Get More Accurate Outsourcing ROI in Six Easy Steps

Everybody wants ROI from their outsourcing projects. Many (on both the buy and the sell side) claim it. But relatively few have the knowledge or background to calculate it correctly. This not only makes it harder to make good decisions, but saps the credibility of whoever is doing the calculations.

Far too many operations and procurement professionals try to calculate ROI without a sufficient understanding of it.

They also try to convert subjective value measures to quantifiable numbers and fail to relate ROI to business objectives that might not relate to money, but to harder-to-measure benefits such as innovation or the delivery of new products and services to customers.

First, one must understand what ROI is not. Consider a typical outsourcing decision, such as whether to outsource your e-mail infrastructure. Just because Option A costs less than Option B, while delivering similar service levels, does not demonstrate ROI. It just means you have lowered the cost of doing business – the cost of operations. You cannot claim ROI because you have not done anything to generate more revenue.

ROI is the result of the Gain from Investment less the Cost of the Investment all divided by the Cost of Investment. You achieve ROI when, and only when, it supports the operation of a profit center, rather than a support center where any savings are likely to be consumed by other areas.

So where do we stand?

1. Distinguish between investment and operating costs. An investment will produce a yield, in the form of an improvement in a profit-making operation, while operating costs allow you to keep the lights on for less than you otherwise would.

2. Know your objective. If it’s labor arbitrage then a simple comparison will reveal the spread between domestic and foreign labor costs.

3. Ensure ‘like’ comparisons. Are the processes you are comparing both fully optimized? All too often, the function you’re considering for outsourcing is not in best operating form. If it’s a simple “lift-and-drop” situation then cost comparisons would be OK, but if the provider is making changes you need to factor that in. So facilitate process improvement/optimization at some point in the relationship, whether pre- or post-engagement, measure the results and take them into account

4. Take into account all costs. It’s not simply a matter of contract cost vs. prior in-house costs. Take into account other costs that must be amortized over the duration of the contract, such as to transition the function to the provider. Remember new, in-house costs such as for a project management office (PMO) that oversees the outsourced relationship, as well as the need to monitor the quality of the outsourced work.

5. Make sure that you have systems in place that can track operating costs against the estimates you used to make your decision. In some ways this is a bold step because you may wind up finding flaws in your decision making. Don’t use this as an opportunity to find fault, but to improve your estimation and sourcing management skills.

6. Factor in whether you’re getting everything from your service provider you were getting in-house, such as a commitment to environmental efforts or working conditions. This is another way of saying “compare apples to apples,” but in an area that can cause big public embarrassment if you ignore it.

Bottom line: When calculating ROI keep in mind the difference between reducing operating costs and actually improving in business. And, when you’re comparing costs and benefits, make sure you’re doing a fair comparison that takes into account both everything you’re spending and everything you’re getting (or not getting.) The health of your organization – and of your own credibility – depends on it.

Jerry Durant is founder and chairman emeritus of The International Institute for Outsource Management, a trade organization dedicated to the assessment, development, and guidance of outsource service providers in the ITO, BPO, call center, and KPO domain areas.