Process of outsourcing

June 8, 2009

Deciding to outsource

For any customer service or business processing function, the most significant decision is whether to outsource the function or perform it in-house. The decision to outsource is made at a strategic level and many different variables must be considered. The process begins with the firm identifying the activity to be outsourced and generally using a effective ratio analysis to justify the decision. Only once a high level business case has been established for the scope of services will a search begin to choose an outsourcing partner.

Due to the complexity of work definition, codifying requirements, pricing, and legal terms and conditions, clients often utilize the advisory services of outsourcing consultants to assist in scoping, decision making, and vendor evaluation.

Supplier proposals

A Request for Proposal (referred to as RFP) is an invitation for suppliers, often through a bidding process, to submit a proposal on a specific commodity or service. A bidding process is one of the best methods for leveraging a company’s negotiating ability and purchasing power with suppliers. The Request process brings structure to the procurement decision and allows the risks and benefits to be identified clearly upfront.

The RFP may dictate to varying degrees the exact structure and format of the supplier’s response. The creativity and innovation that suppliers choose to build into their proposals may be used to judge supplier proposals against each other, at the risk of failing to capture consistent information between bidders and thus hampering the decision making process. Effective RFPs typically reflect the strategy and short/long-term business objectives, providing detailed insight upon which suppliers will be able to offer a matching perspective.

The selected bidders are again invited for the best quotes they can give, this is generally called negotiation.

Supplier competition

A competition is held where the client marks and scores the supplier proposals. This may involve a number of face-to-face meetings to clarify the client requirements and the supplier response. The suppliers will be qualified out until only a few remain. This is known as down select in the industry. It is normal to go into the due diligence stage with two suppliers to maintain the competition. Following due diligence the suppliers submit a “best and final offer” (BAFO) for the client to make the final down select decision to one supplier. It is not unusual for two suppliers to go into competitive negotiations.

Negotiations

The negotiations take the original RFP, the supplier proposals, BAFO submissions and convert these into the contractual agreement between the client and the supplier. This stage finalizes the documentation and the final pricing structure.

Contract finalization

At the heart of every outsourcing deal is a contractual agreement that defines how the client and the supplier will work together. This is a legally binding document and is core to the governance of the relationship. There are three significant dates that each party signs up to the contract signature date, the effective date when the contract terms become active and a service commencement date when the supplier will take over the services.

Transition

The transition will begin from the effective date and normally runs between one to four months after service commencement date. This is the process for the staff and knowledge transfer and the take-on of services.

Transformation

The transformation is the execution of a set of projects to implement the Service Level Agreement (SLA), to reduce the Total cost of Ownership (TCO) or to implement new services. Emphasis is on ‘standardization’ and ‘centralization’.

Ongoing service delivery

This is the execution of the agreement and lasts for the term of the contract.

Benchmarking

Some outsourcing contracts contain clauses giving the client the right to benchmark the price paid to the provider at certain milestones during the life of the agreement. A third party benchmarking firm is selected according to the terms agreed to at contract signing (e.g. selected by client, selected by provider, selected by mutual agreement, or pre-selected at contract signing), and conducts a comparison of the price being paid to current market prices. If the terms of the contract provide for it, the provider and client may adjust the pricing based on the results of the benchmark.

Termination or renewal

Near the end of the contract term a decision will be made to terminate or renew the contract.

Reasons for outsourcing

Organizations that outsource are seeking to realize benefits or address the following issues:

Cost savings. The lowering of the overall cost of the service to the business. This will involve reducing the scope, defining quality levels, re-pricing, re-negotiation, cost re-structuring. Access to lower cost economies through off shoring called “labor arbitrage” generated by the wage gap between industrialized and developing nations.
Focus on Core Business. Resources (for example investment, people, infrastructure) are focused on developing the core business. For example often organizations outsource their IT support to specilaised IT services companies.
Cost restructuring. Operating leverage is a measure that compares fixed costs to variable costs. Outsourcing changes the balance of this ratio by offering a move from fixed to variable cost and also by making variable costs more predictable.
Improve quality. Achieve a step change in quality through contracting out the service with a new service level agreement.
Knowledge. Access to intellectual property and wider experience and knowledge.
Contract. Services will be provided to a legally binding contract with financial penalties and legal redress. This is not the case with internal services.
Operational expertise. Access to operational best practice that would be too difficult or time consuming to develop in-house.
Access to talent. Access to a larger talent pool and a sustainable source of skills, in particular in science and engineering.
Capacity management. An improved method of capacity management of services and technology where the risk in providing the excess capacity is borne by the supplier.
Catalyst for change. An organization can use an outsourcing agreement as a catalyst for major step change that can not be achieved alone. The outsourcer becomes a Change Agent in the process.
Enhance capacity for innovation. Companies increasingly use external knowledge service providers to supplement limited in-house capacity for product innovation.^[
Reduce time to market. The acceleration of the development or production of a product through the additional capability brought by the supplier.
Risk management. An approach to risk Management for some types of risks is to partner with an outsourcer who is better able to provide the mitigation.
Tax Benefit. Countries offer tax incentives to move manufacturing operations to counter high corporate taxes within another country.