Outsourcing is, or at least should be, about a lot more than just moving jobs to a place that plays less. Putting work in a lower-cost location can be a legitimate part of outsourcing, but when cost arbitrage is the entire program, you are almost always headed towards trouble. A program that only “lifts and shifts” does provide benefits… short-term benefits.
The failure rate for outsourcing programs is usually 50%. Of course, that was before the current wave of outsourcing, where project selection has been far less stringent. This ”rush to outsource,” with a focus only on cost reduction, will almost surely result in a higher failure rate. The reasons for failure are usually obvious, and often easy to correct. If you’re going to run an outsourcing program, you also NEED to run an improvement program. Ignoring the importance of improvement invariably sets you on a path to failure.
When business functions are identified for outsourcing, the first programs on the list aren’t at the top by accident. Yes, many programs will have a goal of costs reduction; but to move to the top of the list, a program has also been identified as a poor performer: customer complaints, lack of internal metrics, problems with on time delivery or excessive errors and defects. Moving work to a lower cost location provides a one-time cost benefit, but it doesn’t change the way that the work more efficient. At the end of your 1st contract, when the original benefits are now 3 or more years in the past, your team will expect new improvements in the next agreement. However, without innovation this expectation will not be met.
As the economy continues to improve, costs are rising. Costs are risking very slowly domestically, and much more rapidly offshore. Remember, your local economic conditions are not the same as where your offshore program operates. After all, you chose to outsource to these locations BECAUSE they had different economic conditions. Take a location like Fargo North Dakota. Fargo has had consistently lower unemployment than most big cities. Today Fargo has an unemployment rate of 2.8%, vs. 9.6% in New York City. Lower unemployment is driving higher wage increases. Offshore, the metric to watch is the rate of inflation. In India, the rate of inflation in May was over 10%, vs. -0.3% in the US. However, even if you moved all of your operations to India, not all of your outsourcers' expenses will be in India. Your rate may not increases by 10% times the number of years in your contract, but you can expect a much a larger increase in rates offshore than onshore.
That’s why outsourcing has got to do more than just lift and shift. You MUST have continuous improvement. Go back to the reasons why your services were outsourced in the first place. Have you tried to address these issues before you outsourced? Did you know the changes you needed to put in place, but you didn’t know how to get approval to implement the changes? After the advantages of arbitrage exhausted, and your second contract begins, you need an offset against rising contract costs.
When you build your first contract, there is usually pressure to create a “management by contract” culture, making it difficult to implement significant programatic changes, even if these changes will improve the project or further lower cost. Perhaps it’s just a matter of lack of trust. But once the benefits of arbitrage are exhausted, you need to turn to process improvement.
What can you improve? Virtually everything! If your service was generating excessive customer complaints, then it could be that: the staff is not properly trained; the metrics for the function have not been defined; management reports are not being produced; work products are not being tested for quality; the wrong products are produced, etc. Each of these problems has different solutions, but these solutions are not directly related to the cost per hour for workers. If you had a problem with on-time delivery, and the solution would cost nothing to implement, but would involve fundamental changes to process… what are the processes built into your contract for approving this sort of change? In most cases, outsourcing contract have no explicit process for approving major process changes.
Most manager will not have solutions at the ready for their outsourcing programs. In order to find the right solutions, these managers need the freedom to experiment. Today’s “total outsourcing” contracts do not allow managers that freedom. Unless this is corrected in their next contract, innovation in these programs will grind to a halt, and will not be able to offset the rising cost of labor in the most popular outsourcing locations. That’s why innovation is not an option, it’s a necessary part of every successful outsourcing program. If your program has contractual restrictions that will prevent you from experimenting with the way you perform work, you need to start working on a new contract framework. If you allow for outsourcing innovation, you’re going to take a big step towards guaranteeing your program’s success!