How to make the right decision on outsourcing
The drive to concentrate on core business activities and to increase value for shareholders has encouraged many organisations to examine opportunities for outsourcing. But any decision to outsource should never be a simple, quick-fix to hive off what management considers non-core activities. Outsourcing decisions are complex business initiatives, requiring considerable investigation. Here are some essential precursors to a final decision...
1. Be aware: outsourcing isn’t always the answer.
The motto of ‘core in, and non-core out’ is a gross oversimplification of the outsourcing process - even if ‘core’ and ‘non-core’ could be clearly distinguished. For example, take IT, an activity frequently identified as ‘non-core’. One study involving organisations outsourcing more than 80 per cent of their IT operations found high levels of dissatisfaction with the results achieved. Another study found that one-third of 116 large organisations outsourcing IT in the US and the UK experienced dramatic cost blow-outs, disputes, high levels of failure, and loss of control. So, rather than try to distinguish ‘core’ from ‘non-core’, try discriminating between 'effectiveness’ and 'risk'.
2. Weigh up first your case for outsourcing.
First, discriminate between effectiveness and risk.
Use a simple four-squared matrix to decide whether to outsource an activity. On the one side are the risks associated with outsourcing the activity, e.g. costs or loss of know-how, and, on the other side, the effectiveness of the activity when performed in-house rather than outside:
| Risk | Q4 | Q3 |
| Q1 | Q2 | |
| Effectiveness | ||
If effectiveness is low and the associated risks are low (Quadrant 1), the logical action could be to outsource the activity.
If effectiveness is high and the associated risks are low (Q2), it would be logical to keep that activity in-house (assuming that the company can maintain that level of effectiveness in the future).
If the effectiveness is high and the associated risks are high (Q3), the activity would be better controlled in-house.
A problem arises when effectiveness is low and risks are high (Q4). The challenge for management is to redesign the task so that either it becomes more effective or the risks become lower. Only after the job has been moved out of this quadrant should outsourcing be considered.
Second, assess the pros and cons.
Some of the most common reasons given for outsourcing are these:
- Cost efficiency
- Inability to develop in-house competencies quickly enough
- The need for a quicker response
- Small production runs too costly
- More effective and profitable asset management
- Economies of scale - providers can usually handle sudden hikes in demand
- Emergence of efficient supply market - transport, for example
- Improved operating performance
- Reduces overhead costs
- Some training and other employee-development activities become the provider’s responsibility.
Some of the most common reasons for not outsourcing include these:
- Loss of know-how - outsourcing companies later become competitors
- Managing outsourcing too expensive or too difficult
- Cultural dissonance between the organisations involved.
Having weighed the advantages and drawbacks of outsourcing a task, you will be in a better position to make a confident decision.
3. Refocus your attention on specific activities.
Evaluating an outsourcing alternative can often improve the activity under review. An activity not considered central by top management might not have received much attention and therefore might have been allowed to become inefficient. Renewed attention to the activity, brought on by looking at possible outsourcing options, can cause the activity to be revisited. That attention may be all that’s required to increase the in-house effectiveness of the activity - and to suppress thoughts of outsourcing.
