Outsourcing - more than a passing fad?

The most visible management fad of the early 1990s was outsourcing.

Fiftysomething company directors overwhelmed by the ever-changing capabilities of technology seemed only too happy to shunt responsibility for running their IT, their buildings and even selling their products onto a new breed of aggressive outsourcing company.

Such was the stampede to outsource that it was only later some companies found they were trapped in excessively long contracts, receiving inadequate service under a poorly drafted specification – and with lots of obstacles put in the way of the search for an alternative supplier.

Not surprisingly, there has been a backlash, and the concept of outsourcing, less fashionable than it once was, is coming under serious examination.

Certainly there is no evidence finance directors in the private sector are consumed with enthusiasm for letting another company run their payrolls, administer their pension scheme or process their invoices. So has outsourcing run out of steam?

Forecasts can always go wrong, but those currently available appear to show the outsourcing industry still has a lot of growing to do. The most authoritative attempt to predict its future was a survey by PA Consulting last year that claimed outsourcing turnover would increase by 46% by the year 2000. The report says there are “clear signs that outsourcing is moving towards the centre of organisations”.

While most growth is expected to be in IT outsourcing, PA Consulting also expects “significant growth” in finance services. In a recent poll of more than 1,000 directors and senior managers from public and private sector organisations in Europe and the US, more than 30% of respondents planned to outsource payroll within the next five years. In light of current business trends, the Outsourcing Institute expects turnover in the US to grow by 35% in 1996/97 alone.

Capita, one of the UK’s leading outsourcing companies, has grown from a market capitalisation of #8m when it floated in 1989 to #500m now on the back of outsourcing mainly in the public sector. So it is clear outsourcing still appeals to businesses, despite some bad experiences in the past.

Companies appear to be taking the view that previous clumsy applications of outsourcing do not invalidate the principles behind it. But there are mixed views about whether outsourcing practice is improving. According to KPMG, for which consulting on outsourcing is a multi-million pound business: “Successful implementation can provide unparalleled competitive advantage, but organisations which get it wrong run huge risks.” Despite these risks it says “many organisations are outsourcing, but few are doing it well”.

Rory Graham, a partner at City law firm Bird & Bird, agrees that early attempts at outsourcing left much room for improvement. “A lot of people went into outsourcing with their eyes shut because it was fashionable and they wanted to cut costs,” he explains. “Often they did not even know what the service was costing to provide in-house, so they had no yardstick against which to measure savings.” But Graham believes organisations have a “more sophisticated approach” these days, demanding better service and expecting suppliers “to manage future expectations so the client is not trapped into their existing supplier”.

So what is it about outsourcing that makes people come back, even after bad experiences? A minor reason, of course, is that once you have outsourced a function it is extremely difficult to take it back. Much more fundamentally, outsourcing has managed to reinvent itself as the answer to business people’s end-of-century angst about the pace of change. When it started, outsourcing was about cost-cutting. This applied most of all to IT. Where one company’s computer requirements were much like another’s, an IT company such as IBM could pool them together, generating substantial economies of scale and cost savings.

The rhetoric from the outsourcing industry has now moved on. Keith Griffiths, managing partner of IBM Global Services, says that in the past companies liked to outsource what they already did to reduce costs and improve quality.

“The trend nowadays,” says Griffiths, “is that people are looking for assistance in business transformation, particularly in finding a way to use new technologies such as the internet.” He says change in technology applications is so rapid that it takes a specialist company such as IBM to make sense of it and make the technology available to other organisations.

KPMG puts it in the hyperbolic language of the consulting industry. It says outsourcing offers the prospect of “sweeping away at a stroke” legacies of obsolete technology, assets, culture and people.

This focus on specialism applies outside the IT industry as well. Outsourcing suppliers are telling businesses to focus on their core activities, and contract out the rest. It is important to remember this is not a new phenomenon: motor manufacturers, for instance, have never sold cars to the private motorist – they contract out the job to dealerships. Similarly, companies are quite happy to hand the creation of advertising to specialists, even though advertising is a “core” marketing function.

But it could be that there is a mismatch between the way outsourcers want to sell what they do on the one hand and the reason companies contract functions out to them. In its recent report, Redefining core capabilities: a business guide to outsourcing, KPMG tells businesses that “others may be able to carry out some functions better and more cheaply” and that they should “retain those few functions which they believe are the core competencies which define the business they are in”.

In fact, companies are not necessarily looking at a list of their business functions, ticking those that are “core” and outsourcing the rest. Rather, they are looking to get the best value and the best service from each function. Outsourcing might be the preferred option, but because it offers the best value rather than because the function is “non-core”.

One plc to adopt this pick ‘n’ mix approach to outsourcing is Whitbread.

