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Home > Performance Management Viewpoints > Outside Right? Outsourcing and the Future

Performance Management Viewpoints

Outside Right? Outsourcing and the Future

by William Kay

Introduction

This article was first published in Quantum magazine.

The views of investment managers and management consultants about outsourcing, a market that is now worth $100 billion a year, swing wildly between admiration and scepticism, seemingly blowing hot and cold with economic fashion.

It can be a convenient way of reducing costs, sometimes by as much as 30%, but critics warn that it can also mean that a business loses touch with vital tasks and skills, possibly even to the point of being squeezed out of activities they had previously dominated. This means that investors and fund managers are now paying more attention than ever to the outsourcing strategies of quoted companies.

“We look for companies where you can see some kind of stability and profit stream,” says Philip Matthews, who manages the Growth and Income Fund of Jupiter Asset Management in the United Kingdom. “And we always try to price in associated risk—mainly by looking at the historic volatility of income streams for these kind of businesses, as this is one measure of risk. Outsourcing is one of the factors that can affect that volatility.”

Why Outsource?

Companies that do not outsource can find their overheads loaded with activities which are beyond their competence. Retail chains long ago realized that they cannot avoid taking a view on the property they use: should they own the freeholds, or effectively outsource their property skills by leasing or renting?

Matthews says: “Outsourcing has benefits in that it allows companies to both reduce costs and to use the services of specialist companies, but we are also mindful of companies that are becoming much more capital-intensive to generate the same level of profit.

“You tend to see businesses retain what they deem to be their key point of differentiation, while outsourcing what they can to cut costs or if there is a specialist service needed—but companies are always testing the boundaries. When and where there are major changes happening to the company, you need to be comfortable that they are not purely for the short term, to the detriment of the long-term future of the company.”

He cites the April 2010 BP oil spill in the Gulf of Mexico to illustrate the risks of outsourcing. “Businesses cannot absolve themselves of ultimate responsibility,” he says. “In other words, the parent company can lose control of the processes while potentially bearing the risk, which almost always rests with them.”

What Counts As Outsourcing?

But the BP case highlights a problem in assessing the use of outsourcing to a business: how should outsourcing be defined? Like many outside the oil industry, Philip Matthews believes that the rig suppliers and other companies working with BP in the Gulf of Mexico at the time of the Deepwater Horizon spill were providing outsourcing services.

BP, however, disagrees. “Drilling is not outsourcing. The entire (oil) industry uses (and has for many decades) specialist drilling contractors and specialist cement contractors (and other specialists) like these. As far as I know, no major oil company does its own drilling, or seismic surveying for instance,” says BP spokesman Robert Wine.

He defines outsourcing as “IT services, accounting, facilities management, HR, back office, etc. We have partially or wholly outsourced many of these for many years and it’s now just part and parcel of the business.”

Major Trends in Outsourcing

Government

Governments are much less concerned about precise definition. The British coalition government has put outsourcing high on its political agenda as it tries to cut public sector debt. In his recent spending review, Chancellor of the Exchequer (finance minister) George Osborne made this clear when he said that the government “does not have to be the default provider.”

Local authorities throughout Britain are being pressured into outsourcing through the simple expedient of finding their central government grant cut—though few were expected to go as far as Suffolk County Council, near London, which has said that it wants to become a “virtual council”.

Osborne is only following the example set by hundreds of European and American companies as they have tried to adjust their finances in the wake of the economic downturn. But they are not writing blank checks.

Recovering from the Downturn

“Organisations were expected to emerge from a long period of retrenchment in the first quarter of 2010 with a laundry list of things they wanted to outsource,” says Stan Lepeak, managing director of global research for EquaTerra, an international sourcing adviser. “While there is significant interest in conventional outsourcing, a growing number of buyers are also exploring options like virtual IT infrastructure and software as a service.”

While IT is seen as a way of saving on overheads, other areas of outsourcing have been suffering because demand for them is related to activity. “The global outsourcing market is holding steady and is being upheld by an increase in contract renewals and traction in the IT segment,” said Eric Simonson, managing partner of research at Everest, another major consultant. “The slowing growth in business process outsourcing is not surprising given a slow post-recessionary recovery, as well as anti-offshoring sentiment in the United States.”

As in so many other aspects of business life, the recession prompted companies to rethink outsourcing. The potential savings encouraged many to upgrade its importance.

Mike Morris, head of outsourcing search and selection at Essentia Consulting, says: “The slowdown led to a re-evaluation of how outsourcing benefits businesses. Five years ago, outsourcing was the fashionable option behind many cost-cutting ideas. Now corporations have woken up to the fact it is so much more than just a cost-saving measure, and the extent to which outsourcing can improve their business operations is much more under their control.”

Morris believes that cost reduction has been replaced as a criterion by return on investment in many boardrooms, as clients demand quicker, more transparent results and a total outsourcing package, preferably with global reach.

That thinking sparked some significant mergers and takeovers between outsource service providers last year. Hewlett Packard swallowed EDS, Dell acquired Perot Systems, Xerox bought ACS, and Xchanging took over Cambridge Solutions.

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