Outsourcing: are the last rites premature?

This article was first published on Intelligent Sourcing

Following the recent news about major outsourcing companies struggling, some commentators are keen to start writing outsourcing’s obituary. But having advised on hundreds of outsourcing deals, we know rumours of its death have been greatly exaggerated.

Outsourcing will be a key part of a mixed supply chain for the foreseeable future, as long as these basic principles covered by best practice are followed:

1. Get the strategy right

One-dimensional, dogma-driven sourcing policies invariably produce problems sooner or later as one size won’t fit all. A sourcing strategy – whether in a public or private sector organisation – must take account of numerous factors. Context, business objectives, risk, capability, technological and market changes, regulatory regimes, politics, people, culture, costs – all these aspects and more need to be considered. This leads to a mixed, sometimes complex, supply chain with both insourced and outsourced components, all of which will involve a level of risk that needs to be identified and managed.

2. Don’t use outsourcing just because it’s easier than fixing a problem yourself

Transferring problems to an external supplier and expecting them to be solved isn’t the answer. Expecting the outsourcer to deliver the services at lower cost (‘your mess for less’ as it’s known in the business) is either an admission that management has failed, or a belief that the supplier is better. If the latter, the obvious question is how are they able to deliver services better/faster/cheaper? Where’s the evidence of this capability? How do you know they’re not quoting a low price to win the business and betting they’ll be able to implement improvements that let them deliver a profitable deal? If they lose that bet, you’ll also suffer. Effective due diligence is key to managing that risk.

3. Due diligence must be structured, healthily sceptical, evidence-based and not stop when the deal is signed

Due diligence is the beginning of ongoing risk management that’s reflected in the contract and supplier management approaches that continue throughout the life of the deal. Non-financial due diligence should not be entrusted to procurement departments. Too many private sector procurement functions are goaled (and bonused) almost exclusively on savings. That means – consciously or unconsciously – they have only secondary concerns for quality and capability assessments (in which they’re not expert). Effective supplier management demands sufficiently skilled resource – a so-called ‘intelligent client’ function can be a critical success factor in achieving a successful client/customer relationship.

Checking the supplier’s financials by skimming annual reports and running a Dun and Bradstreet check is a good start. But keeping track of market commentaries from investment analysts and the press (particularly profit warnings, excess leverage and pension fund shortfalls) are the minimum for any reasonable sized deal. Contractual provisions, such as requiring suppliers to follow good practice in terms of paying suppliers (which, of course, you follow – right?), limit the likelihood of a supplier hiding cash flow problems by using sub-contractors as surrogate banks.

There’s no fool-proof system

Such activities don’t eliminate risk (few people foresaw the Satyam scandal caused by falsified accounts in 2009) but they certainly reduce the likelihood of the risks crystallising and becoming issues.

Common sources of problems that are hard to anticipate are poor understanding of requirements, failure to clearly state requirements in contracts, and ineffective governance and remedy regimes. We don’t know to what degree these may have contributed to recent issues, but we do know questions must be asked before entering outsourcing arrangements:

• Do you really know what you want to buy, need to buy, have bought, and how you can change it as your requirements change?
• How do you know if you’re getting what you want? Are the right things being measured to evidence this?
• What remedies do you have if the supplier doesn’t deliver? Financial recompense through service credit regimes are usually wholly inadequate to compensate for the impact on your business. Do you have other means of redress such as step-in, partial termination and transfer to an alternate supplier? Or will you only have the ‘nuclear option’ of termination and litigation (which doesn’t provide service continuity)?
• Do you fully understand the risk represented by your supply chain? Whether that’s the potential impact on critical service components, or overall concentration risk that renders one or more suppliers ‘too big to fail’.

Outsourcing the right things in the right way can deliver significant benefits. However, it‘s not a panacea. Remember the old line that if it looks too good to be true, it probably is.

Mike Dodd and Rob Cann are sourcing experts at PA Consulting Group