Playing with fire

Nobody believes outsourcing is the wonder cure for business woes it was hailed to be in the 1990s. Nevertheless, businesses of all shapes and sizes are accepting the risks of relinquishing non-core activities in an effort to achieve greater economies of scale...

Nobody believes outsourcing is the wonder cure for business woes it was hailed to be in the 1990s. Nevertheless, businesses of all shapes and sizes are accepting the risks of relinquishing non-core activities in an effort to achieve greater economies of scale…

When Henry Forde, the director of technology service provider, net:telecom, ditched one company and signed an agreement in July last year with another to provide maintenance services to his customers, he saw it as a good deal.

‘They were primarily an engineering company,’ reflects Forde. ‘They did a lot of installation. They were struggling with sales and they thought it would be a good fit. I thought it would be a good fit too.’

It wasn’t. Forde explains that as net:telecom started to bring in more sales and grow, the engineering company struggled to maintain the required level of service. ‘Although they valued the business we provided them, they couldn’t meet that demand as they didn’t have the resources and the capital,’ he says.

Other difficulties soon began to surface: ‘I suppose personalities came into this as well. The chap at this company was aged 50-plus, old school, not very flexible, and he had been in the industry a long time and saw margins move from 80 per cent to 30 per cent.’

It was the outsourcing company, says Forde, which suggested the contract should be suspended and they parted ways several months ago. The experience has given Forde some food for thought with regard to what went wrong. He believes that signing the contract per se is not the only issue to concentrate on. With the benefit of hindsight, he thinks it’s essential to factor in eventualities like whether the company to which you’re outsourcing can keep pace with your own company’s growth.

‘It’s about finding the company which is bigger than you are, but has the same ethos and is flexible enough to accommodate you. There’s no point hiring a global giant, as it won’t be able to give you the dedicated attention you need,’ he says. In addition to this, human nature and relationships need to be taken into consideration. ‘Contracts can be signed, but how do you arrange a get-out clause when personalities clash and things don’t work?’ he asks. There is no easy answer to the question. It encapsulates the risk a business takes when embarking on the outsourcing process. As for Forde, he was fortunate in that both net:telecom – which has four staff – and the engineering company were small enough to agree to disagree and amicably move on. (Incidentally, net:telecom is back with the company it initially replaced.)

This experience hasn’t dissuaded Forde from outsourcing. Far from it. He says the company would not have been able to grow like it has since starting up at the end of 2002 without other organisations assisting with its finance, telecoms and IT functions.

Searching for solutions

Many entrepreneurs at organisations, large and small, no doubt agree with Forde, as there is a clear global shift to use outsourcing to make operations focused, efficient and leaner. That said, according to new research by outsourcing consultant TPI, the value of global outsourcing contracts in the first three-quarters of the year is down two per cent on the same period in 2005 and 11 per cent on 2004. It makes the last quarter the worst in four years for the total value of major contracts awarded. Despite this downward turn, though, TPI found the number of major contracts being awarded to companies this year is higher than ever before, bringing in an extra $9.7 billion
(£4.9 billion) in annual revenues. This is three per cent higher than in the same period last year and again a record high. Outsourcing is not going to disappear anytime soon.

Peter Moller, partner in charge of outsourcing advisory services for Deloitte UK, says many observers expected the market to take off in the 1990s, but nothing really happened until ‘Eastern Europe and India started to come on tap’. Off-shoring has, he notes, created a workable labour arbitrage for outsourcers to make their 15 to 20 per cent margins.

Over the past 15 years or so, the outsourcing market has matured greatly on all sides. Peter Brooker, principal consultant for programme management at Molten, a consultancy, notes businesses have moved away from outsourcing operations to one supplier. ‘There is a strong fear in large organisations of vesting too much interest in a single supplier, hence the move to splitting risks across a number of smaller contracts,’ he says. Moller agrees: ‘The market is moving towards more contracts being signed in specific functions like finance and HR, rather than big contracts across all of them.’ When deciding to outsource, no matter what size your business, it’s important to consider what you are letting someone else have access to. Specifically, this includes customer data, market intelligence, client information and other intellectual property directly relating to what your business is doing.

In the case of IT, Brooker comments that ‘some companies fall into the trap of giving away their competitive advantage’. He goes on: ‘It could be lists of clients and whole knowledge banks you would be better able to exploit if you had it all at your disposal, as opposed to saying: “Well, I can’t easily get to that because I’ve outsourced it”.’

The answer here is to think small. Brooker says: ‘You have to ask: “What parts are smart for me to outsource and what parts aren’t?” There are elements you could outsource easily without selling the farm by doing it.’

Finding the balance with outsourcing

Moller makes a similar point in relation to outsourcing finance functions. Up to now, it’s consisted of transaction processing like accounts payable. Now organisations are seeking to provide other accounting services, such as closing the books, producing reporting information and even the financial planning or “business partnering” of
a company. ‘The idea has been you split finance into transaction processing, which gets outsourced, and business partnering, which stays in. And then there is a centre for excellence and decision-making and policy-making which also stays in, along with risk management,’ he says. Relinquishing control and direct oversight of the management accounts used to be deemed unthinkable. Not any more. Moller comments: ‘Outsourcers are saying: “We’ll do your budgeting, forecasting, planning and analysis”.’

