Welcome to this week’s Discuss HR, the blog written for and by members of HumanResources UK.
This week we welcome our latest guest writer, Mark Greenhouse. Mark is a lean management coach and today he discusses the true cost of outsourcing and offshoring. (Ed Scrivener)
Backshoring & Insourcing – the new Black?
“£30k investment brings manufacturing process back to UK”
“ BT to create 300 call centre jobs”
“Santander to bring India call centres back to the UK”
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| The elves were delighted that production wasn't outsourced |
That is bringing back work to the UK or Europe from the low labour cost countries or companies choosing to bring work back in-house. The same is true of US operations, being work back into the US. This isn’t about Protectionism, it’s often having a clear view of ll the costs and not just the product costs on a spreadsheet.
Why bring the work back? Surely the Business Process Re-Engineers and Downsizing fashions of the late 80’s, early 90’s weren’t wrong.
Since that time we’ve the benefit of experience and there are a number of studies into the true costs of Outsourcing and Offshoring. From these a number of “hidden costs” are beginning to be exposed.
Don’t get me wrong it can be great for some functions. E.G. Facilities Management; there can be limited scope within a single firm for development of people and skills. Outsource this and the individuals can become responsible for a range of sites in different sectors and face different challenges. So the individual can develop and the outsourcing company can get access to better skilled staff, as well as cover for holidays, sickness etc built into the provision.
So what are the “Hidden Costs of Outsourcing & Offshoring”
Failure to make initial projected Savings
Imagine you outsource just part of the work of a department of say 20 staff. Doing so saves them from completing 24% of their work; by outsourcing will you lose 24% of them?
24% of 20 is 4.8 people, you can’t lose 0.8, so the maximum saving is 20% or 4 people. The first hidden cost is can you realise the full saving in people terms? And note, the cost often stays in the original business.
- Responsiveness
Possibly not as much of an issue with suppliers in the same time zone but once you start to move across time zones this can become a major issue. The people carrying out work may not be available to speak to, so a day can be lost waiting to speak to the people.
In your outsourcer has raised issues and has gone off at midday UK time and at 4pm you discover that they need an answer – what could the result be? You may have to repeat the work conducted by the outsourcer to fully appreciate their points – wasting effort.
Having outsourcing companies though can mean that responding to customer demands can be difficult, you know have to manage a change process in two organisations not just one.
- Service Level Agreements
Often Service Level Agreements (SLA’s) are worked up between organisations to complete work. Without tight controls on these, misunderstandings can occur and exist for years and the business carries the costs.
When does the clock start on the work, when it is sent from the original company, received at the outsourcer or started at the outsourcer?
This happens more than you’d think. We found an outsourcer receiving & paying bonuses to staff because it deemed targets to have been met. The original company withheld bonuses from it’s own staff, quite correctly, as targets had be missed significantly. The disconnect was due the interpretation of SLAs.
- Training & Development
The training and development of all staff is critical to maintaining business competitiveness. Do you want to retain responsibility for the skills your “staff” have and the pace they learn at? Is it written into your contracts of supply, how often do you measure it?
Could outsourcing of your work give rise to new competitors. Could these outsourced employees be learning from being exposed to your work?
- Reputation
Outsourced companies can treat ethical and Health and Safety with scant regard. We’ve seen high numbers of suicides in manufacturing organisations, explosions, release of toxic chemicals, selling of consumer data etc. This is always an issue when we give work out to others to be completed in our name. What is the cost of protecting your company against such issues should they arise?
Think about which CEO ultimately left his job as a result of the Deepwater Horizon oil platform explosion in 2010? Was it BP or the companies doing the outsourced work?
- Underestimating the set-up costs
How do you account for the costs of setting up the outsourcing, offshoring deals? A recent example in the legal world made reference to their own experience for a small program, where they put the legal costs alone at £25-37k? Does that appear in your cost considerations?
- On-going Management Costs
Well you’ve set-up your outsourcing deal, how do you manage it?
Often the purchasing company assume that the internal resources required to manage the outsourced provider already exist, they may not. The outsourcing provider will often provide you with an “Account Manager/ Relationship Manager” but who will liaise with them from your side? You may find you’ve outsourced operational costs but added in management costs.
Apple have found that they needed to invest considerable resources (management time) to develop, train, monitor and control off shore suppliers than anticipated.
- Finance
If you’re in manufacturing this can be a big issue. Imagine you ship a product in from China, only you don’t ship one item in, you ship a container load. That container could easily take 16 weeks from the Chinese manufacturer to being unloaded at your place. So who pays for the 16 weeks of stock in your system?
You do. Only it’s likely to have several cost implications – you’ll need the money on hand to keep purchasing this stock. You probably need to commit cash to stock well in advance of sales and ahead of other potential investments. You’re probably paying finance costs on that cash as well in the form of loan and overdraft costs.
If you bring these costs down by reducing the time what would it mean for your finances?
- Are you paying for your competitors?
When involved in several outsourcing provision situations my department costs were never split into pots to be attributed to each client. Though I knew which clients took up 2% of my department budget and others 10-12%. Experience tells me that costs in the outsourcing provider, not directly related to the product, will be apportioned on an overhead basis, not on consumption.
So you could end up paying for your competitors work.
- Quality Control
There are numerous reasons why this occurs and manufacturing, were the outputs are very similar often suffers from this, so what about industries where everything is bespoke?
Recently we’ve seen service industries with an outsourced function who send work back to the UK with 40% of it not suitable to progress. At a manufacturing plant, who outsource some part production, we found 25% of incoming parts needed to be re-worked.
Re-work eats into the time available to do work, if it increases it impacts on plans and delivery commitments. The effects of poor quality on customers are well documented, what is often not considered is the effect on costs.
Hidden Risks - some of these risks include;
- Changing customs regulations and local practices can require the skills of specialists to avoid fines and penalties.
- Geographic risk from natural disasters that require contingency plans be developed and maintained.
- There may be Judicial, Political and Cultural instability which also require contingency planning.
These risks aren’t reasons to avoid outsourcing but they need to be properly considered.
So outsourcing v offshoring isn’t as straight forward as considering the pure product costs; there are a host of hidden costs that need to be considered.
If you think this might just be the current fashion or fad, then you’d be partially right. In the price conscious market of high street fashion, one chain makes 76% of it’s clothing in the Eurozone. Zara have found that this has given them 30 years of growth and it allows them to respond quickly to changing fashions and trends.
Next time you think about outsourcing or offshoring think consider this quote from the MD of a legal firm “if a supplier is to cut your costs by 10%, then realistically, they have to provide the same service for 25% less than your internal costs to allow for their margins. So how can they provide the same level of service for 25% less?”
What does this supplier know that you don’t?
About the author
Mark began as an Operations Improvement Manager, moving to Marketing in the early 2000’s. He’s held several roles in the outsourcing companies in Food and Drink, FMCG, and Finance. He’s a Masters qualified engineer with a Diploma in Direct Marketing. A Lean Management consultant to MAS, the Manufacturing Advisory Service, he lectures on the application of Lean Management at the University of Leeds Business School, on the undergraduates and postgrad courses. Mark has also published articles on the application of Lean Management in Marketing and Legal environments.
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Discuss HR is the blog for Human Resources UK, the leading LinkedIn group for those involved with HR in the UK. Next week’s Discuss HR will be published on Thursday 18thAugust and will be written by Leadership Coach Dorothy Nesbit.
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