Outsourcing Woes Trouble Leading Companies

Outsourcing IT and business processes isn't working as well as many executives had hoped, at least among a handful of leading companies.

That's the conclusion of a study issued Tuesday of 25 large companies conducted by the business consulting firm Deloitte Consulting, in which 70% of survey participants say they had significant negative experiences with outsourcing projects and now exercise greater caution in approaching such deals.

One-quarter of the companies have brought functions back in-house after realizing they could be addressed more successfully and at lower costs; 44% say outsourcing didn't save any money. And nearly half of the surveyed executives identified hidden costs as the most common problem when managing outsourcing projects.

The study, titled Calling A Change In The Outsourcing Market, contends that participants initially engaged outsourcers to cut costs, simplify project execution, and provide expertise they lacked in-house. Instead of simplifying operations, the study says, many companies have found that outsourcing activities can introduce unexpected complexity, add cost and friction into the value chain, and require more senior management attention and deeper management skills than anticipated.

The problems execs from the largest companies have with outsourcing are twofold, Ken Landis, Deloitte's senior strategy principal, says in an interview. First, manufacturing outsourcing--born in the shadow World War II--served as the pattern for IT and business-process outsourcing, but the dynamics of the two are vastly different and can't be duplicated, he says. Second, services outsourcing came to the fore during a recession, and the economy isn't in an economic decline these days. In a recession, he says, cost saving is a prime corporate motivation. But when the economy is growing, other factors such as customer satisfaction and growth compete with controlling costs, and outsourcing services limit a company's control over those matters. "They see outsourcing creating a structural disadvantage," Landis says.

More than eight in 10 respondents complain that they have little or no transparency into a vendor's pricing and cost structure, meaning they might be paying more than they should. Half of the executives ranked cost-related issues as the main risks of outsourcing. Nearly that many survey participants indicated they don't have a standard method of evaluating the business case for outsourcing.

The study suggests an evolving outsourcing model, as 83% of executives say they have renegotiated outsourcing deals because of pricing and business, technology, and regulatory environment changes. More than half have moved to shorter contracts--up to five years--from long-term agreements of six to 10 years.

Nearly half of the respondents work with multiple vendors to limit their dependency on a single service provider. Forty-five percent say they felt forced to include gain-sharing clauses in vendor contracts as motivation for innovation, highlighting continuing concerns about vendor complacency.

Despite these reservations, outsourcing as a business mechanism is far from dead. Outsourcing can still deliver value to companies that enter into deals for the right reasons, Deloitte says, and if they use the right business model, such as centralize-standardize-outsource, transform-operate-transfer, commodities outsourcing, risk transfer, and shifting fixed costs to variable. Another requirement is having superb talent in-house to manage deals from inception to execution.

Deloitte conducted in-person interviews with executives from 25 "world-class organizations" between October and December. Nearly half of the participants are executives from the 500 largest U.S. public companies, while another quarter are from privately held or public-sector entities. Four are with companies headquartered outside the United States.