Outsourcing is not a new concept as basically it’s a “subcontracting of tasks” which were prevalent & even prevalent today, & we know that the Rationale for subcontracting is to save cost & time so that the party subcontracting the task may specialize itself in its core competencies without wasting time & intellect in the task that may be subcontracted.
When we talk about outsourcing we say that An organization entering into a contract with another organization to operate and manage one or more of its business processes. We call it as outsourcing of process. Outsourcing originated and became popular as a cost-saving strategy during a recessionary environment. Usually the processes that are outsourced are the support processes and not of extremely high strategic importance, but necessary for doing business. In a nutshell outsourcing deals with the people and processes in and around business.
No doubt about the success of outsourcing which is visible in present context & even a favourable regime for a country like India where human capital is abundant. But Organizations have now begun to recognize the real costs and inherent risks of outsourcing. Instead of simplifying operations, outsourcing often introduces complexity, increased cost, and friction into the value chain, requiring more senior management attention and deeper management skills than anticipated. It is generally said that “Outsourcing is an extraordinarily complex process, and the anticipated benefits often fail to materialize.”
The outsourcing requires a complex series of tradeoffs: cost savings versus growth, speed versus quality of service delivery, and maintaining organizational cohesion versus knowledge and innovation. Service providers and organizations have inherently conflicting objectives, putting the organization’s objective for innovation, cost savings, and quality at risk. Moreover, the service provider’s structural advantages do not always translate into cheaper, better, or faster services. The world’s largest companies should be able to replicate the service provider’s structural advantages in-house and rely on the service provider only under specific circumstances, such as fixing deep-seated structural problems or maintaining infrastructure operations.
An unfavorable mix of rising costs and increased demand will drive up the cost of outsourcing for organizations and vendors. Weaknesses in operational management will result in more deal failures, prompting organizations to bring more operations back in-house. In the long run, organizations that continue to outsource will experience a loss of bargaining power to vendors as the supply side consolidates. Those that apply strong skills in deal structuring and risk management and strong management skills to oversee deals from inception to execution will be best positioned to reap the benefits of outsourcing.
In the Real World, Outsourcing Frequently Fails to Deliver Its Promise. To prove this statement Here is a chart which represent that what were the expectations of the companies & what were the resultant of the outsourcing there task.
Outsourcing of jobs were done to increase the efficiency of the Outsourcing company & to increase their core competency as we said earlier but the trade offs are heavy as compared to the benefits which are anticipated.
Let’s understand that what may be the various risks which are attached with this process.
Concerns over Data Security
It is an important factor which is bothering the minds of top management of the companies whose core business involves transfer of confidential data, like banks.
Two successive well published cases in the immediate past of Indian BPO’s not being able to protect confidential client data bring into sharp focus not just the security issues connected with one of India’s fastest growing areas in the services sector.
The first case involves a fast growing areas listed BPO which has a strong business relationship with Citicorp, the worlds largest financial service group one of the pioneers of outsourcing.
A few employee of the BPO allegedly obtained, through fraudulent means, confidential data including passwords from their clients. All citibank’s customers in US & thereafter withdraw money.
The most recent case has arisen out of a “sting operation” mounted by a British tabloid. One of its undercover reporters managed to “buy” data of some 1000 account holders of several British banks from a junior employee of a delhi based BPO, to which the banks had outsourced a chunk of their routine business.
Here the tradeoff is clear easiness of work at the cost of Data Security. Is outsourcing really reducing the burden?
Outsourcing Generates Fundamental Risks and Concerns, More than Half of Which Are Structural and Cannot Be Fully Mitigated. Companies are exposed to fundamental outsourcing risks and are facing go/no-go challenges as new risks emerge. 45 percent of the companies who outsoucing stated that an organization should not outsource processes that it does not fully understand. emphasized that outsourcing without fully understanding the organization’s processes and cost structure is extremely risky because the organization will not know what to demand from vendors and how much to pay. In the below given graph are given some structural risks which are faced by the companies.
Limited transparency and an increased lack of control due to vendors’ subcontracting is again defecting the objectives of outsourcing. Global companies often are unable to find global vendors to provide standardized services across the different regions, driving them to employ multiple vendor relationships or scale back outsourcing objectives.
Loss of Control
Loss of control over outsourced functions poses a substantial threat to ongoing operations. It is viewed that loss of control over outsourced functions is a substantial risk.
– “Avoid outsourcing ‘lock, stock, and barrel,’ in order to maintain control (over our value chain).” Said by an top management official who is not in favour of outsourcing.
Due to the above cause many companies are bringing outsourced functions back inhouse because they realize they have lost control over critical processes. – “Too much outsourcing results in lack of control. Companies should not outsource key areas where losing control can be disastrous.” Is a statement which shows again a serious tradeoff i.e outsourcing a critical process is to save cost but at the cost of loss of control over that process & finally increased dependency.
Reduction in the Responsiveness to the changing environment
Outsourcing Often Reduces Organizations’ Responsiveness to Market Changes and Poses
Internal Political, Organizational, and Cultural Challenges. Multi-year contracts result in a loss of flexibility to react to market changes, hurting companies’ competitiveness. are concerned about the loss of flexibility to react to changes in the market (e.g., competitive, regulatory), as a result of being locked into multi-year deals.
