Exploding the outsourcing myth

Apr 27 2007 by Brian Amble Print This Article

Europe's 4bn outsourcing industry is facing a mid-life crisis as organisations find that far from saving them money, IT and business processing outsourcing deals end up costing them far more than they would have done had the work been kept in-house.

To make matters worse, research by Compass Management Consulting has also found that as many as two thirds of outsourcing contracts worth more than 20m start to fall apart before the end of their contract terms.

And with a combination of high profile outsourcing deals being taken back in-house and dissatisfaction with the business impact of sourcing decisions such as uncompetitive costs and the negative customer services impact of offshoring it is hardly surprising that a new mood of mistrust is emerging in many outsourcing relationships. "The costs to both parties of this level of failure are high and the legal and advisory costs can quickly escalate," said Simon Scarrott, Head of Business Development and Marketing at Compass.

"However, the real cost impact arises as the issue becomes a business problem and constrains strategic freedom for the future as well as the negative effect on current operations."

The research, based on an analysis of 240 deals worth more than 20m, found that outsourcing providers were winning business by pricing contracts in such a way that they produced savings of up 18 per cent in the first year compared to the cost of doing the work in house.

But costs quickly began to climb in subsequent years, reaching 36 per cent above comparable top quartile internal operations by year three.

There can be sound strategic reasons for outsourcing but saving money over the long term is not one of them

Compass also found that that most tier one outsourcing vendors are charging an average of 30 per cent and sometimes as high as 45 per cent above the comparable internal market rate in the final years of the contract.

The reason for this is simple. Outsourcers have to be at least 20 per cent better than the in-house operation they replaced just to cover the costs of winning the business and break-even and most are not.

Additionally, outsourcers' requirements to generate profits plus allowances for risk and corporate overhead further uplift the cost of their service typically by 20 per cent more than a well-performing in-house operation.

"With those figures, it is easy to see why the claim that all outsourcing will save money is a myth," said Scarrott.

"There can be sound strategic reasons for outsourcing but saving money over the long term is not one of them."

"Outsourcing providers are not that different from an in-house operation," he added. "Indeed, they often use the same people as the in-house operation after the deal is signed and outsourcers cannot perform alchemy on a business process and turn an operation into gold."