Outsourcing - Watch Your budget!

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Outsourcing could be seen as a contemporary product of the network economy where an organization should focus on its strengths and leave its weaknesses to others. This is only possible as long the productivity is not at danger.

The term ‘productivity’ does not only origin from (self) ‘production’ but also depends on three other economic functions; supply (by others), exchange (with third parties) and sales (to customers). This pattern is both present on a country level and within companies (and even on a personal level – imagine yourself what productive element you excel in). Companies are dependent of some main supplies by others (main infrastructural support), they purchase (raw) materials from third parties with which they produce their own product they finally sell to customers.

If we examine the productivity of a company that is in the process of outsourcing (or in-sourcing in which the same applies) the distribution and the internal balance between these four main business functions will alter. Where you give up a part of the self-production, you will receive a new exchange-process in return. This is what managers sometimes forget.

First you need to know how your business productivity will increase. This will only be the case when the new situation is more profitable than the old one; where the third-party-production (that part of the production that is outsourced) added with the new exchange function is more economical than the old situation where you where the only producer.

Companies that have no experience in outsourcing will have difficulties in mastering the exchange-part. They must all of a sudden manage others that are also outside their own company and that requires new skills. Where in the old situation the communication was merely implicit, in the new situation you must make all the communication explicit. That is when you realize how complex the process is. To untangle that specific part from you business and pass it to a third party is not easy. Less is the management of this disentanglement process and the management of the new situation. All at once.

It also requires a new culture. One element of self-producing companies is the ‘not-invented-here’-rule. This rules conflicts with a new approach where you make yourself highly dependent of others. Management of this cultural change takes time and coincides with the moment when you experience new issues.

One of these issues is that what you have been (self) producing will never be the same when the job will be done by others. The part that will be outsourced is to be done market-conform. This means that the supplier (the in-sourcing company) of the process will determine the standard of the output. This must be done otherwise both companies will lose productivity. The in-sourcing company will provide a service that is based on what they provide to the market. As long as the in-sourcing is in conformity with this standard they can increase their scale. If the outsourcing company will demand changes, this economies-of-scale will not be achieved because of this tailor-made approach and the process will be more expensive than before.

The interaction between the two companies will also experience cultural challenges in the beginning. Both parties have there own culture. The in-sourcer is normally focused on efficiency rather than on flexibility and the outsourcing company does not only require efficiency but also time-to-market for new developments.

An intermediary step before the current situation and outsourcing could be to start treating the organization that is subject to outsourcing as such (an island within your company).

More important, I think, is that a feasibility study (focused on outsourcing) should be preceded by a thorough strategic analysis. In this analysis and the implementation plan the budget rule should be presented. You should ask yourself whether the budget you spend on outsourcing could not spend better otherwise. This is where the outsourcing discussion started. If you address a part of the budget to the relatively weaker parts (and decide to outsource) you should also address a significant amount to the relatively stronger parts. If these two elements are not known you are dealing with an unbalanced situation. Outsourcing will not help you other than it cumulates the focus problems you are dealing with. Solve them first.

© 2005 Hans Bool / Astor White

Hans Bool (The Netherlands) is the founder of Astor White a consulting company dedicated to (the human side of) management consulting and e-advice. He has many years of experience in (project) management, consulting and business architecture. He studied economics and has recently published the book: “How to manage your organizational portfolio – just stick to your rules”. http://www.astorwhite.com


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