Wait A Minute: If Outsourcing is So Painful, Why Do it at All?

Outsourcing, and its more radical cousin offshoring, has become a rather explosive topic of late.  Some see it as a legitimate management tool allowing companies to enhance customer value or manage costs.

Others see outsourcing as a cold and callous business practices and an oddity at a time when, just as companies have extensive programs to gain customer loyalty, they are showing scant loyalty to their own employees.  As is often the case in complex issues, both sides are correct and both are naively mistaken.

In truth, outsourcing is nothing new.  Though the term was not applied, it can be seen in manufacturing organizations in the 1960s purchasing components from subsidiaries or outside suppliers rather than producing them internally.  The only real difference between then and now is the scope and scale – outsourcing involves removing entire boxes from an organizational chart.  Even the degree of outsourcing differs. It can be as modest as rebadging (employees leave Friday night wearing A company IDs and show up for the same job Monday morning sporting B company IDs) or as radical as offshoring (where the job, but not the employee, moves to a different country).

There are two popular arguments for outsourcing: cost reduction and quality enhancement.  Both goals have proved elusive for a surprising number of companies.

Though some companies have reduced costs, for others the savings have been hard to realize.  In one of the biggest IT outsourcing deals, JPMorgan Chase turned over its IT organization to IBM as part of a $5 billion seven year contract.  The goal was to save millions.  Twenty-two months later JPMorgan re-internalized its IT shop at a cost of millions.  JPMorgan’s argument for canceling the contract was that it could achieve better cost savings through internal management.  JPMorgan is not alone.  According to a study by consultancy Ventoro, many organizations have been disappointed with outsourcing savings.  Some even found it more expensive.

If the savings from outsourcing are smaller than advertised and if there are quality issues, then why do companies outsource? Why go through such a painful, disruptive and risky exercise for such small gains?

Unfulfilled Expectations

The results of the quality enhancement argument for outsourcing are just as mixed.  Quality improvements are usually attributed to gaining access to more highly skilled staff.  By outsourcing to IBM, JPMorgan Chase expected quality improvements from being supported by IBM’s highly trained staff.  However, there were fundamental problems with this model.  First, where do the outsourced employees go?  In the JPMorgan example the majority of the bank’s employees were rebadged as IBM employees.

It is hard to see the skill advantage if JPMorgan was supported by the same IT people the day after the outsource as it was the day before.  With offshoring you get different employees who just might be offshoring experts – a plus – but may not be experts in the company’s line of business or even conversant in your native tongue —   a real minus.

Cultural issues can also come into play.  The manager of a US financial institution’s research department was frustrated with the quality of the work outsourced to India.  The problem was not with the intelligence or effort of the Indian workers but their culture.  US workers, she reported, were more likely to challenge incorrect assumptions or suggest better ways of accomplishing goals.  Their Indian counterparts were less questioning.  The result:  much of the work completed in India had to be redone in New York.

The quality issue is not just a problem with highly skilled workers.  In 2009 both United and Delta airlines canceled large customer service center offshoring contracts in India for quality reasons. (Editor’s Note: Delta relocated much of its work to Jamaica subsequently.)

Internal Effects

Just the threat of outsourcing can result in quality, cost and productivity issues with formerly efficient in-house staff. According to an InformationWeek survey outsourcing resulted in morale and productivity problems among staff whose jobs were not even affected.

None of this is new news, which raises an interesting question.  If the savings from outsourcing are smaller than advertised and if there are quality issues, then why do companies outsource? Why go through such a painful, disruptive and risky exercise for such small gains?

As a management consultant for two decades I discovered that there is a third and less publicized reason companies outsource.  There are a number of firms who outsource a function, not to save money, not to gain additional skills, but to jettison a troubled organization.  Outsourcing has become the organizational equivalent of “tossing it over the transom,” or trading in an automotive lemon.  If your IT, HR or shipping organization is out of control, requiring inordinate amounts of senior management time, then make it someone else’s problem.  While this strategy can work in the short run, it is often a poor long term solution.

Consultants have long held that before you outsource you should get your organization in shape.  Reengineering, business process management or almost any technique that revitalizes an organization will provide better outsourcing value to a company for one simple reason.  A critical component in the pricing of an outsourcing deal is the current customer spend.  If your company is spending $10 million a year on a call center, don’t expect the price quoted by the vendor to stray too far from $10million  a year.  If current spend is closer to $8 million then the contract is likely to be closer to $8 million.

So the first rule of outsourcing is (or should be) to get the organization you wish to outsource into its best shape possible to realize the best outsourcing deal.  However, if you successfully reengineer the troubled department, reducing costs and improving service, then why outsource?  If your formerly troubled organization is now cost efficient and providing quality service, why give it to someone else?  It would seem that for many organizations the reasonable approach to preparing for outsourcing would abrogate the need to outsource.  So just maybe, the real value of outsourcing is not giving a function to another organization but a wakeup call for better internal management.

George Tillmann is a retired Booz Allen Hamilton vice president and former CIO