responsibilities, and then put in place a process for negotiating changes.

The risks of writing an overly complex contract are significant. In some cases, we learned that a protracted and contentious contract-negotiation process can sour relations between vendor and client even before the beginning of the outsourcing project.

Moreover, sometimes deals are so inflexible that customers must sign a fresh contract to handle any unexpected changes, such as new industry regulations or a change in business strategy. The "simple" act of negotiating and writing a contract also brings high legal fees, and it may lead to productivity losses, as middle managers hold up a job until a new agreement is in place.

Sometimes contracts are so long and convoluted that nobody involved has the time or patience to read or understand them. Managers end up working off rules of thumb, making the contract provisions irrelevant.

Rory Graham, a partner in the technology and outsourcing practice of global law firm Morgan Lewis, related a revealing anecdote. A large U.K. government department that outsourced information-technology services thought it wasn't getting the best out of its contract. So it engaged Mr. Graham, who was then at another firm, to study the contract and other documentation to identify possible noncompliance or breach of contract that it could use as leverage in renegotiating the deal.

Mr. Graham walked into a meeting and was confronted with a document that was 1,200 pages long. Aghast, he asked why it was so long.
"So we can control the vendor," was the response.

"Well, clearly, that isn't happening now or I wouldn't be here," he countered.

Page 1, Page 2