Effective outsourcing measurement

Outsourcing is not always straightforward and requires careful monitoring. Dr Ilan Oshri, Associate Fellow at Warwick Business School and Associate Professor at Rotterdam School of Management*, offers an approach to effective outsourcing measurement

Few companies calculate the financial impact of outsourcing on their bottom line

Outsourcing is not always straightforward and requires careful monitoring. Dr Ilan Oshri, Associate Fellow at Warwick Business School and Associate Professor at Rotterdam School of Management, offers an approach to effective outsourcing measurement

Today companies are more pressed than ever to demonstrate returns on investment in outsourcing. While the initial returns can always be associated with one-off cost cutting, outsourcing arrangements are complex, often involving inter-related high-value activities, which makes the realisation of long-term benefits from outsourcing a challenge. Client companies are no longer satisfied with the same level of service delivery through the outsourcing lifecycle. They seek to achieve business transformation and innovation in their services, beyond satisfying service level agreements (SLAs).

Clearly the business world is facing a new challenge: an outsourcing delivery system of high-value activities that demonstrates value over time and across business functions. However, despite such expectations, many client companies are in the dark when trying to measure and quantify the return on outsourcing investments. Results of research1 conducted with Cognizant in 2009 show that less than half of all CIOs and CFOs (43%) have attempted to calculate the financial impact of outsourcing on their bottom line, indicating that the financial benefits are difficult to quantify (51%).

There is no doubt that companies need to improve their ability to measure the benefits of outsourcing. These benefits go beyond the one-time cost saving. They strongly relate to the company’s competitive advantage and therefore often represent the key success factors (KSFs) in industry. Our research has led us to identify six lessons that will guide executives to achieve better results from outsourcing engagements.

Lesson 1: Work out the context of the outsourcing activity – A good starting point is to understand why the company would like to outsource a service and what resources are available to outsource a project successfully. We observed a couple of common mistakes in this regard: a bandwagon effect in which companies outsource because the competition does so or companies outsource ‘a problem’. These are the wrong reasons to outsource a service, and the consequences can be dire.

Instead, companies should follow a systematic approach to analysing the context of the outsourcing activity. There are several criteria that should be examined, including the overall goal, how critical the service is to competitive advantage, how dependent the service is on other inputs from the firm, how work will be codified and monitored (and the precision of the metrics) and how mature the firm is in managing outsourcing arrangements.

Exploring these areas should deliver a clear understanding of the drivers to outsource, internal resources and expectations. Realising the benefits of an embedded service that is difficult to codify could be challenging as it increases operational risks. Likewise, outsourcing processes that are difficult to monitor (e.g. r&d, supply chain co-ordination), in particular when the company does not have precise metrics to evaluate quality, is not recommended. In these cases, the company should examine its maturity level in outsourcing.

A high degree of outsourcing maturity and sophistication will allow a company to devise methods that overcome certain challenges and mitigate some operational and structural risks.

Lesson 2: Work out the outsourcing strategy The outsourcing strategy will dictate the complexity of the outsourcing arrangement and therefore the ability to realise benefits. Our advice is to choose an outsourcing strategy that the firm’s resources and capabilities can cope with. By doing so, you will be able to assess and realise the benefits gained from your outsourcing arrangements.

Many companies experiment with sourcing models that are beyond their organisational capabilities. For example, in recent years some companies experimented with multi-vendor sourcing arrangements, but few companies can actually realise the benefits offered by the multi-vendor model. It takes advanced sourcing capabilities effectively to manage a single vendor in a particular business function, let alone multiple vendors.

Another example is the outsourcing of a range of services within a particular business function (e.g. HR) to a single vendor. While the client might perceive this as a straightforward arrangement in which the benefits should be easily realised, as there is only one vendor involved, the client will need to develop sophisticated outsourcing capabilities that allow the benefits from synergies between outsourced services to be achieved. We have learned that most clients failed to realise this promise.

Lesson 3: Work out the benchmark – Many companies rely on SLAs as the main means through which value from an outsourcing arrangement can be realised. SLAs are critical in any outsourcing arrangement; however, they do not give the entire picture and in some cases can be misleading. Companies that rely on SLAs are essentially monitoring service performance, which can be meeting the service provisions but offers little transformation. Therefore, the challenge for companies is to realise the impact of outsourcing on the business and not on the service performance.

For this reason, companies must figure out the benchmark to use when measuring real benefits, usually a KSF in the industry – for example, time to market of a new product or quality. Once a benchmark has been identified, SLAs can be drafted to correspond with the provisions that generate a competitive edge.

Lesson 4: Realise what is value over time – Value is a dynamic concept. The desired value to be delivered from an outsourcing arrange-ment set by the client and vendor at the beginning of the project is destined to change over time. Few companies are aware of this and even fewer take steps to mitigate this risk. By not sensing the changes in value over the outsourcing project life, disagreements are likely to emerge between parties that will eventually erode the project’s benefits.

At the same time, the dynamic nature of value does not mean that clients are entitled to redefine their expectations every week. There should be a joint approach to address this challenge. The first step is therefore to develop sensing mechanisms for changes in value.

Sensing mechanisms are best supported through shared learning between the client and the vendor. The more shared learning opportunities are created between the client and vendor teams, the more likely that value as a dynamic concept will be monitored.

Lesson 5: Build the retained organisation – Companies should build the retained organisation to act as a change agent that monitors value delivery. Most companies consider the retained organisation as the minimum resource needed to support function continuity. The mistake in this approach is the focus on function continuity. Instead, the retained organisation should be perceived as the resource that drives a firm’s transformation and innovation.

For example, in many outsourcing arrang-ements the client transfers staff to the vendor. A common mistake is for companies to keep bright and talented staff in house, rather than transfer them across to the vendor in those areas that the vendor is expected to take leadership, for example application development. At the same time, the companies should build new expertise to ensure that its focus is on continuity, transformation and innovation.

Lesson 6: Invest in outsourcing learning capabilities – One of the most critical capabilities that outsourcing clients need to develop is learning. Yet clients still tend to take a narrow approach to learning by focusing on learnt lessons from a single outsourcing arrangement and often paying little attention to building a learning capability across multiple outsourcing arrangements.

Furthermore, clients often apply all their resources to ensure that vendors meet the service provisions while ignoring opportunities to learn from them. Consider the vast experience acquired by a vendor over time in a particular industry. Also consider the growing specialis-ation of vendors in a particular industry or technology achieved through the knowledge acquired by centres of excellence (CoEs). Experts from these CoEs have dealt with multiple outsourcing arrangements, reviewed numerous contracts, negotiated benchmark and SLAs metrics and worked together with various clients to achieve success.

Removing these learning barriers requires vision and courage. If a firm is to become a sophisticated outsourcing player, it has to learn from its vendor first to avoid mistakes we have seen made again and again by the inexperienced.

Any company would clearly like to present the benefits from its outsourcing arrangements. However, many companies will eventually realise that they do not know what exactly they have gained and at what price. By following these lessons, companies can take better control of outsourcing contracts and ensure they are achieving their intended, specified goals.

*This article is adapted from a report by Dr Ilan Oshri, Associate Fellow at Warwick Business School and Associate Professor at Rotterdam School of Management. To read the full report visit www.quantifyingoutsourcingbenefits.com