The Evolution of Outsourcing

By McDermott, Michael J. | Chief Executive (U.S.), June 2002 | Go to article overview

The Evolution of Outsourcing


McDermott, Michael J., Chief Executive (U.S.)


The next step for many companies is "transformational outsourcing," allowing them to leverage strategic relationships to enhance their own capabilities.

Enterprises choose to outsource various functions for all kinds of reasons. The most common ones, according to the Outsourcing Institute, are to reduce and control operating costs, to improve company focus, to gain access to world-class capabilities and to free internal resources for other purposes, in that order. While all are valid reasons, in some important respects they are more retrospective than indicative of where outsourcing is headed.

"Traditionally, the outsourcing market focused on infrastructure, data operations and cost takeout as primary drivers," explains Martin Cole, managing partner for Outsourcing and Infrastructure Delivery at Accenture. "Now, in addition to reducing the cost of operations, enterprises are looking to outsource business areas to achieve greater flexibility and to gain greater ability to respond nimbly. It is critical to be able to respond to changing market conditions and a competitive environment frequently driven by mergers and acquisitions."

Essentially, outsourcing is evolving into a strategic tool for change - a development Accenture dubs "transformational outsourcing" - and this change is having an impact on the types of services involved, suggests Dr. James Brian Quinn, a professor at Dartmouth College's Amos Tuck School and author of Innovation Explosion: Using Intellect and Software to Revolutionize Growth Strategies (Free Press, 1997). He posits that the big shift in this area has been to intellectually based service activities, such as research, product development, logistics, human relations, accounting, legal work, and marketing and market research.

Quinn, who has been studying innovation for 50 years and wrote some of the first articles on core competencies and strategic outsourcing, asserts that if an enterprise does not excel in an area yet continues to do it in-house, it gives up an important competitive edge. "Outsourcing to the best in the world ups the value and lowers the cost," he says.

A collaborative approach

Allie Young, a chief analyst at Stamford, Conn.-based Gartner, Inc., explains that the outsourcing market has been shifting gradually from a cost focus to a business focus, and that a new emphasis on access and speed to market has emerged. "The focus now is on business outcomes, not just infrastructure," she says. "This is about taking advantage of relationship types and models, and a variety of contracting modes and structures. It is very complex."

Another factor contributing to that complexity is the truly collaborative nature of these agreements. "Since the late '90s, we've seen a trend toward a more collaborative approach to outsourcing," says Cole. To be effective, a transformational outsourcing deal requires that each partner have a considerable stake in the game, and often that means sharing both risk and reward. To make that work, the deal must fund the necessary investment at the best possible cost of capital and simultaneously motivate the outsourcing partners' commitment by aligning goals.

While the financial structure of conventional outsourcing arrangements typically includes bonuses and penalties based on the achievement of minimum service levels by the supplier of the outsourced service, business transformation outsourcing deals focus instead on upside targets. They align incentives around enterprise-level outcomes such as market share and return on equity.

As might be expected, outsourcing at this level raises a number of challenges, particularly in the areas of management and measuring results.

With intellectually based service activities, the job of coordination becomes more "interesting," Quinn understates. Companies are dealing with best-in-world suppliers of intellect as opposed to very Rood suppliers of a physical product or conventional service. …

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