New Options Emerge in a Maturing Outsourcing Market

As your existing outsourcing contracts approach their termination dates, you’ll face some fundamental questions: Are you getting value for your investment? Should you renew with the incumbent service provider? Should you solicit responses from alternative service providers through a formal, competitive review process? Should you engage multiple vendors? Should you bring services back in-house?

In this article I discuss three trends I see emerging as a result of the ongoing maturing of the business of outsourcing.

Thanks to a maturing outsourcing market, client companies are increasingly well-positioned to address the questions I pose above from a strategic perspective, to revisit their overall approach to service delivery and to explore new options that weren’t available when they initially outsourced.

Increased client confidence in navigating the challenges of managing a successful sourcing relationship is key to this emerging trend. More and more client organizations are developing competent internal retained functions with the skills needed to define objectives and evaluate vendor proposals, align IT operations with business objectives, engage multiple service providers to achieve a “best-of-breed” solution and, if necessary, bring services back in-house.

Proxy Bids: Evaluating Existing Outsourcing Relationships and New Proposals

One of the central challenges of outsourcing has traditionally been gauging existing services or new proposals in a competitive context. Because contracts are typically structured to address the unique conditions of a business environment, apples-to-apples comparisons are difficult, and clients struggle to understand whether services are being delivered at fair rates. Rather than embark on a costly and disruptive formal RFP process, clients often choose to simply renew with the incumbent and hope for the best. Uncertainty similarly surrounds new proposals: Is the pricing being offered competitive? Is it unrealistically low and unsustainable?

The concept of the “proxy bid” is emerging as an effective tool to help address this quandary. A proxy bid is an analytical approach to comparing the actual price you pay for a “basket” of services with the prevailing market price of a comparable basket of services. This bid is developed by a third party with access to detailed and granular pricing data for outsourced processes and services, and a thorough understanding of the service provider’s operations and price drivers.

The “proxy bid” approach allows you as the client organization to circumvent the time and expense of a formal review process to accurately assess whether an existing or proposed outsourcing arrangement is financially sound and competitive with market rates. Proxy bids are increasingly being applied as an alternative to a benchmarking clause or some other provision mandating a rigorous analysis of price and performance.

If you’re considering a multi-sourcing scenario, you’ll want to understand the financial implications of disaggregating a full-scope outsourcing contract into regional, offshored or insourced scenarios. The proxy bid can be particularly effective in resolving situations where the financial terms of a contract are less than ideal, but not sufficiently onerous to warrant putting the contract out to open tender.

For service providers, a proxy bid can be useful as a way to assess the competitiveness of a pricing proposal relative to current market conditions or to define the internal costs required to deliver the services.

Insourcing: The New Outsourcing Option

Another trend characterizing the sourcing market today is the growing consideration of insourcing as a strategic option. In many cases, insourcing is driven simply by a failure of outsourcing to achieve anticipated cost savings. Compass analyses of large outsourcing contracts show, on average, a cost reduction of 15% over the first 18 months of the agreement. But because of the “back-end loaded” nature of many contracts and because of excessive charges for out-of-scope services, by the end of the term, costs can be as much as 30% higher than those of a well-managed internal operation.

Frequently in the past organizations outsourced to reap short-term financial gains — getting employees off their books, realizing immediate IT cost savings or receiving a cash infusion in exchange for assets. If this describes your organization’s situation and your company’s financial situation has stabilized, you may wish to revisit your outsourcing strategy to determine if you can manage operations more efficiently in-house.

In other instances, service providers have been victimized by their own success. Following acquisitions and mergers or other major transitions, providers have committed the resources and resolve the client lacked to deliver well-run global operations with consolidated standards, processes and systems. Now, clients are bringing the improved operation back in-house, exploiting the investment and reaping the rewards in terms of on-going cost savings.

In a broader sense, insourcing reflects clients’ enhanced ability to define sourcing requirements and determine what should be outsourced and what should be kept in-house. This more nuanced approach recognizes that outsourcing presents some management challenges and requires significant investment — a recognition that, until recently, was lacking. And, having discovered that managing an outsourcer is difficult, clients now believe that running the operation directly may be less of a challenge.

Another consideration: Truly global organizations can be their own service providers and gain many of the benefits of offshore service providers. A multi-national bank with operations, for example, in Poland could consolidate mainframe operations there and take advantage of a highly skilled workforce and low labor rates, as well as reap the benefits of consolidation. Large organizations can also afford to hire the best talent, as well as leverage economies of scale as does a service provider.

Fifteen years of Compass benchmarking data shows that a large, well-run internal organization can provide services more cost effectively than a service provider. Such organizations are able to replicate the service providers’ advantages in-house, leverage economies of scale and consistently drive costs down year over year. However, achieving top performer status requires a significant commitment and investment towards creating a culture of excellence.

If your organization does pursue repatriation, you should recognize the challenges and ensure a strong internal management function is in place to address the confusion and disruption that inevitably accompany a repatriation initiative. The internal management team may be able to count on the goodwill of the business units, but only up to a point. Users will likely treat the internal team as a service provider and will have the same expectations.

In addition, transition costs, which can range from 12% to 17% of the yearly charges, depending on the operational area, must be considered in an insourcing decision. These costs may be higher than the original outsourcing transition and can include equipment purchases and real estate requirements.

Selective Sourcing: Megadeals Are Out

Despite increasing interest in repatriation, most organizations will ultimately pursue a strategy of selective sourcing, whereby some services are kept in-house and others are outsourced to multiple vendors to achieve a “best of breed” solution. This approach is partly driven by the aforementioned development of client confidence and management capabilities.

In addition, a key enabler of selective sourcing is the emergence of “tier two” regional outsourcers. Mid-sized service providers can provide more options in terms of selective sourcing, allowing clients to define specific functions to outsource — as well as specific functions to keep in-house.

The selective sourcing approach also reflects a disenchantment with all-encompassing “megadeals” with global outsourcers. In reassessing their sourcing strategies, client organizations are finding that a selective approach employing a mix of regional players and insourcing can be the optimal “global” mix.

Useful Links

Compass
http://www.compassmc.com/services/destinations/sourcing.htm