Vendors push for long-term deals to recoup initial investments and make profits. When pressed to shorten deal length, prices increase. Here we find a There is an explicit trade-off between maintaining flexibility and lowering cost.
We find a clear Shift of Bargaining Power to the Vendors, While Contracts Often Provide
Limited Protection. Handover of control and knowledge to the vendor creates an ongoing dependency on the vendor. This dependency ultimately shifts power to the vendor and weakens the organization. This is slow but sure process, Once an organization has gone through the process of adjusting its retained organization and its skill sets, it no longer holds the capabilities and skill sets to manage these functions in-house, increasing dependency on the vendor.
Long-term contracts and proprietary systems further increase vendors’ bargaining power. Vendors might lock companies into using proprietary systems, making it difficult to switch vendors in the future.
Organizations are trying to offset this trend by negotiating shorter-term, more flexible contracts and by working with multiple vendors. However, these mitigation strategies provide limited protection. Short-term deals even (less than three years) often create high dependency on vendors, holding organizations captive. “Second sourcing” (wherein two outsourcers provide services to forestall monopoly pricing power) is difficult with services outsourcing. Multi-vendor models increase the level of complexity, requiring additional resources from the organization. Vendor dependency cannot be fully mitigated because the organization no longer owns the functions, knowledge, people, and systems.
And, organizations then find themselves trapped in deals with higher rates and low-quality delivery.
Illusion of Costs saving
Outsourcing, which originated as a popular cost-saving strategy during a recessionary economic environment, is still dominantly driven by cost-related objectives and the perception that organizations benefit from vendors’ economies of scale. However, evidence of tailored deals and inhouse economies of scale at large organizations suggests that vendors’ scale advantages may be illusory. Lack of transparency, bundling of services, and a variety of marketing techniques have created suspicion about the savings from outsourcing. Real-world experiences suggest that the potential for cost savings has been overstated.
Limited transparency to a vendor’s pricing and cost structure makes it difficult to understand cost savings. Transparency to a vendor’s costs decreases as outsourcing contracts are bundled with other services. Bundling makes it difficult for organizations to distinguish unit costs and complicates business cases. Bundling allows financial engineering that hides the true economics of the deals. Vendors employ marketing techniques that can create illusory cost savings. Under-market pricing is common due to fierce competition among vendors. Vendors undertake contracts that are not economically viable for them, especially with early mega-deals or strong brand entrants. Which results in poor performance & losing quality.
Organizations have now begun to recognize the real costs and inherent risks of outsourcing. Instead of simplifying operations, outsourcing often introduces complexity, increased cost, and friction into the value chain, requiring more senior management attention and deeper management skills than anticipated. In addition, outsourcing has allowed organizations to transfer financial and operational risk to vendors, but organizations are discovering that their contracts will never fully protect them against customer damage and business losses caused by service disruption. Many have responded by bringing operations back in-house.
Outsourcing will lose “holy grail” status. In the future, companies will not outsource because it is the latest management fad, and “it is the thing to do.” Vendors will become more selective in choosing new clients to avoid taking on “mess for less.” Organizations will outsource less. Organizations will carefully define core, strategic, and “thought-leadership” functions and will keep those inhouse to retain knowledge, confidentiality, and control over key functions. Some organizations will decide to outsource only short-term using the Transform-Operate-Transfer model. As a result of outsourcing only “commodity processes” or outsourcing temporarily for a transformation, organizations will outsource a smaller percentage of their operating expenses. Many organizations will also engage in large scale reinsourcing thereby further eroding the outsourcing market. Organizations’ attempts to manage margins and increase the level of caution when outsourcing will lead to shorter contracts and a squeeze on profit margins of large providers. This situation will prompt Vendors to continue to rationalize services, cost structure, and pricing.
However, Outsourcing Will Remain a Useful Solution Within the Conservative Context of These Five Models.
o Initially, organizational processes that have been targeted for outsourcing are centralized and standardized, allowing the company to achieve efficiencies internally and to gain detailed management insights into processes and costs.
o Newly-achieved efficiencies allow visibility into potential outsourcing business cases.
o Increased management insight into the functions enables clear definition of operational and cost demands from vendors.
o These companies will engage in typically lower levels of outsourcing, and will keep most cost savings in-house rather than sharing them with the vendor.
o Organizations employ vendors to transform a function and to run it for a short-term period.
o Transformations are often more easily achieved externally than internally; thus, the benefits outweigh short-term outsourcing costs.
o This model is relevant especially for companies in volatile/ fast-moving industries, where rapid changes and adjustments are required.
o Companies will pursue outsourcing of non-core, non strategic, and non-differentiating functions (e.g., Webhosting and mailroom services).
o Companies will outsource these types of functions to vendors that specialize in these areas. The vendors’ “economies of expertise” suggest the vendor will better manage and run these functions.
Risk Transfer (“Insurance”)
o Outsourcing functions, such as disaster recovery, enables organizations to spread the operational and financial risk for functions that they are less able to perform in-house, providing insurance-like protection.
Shifting Fixed Costs to Variable Costs
o In human and financial capital intensive areas, such as legal or infrastructure, vendors offer organizations economies of scale and flexibility, allowing the shift from fixed costs to variable costs.