For the last 20 years, CEOs and CIOs have heard the same arguments for outsourcing: costs would decrease; valuable internal resources would be better employed on strategic tasks; and risks would be transferred to a third party, much like buying insurance. However, for many, the analogy with insurance has unfortunately proven all too real. High deductibles, exclusions from coverage, questionable service and opaque pricing have all raised questions as to outsourcing's value. Knowing all this, how do you ensure the realization of outsourcing's often-touted but infrequently realized benefits?

Based on answerthink's best-practices research, companies that successfully leverage outsourcing as part of their overall business operations share four common characteristics: a clear and measurable rationale, an understanding of the economics of third-party agreements, proven negotiation skills and capable strong management.

Too often outsourcing decisions are made for emotional reasons: no one understands a function's value so no one is driven to fix it; everyone else is doing outsourcing so it must be okay; and, worse yet, let's make functional dysfunction someone else's problem. In most cases, shifting responsibility to a third party simply makes a problem more visible and painful than when it was buried inside the organization.

Our research shows that a best-practices company makes outsourcing decisions using the following criteria: demonstrably lowers operating costs, increases service quality, reduces business risk, secures scarce skill sets and refocuses management on strategic matters.

The key to outsourcing success is that for each expected benefit there are quantifiable metrics that define and assign clear accountability, and those metrics are built into contracts with service providers and internal process owners.

Outsourcing basically has two immutable truths:

  1. If you outsource an inefficient process, the contractor will charge you for your inefficiency and use it to make a profit. One of the easiest ways for an outsourcer to make money is to take your inefficient process, clean it up and reduce costs by 60 percent, giving you half of those savings staggered over the life of the contract while pocketing the rest. This realization leads to a very simple maxim for addressing the economic viability of outsourcing: Seek to eliminate the activity. If you cannot simplify it, then automate it out of existence and if it's still existing, consider outsourcing it.
  2. Instead of comparing the current cost of an inefficient process to an outsourcer's best bid, use the lowest price you can achieve internally as the starting point of negotiation. Credible process benchmarks from research firms provide a useful starting point, as well as offer a basis for performance incentives that can be built into the contract to ensure mutual gain-sharing over the life of the contract.

Service providers negotiate contracts every day. For most of you, it is relatively rare occurrence. So who do you think is more experienced negotiating outsourcing contracts? Who will have a better draft of a contract prepared? When negotiating:

  1. Avoid the "current level of service" curse. This is a term that initially appears attractive because it "guarantees" the current service level. In reality, however, if the current level of service was so good, why would you need to outsource? Today's best service offering will be obsolete tomorrow, so build benchmarks into the agreement that ensure service levels keep pace with the latest best practices.
  2. Avoid agreeing to statements such as, "everything outside the terms of this contract is extra and will be charged at standard rates." This is a very naive term to accept. Over the life of the agreement, your needs will change and you will never be able to anticipate them up front. Plan for ambiguity and ensure the contract offers a reasonable amount of flexibility.

Once a sound contract has been negotiated, the hard work really starts. The best arrangements exhibit a number of common characteristics:

  • Management/accountability is re-tained by your company.
  • Service agreements are agreed upon up front and monitored routinely for compliance and continued applicability.
  • Supplier schedules and status reports are integrated into internal planning and management processes.
  • Gain-sharing is set against credible benchmark targets.
  • Partner incentives are linked to improvements in overall business performance.

The pervasive nature of the e-business revolution is increasing the breadth and complexity of processes that can be handled by third parties. Perhaps one of the most intriguing trends is the increasing use of hosting services. These can range from management of a Web site through the provision of application processing capabilities over the Web. Ironically, they mark a return to vogue of timesharing services that were popular in the 1960s. The difference now is that instead of the driver being the prohibitively high costs of computer technology, it is the very low cost and high speed of communications that make it more attractive to rent than buy. All these trends point to the need for CEOs and executive management to be skilled in the negotiation and management of third-party service agreements, so that companies can retain their competitive edge in the ever-changing world of business.

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