Insourcing or Outsourcing? Pain or Competitive Leverage?
Insourcing or Outsourcing? Pain or the panacea for competitive leverage?
It would appear that many companies swing between insourcing and outsourcing and – there is not really a pattern to what business tend to do.
Except…. very often it has to do with profitability, productivity and headcount. It often appears to be a quick fix rather than a strategic long term outlook.
The question about the trends around insourcing versus outsourcing come up regularly.
It is not an easy question to answer – the crystal ball always cracks on this question….
For example, when there was a downturn in the resources industry in Western Australia, some companies chose to pull back the strings in-house and insource whilst others outsourced many functions.
The decisions appear to be based on:
- improving cash flow,
- optimising current assets and
- improving head count numbers.
What is the difference between outsourcing and insourcing?
In simple terms:
- Insourcing is when a business choses to manage all its functions in-house with its own assets, people and infrastructure.
- Outsourcing is the when a business choses to (selectively) manage certain functions through external third parties with the third party using its assets, people and equipment and charging a fee back to the business.
Why make the decision to outsource rather than insource?
Outsourcing allows business to focus on its core and critical business activities, whilst contracting non-core activities and functions out to a third party that can manage those non-core activities:
- more effective;
- more efficient;
- with less capital outlay ;
- with fewer people; and/or
- with the ability to leverage systems, processes and/or people,
in a manner that delivers better value for money from a total cost of ownership perspective than a business could deliver on an in-sourced basis.
It works really well with repetitive, transactional processes where efficiency and not necessarily effectiveness plays a key role.
Thus typical areas of outsourcing include payroll, accounts payable, day-to-day purchasing/buying.
However, business never outsources the responsibility to manage the risks around the functions outsourced (notwithstanding the lengthy contracts claiming to do so!) or the reputation of the business.
Thus, when considering the decision to outsource any function, it becomes really important to ensure:
- ongoing contract management,
- regular change management review, and
- performance review
to track and monitor success.
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Procurement plays an important role in the scoping, outsourcing, commercial management and sustainable success of any outsourced functions.
Managing the risk
The decision to outsource is a complex one.
Outsourcing works well when business understands the risks and manage the risks.
However, it is important to realise that business cannot outsource its accountability to manage the risks around outsourcing.
Some examples of risk factors to consider as part of the decision-making process, include:
- the complexity around being able to insource in future;
- outsourcing core business processes, functions or people and thus losing critical business knowledge and assets;
- the inability to deliver the anticipated benefits and value around outsourcing;
- poor scoping resulting in an increase in costs rather than a reduction;
- poor management of staff morale especially where redundancies and reduction in headcount occur;
- lack of proper change management complicating the outsourcing process and resulting in a delay in outsourcing;
- outsourcing control and reduction in transparency;
- the solution does not provide a more cost effective, smarter or efficient process; and/or
- loss of critical skills and knowledge base and difficulty to resource these in future.
Therefore it is important to remember at all times:
Proper change management forms a critical part of the decision to outsource.
Some of the key reasons why business often considers outsourcing relate to the benefits such as:
- the ability to focus on core business activities and improve its competitive market position;
- reduction in headcount and thus an improvement in productivity;
- removing liabilities off balance sheet to profit and loss as an expense item rather than as a liability on the balance sheet;
- reduced capital and cash-flow requirements for non-core assets, systems and processes;
- competitive leverage provided by the economy of scale provided by the outsourced provider.
As mentioned previously, outsourcing works best for non-core business where a third party can deliver a non-core business function smarter, faster, more efficient or cost effective than the in-house equivalent.
Ultimately, outsourcing must deliver an overall reduction on a total cost of ownership basis and must provide business with a competitive leverage it would not have otherwise.
Outsourcing works when it provides business with an opportunity to focus on its core business in order to improve its competitiveness in the market.
Pain or Panacea?
There is no right or wrong answer that will fit all businesses. The decision to outsource has no short cuts and certainly does not deliver some magic pill.
Business should consider the decision to insource or outsource as part of its strategic business planning processes – on a regular basis measured against its vision, strategic initiatives and action plans.
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The decision to insource or outsource will always be a strategic business decision – a business decision that requires proper change management, a dedicated project manager and procurement playing a critical role in the process.
Where any function is outsourced, a dedicated contract owner and commercial/procurement owner must be appointed to measure the ongoing success of the outsourced business functions to avoid it being a painful, unsuccessful process that cost more than deliver benefits.
Finally, business must consider whether the final decision will result in:
Short term gain for long term pain or short term pain for long term gain?
Contact Ichiban today to work with your procurement team on strategic sourcing development and benchmarking. We also work with your procurement team to do a health check to benchmark your procurement team’s performance and improve their overall performance, leadership and productivity.