Procurement’s View of Outsourcing (Part 3)

See Part 1 and Part 2 in this series as well.

We have considered previously the role that procurement can play in outsourcing transactions and why it is sometimes difficult for the function to establish that role. One early contribution procurement can make is in the development or analysis of the business case for outsourcing.

A typical case might be an organisation that thinks it may not get enough use out of outsourcing, so the board asks that a range of opportunities be considered, with some sort of review and proposal to be approved. (I’ve had involvement in such a case as both a line CPO and as a consultant – and it can be a fairly vague “feeling” from top management that opportunities exist, or a clearer view of where outsourcing might add value).

The second case is where procurement are involved directly in an outsourcing decision, and have a chance to contribute to the development of the business case or the go/don’t go decision. In either case, there are a number of factors that should influence the decision in whichever direction.

The first group of factors are internally focused around the current situation in the organisation.

What is the state of readiness of the function/process area to be outsourced?

This leads us straight into one of the most common outsourcing beliefs: “Don’t outsource a mess. You’ll get an outsourced mess.” The argument goes that the organisation should work internally to bring the area at least up to a reasonable level before outsourcing, to improve the chances of successful transition. The other justification is the cost argument. You will pay a lot of money for the outsourcer to sort out your problems if you transfer a fundamentally inefficient operation.

Whilst the view is understandable, it can be challenged on two counts. Sometimes a really good outsourced service provider can turn “a mess” into something very satisfactory or even better. The other dilemma is that sometimes an organisation really doesn’t have the capability to improve the area in question. And if the only way to improve matters is expensive consultancy, or a long and expensive internal development programme, then yes, sometimes it can be better to outsource a mess. But these matters must be considered as part of the overall outsource/don’t outsource decision. And in general terms, the outsourcing transaction for a process or area that is tolerably effective is likely to be easier.

How strategically important is the potential outsources process/function/area to the organisation?

The general view is that outsourcing is best when the area in question is not part of the core strategic proposition of the organisation. That is true in most cases. Look at it from the perspective of the organisation’s own customers. If some key element of your purchase is actually the work of a third party, then why not go direct to the third party?

However, again, we can challenge this to some extent. Some organisations have changed the parameters of the debate by outsourcing virtually everything. In a sense, they are saying, “our core skill is in managing a complex network of outsourced service (or product) suppliers and pulling that together into an overall business proposition”. So the key question is probably something more connected with competitive substitution – does outsourcing weaken the market position or make it more likely that someone (and that could even be the outsourced provider) could negatively impact the organisation’s strategic position?

Does the organisation have the capability to manage the service provider?

Surprisingly, this is often a major issue. It can be managed – through investment in additional resource if necessary – but we include it to point out that it needs consideration. Retaining an intelligent client function is critical, which might mean not transferring all employees in the area under consideration to the service provider. And if the outsource is so esoteric, specialist or difficult that managing the ongoing contract is a real concern, then the whole strategy needs to be questioned.

Then we have the cost/benefit financial factors to consider.

What are the likely cost savings from the outsource?

This is conceptually easy to understand, although obtaining the appropriate information to support a business case can be challenging. Clearly, service providers may offer savings through economies of scale, greater expertise, or innovation. Work will need to be done prior to the business case development as this will inevitably form an important part of the analysis.

What other “softer” benefits might arise from the outsource?

This might be (for instance) better customer service via a service provider with higher performance levels than have been achieved internally; greater innovation leading to top-line business gains; or the (somewhat mythical in our view) “focusing on our core business”. On that last note, whilst there is no doubt that some organisations are over-complicated and would benefit from some simplification –which might mean outsourcing certain parts of the business– our experience is that these “core business” benefits are very hard to quantify before or even after the transaction.

What will the process of outsourcing cost?

One potential outsource some years back had a business case that was excellent in many ways. The supply market was competitive and capable, the business area clearly wasn’t core, the staff would have been better off in the outsourced firm, and there were savings to be had. However, the sheer cost of the outsourcing process, both the transaction costs and compensating staff payments (for pension rights, etc.) meant that the payback was not attractive. (Perhaps half a million upfront costs; $50K/year savings).

Whilst outsourcing can be executed in the private sector (at least in a quick and dirty manner), it’s not advisable. So the costs should not be underestimated in the business case, both those directly related to the project and any staff issues, or compensating recruitment that might have to take place (see comments above on the intelligent client).

Finally, we need to look at the market.

How attractive and established is the market for the type of outsourcing we require?

Clearly, a business case is likely to be more attractive when there is a mature, competitive market available for the services that will be transferred. That gives the outsourcer a choice of provider, making it more likely that a good “fit” can be found; suggests that there will be strong competitive pressure amongst providers which should drive value for money and performance; provides some resilience for the future supply situation; and probably means that the market and providers are experienced in delivering the service successfully.

Being the first organisation in the world to outsource “Service X” to a brand new provider might just bring amazing competitive advantage. But we would suggest it is a brave CPO who recommends doing so, given the obvious issues.

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