Outsourcing: Risks and Dangers

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A fun but sad example of poorly managed outsourcing¹ was published earlier this week. Shane Snow outsourced some data entry work and was concerned with the late deliverables, so few of them, which led him to ask: what did my outsourced data entry person do for 50 hours?

In looking at his time logs, here’s what he found²:

From the perspective of the customer, only 20 minutes of the 420 minutes was value add. In other words, 0.4% was value add and 99.6% is waste.

0.4% is value add and 99.6% is waste.

Okay, this is a funny generalization of outsourcing, but it gives us a sense of the risks with outsourcing and can lead us to reconsider whether we should outsource.

Why Organizations Outsource?

There are several reasons why corporations decide to outsource. Below are just a few taken from Wikipedia:

• Cost savings — The lowering of the overall cost of the service to the business. This will involve reducing the scope, defining quality levels, re-pricing, re-negotiation, cost re-structuring. Access to lower cost economies through offshoring called “labor arbitrage” generated by the wage gap between industrialized and developing nations.
• Focus on Core Business — Resources (for example investment, people, infrastructure) are focused on developing the core business. For example often organizations outsource their IT support to specialised IT services companies.
• Cost restructuring — Operating leverage is a measure that compares fixed costs to variable costs. Outsourcing changes the balance of this ratio by offering a move from fixed to variable cost and also by making variable costs more predictable.
• Improve quality — Achieve a steep change in quality through contracting out the service with a new service level agreement.
• Knowledge — Access to intellectual property and wider experience and knowledge.
• Contract — Services will be provided to a legally binding contract with financial penalties and legal redress. This is not the case with internal services.
• Operational expertise — Access to operational best practice that would be too difficult or time consuming to develop in-house.
• Access to talent — Access to a larger talent pool and a sustainable source of skills, in particular in science and engineering.
• Capacity management — An improved method of capacity management of services and technology where the risk in providing the excess capacity is borne by the supplier.
• Catalyst for change — An organization can use an outsourcing agreement as a catalyst for major step change that can not be achieved alone. The outsourcer becomes a Change agent in the process.
• Enhance capacity for innovation — Companies increasingly use external knowledge service providers to supplement limited in-house capacity for product innovation.
• Reduce time to market — The acceleration of the development or production of a product through the additional capability brought by the supplier.
• Commodification — The trend of standardizing business processes, IT Services, and application services which enable to buy at the right price, allows businesses access to services which were only available to large corporations.
• Risk management — An approach to risk management for some types of risks is to partner with an outsourcer who is better able to provide the mitigation.
• Venture Capital — Some countries match government funds venture capital with private venture capital for start-ups that start businesses in their country.
• Tax Benefit — Countries offer tax incentives to move manufacturing operations to counter high corporate taxes within another country.
• Scalability — The outsourced company will usually be prepared to manage a temporary or permanent increase or decrease in production.
• Creating leisure time — Individuals may wish to outsource their work in order to optimise their work-leisure balance.

I think there’s some benefit to outsourcing as long as the following are not compromised:

1. The customer experience must not be compromised.
2. The product quality must not be compromised.
3. The key processes and unique value-creation processes are not outsourced, but remain within the company.

True, both (1) and (2) and (3) above carry a lot of implications. For example, customer experience means both language, customer service, and timeliness of product delivery – those are often the risks that come with outsourcing.

Lean and Outsourcing

The last decade is full of frenzy with outsourcing, but more recently, organizations are now “reshoring” or “onshoring” those previously outsourced processes because the costs and risks were too high. Unfortunately, it took several years to realize what lean practitioners have known for over a decade.

In general, most organizations that subscribe to Lean Thinking prefer not to outsource. The rationale is that the service and product ought to be close to the customer. This makes sense, but in practice it’s difficult and in some industries, it makes more sense to actually outsource. For example, call center outsourcing is common and if it’s done to provide the customer with 24/7 access and there are no language or customer experience issues, then that actually makes sense and would benefit the customer.

There’s an ongoing debate with Lean and outsourcing. I’m pragmatic in the sense that if it works in the long-run, then there’s truth to the practice and the principle. If not, then try something else. In general, Lean Thinking rejects outsourcing; but, in practice, business conditions might suggest otherwise.

	This post was written by Pete Abilla