Many of the world's largest organizations that were quick to participate in information technology and business process outsourcing are bringing operations back in-house and exploring alternatives, according to a new study released today by Deloitte Consulting LLP.
Ironically, dissatisfaction in areas that traditional outsourcing was expected to improve, such as costs and complexity, was found to be the primary reason behind participants' negative responses.
The study, "Calling a Change in the Outsourcing Market," reveals that 70 per cent of participants have had significant negative experiences with outsourcing projects and are now exercising greater caution in approaching outsourcing. One in four participants have brought functions back in-house after realizing that they could be addressed more successfully and/or at a lower cost internally, while 44 per cent did not see cost savings materializing as a result of outsourcing.
Moreover, 57 per cent of participants absorbed costs for services they believed were included in the contracts with vendors. Nearly half of the study participants identified hidden costs as the most common problem when managing outsourcing projects.
"There are fundamental differences between product outsourcing and the outsourcing of service functions, differences that were overlooked but have now come to the fore," says Ken Landis, a Senior Strategy Principal at Deloitte. "Outsourcing vendors and companies may have conflicting objectives, putting at risk clients' desire for innovation, cost savings, and quality. Moreover, the structural advantages envisioned do not always translate into cheaper, better, or faster services. As a result, larger companies are scrutinizing new outsourcing deals more closely, re-negotiating existing agreements, and bringing functions back in-house with increasing frequency."
According to the study, participants originally engaged in outsourcing activities for a variety of reasons: cost savings, ease of execution, flexibility, and lack of in-house capability. However, instead of simplifying operations, 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.
Additional compelling, key study findings that illustrate pitfalls encountered include:
The Anticipated Level of Value is Not Always Realized
- 62 per cent of participants realized that they require more management efforts in comparison to the original estimates.
- 57 per cent of participants said they could not free up internal resources for other projects, leading to larger than anticipated deal management overhead.
- 52 per cent of participants ranked cost-related issues as the main risks of outsourcing.
- 81 per cent of participants have limited or no transparency to a vendor's pricing and cost structure, resulting in increased chances of paying additional costs.
- 48 per cent of participants indicated that they do not have a standardized methodology to evaluate the business case for outsourcing.
For Outsourcing Vendors, the Paradigm Is Shifting
- 83 per cent of participants said they have renegotiated outsourcing deals due to pricing and to business, technology, and regulatory environment changes.
- 53 per cent of participants have moved from long-term contracts (six to ten years) to shorter contracts (up to five years) to increase flexibility and bargaining power.
- 73 per cent of the participants are working with multiple vendors to reduce vendor dependency. Participants that had exclusive deals in the past warn that they are very risky, and they will not enter into them again.
- 45 per cent of participants are forced to include gain-sharing clauses in vendor contracts as motivation for innovation, highlighting continuing concern about vendor complacency.
"In the near term, outsourcing will become less appealing for large companies because it is not delivering the value as promised, and its appeal as a cost-savings strategy will also diminish as the economy recovers from recession and companies look for differentiated solutions to support their growth," says Landis. "However, outsourcing can still deliver value to companies that enter into outsourcing for the right reasons using a right model such as centralize-standardize-outsource, transform-operate-transfer, commodities outsourcing, risk transfer, and shifting fixed costs to variable, and have superb talent in-house to manage these deals from inception to execution."