Letting a contractor deal with ‘your mess for less’ is the conventional attraction of outsourcing – customers save money by handing over their hardware, software, networking and even information technology staff to a third party. Clients often say they want to outsource to focus on their core business, to improve flexibility or to access skilled staff, says
Neville Howard, a partner in the technology integration team at Deloitte, the business advisers. ‘But I haven’t seen one yet that doesn’t want to save money on operating costs.’

Traditional IT outsourcing contracts last five, seven or even 10 years, and offer annual savings of about 20 per cent. Suppliers tend to lose money in the first year or two because of the investment required in taking over legacy systems. Over the long term, they save by shedding staff, streamlining systems and achieving economies of scale. In recent years, this pricing model has become harder to achieve because of a shortage of capital to borrow.

Clients’ discomfort with the idea of their IT being handled at long distances has also made it more difficult for suppliers to cut costs by offshoring. The advent of cloud computing and software as a service, with their pay-as-you-go pricing, has also increased the financial pressure on outsourcing suppliers. Many have made unrealistic promises to win contracts and then underinvested. ‘Service levels dip and customers become frustrated. We hear that again and again,’ says Mr Howard. Customers should be careful about driving a hard bargain, he says, because what looks like a lower price might end up costing more.

Martin Burvill, group vice-president of global solutions at Verizon Business, the US IT services provider, says that customers who just want to save money by outsourcing and ruthlessly drive down suppliers on price are making a big mistake. ‘Suppliers try to recover their losses by charging for all the extras or cutting back resources, so there is a huge gulf between expectation and execution.’

Customers can’t expect to get a cheaper service unless they are prepared to let suppliers change the operating model and methodology, Mr Burvill says. ‘Without transformation, the supplier won’t make money. This is pure logic, but it gets forgotten,’ he says. Customers have to be prepared to adapt, he adds, and the more they can move to the outsourcing provider’s systems, the greater the potential savings. Customers can often get better value for money by focusing on how the outsourcing provider can make them more competitive or help to bring out products faster, says Jonathan Cooper-Bagnall, head of outsourcing at PA Consulting.

‘That might mean switching some services off or scaling them back, or shifting the speed of transition from legacy infrastructure to new customer-focused applications.’ They could also request fewer estimates for new applications, which are expensive, he says.

For outsourcing providers, moving away from guaranteed returns and minimum commitments is a big step, says Mr Cooper-Bagnall. ‘It fundamentally changes the way they can sell, because it’s not about length of contract. They have to change the incentive structure for sales staff, and think about whether it cannibalises a service they already provide.’ Nick Grossman, group business development director of 2e2, an IT services provider, suggests that customers should set challenges for outsourcing suppliers, such as reducing the time and cost of processing documents. ‘With measurable targets, suppliers can be offered a share in the risks and rewards of improving business efficiency,’ he says.

Keeping outsourcing providers to a minimum also helps to reduce costs, says Don Herring, the New Jersey-based senior vice-president of network sourcing at AT&T, the communications company. AT&T encourages clients to engage a maximum of three suppliers to handle computing, applications and networking respectively, and to expect them to collaborate. This can result in savings of up to 35 per cent, says Mr Herring. Having multiple suppliers can also help to keep prices low by introducing competition. It is smart to have a couple of providers for activities such as maintenance and application development, says Deloitte’s Mr Howard. Then you can have a mini contest between the two.

‘Otherwise,’ he says, ‘it’s very hard to know how long they need; you might get a low hourly rate that ends up costing more than another provider that charges more but does the job quicker. Minimising the use of consultants also saves money, says Mr Burvill at Verizon. ‘Being paid by the day motivates consultants to prolong their contracts by continuously changing the specification.’ There is a lot of emotion in outsourcing, especially as it often involves transferring staff, which is upsetting and causes upheaval. This disruption is one reason why about 40 per cent of clients for which Deloitte looks at outsourcing end up keeping the service in-house. They decide there are not enough cost savings, or the risks outweigh the benefits, particularly for small and medium-sized businesses. A number of Deloitte’s clients that have tried outsourcing are bringing it back in house, Mr Howard says. ‘It is a bit like marriage – there can be lots of suffering and violence, and occasionally a messy divorce.’

To avoid breakdown, customers should be prepared to share the financial rewards of improved efficiency. A level of mild dissatisfaction is not unusual in customers, Mr Howard says. ‘But responsibility for making it work rests as much with them as with suppliers.’

Question 1 (15 Marks)

With reference to literature, examine the effects and impact of outsourcing.

Question 2 (15 Marks)

Discuss why outsourcing would be bad for the economy.

Answers to above questions on Outsourcing Case Study

Answer 1: Outsourcing is considered as an important strategy for businesses because it allows them to focus on the core business by outsourcing less important tasks. However an analysis of an existing literature indicates that there are both the positive as well as negative effects of outsourcing to businesses. The positive benefit is mainly in terms of allowing the business to focus on the core activities and achieve improvement over it, but the negative consequences are identified in the form of lowering barriers to entry, increase in the level of competition, negative effect on brand loyalty and satisfaction and many more.