Monday, February 22, 2010

IT Outsourcing Mistakes

While outsourcing is a powerful tool to cut costs, improve performance, and refocus on the core business, outsourcing initiatives often fall short of management’s expectations. Outsourcing failures are rarely reported because firms are reluctant to publicize them. However, contrasting them with more successful outsourcing efforts can yield useful “best practices”. In this post I will underlie most failed outsourcing efforts.

  1. Outsourcing activities that should not be outsourced. Determining which activities can be best performed by outside vendors requires a good understanding of where the firm’s competitive advantage comes from. Resources and capabilities that are valuable, rare, difficult to imitate, and difficult to substitute for lead to superior performance. Activities that are based on such resources and capabilities (i.e., core activities) should not be outsourced because firms risk losing competitive advantage.
  2. Selecting the wrong vendor. Selecting a good vendor is crucial for successful outsourcing. A useful distinction can be made between hard and soft qualifications. Hard qualifications refer to the ability of vendors to provide low-cost and state-of the-art solutions. Important criteria also include business experience and financial strength. Soft qualifications include a good cultural fit, a commitment to continuous improvement, flexibility, and a commitment to develop long-term relationships.
  3. Writing a poor contract. A good contract is essential to outsourcing success because the contract helps establish a balance of power between the client and the vendor. Spending too little time negotiating the contract and pretending that the partnership relationship with the vendor will take care of everything is a mistake. Drafting a good contract is always important because it allows partners to set expectations and to commit themselves to short-term goals.
  4. Overlooking personnel issues. The efficient management of personnel issues is crucial because employees generally view outsourcing as an underestimation of their skills. This may result in a massive exodus even before an actual outsourcing decision has been made. Firms that contemplate outsourcing must face two interrelated personnel issues. First, key employees must be retained and motivated. A second personnel issue is that the commitment of employees transferred to the vendor must also be secured.
  5. Losing control over the outsourced activity. When an activity is outsourced, it is crucial to retain a small group of managers to handle the vendor. These managers must be able to develop the strategy of the outsourced activity and keep it in alignment with the overall corporate strategy. While vendor management skills are very important, they must also be complemented with technical skills. If no one in the company is able to assess technological developments, outsourcing is bound to fail.
  6. Overlooking the hidden costs of outsourcing. Transaction cost economics (TCE) suggests two main types of outsourcing hidden costs. First, outsourcing vendor search and contracting costs. Search costs are the costs of gathering information to identify and assess suitable vendors. Contracting costs are the costs of negotiating and writing the outsourced contract. Second, outsourcing management costs: monitoring the agreement to ensure that vendors fulfill their contractual obligations, bargaining with vendors and sanctioning them when they do not perform according to the contract when unforeseen circumstances arise.
  7. Failing to plan an exit strategy. Many managers often fail to plan an exit strategy (i.e., vendor switch or reintegration of an outsourced activity). Actually, outsourcing relationships can be viewed on a continuum. At one end are large-term relationships where investments specific to the relationships have been made by one or both partners. At the other end are market relationships where the client has a choice of many vendors and the ability to switch vendors with little cost and inconveniences. In this case, there is no real advantage in recontracting with the same vendor.

This article is a shortened article of Jérôme Barthélemy “The seven deadly sins of outsourcing”

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