In the search for better operating margins, companies have turned to outside organisations to provide non-core services, such as HR, finance and IT.
Large outsourcing deals – including the transfer of work to such offshore centres as India and the Philippines – have made a significant contribution to business’s profits over the past few years.
The logic has been that businesses will be more efficient, more effective and more profitable by concentrating on core activities, and by letting specialist service providers run the rest. Specialisation allows the outsourcer to provide a cheaper, and often better, service. This has been especially true in information technology, where economies of scale, labour arbitrage and adherence to best practice often allow outsourcing providers to deliver a cost reduction of between 15 and 20 per cent in the first year of a contract.
With such savings on the table, businesses faced with a tough trading environment might be tempted to farm out an increasing amount of work, including IT operations, to third parties. But experts warn that outsourcing is unlikely to deliver the rapid savings that finance directors want.
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Conventional outsourcing deals forced companies to lock in to multi-year contracts to run large elements of IT infrastructure, such as data centres or the desktop PC network. Such deals worked by promising the client cost-savings in the first one or two years. The service provider would claw back profits in the later years of the contract through internal efficiencies and the falling cost of IT. However, such contracts often made little in the way of provision for reducing IT capacity, should business demand fall back. And adding additional capabilities was often expensive, sometimes to the point where it was no longer financially viable to take on new services.
“Outsourcing contracts were inflexible, with fixed baselines,” says Jonathan Cooper-Bagnall, head of sourcing consultancy at PA Consulting. “The next wave of contracts will go beyond that to include virtual services, such as Google Apps or e-mail.”
Conventional outsourcing contracts have improved, Mr Cooper-Bagnall suggests, and companies that devote time and effort to drafting a good-quality contract will be able to avoid many of the pitfalls of first-generation outsourcing deals.
Businesses, especially larger ones, might be able to reduce their overall IT costs by switching some functions from conventional outsourcing contracts to a services-based model. But such moves will only be effective if the business is prepared to devote resources to the IT organisation it retains, too, suggests Doug Plotkin, head of sourcing for the US at PA Consulting.
“The integration issue goes right back to the capabilities of your retained organisation, and your sourcing strategy,” he says. “You need to look hard at the capabilities within your own organisation, and it may well be that you need to build some capabilities back in, in order to work in a multi-vendor environment.”