For Moller, this is a step too far. The point of outsourcing, he thinks, is to bring onboard specialists better able to focus on periphery aspects of a company, thereby freeing up management to allow them to fully concentrate on what the business is about.

This has certainly been the case for Paul Blundell, the managing director of Optima Diagnostics, which specialises in online health and safety management. The business was set up in 2000 and after a couple of years it needed to gear up its sales. Blundell says: ‘As an organisation, at that time, you probably don’t have people with professional sales capabilities, so we were faced with the problem of which route to go down. Do we go out and try and recruit people? Without any background knowledge in that area, we felt a high level of risk going on that route.’ Back then, the size of the company was four people. Blundell found the answer to the dilemma lay with a company offering outsourced sales. ‘It soon proved to be the right decision and we saw significant lead activity and generation taking place,’ he says. Optima Diagnostics has grown to 12 employees and now has an in-house account manager for sales. Blundell comments: ‘The one thing you have to manage when outsourcing is the relationship. On the sales side, make sure there is proper alignment and goal congruence so the people are working within your targets.’

What to look for in Outsourcing Contracts

As for giving away too much intelligence about the company and relinquishing control of core parts of the business, Blundell remarks that the outsourced sales team is given enough information to generate new leads but never to close a deal. He says: ‘From a sales perspective, there has to be enough information at their disposal to ensure they can do the job effectively, but we haven’t had to reveal significant amounts of confidential information. We provide general ballpark figures for them but we finalise everything ourselves. There is a point in the sales process when it comes back to us.’

When signing a contract with an outsourcer, Blundell recommends that you keep it only three to six months long. This allows time to review how the relationship is working out.

However, Gary Woodward, CEO of IT services company Pasporte, notes that for a larger organisation it is perhaps more usual to agree contracts which are ‘typically three years and upwards from that’. Deloitte’s Moller points out that a business needs to consider carefully how it will develop – anticipating various scenarios like Forde now does at net:telecom – to avoid penalties for deviating from an agreement. He warns: ‘The outsourcers have gone through contract negotiations many times before. They know the small print. You can bet the outsource provider isn’t going to lose money on a change of order.’

Although it may be tough to negotiate, a degree of flexibility is required. ‘It would be a brave company that knew exactly how they were going to grow and develop over the next few years,’ says Woodward. Like Forde, Blundell has had a bad experience, in this instance when outsourcing a finance process, but he too remains upbeat about streamlining operations: ‘I wouldn’t say it is the complete solution for everybody all of the time. What I would say is that, for a particular stage in the evolution of a business, I think it makes a lot of sense. ‘If you do your homework and find someone who is good at it, then you have as much chance of them doing it well as you have of doing it internally yourself.’

Woodward believes it would’ve been impossible for the company to have grown like it has without using other organisations. ‘What we actually offer our clients is very broad and there is no way we could have got all of those in-house skills in place from the beginning,’ he says.

Thinking strategically

Arguably, one of the misconceptions about outsourcing, especially in IT and telecoms, is that it’s cheaper than keeping it in-house. Barrie Desmond, director of business development at network services provider Sirocom, argues that cutting costs should not be taken for granted: ‘Is it going to save them money? Probably not. Is it going to get them to where they want to go quicker than they would otherwise be able to: absolutely.’ He continues: ‘I would advise companies: do not go into outsourcing if you want one-off cost savings. Some people promise up to 30 per cent savings and that kind of thing, but that is when sourcing is sub-optimal. Quite frankly, organisations can do that themselves.’ An interesting conundrum for businesses is when to bring matters back in-house. Forde admits: ‘If we had investment we could view it differently. Even so, we could have more sales and admin people in-house, but keep the operations outsourced.’

Blundell shares this assessment in relation to the Optima Diagnostics’ outsourced sales team. ‘We will see in the future if they’ll still represent a useful form of campaigning. If we were going out and focusing on an area, we might give them a shorter-term contract to target an area for us.’ For many businesses, decentralising through outsourcing is a risk worth taking. Martyn Hart, chairman of the National Outsourcing Association, is blunt about why things sometimes don’t go according to plan. ‘Most companies don’t know how their businesses work,’ he claims. ‘Outsourcing contracts don’t go wrong, they just don’t deliver what you think they are going to deliver.’ Be that as it may, it is evident that managing expectations and forging trust are fundamental to making outsourcing a success. Although you may be moving an operation away from your immediate control, it cannot be a case of out of sight, out of mind.

Ultimately, outsourcing, like any aspect of a well-run business, requires hard work. Forde comments: ‘What we focus on is mastering the art of managing all of our partners, and getting this right, and always having alternative companies, so if one goes belly-up, there is always someone else to pick up the reins and move on.’

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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