The Leading Edge of Outsourcing

As a business practice, outsourcing has taken its lumps in recent years, causing some experts to claim that it’s becoming less attractive to large organizations. Others think outsourcing could be entering a new and more potent phase, one that will change the way companies are organized and, in some cases, even what they consider the core of their businesses.
Outsourcing does not always turn out well for companies. A recent study from Deloitte Consulting found that fully 70% of surveyed companies “had significant negative experiences and are outsourcing with increasing caution and in a conservative manner.” In fact, Deloitte predicts that outsourcing will “increasingly lose luster” even while remaining a useful solution within certain contexts (Deloitte, 2005; Savvas, 2005).

One of the biggest problems is that, although saving money is the most common reason companies give for outsourcing, slightly over half of respondents (52%) considered factors related to cost to be among the primary risks of outsourcing, and half said that hidden costs were the most common problem related to the management of outsourcing deals.

The outsourcing of services can be particularly tricky because it’s often hard to measure service quality. What’s more, according to Deloitte’s Calling a Change in the Outsourcing Market report, “[H]igh interdependence of services requires closer working relationships with every vendor and among vendors, increasing the complexity of the relationships and requiring far more management resources than product outsourcing” (p. 23).

So, has outsourcing already run its course as one of the premier ideas for cost-cutting, boosting quality and focusing on core competencies? Not so fast, suggest some experts. It all depends on how well sourcing arrangements are managed and whether business processes will be commoditized in the future.

In a paper called “Strategic Sourcing: From Periphery to the Core,” published in Harvard Business Review, the authors argue that outsourcing has become so sophisticated that even some core functions can be moved outside of organizations. “It’s no longer a company’s ownership of capabilities that matters but rather its ability to control and make the most of critical capabilities, whether or not they reside on the company’s balance sheet” (Gottfredson, Puryear, & Phillips, 2005, p. 132).

They call the practice of effectively sourcing every activity in the business value chain “capability sourcing.” The authors, all partners at global management firm Bain & Company, argue that the reason so many companies are dissatisfied with outsourcing arrangements is that they make sourcing decisions in a piecemeal fashion. One of the companies they point to as sourcing things in a more cohesive fashion is 7-Eleven. It went from being vertically integrated and doing nearly everything itself (including owning the cows that produced its milk products) to outsourcing everything but the most mission-critical functions (Gottfredson, Puryear, & Phillips, 2005).

For example, the company allows Frito-Lay to directly distribute its products to 7-Eleven stores, but 7-Eleven maintains control over decisions such as shelf placement and the quantities of product delivered. That is, 7-Eleven takes advantage of Frito-Lay’s capabilities even while maintaining control of and leveraging some of its own core competencies: merchandising and customer data analysis. It was this kind of transformative strategy, suggest the authors, that allowed 7-Eleven to dominate many areas of its industry in recent years.

Bain & Company’s Rudy Puryear (2004) believes that companies that excel at capabilities sourcing will have distinct advantages in coming years. “Now, we’re entering a third phase of competition.... The way a company manages its sourcing network lies at the very core of this new mode of competition.”

Others think that the degree to which this new era truly arrives could hinge on other factors, especially the degree to which business processes become truly commoditized. Prof. Thomas Davenport (2005) of Babson College argues that commoditization is already emerging thanks to the work of organizations such as Carnegie Mellon’s Software Engineering Institute, which developed a global process management standard for software called the Capability Maturity Model (CMM). Companies that have the highest level of CMM certification are more likely to win contracts with the best companies, a signal that the commoditization of processes is coming to the software outsourcing business.

Davenport writes, “Process standards could revolutionize how businesses work. They could dramatically increase the level and breadth of outsourcing and reduce the number of processes that organizations decide to perform for themselves.” The number of companies providing such processes will grow, he predicts, and process standards will become common in most industries. This should, in turn, bring down the cost of services and perhaps lead to another surge of outsourcing.

So, perhaps outsourcing won’t lose its luster in the long term despite its current problems. Maybe it’s only a matter of time before better management tools and business process standards allow outsourcing to achieve its full potential. If so, organizations of the future could become more flexible and modular, allowing them to react more quickly to shifts in global markets.



For a PDF version of Deloitte’s Calling a Change in the Outsourcing Market report, click here. For more on Deloitte, click here.

For a Chief Executive article called “Sourcing Strategy: The Next Frontier,” click here.

For a Computerworld article called “Keep the Core? No More!” click here.

For more information on “Strategic Sourcing: From Periphery to the Core,” click here.

For more information on “The Coming Commoditization of Processes,” click here.

Documents used in the preparation of this TrendWatcher include:

Davenport, Thomas H. “The Coming Commoditization of Processes.” Harvard Business Review. EBSCO. June 2005.

Deloitte Consulting. Calling a Change in the Outsourcing Market: The Realities of the World’s Largest Organizations. April 2005.

Gottfredson, Mark, Rudy Puryear, and Stephen Phillips. “Strategic Sourcing: From Periphery to the Core.” Harvard Business Review, February 2005, pp. 132-139.

Melymuka, Kathleen. “Keep the Core? No More!” Computerworld. ProQuest. February, 14, 2005, p. 40.

Puryear, Rudy. “Sourcing Strategy: The Next Frontier.” Chief Executive, March 2004.

Savvas, Antony. “Disappointed Corporates Bring Outsourcing Back in House.” Computer Weekly. ProQuest. April 26, 2005.