Outsourcing: The Feasibility Analysis

by Alfredo Funes Cervantes

Beyond all doubt, the trend to outsource functions developed inside an enterprise or a government agency is at its peak. This phenomenon is not limited to IT; it's under consideration in several areas of an organization. Although outsourcing is a very appealing concept, it is essential for a company to be properly prepared for this kind of change.

In both the public and private sectors, it is common to find operating plans that have met their needs by using internal resources. A framework of processes, assets, and human beings has been built over the years to keep the business afloat. This framework is now threatened by a model that suggests operations be carried out externally while keeping the strategy, the negotiation, and oversight inhouse.

Like any management initiative, you can't grade this trend good or bad. It is not a black-or-white matter. You must be aware of the shades of color created by opportunities, advantages, risks, costs, organizational culture, idiosyncrasies, and provider quality. In other words, to outline the optimal strategy, you need a preliminary analysis to weigh costs and benefits. Once defined, that strategy may succeed or fail according to the way you implement it.

This Advisor offers our view of the first phase of an outsourcing strategy: the feasibility analysis, when we assess the likelihood of putting outsourcing into effect.

Feasibility Analysis Phase

Which are the key drivers for outsourcing? According to Michael F. Corbett, in his book The Outsourcing Revolution, cost reduction is at the top [1]. Almost half of those polled identified an economic reason as the main driver for outsourcing. Other key reasons include increasing focus on the business core, variable costs structure, access to best practices, ROI growth, enhancing service quality, capital retention, and innovation.

To this list of reasons, we should add the burnout caused by daily operative problems that, after a few years, call for redefining the operational plan. Once highly skilled professionals are well acquainted with the environment, they find that the inhouse operational plan is an obstruction to progress and development, or maybe the dynamics of growth or the changes in the enterprise or government agency are so strong that it is necessary to reconsider how things are done.

No matter what drives outsourcing, the truth is that with this initiative we are creating a competition with the external market regarding the way we handle the economic, technical, and administrative issues.

Failure to analyze the outsourcing option is equivalent to denying a comparative analysis to measure and, therefore, inhibits improvement possibilities. It has been rightly said that "only what's been measured can be improved."

Facing this scenario, you should avoid being carried away by "the song of the sirens" regarding possible benefits. Keep in mind that outsourcing is only a management tool, and this tool is used to move from a vertically integrated self-sufficient structure to an unbundled model that should provide agility, efficiency, and costs savings.

A change in the method of operating means being alert to several complexities. These include losing control, outsourcing critical issues, losing flexibility, internal customer negative reaction, and employee resistance.

Failure to thoroughly analyze the impact of outsourcing can seriously affect not only daily operations, but efficiency, cost, attention, and the working environment. To make a decision of this kind, you must visualize benefits and costs with objectivity and impartiality.

There is no right or wrong decision regarding outsourcing; it depends on each company or government agency. There are many examples of success or failure, with significant increases in revenue as well as great losses.

If you have a serious dilemma between the inhouse model and outsourcing, you are superbly situated to make the best decision. Here are some ideas that you should consider as key elements for this decision.

Current Internal Situation Analysis

The first step is to know where you stand. Are you efficient? How expensive is your current service? How stable is your working environment? Are you aligned to your business goals? Are you able to make a decision, or has it already been made? These are only some of the issues you need to identify before making a decision.

Beyond the final decision, it is very healthy to get a snapshot of your operation. IT's "as is" means to make an inventory of the systems, equipment, and licenses; get an X-ray of the real organizational structure; state every current costs, including those called "occupation costs." These include physical space, electricity, water, parking, and telephone.

Most of the time, you have only a partial picture that does not include these concepts. The as-is snapshot gives you the opportunity to see in black and white how the infrastructure, application, and management areas look. It is useful to have a document that allows you to visualize your operation, opportunities, lacks, excesses, and strengths. However, this analysis is not simple or fast; it can take months, depending on the installed based and the amount of information that has to be gathered, grouped, filtered, and debugged.

Pleasant and unpleasant surprises result from this exercise, and regardless of the decision to outsource, it provides a global vision of the operation. It is common that, while taking care of daily needs, your processes, organizational structure, systems, and infrastructure gradually change in no orderly way, and, after some time, reorganization is needed. The as-is snapshot provides the opportunity to make such an assessment. The decision for outsourcing without the proper internal analysis is very risky because comparison with the external alternative will have no value.

Current External Situation Analysis

Can you trust your providers? Is their credibility based on results? It is common that they offer more than they can provide. Analysis of the external situation will allow you to assess an eligible provider. Each provider has particular specialties, strengths, and weaknesses.

The first point for evaluation is: do you want one provider or multiple providers? This is a tough decision, which can result in varying implications.

One provider, with sole responsibility, is easier to manage. In most cases, the provider becomes an integrator, who in turn has contracts with other providers, but the lone provider is the one who faces the consequences, avoiding the risk of dispersed responsibility. Features that need to be assessed when having only one provider include whether the provider has proven skills to face such commitment. All say they do, but have you confirmed it? On the other hand, as an integrator, the provider will increase costs because of the level of responsibility and management, and these will be reflected in the price.

Multiple providers (multisourcing) requires more complex administrative structure inhouse, including high administrative and technical skills. The service-level agreements between providers should be highly precise to avoid inefficient operation or situations where "nobody" is responsible. The advantage of this model is the possibility to leverage each provider's strength and, if well managed, can be very effective and less expensive than the sole-provider option.

Risk Analysis

Outsourcing involves four kinds of risk: strategic, operational, results, and transactional risks.

Among strategic risks are such issues as handing over and losing control of future business decisions, knowledge loss regarding the protection of intellectual property, and structural changes regarding the service provider. If offshore activities are under consideration, be aware of the risks associated with cultural, idiomatic, and geopolitical differences. Each of these risks is worth a detailed analysis; medium-to-long-term impact is highly relevant.

Operational risks include the impact of outsourcing on the organization's or government agency's staff, including those who will be transferred and those who will remain in the organization. In addition, such risks include those associated with the integration of the provider into the organizational culture, the possibility of a poor or inefficient performance, and, in the case of offshore activities, the threat associated with the impact of legislation and changed regulations.

Results risks focus on thoughtful considerations: do you have the governance model and administrative skills/ability to control and collaborate with the service provider(s) and attain the desired benefits?

Transactional risks involve agreements and agreement clauses, such as termination, compensation, warranties, intellectual property rights, penalties, and achievement bonuses.

Proper analysis and assessment of these risks allows you to put into perspective not only whether the decision to outsource is the right one, but it can also give you a clear idea about the right time to carry out the outsourcing decision.

If you are likely to assess outsourcing in the feasibility analysis phase, I suggest you include both the internal and external situations, as well as thoroughly review the four types of risks mentioned here.

I welcome your comments on this issue of the Cutter Edge and encourage you to send your insights on the market in general to me at comments@cutter.com.

-- Alfredo Funes Cervantes

Reference

1. Corbett, Michael F. The Outsourcing Revolution: Why It Makes Sense and How to Do It Right. Kaplan Publishing, 2004.