VideoBy many measures, outsourcing is a great success story. Service providers may have taken a severe beating from politicians and the press this election season, but they seem to have won the battle that counts most — persuading executives that outsiders can often do nonstrategic work cheaper and better. The result is a worldwide IT and process outsourcing market that Gartner predicts will swell from $293 billion in 2003 to $429 billion by 2008. As one executive said in a CFO magazine survey last summer, "Outsourcing cannot be stopped."
But you don't need to look far for signs of trouble. First, there are the high-profile flops, including JPMorgan Chase & Co.'s recent decision to pull the plug on a seven-year, $5 billion deal with IBM; the cancellation of a big contract between The Dow Chemical Co. and EDS; and EDS's ongoing trials with the U.S. Navy, which have cost the outsourcer $1.1 billion and contributed to a recent credit downgrade. Then there are the failure rates for outsourcing in general, which range from 25 percent to well over 50 percent, depending on the study.
Granted, failed transactions are nothing new. But the size of these failed deals alone demands a closer look at what went wrong — shredding a $5 billion contract is jarring for both client and provider. Moreover, it appears that better project management may not be the answer: most outsourcing problems derive from the way executives conceive their deals and set them up.
Inside Outsourcing
Last year, the board of a New England-based technology company decided that the firm should emulate its peers and outsource its software development to India. It seemed like a good idea — the average hourly cost of a software developer in India is $6, compared with $60 in the United States. But the project has gone poorly: the U.S.-based employees are struggling to manage programmers sitting halfway around the world, and much of the work coming back from India has been subpar. "The board said, 'We want you to outsource,' " reports a finance manager at the company. "That command flowed down to the executive team and they forced it onto the guys managing the project. We just rushed into it."
This illustrates two problems that undermine many outsourcing efforts. One is that companies simply sign up for projects without enough preparation. "It can be like an M&A activity," says Mark Lutchen, partner and leader of PricewaterhouseCoopers's IT business risk management practice. "Once the CEO has decided he wants to do the deal, it's up to the CFO and everybody else to make it work."
The second problem is more worrisome: executives often strike big deals for the wrong reasons. They may, for instance, blindly imitate competitors when in fact outsourcing is not appropriate. Or they may turn to outsourcing as a way of papering over deeper problems.
Consider a situation that was common in the early 1990s — outsourcing as a backdoor way for financially strapped companies to raise cash. "The dark side of outsourcing has always been that it can really just be financial engineering," says Bruce Caldwell, an analyst at Gartner. "The outsourcer might say, 'We'll take over your assets to help you balance your books. You'll get some cash to the bottom line for the next quarter, and in exchange we'll have revenue from you for the next 10 years.' It's basically a loan."
Such deals are less common today, not least because they pose big risks for outsourcers themselves. But analysts and consultants say that companies continue to make another error — outsourcing as a way of shifting responsibility for a bad process. "Sometimes with large outsourcing projects, companies think that they're transferring responsibility," says Brian Keane, CEO of Keane Inc., an IT outsourcer and consulting firm.
This rarely works. One reason is that complexity actually increases with outsourcing. What was formerly a technical job when the process was in-house becomes a management challenge complete with detailed performance measures, outside relationships, and the need to adjust the outsourcing project to changes in the business.
Furthermore, when a company hands off a defective process with no plan for a fix, the process just gets worse. "I've seen companies say, 'We hate our process and our systems,' but their fundamental proposition is to do it cheaper," comments Bob Pryor, CEO of Capgemini Energy, a joint venture between Capgemini and TXU, a Texas-based energy concern. "Employees think they've got someone to fix the problems. But when they don't see a fix — in fact, the process may be worse in some areas — you take real hits to consumer satisfaction."
As with nearly any business concern, help is available — for a fee. In recent years, a subindustry has sprung up around outsourcing. Former executives, lawyers, and other consultants are all hiring themselves out to help decide whether and how to outsource.
An obvious choice for many companies is to bring in consultants from the big service providers to tell them how to repair their processes. But caution is in order here. According to analysts and former employees of the service providers, because the consultants have a strong incentive to win more outsourcing business for their firms, the client may not receive unbiased advice.
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