When Outsourcing is a Mistake
Introduction
Outsourcing seems to be every company’s favorite way to grow, cut costs, or respond to market changes. It seems anything today can be contracted: sales, marketing, payroll, manufacturing, logistics, and even new product development. While outsourcing does have advantages, are there times when something should not be outsourced? How do companies know when they should farm out a tough operation or struggle through it themselves? Simply put, companies outsource operations when the total operational costs are lowered by going outside the firm. Typically, there are three benefits cited: quicker implementation, fewer idle resources, and cost reduction due to economies of scale. While there may be times when this is true, there are other situations where the perceived benefits are illusory and, in reality, cost the organization more to outsource.
The Mistakes of Quick Implementations
When there is a need for speed, then an outsourced solution may be implemented more quickly than using internal resources. This reduces the need for highly skilled or experienced hires who command a premium salary. By outsourcing the operation, they rent specialized talent cutting out the learning curve associated with the new or improved operation. A commonly uttered sentence in these organizations is, “We need to complete this quickly.” For companies in this mode of thinking, time is more valuable than saving money as the competition drives the decision-making process. For example, customer relationship management (CRM) is the latest sales trend. Technologically, it is nothing more than sophisticated contact management software. Enabling feedback from customers to be communicated to the rest of the organization, it improves marketing, sales, manufacturing, and new product development. Instead of deploying a manual system based on forms and procedures, a company can contract with a firm to supply them with the software, hardware, and training. This enables the organization to focus on properly applying CRM to their business as opposed to wrestling with the implementation details.
When the need for speed blinds an organization, the outsourced solution can take just as long or longer to implement. One needs to ask why they believe an outsider will be quicker. If proprietary knowledge is required to achieve the goals, then there will be no difference in time under the best of circumstances. Both in-house and external help will need time to absorb and digest this new information. Furthermore, because the in-house people are already familiar with the current operations, they will probably be able to apply the information more quickly. If the external resources abandon the organization, they will have to develop and educate a new outside supplier all over again. Alternatively, internal resources tend to stay with a company longer and their knowledge is more easily dispersed throughout an organization. For example, most sales forces would be a bad operation to outsource. Customer lists, value proposition, and intangible client relationships are all critical proprietary resources that is indispensable. If the supplier were to leave, the company could go out of business as it scrambles to learn how to sell to its current customers.
Another situation that arises is when the contracting operation is less capable than the hiring operation. Additional time must then be spent to both raise their performance and implement the transition. These situations can occur when the company’s standards are higher than the rest of the industry or the vendor is unable or unwilling to comply. For example, 21CFR§11 or electronic records and signatures (ERES) is currently partially implemented in the medical device industry. While some companies have defined strong ERES programs, others are depending on FDA enforcement discretion to stay in operation. In the case of a more compliant customer, the company either has to find another supplier or work with the current one to elevate their customer specific processes into compliance. The higher the standards, the fewer suppliers will be able or interested in compliance. For those that do qualify, undoubtedly this will translate into a premium price which could negate any cost advantage of outsourcing. In-house resources are clearly better in these situations where there is a single compliance standard.
Temporary Needs or Permanent Challenges
Outsourcing is also pursued when occasional needs do not warrant a permanent solution. Expensive equipment or software may be required to perform an annual project but remain idle the rest of the time. For example, new primary packaging for a medical device requires material testing such as impact, hardness, tensile strength, leak, and vibration, for example. Instead of buying the equipment for this presumably infrequent project, outside laboratories offer these tests at a fraction of the cost of the equipment. Furthermore, money is saved because software and hardware will draw some resources for maintenance, calibration, and validation. The employment of highly technical specialists is another reason to outsource. Although their services are needed sparingly, many times companies hire them permanently to ensure their continual availability. Scientists and engineers usually fall into this category. Maybe the scientist is needed for a single phase or period of a project. Afterward the project is over, these learned men can consume prodigious resources as they engage in conducting irrelevant studies and writing unread white papers. As a result, outsourcing is an attractive alternative. For example, if a company wants to improve their quality to meet a specific customer’s requirements, a quality consultant is a more effective use of resources than hiring a full-time Six Sigma Black Belt. Once the project is over, the consultant’s contract is terminated while the Black Belt will want to move on to the next customer’s product and try to improve it despite the fact there may be no business reason to do so.
