Q: Are we ever going to see a backlash against outsourcing?

TL: It seems that the market has been predicting a backlash against outsourcing for a long time now, but we are still waiting to see it happen. Certainly there have been some high profile deals which have been bought back in-house, and organisations continue to make decisions to set up captive shared services centres, but there has been no general movement away from outsourcing – most analysts still predict continuing double-digit growth.

Indeed, there has been a noticeable trend in “first generation” in-house shared service centres (SSCs) being outsourced – one thinks for example of BT’s HR centre which went to Accenture (via an initial Joint Venture) and Proctor & Gamble’s HR centres, which went to IBM. The same has also been seen in F&A – for example Kimberly-Clark’s recent deal with Genpact. So what is driving this change?

Q: What is the most cost-effective option: an Out-Sourcing or In-Sourcing solution?

TL: When clients first consider whether to outsource or set up in-house, the initial business case often indicates that it is more cost-effective to go in-house. This is because of the simplistic assumption that all costs will be equal, but that the client will have to pay the supplier’s margin in an outsourcing arrangement. Of course, all things are not equal, and a rigorous business case would take into account appropriate risk premiums and efficiency ratios, as well as the costs of using outside consultants, expatriate management arrangements and other items which might add to the cost of an in-house approach.

But what we are increasingly seeing is a situation where clients have successfully set up a first generation shared services centre, but after several years believe that a third party can take the services further than they can internally.

Q: Why would a company want to outsource a successful first generation SSC?

TL: There are, I believe, three main reasons for this.

The first is the impact of the offshore labour arbitrage opportunity which has become available over the last 5 years in particular. First generation SSCs were often set up in on-shore locations with flexible labour-markets and the ability to attract international employees. These were mainly in the UK, Ireland and Holland. After 5-10 years these have become relatively expensive locations, compared to India, Eastern Europe and other offshore and nearshore destinations. However, few organisations have the appetite or experience to set up from scratch in these territories – hence the trend to use outsourcing suppliers who have already set up offshore to capture the benefits of labour arbitrage with a perceived lower risk profile. And the entry to the market of the Indian suppliers has increased supply in the market, encouraging the trend.

The second main reason is business case realisation. Many in-house first generation SSCs failed to meet their business case projections, sometimes made by often over-eager consultants. Basically, it was harder and more expensive to set up SSCs, get all the work migrated to them, and drive out the savings in the retained organisation, than had been anticipated. Hence organisations’ willingness to try to contract with an expert third-party to increase the certainty of achieving the benefits.

And a related reason is service quality. Many in-house SSCs have struggled to implement disciplined service management without the support of a commercial contract which imposes responsibilities and obligations on both parties. In short, the business/user side in many in-house SSC’s does not keep its part of the bargain, and there is little or nothing that the SSC can do about it.

Q: Is the profit centre standpoint ever a driver?

TL: Interestingly, creating a market-facing profit centre out of the SSC does not seem to have been a major driver. I can think of few instances of this, and fewer still that succeeded. But it remains a temptation for many.

It is also interesting to note that this trend is by no means universal. There are several high profile examples (Norwich Union amongst them) of organisations setting up Build-Operate-Transfer arrangements with outsourcing suppliers. The reasoning here tends to be that they lack the skills to set up and implement an offshore centre, but once established they have the capability to run it in-house, and therefore it should be taken back to avoid unnecessary leakage of margin to the supplier. It remains to be seen whether this model will catch on, or whether once a service is established and working offshore the client decides that it is as well to leave it as it is.

As ever, outsourcing is simply a commercial vehicle used to deliver a solution. Whether that vehicle is always the best one always depends on the specifics of every individual circumstance.