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Outsourcing Part 3: How to stack the numbers

It's all about the money! Or is it?

In my last two blogs, I went into the details of why a company would decide to outsource and some of the factors to take into account. It's very important that you understand the pros and cons of outsourcing (and both) before you start a program to bring other companies to help drive parts of your business.

In this last blog on the subject, I cover financial conditions. Of course, the cost is big, but it's not the only one. I also want to cover some areas you need to take into consideration to avoid some of the most common pitfalls in outsourcing.

OK. Cost is usually the biggest factor

The biggest economic factor in outsourcing is usually cost reduction. However, it can be useful to understand how cost reductions come from. Just doing something cheaper usually means lower quality, so understanding * how * the supplier can deliver a service that is cheaper is important.

Scale economics

Outsourcing providers can often achieve cost savings through economies of scale. Larger purchasing power usually results in a lower unit cost, so a host provider is likely to get better rates for servers than a client with less demand. You can also generate cost savings from higher utilization coming from a larger scale. For example, a company may need a specialized package, but only need 25% of capacity. An outsourcer can spread the price over a number of customers.

Outsourcers can also sometimes achieve better financing agreements due to volume. This advantage can be transferred to the customer. They can also spread over the clients again and lower the unit cost.

It's a scale in being able to afford experts and spread their costs across a variety of customers. A good example of this would be a translation service where a client may not need a full-time Russian speaker but can use an expert through an outsource service that spreads costs across a variety of customers.

Salary Arbitrage

A popular way to reduce costs through outsourcing and one that is high in the minds of the public is labor arbitration. Provides service from a cheaper country like India. Wage or labor arbitration drove a large amount of outsourcing, especially in labor-intensive functions such as call centers. It's not always popular, but cost savings are significant.

What are the other economic benefits other than cost reduction?

Stripping or Converting Fixed Costs

A major specialist outsourcer can convert your fixed costs into variable costs. This helps to link your costs to activity levels that often reflect your earnings. Dips in activity are then not so serious in their impact on the bottom line and cash flow, as some of your costs may fall proportionally. An example of this is cloud hosting. Instead of the fixed costs of buying and maintaining your own servers, large cloud providers can offer a payroll when you go on a cost model. You only pay for what you use.

Strengthening the Balance

Cloud hosting helps cash flow, but it can also increase the company's balance. If the customer does not pay the capital cost, all necessary equipment can be out of balance, reduce fixed assets and the need to write off. For example, you can rent equipment instead of buying it to keep the capital cost out of balance. Accounting standards must obviously be met.

Risk Sharing

Risk Sharing can have an economic advantage. In an internal operation, the client is at all risk. In an outsourced operation, the supplier may take part of that risk. I cautiously try to put too much of the risk on the supplier, as they should only take on the risks they can control. Trying to put too much risk on the supplier only supports the costs.
Outsourcing can also increase the level of cost review. Internal costs are usually confused with overhead allocation. An invoice from a vendor, but certainly not the entire picture, gives greater transparency.

As you can see cost savings are an important factor in outsourcing, but they are not the only economic factor.

Why things go wrong and what can we do to avoid problems?

Finally, I will briefly review some of the pitfalls I have come across and how to avoid them.

Outsourcing fails. However, my experience is that when it makes mistakes, it's usually (sorry) the customer's mistake. Just as a staff member cares, look at things objectively and admit that you hired them and you managed them. Employee / outsourcer may fail because they do not have the skills … but you picked them!

As with employees, outsourcing success depends very much on picking the right person and managing them well. You must also understand what your own expectations are of what you want them to do and make sure their understanding is the same as yours.

Checklist of Things to Take Care of

  • Make sure you understand what is being outsourced. There is little chance that the supplier will get it right if you do not know what you want them to do.
  • Avoid being too proscriptive and aiming for outbound contracts. You want the provider to deliver an output so you should not tell them how to do it. The more you tell them how to do it, the less they are able to use their own skills and the more you will be responsible if it does not work. It will probably cost more and not work as well.
  • Get as much transparency in pricing as possible. If you need to swap service (and at some point you will) it will be much easier to do if you understand the underlying costs. It is easier to get openness at the place of the bid than to ask for it when the agreement is signed.
  • Be realistic about risk. My default is if the supplier can control it is their risk. If you can control it, your risk is and if no one can control it, your risk is. After all, it is your service regardless of who is delivering it.
  • Make sure you are corrected to manage the provider. As a staff member, you can not just leave them and hope it's going to be good no matter how competent they are.
  • Not everything can or should be outsourced.

Finally, never forget that it is your * responsibility. The customer does not care why you failed or if it was a vendor's fault. They look at it as your mistake.

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