OUTSOURCING of information technology - and to a lesser extent business processes such as finance, administration or human resources - is now so prevalent that it has become the default: companies, and particularly the public sector, have to explain themselves if they don't outsource, the underlying assumptions being that they are (a) missing out on automatic cost reductions attendant on shedding routine operations to specialists and (b) by the same token, handing competitive advantage to those who do.
Yet outsourcing is going through 'a mid-life crisis', according to Compass, a management consultancy. When Compass analysed 240 large outsourcing contracts in Europe and the US, it found that fully two-thirds were unravelling before the contract's full term. Far from cutting costs, in many cases outsourcing ended up costing more than keeping the services in-house.
Terminating a contract in mid-term is expensive, but some buyers are finding that the cost of remaining locked in to an inflexible deal is higher still. Sainsbury and JP Morgan are two firms that have scrapped multi-million-pound deals (with Accenture and IBM) over the past couple of years to bring IT operations back in-house others probably would (and should) do the same, except that they no longer have the necessary expertise to do so.
Ironically, the inflexibilities are often negotiated into the contract by buyers, whose faith in the existence of large cost advantages is akin to a belief in alchemy, according to Scott Scarrott, Compass's head of business development. 'There's no magic,' he says. An outsourcer has to be 20 per cent better than the in-house operation just to cover set-up costs and break even. Factor in a margin for risk, overhead and profit and that rises to 40 per cent. That's a handicap that can't be offset by simple 'labour arbitrage' even in low-wage countries such as India, where high labour turnover and low productivity compound the disadvantages.
Yet buyers still insist on negotiating heavily legalistic, cheapest-possible deals with almost no 'wriggle room'. They usually live to regret it. Two or three years in, buyers find that hardware costs have come down, while - under heavily back-end-loaded deals - costs are rising rapidly. By the end of a seven-year contract, some companies examined by Compass were paying 40 per cent more for their outsourced services than they would have by doing them themselves.
Scarrott stresses that this is not the type of deal vendors prefer, but it is the one that cost-obsessed buyers insist on. 'For every bad vendor there are at least five bad buyers,' he says. The mistakes are all the bad old management habits, speeded up and updated for an IT-enabled world: short-termism, wrong yardsticks (speed and labour costs rather than anything connected with the business), failure to retain know-how to manage the new relationship, inadequate attention to governance, and an unappealing combination of greed, laziness and cowardice that is manifested in the all-too-common practice of 'lift and shift' - simply taking an inefficient operation and handing it over to someone else to deal with, often, in the medium term, by sacking people. In short, outsourcing has become a classic management fad.
Depressingly, the public sector is a serial offender, adding to poor procurement a dogged failure to learn: a contract's true value can only be evaluated after two or three years, but since those who do the deals are only concerned with procurement, that rarely happens. So outsourcing is frequently the worst of all worlds: the wrong solution to the wrong problem, done badly.
Given that IT outsourcing is three generations old, you might expect the lessons to have been learnt by now. A few companies, having found out the hard way, are indeed beginning to take a more selective attitude to the practice: lowering cost-saving expectations, bringing back some operations and retaining much more expertise even in those they outsource. However, Compass sees many of the same mistakes being made all over again as new industries, such as insurance, pile on the bandwagon.
Perhaps the most worrying aspect of this catalogue is what it says about companies' underlying strategy. None of the hi-tech trappings or jargon can disguise the fact that 'lift and shift' represents the management equivalent of football's 'route one' - heads down, hack the ball upfield and chase.
No wonder customers are unhappy. If they are cynical about customer service with a foreign accent, it's because they know it's an accurate reflection of suppliers' reliance on low-cost and mass-production methods for dealing with them. That's a model that has run its course - so shareholders should be worried, too.
The Observer, 13 May 2007