Is Insourcing the New Outsourcing?

A recent Compass poll of executives from 70 outsourced companies in North America found that only 4 percent of organizations would not consider taking all or some services back in-house when their contract term expired. Two years ago, this result would have been surprising, but recently an increasing number of client organizations view repatriation of services or insourcing as a viable option.

The growing popularity of insourcing results from a variety of factors, including acquisition of outsourced companies by insourced companies, clients’ disillusionment with their outsourcing deal, an increased focus on selective sourcing (and retaining strategic services in-house), and a growing confidence within companies in their ability to efficiently manage an IT operation.

Sourcing Scope

Over the next 18 months, according to published reports, outsourcing contracts worth more than $90 billion will be up for renewal. A variety of factors suggest that many client organizations are seriously considering insourcing a significant portion of those outsourced services.

The key factor driving the consideration of insourcing has been the failure of outsourcing to achieve the consistent, long-term and significant cost savings clients anticipated. Compass analyses of large outsourcing contracts show, on average, a cost reduction of 15 percent over the first 18 months of the agreement. However, because of growing demand for services, and the “back-end loaded” nature of many outsourcing contracts, the client’s costs are oftenby the end of the term30 percent higher than those of a well-managed internal operation.

In some cases, organizations facing financial difficulties outsourced with the clearly defined objective of short-term financial gains, such as getting employees off their books, realizing immediate IT cost savings or receiving a cash infusion in exchange for assets. Organizations whose financial situation has subsequently stabilized may now be revisiting their outsourcing strategy and determining that they can manage operations more efficiently in-house.

Meanwhile, organizations that expected the best of both worlds from outsourcinglow cost and “value-added” responsiveness and commitmenthave inevitably been disappointed, and are now revisiting their decision to outsource.

In other instances, outsourcers have become victims of their own success. Consider: An organization hires an outsourcer to tackle daunting challenges such as consolidating standards, processes and systems following an acquisition or merger. After the outsourcer commits the resources and resolve the client lacked, and delivers a well-run, standardized global operation, the client brings the operation back in-house, exploiting the outsourcer’s investment and reaping the rewards in terms of ongoing cost savings. It’s an unfortunate situation for the outsourcer, which has invested substantial resources in anticipation of a long-term relationship.

Revisiting Strategy

In a broader sense, the increasing consideration of the insourcing option as contracts reach their termination dates signals not so much the failure of outsourcing as it does a revision of an overall delivery strategy on the part of client organizations.

For one thing, insourcing reflects the growing maturity of the outsourcing marketplace. Specifically, clients are undertaking a comprehensive analysis of their sourcing requirements to determine what should be outsourced and what should be kept in-house. This more nuanced approach recognizes that outsourcing in and of itself is not a solution to management challenges. Clients are also becoming more confident in their ability to manage operations, and senior executives are becoming more willing to consider an internal IT organization’s business case for insourcing. This was not the case a few years ago.

Organizations with a truly global scope, moreover, can be their own outsourcers, and gain many of the benefits of utilizing offshore service providers directly. For example, a multinational bank with operations in Poland could consolidate mainframe operations there and take advantage of that market’s highly skilled workforce and low labor rates, as well as the benefits of consolidation. Large organizations can also afford to hire the best talent, as well as leverage economies of scale as do the large service providers.

Tier Two Players

The emergence of “tier two” regional outsourcers has been another key factor in changing clients’ sourcing strategies. For one thing, midsize vendors provide more options in terms of selective sourcing, allowing clients to define specific functions to outsourceas well as specific functions to keep in-house.

Smaller, regional service providers are also proving to be more adept at, and committed to, delivering commodity services. Such relationshipswhere the client’s objectives are clearly defined as receiving services of reasonable quality as cost-efficiently as possibletend to be most effective.

The growing popularity of smaller outsourcers also reflects a growing disenchantment with all-encompassing “megadeals” with global outsourcers. Rather, in reassessing their sourcing strategies, client organizations are finding that a selective approach employing a mix of regional players and insourcing can be the optimal “global” mix. Finally, for smaller client organizations, regional vendors can be a better fit organizationally, whereas working with the major players often results in a disadvantaged negotiating position.

Cautions and Considerations

Despite recent trends showing insourcing in a favorable light, client organizations should not underestimate the challenges of repatriation, and must ensure that they have a strong internal management function that can address the confusion and disruption that inevitably accompanies a repatriation initiative.

A sound financial business case, based on an analysis of existing costs and service quality, is essential to any client organization considering insourcing, and should be applied to assess and navigate various scenarios. For instance:

• If clients believe they are being overcharged by a service provider and seek to remedy the situation through insourcing, a cost analysis is necessary to validate the assumption.
• If the business case analysis demonstrates that a vendor is in fact overcharging, the client organization should consider the option of presenting a “proxy bid” cost analysis based on market rates to the vendor as a negotiating tool.
• In planning for repatriation, client organizations must recognize that the process requires defining a long-term price structure, and identifying the benefits of different strategies. For example, what will be the potential impact of consolidation or offshoring over a period of two to three years? A repatriation initiative should be built around a fact-bases analysis of options and long-term impacts.
• Insourcing requires a thorough assessment of internal skills and management capabilities. Do the necessary capabilities exist? Is the client organization willing to invest the resources to develop the necessary internal capabilities?

Compass expects to see an increase in companies repatriating services over the near term. Ultimately, however, most organizations will pursue a more balanced delivery strategy and take the selective outsourcing routekeeping some services in-house and outsourcing others.

Bill Fowler directs Compass Sourcing Services in North America. He is based in Chicago.