Its director of facilities management, Chris Scott, recently signed a long-term “partnership sourcing” agreement with a number of suppliers including Avis, the fleet leasing company. The agreement is intended as a deepening of the relationship between Whitbread and a small number of its key suppliers. He is a keen supporter of outsourcing: he contracts with suppliers to run activities such as maintaining company cars because he says there is no sense in a brewing and leisure company having that kind of expertise.

Under his partnership agreement, he now trusts his key suppliers to be “doing their darnedest to meet my needs”. He says it is impossible to cover every eventuality in a service level agreement. Under a partnership charter with his key suppliers, he now feels assured that they will be working in Whitbread’s best interests.

But Whitbread’s company policy is not in favour of simply outsourcing non-core activities – it is, as they call it, “smartsourcing” – getting ethings in the best way possible. The finance department has a large number eof functions that are not, according to the consultants’ definition, core activities. But Derek Edmond, finance services director, says he has not yet been persuaded to outsource any of the functions in his domain, although he is currently studying the options.

“There are plenty of payroll bureaux, for instance, that could handle that side of our finances, but in Whitbread we do more than simply processing, we also correct errors and advise the various business units on ways to improve their financial administration. In effect, we nanny the business,” says Edmund. Because his in-house team shares exactly the same objective as the business – helping Whitbread work better – it provides a service it would be difficult to imagine coming from an outside supplier.

In fact, it is just this kind of issue that Chris Scott’s partnership sourcing, a concept which has the backing of the confederation of British industry and the department of trade and industry, tries to address. Outsourcing becomes challenging and risky at exactly the point at which a critical service is being supplied that is not readily measured or defined – and yet that is the area that the outsourcing industry wants to push into.

Partnership sourcing is meant to help suppliers and clients go beyond the contract to what Scott calls “a spirit of trust” in which each side tries to act in the best interests of the other.

But Rory Graham is sceptical of the moves towards “partnership sourcing”, a term he regards as “marketing hype”. He says it is all too easy for people to get “wrapped in a rosy glow” and to forget the basic fact that “a client wants a service and a supplier wants money”. In his view, the client has a better chance of getting good service if that is specified in the contract than if it relies on the goodwill of the supplier.

If Graham is right, the limit to the growth of outsourcing is going to be people’s faith in the power of a contract to deliver performance that could not be matched by an in-house team. Some remarkable instances of such faith already exist. CPM, a company based in Oxfordshire, runs a “field sales” service. This means it employs staff locally to sell clients’ products for them.

Typically this means CPM staff trying to persuade high street retailers to stock the goods of its clients in the fast-moving consumer goods industry.

Each member of the CPM sales staff works for just one client, and often goes to work in the client’s uniform. Not surprisingly, CPM managing director Eddie Phillips says the biggest task he faces is in persuading potential clients that a contracted out salesforce will reflect the client’s culture and responsibly represent it. Nevertheless, he says he is having considerable success in doing this – CPM’s turnover has grown from #2m in the late 1970s to #50m now.

The public sector has in fact gone further down this road than much of the private sector. Rod Aldridge, executive chairman of Capita, highlights its contract to administer the written part of the driving test. In this case, the government has not outsourced a discrete function – it has asked Capita to run what would not long ago have been seen as a part of the mainstream civil service. Capita’s service includes taking bookings from the public, marking papers and sending out results as well as maintaining the buildings in which all this happens.

This is the basis of Aldridge’s huge ambitions for Capita. Its growth, he maintains, will not come from offering superior expertise in one specific function; he says Capita’s expertise is in a broad range of activities that includes form processing, dealing with money and customer management.

“Our expertise is in managing and changing what we take over. The basic ingredients in most of our contracts are pretty common, but the application of them is as broad as you can imagine,” he says. Capita is already a big pensions administrator, and Aldridge has ambitions to run back office administration in the banking and insurance industries. On top of that, Capita’s capability in “form processing” is applicable to most of the UK civil service, which currently employs nearly half a million people.

Aldridge’s vision of the future is not far from the outsourcers’ dream, of the virtual company, a marketing entity with a board of directors but no other staff. According to PA Consulting, however, “for the foreseeable future the appearance of the virtual corporation, in which a tiny core is surrounded by a range of contractual relationships, appears likely to remain simply a concept for most”.

However, it would be a mistake to think, that because the virtual company seems impossible now, it will always be so. Outsourcing appears to be an extremely attractive tool for senior managements that need to achieve defined service levels at set costs. If outsourcing has, as Rod Aldridge says, “not even started yet” in the private sector it is not because it is fundamentally unappealing, but because it takes managers some time to become confident in their own ability to negotiate contracts for services that often remain unspecified when provided in-house.

Business has already learned a great deal about how to outsource better during the 1990s. It is worth betting that the more it learns about outsourcing, the more that it will do it in future.