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Outsourcing: A Tool for Survival
Posted in Growth
Written by Suzanne Bell and Daniel Stevenson of Wilson, Sonsini, Goodrich & Rosati’s, as part of the firm’s Winter 2008 newsletter.
In an economic environment where virtually every CEO’s mandate includes cost-cutting, smart and strategic use of outsourcing may differentiate companies that survive this downturn from those that will not make it.
Outsourcing is not a new cost-saving strategy, but over the last decade, the outsourcing-service-provider market has matured in a way that makes outsourcing an option for companies of all sizes. Niche-focused service providers have emerged, offering outsourcing possibilities that previously were not available to start-up companies.
What Is Outsourcing?
Ask 10 people what “outsourcing” means and you are likely to get 10 different responses. Part of the reason for this is that outsourcing covers many different areas. For one respondent, it may mean manufacturing, for another it may mean a help desk, while for another it may mean payroll processing.
At its essence, outsourcing is hiring a service provider to do something (anything from hosting data to software development to customer service) that the company could do for itself, but is better and less expensively done by the service provider. Because outsourcing can be integrated into a company’s strategy in many different ways, there is no one-size-fits-all answer for what and how a company should outsource. Successful outsourcing arrangements are founded on a careful evaluation of what functions the company is currently performing that could be done better and less expensively by a service provider.
Does Outsourcing Really Result in Cost Savings?
Outsourcing in general has proven to be an effective cost-saving strategy because it gives a company access to less-expensive work forces and allows the company to delay upfront capital investments. In a recent study by Deloitte Consulting, 83% of the 300 executives participating in the study reported that their outsourcing projects met their ROI goals of more than 25%.
These responses suggest that outsourcing certainly can be a powerful cost-saving tool. To increase the likelihood of realizing a company’s ROI goals, it is important to keep track of hidden costs (e.g., travel, vendor selection, and legal fees, as well as transition costs) when modeling an outsourcing arrangement.
Successful outsourcing arrangements are founded on a careful evaluation of what functions the company is currently performing that could be done better and less expensively by a service provider.
Additional Reasons to Outsource
In addition to cost savings, there are other compelling reasons to outsource. In many instances, these reasons provide companies with the greatest ability to differentiate themselves from competitors through outsourcing.
They include:
• access to best-of-breed expertise;
• freeing internal resources to focus on strategic internal projects;
• hastening time-to-market capabilities; and
• leveraging around-the-clock capabilities through international locations.
Outsourcing Can Be Scary
As great as outsourcing can be for a company’s bottom line, it is not without its risks. Careless outsourcing can irreversibly affect a company’s culture, damage customers’ perception of a company’s products, and heighten the risk of losing intellectual property. Outsourcing may be what a company needs to make it through this downturn, but careful execution is crucial to avoiding the risks and reaping the rewards of a successful strategy.
Keys to Successful Outsourcing
Given that outsourcing is, or will likely be, a key component of most companies’ cost-saving strategies, here are some important issues to consider:
Plan with the big picture in mind. Almost every company can find additional cost savings through outsourcing, but some types of outsourcing, regardless of the potential cost savings, will not be a good fit for certain companies. To find the right fit, a company should consider where its core competencies and greatest competitive advantages lie. Functions and processes that don’t fall within the core-competency circle are all candidates for outsourcing. In many instances, after some internal evaluation, it makes sense to seek the help of a consultant who specializes in outsourcing to help maximize the value the company can find.
Watch out for legal pitfalls. Each outsourcing transaction needs to be considered for its particular legal issues, of course, but there are certain legal pitfalls that tend to apply to most outsourcing arrangements. Perennial legal pitfalls include: (1) data privacy laws, (2) employment laws, (3) export controls, and (4) intellectual property protection. These issues can be especially thorny in international transactions. For example, under the European Union Data Privacy Directive, which is implemented independently by each EU member state, personally identifiable information about an employee or customer who is a citizen of the EU can only be transferred to another country that has privacy laws as protective of personal data as the EU. Because
Select the right vendor. Just as when a company hires an employee, there needs to be a good cultural match when selecting an outsourcing vendor. Identifying the right vendor requires good due diligence, including checking references and, in some cases, a competitive bidding and parallel negotiation process. The information learned in the solution architecture and contract negotiation process regarding the vendor’s attitude and approach to risk-sharing should not be discounted, as these traits are often magnified after contract-signing. In the Deloitte Consulting study referenced above, of the executives who were not very satisfied with outsourcing, 55% wished they had spent more time on vendor evaluation and selection.
Describe the services carefully. The scope of services in an outsourcing agreement typically is set forth in a statement of work. Sometimes clients are tempted to handle a statement of work without help from their legal counsel because such statements “contain only business terms.” But experience shows that most disputes arising from an outsourcing agreement can be tied back to a disagreement over the scope of the services. Allowing legal counsel to carefully review the statement of work to make sure the services are clearly described can help identify potential areas of disagreement and eliminate them.
Create flexibility in the agreement. An outsourcing agreement needs to be dynamic and flexible. Conceptually, from a cost-saving standpoint, one of the greatest advantages of outsourcing is that the company should only pay for what it uses. In most cases, the pricing in the agreement should reflect this advantage with variable pricing based on consumption. Additionally, a good outsourcing agreement needs to account for changes and improvement to the services, acquisitions and divestitures by the company, and termination rights.
Build a contract that delivers early warning of potential failure points. A well-drafted outsourcing agreement is a living document. Rather than being stashed in a drawer after signature, the outsourcing agreement should be used as a ready-reference handbook setting the parameters to guide the parties through day-to-day operations. Through well-crafted service levels, reporting policies, and governance procedures, the contract should flag issues well before they get out of hand, provide incentives for the service provider to resolve issues quickly, and give both parties ample opportunity to get things right before business operations are adversely affected.
Focus on transition. Transition is the phase in which the work that was being performed inside the company is transferred to the service provider. Like an airplane takeoff on a runway, the transition stage is crucial in an outsourcing agreement. A successful launch requires careful planning and communication, much of which happens after the contract is signed. Because of the politics that can be involved with an outsourcing agreement, a failed transition can result in much more harm than just the lost time and transition fees. Doomed launches are often marked by an over-reliance on the service provider and ignoring milestones and other critical deliverables that were agreed to in the contract.
Manage the contract after signature. Successful outsourcing requires careful management of the relationship after signature of the agreement. In many ways, the outsourcing vendor needs to be managed like an internal division of the company would be managed. Because management of the agreement will have a dramatic impact on the overall success of the arrangement, the manager should be chosen carefully, keeping in mind that the skills required to manage the vendor often differ from the skills required to perform the services themselves.
While the risks of outsourcing are real, the opportunity for start-ups to successfully leverage outsourcing never has been greater. If implemented thoughtfully and carefully, outsourcing can be a powerful cost-saving strategy that can help companies get more out of their money and maximize their competitive advantages.