Many firms are now contracting with outsourcing vendors for selected activities. Indeed, the use of contractors and consultants, which is quite common, can be profitable, as long as internal staff and external service providers are used for the tasks for which they're best suited.
But decision makers must remember that vendors work for other people’s shareholders. To gain the payoff while minimizing costs and risks, vendors must be carefully managed.
A manufacturing company learned this when it outsourced its entire IT function. It retained only three internal staff to look after the contract, accounting and security issues. In spite of good relations for the first couple years of the contract, the CIO said:
"It takes a tremendous amount of time to manage outsourcers. It takes all the usual technical guidance. It takes attention to HR issues. For example, we had to stay on them to fill vacancies; then, we had to hound them if the person wasn’t good enough. It takes more administration than we expected.
"Also, we had to spend time holding them at bay while we considered our alternatives for new projects; they were all over us. Plus, we needed a legal staff to monitor the contract. It’s amazing how much time we spent in meetings worrying about how to manage the outsourcers.
"We seriously misgauged how many people we’d need in-house. To cut costs, we cut our staff to the minimum. This hurt us. In negotiations, for example, the vendor could bring much more to the table than could be dealt with internally; they had us at a disadvantage.
"As a result, we gradually surrendered control over the technical architecture, and over how the service was delivered. We didn’t even have enough people to monitor service levels and our clients’ reactions.”
Lock-stock-and-barrel outsourcing of entire functions is highly risky. There are so many profession-specific (e.g., technical) issues that need to be managed by insiders. The fact is, executives are ill-equipped to personally decide when vendors should be used or to manage their day-to-day work. They haven’t the time or the detailed professional knowledge.
Instead, executives should focus on setting up organizational processes that make the right decisions day after day, and that manage vendors within the objectives and standards of the company.
So the first question to ask in determining how those ongoing processes might work is: Who should manage outsourcing vendors?
If clients buy outsourcing directly, then they must manage the vendors and contractors. On the other hand, if the internal staff uses vendors and contractors to extend their capabilities, then they add value by managing outsourcing for clients.
To decide which approach is best, consider what’s involved in managing vendors and contractors:
1. Someone must carefully analyze the trade-offs and decide when to bring in vendors and contractors — not at a high level for entire functions, and not just once a year. The costs and benefits should be considered within the context of each specific project and task.
2. Vendors must be chosen carefully. The people judging the competence of a vendor must be familiar with the vendor’s profession or industry to make well-informed selection decisions. It’s a lot like hiring. If you don’t know a bit about the profession, it’s tough to know whether a candidate is fully qualified.
3. Vendors must be managed so that they conform to internal standards of quality and integration. Most vendors are paid to deliver near-term results in the most efficient way possible. They have little incentive to ensure that their work lasts for its intended life-cycle, and they may not be concerned about the company’s architectural standards that facilitate integration with other products. Someone must oversee vendors’ work to look after the long-term interests of the company.
4. Vendors’ knowledge must be transferred to those within the organization who will support their products over time. Otherwise, the company risks a costly dependence on outsiders.
These four requirements suggest that every vendor contract be managed by people of the same profession.
We call this “extended staffing.” In an extended-staffing strategy, outsourcers are treated as part of the internal group that offers the same skills and products.
Internal staff remain accountable for a line of business. Each of these internal entrepreneurs judges make-vs.-buy in the context of specific projects and services, and hires whatever help is needed to produce his or her product line. And clients can hold accountable staff that report to the same corporation.
The alternative — expecting clients to work directly with outside contractors — not only puts a greater burden on clients. It also builds the habit of buying elsewhere, which leads to permanent losses of market share by the internal service provider. As internal service providers shrink, they lose critical mass and find it tougher to stay competitive. This can lead to a “death spiral” that decimates an internal service provider and dissipates a resource (loyal staff and institutional knowledge) that's critical to a corporation's future.
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