April 21, 2005 FEATURE ARTICLE

OUTSOURCING: Three Fundamentals for Success

Outsourcing is not an end unto itself. Rather, it is a strategic tool – with the emphasis on “strategic.”

Nor is outsourcing something new. Few people would be surprised to learn that at least two-thirds of every car made in North America comes from parts suppliers elsewhere. What is new is the trend’s rapid escalation and expansion into infrastructure services and higher-level strategic functions. From 1999 to 2000 alone, the outsourcing of a wide variety of services and products increased by 18 percent.

This is the first of two articles addressing the complex issues associated with successful outsourcing. In this section we explore the outsourcing process in general in contrast to keeping designated functions in-house. This includes strategies for obtaining and retaining the outsourced services needed. The second article, to follow in next month’s Hub News, looks at outsourcing considerations within an M&A deal.

Steps for Successful Outsourcing

A recent study by McKinsey & Co. found that 40% of executives are not satisfied or are outright dissatisfied with current outsourcing arrangements. These difficulties arise from “unexpected high costs” and a failure of the outsourcer to “understand what they were supposed to do.” A 2000 Dunn & Bradstreet survey reports that 20 to 25% of all outsourcing relationships fail within two years and 50% fall apart within five years.

What’s behind such failure rates? To answer this question and to begin to map out successful outsourcing strategies, the authors propose the following three-step approach:

1. Preparing and Planning: Define how we do business and why we do it that way.
Successful outsourcers begin by taking a strategic view of the functions they are consider outsourcing and those they favor keeping in-house. The human resources function offers a good example. In many cases, it should be thought of as strategic; it defines culture, provides future leadership, and establishes an organization’s place in its industry. We recommend that HR is not handed off wholesale to outside parties without a thorough study of the consequences. Yet each company’s analysis of its situation and distinctive characteristics provides the data with which to decide about “farming out” any function. If detailed analysis reveals that HR acts as little more than a specialized staffing agency, outsourcing may indeed make good business sense.

2. Drafting and Negotiating an Agreement: Document, document, then document some more.
Organizations must transform the ways they previously managed the functions they’ve outsourced; the emphasis now must be on managing the outsourcing service provider. As such, the individuals who handled the tasks in-house may not have the best skill sets for managing the vendor agreement. This step uses the information gathered in Step One, defining exactly what is expected, when it is expected, and how it will be delivered.

This transition and transformation phase involves creating the operating agreements between the business and its outsourcing partners. When defining service level agreements, it is vital to include the performance standards of parties, contracts, contract management terms, and a relationship management process. That step ensures that the transactional requirements of the agreement and the strategic outsourcing objectives are met. Companies sometimes also negotiate the transfer of personnel to the outsourcing firm.

3. Ongoing Monitoring and Relationship Management: Don’t outsource and forget it.
Managing the strategic implications of outsourcing (relationship and portfolio management) requires that a company protects itself from disruptive and costly midstream changes. Organizations often assign the responsibility of managing the outsourcing vendor to an internal person who knows the function well. Although that decision appears to make sense, the designated person may have skills different from those needed to manage an ongoing outsourcing relationship. That person also may lack the necessary organizational rank to hold the vendor to the agreement.


Although it is often assumed that it’s easier to manage outside providers than internal resources, the 2000 Dunn & Bradstreet study notes that that is not the case. Continuing relationship management requires going beyond measuring the outsourcer’s transactional performance. The complex process involves making certain that internal strategic changes are correctly reflected in the outsourcer’s work.

Both regularly scheduled contacts and incidental exchanges of information address unanticipated needs. Outsourcing consultant Equaterra identifies more than 30 critical processes that it uses to ensure an effective ongoing relationship. The checklist covers service delivery, governance, contract management, and financial administration.


Acting as a strategic partner, an outsourcer can serve as a valuable resource of accumulated specialty knowledge. Outsourcing is not the answer to every challenge that companies face today. However, it can provide a very satisfactory solution when adopted for appropriate strategic reasons – and as long as there is comprehensive due diligence of the vendors involved.



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