But when the organizations’ “temporary contractor” is permanently needed, the company continuously employs the resource. With one project falling on the heels of another, the outsourced solution is obscured by the organizations that employ them. Moving from one budget to another, but keeping the same office, these contractors fly underneath the radar. This happens when organizations incorrectly anticipate the amount of change. This can cause an organization to continuously contract for project managers, engineers, scientists, or consultants to accommodate unknown, but predictable, customer requests, market changes, or business needs. This may be because a new device that it was unique and profitable loses appeal when copycat devices emerged. For example, a customer may ask a device to be sent packaged and sterilized instead of bulk shipped. When the company changes the product, it will have to go through Design Controls and require engineering, quality, and marketing support as well as overall project management. While it may be tempting to outsource, realistically will this product not have to be changed again? While each project appears to be a one-time event, in reality the product requires regular support to keep it updated and profitable. Validation is another example of an activity that appears transient, but in reality is a perpetual activity. Is it really likely that all of the equipment, software, and processes will only have small like-for-like changes? No, it is not likely. Even if an entire operation freezes its configuration, the suppliers will still make changes to their processes and eventually one will be made that will affect the finished product.
One Size Fits All
A final reason co mpanies outsource is that lower costs can be achieved outside the organization because of economies of scale. Particularly for capital intensive operations, equipment and personnel can specialize achieving enormous gains in productivity. For example, if a company wants to sell a sterilized product, it will need to evaluate and possibly upgrade its packaging processes, add quality systems to document and assure sterilization requirements, and develop manufacturing personnel to work with sterile products. Alternatively, outsourcing this moves all of the work to the supplier. Since the supplier is spreading these quality systems and knowledge over multiple clients, they can provide this service at a lower cost than an in-house operation.
While large specialized operations appear to have good economies of scale, they may be too rigid or inflexible for a specific company’s requirements. These companies achieve their lower costs by standardizing and specializing. This means that the customer must learn to conform to the supplier’s requirements and not vice versa. For example, web based software solutions are becoming vogue as the costs of both the hardware, upgrades, and technical support can be moved onto the supplier. For example, if a company outsources their inventory management, it may not be sufficiently configurable to accommodate a medical device. If the system does not have the ability for Quality Assurance (QA) to place product on hold, search release dates in case of a recall, or automatically remove expired product from inventory, the buyer will have to develop systems that augment the outsourced solution. On one hand, Information Systems' costs are reduced by outsourcing, but QA costs are increased to accommodate the system's shortcomings. Since the QA systems will be manually developed, the total costs will likely be greater after the transition.
Furthermore, as the economically efficient organizations change their operations to continuously reduce costs, the buyers must also keep changing their practices to accommodate them. A contract packager, for example, could eliminate a package size to better utilize resources, or perhaps they transition from radiofrequency sealing in favor of heat sealing. Regardless, these changes will be transmitted upstream to the product development team. Instead of spending resources to develop new and innovative products, contracting organizations will have to spend money to keep doing business with their suppliers. Of course, the customer could go shopping for a new supplier, but that would take time and effort. Organizations that have realized the cost savings of an outside vendor are highly unlikely to move the operations back in-house for both practical as well as political reasons.
Conclusion
While outsourcing enables companies to grow quickly and lower costs, there are times when it is the wrong solution. In situations involving proprietary knowledge, highly technical or customized operations, the outsourced solution may not only be more expensive, but a complete disaster if they turn out to be intransigent or incompetent. Unfortunately, both of these are realized after the transition takes place, so be wary when outsourcing any operation.