April 19, 2005, 12:00 AM

Outsourcing falls out of favor among big firms, says new Deloitte survey

Deloitte’s study on outsourcing reports that 70% of participants have had “significant negative experiences” with outsourcing projects and are now exercising greater caution in approaching outsourcing.


Outsourcing, which many large businesses have adopted in the past few years as a way to deploy technology quickly without a huge investment is falling out of favor, according to a new survey from Deloitte Consulting LLP.

Deloitte’s study "Calling a Change in the Outsourcing Market," reports that 70% of participants have had “significant negative experiences” with outsourcing projects and are now exercising greater caution in approaching outsourcing. One in four participants have brought functions back in-house after realizing that they could be addressed more successfully and/or at a lower cost internally, while 44% did not see cost savings materializing as a result of outsourcing.

“Ironically, dissatisfaction in areas that traditional outsourcing was expected to improve, such as costs and complexity, was the primary reason behind participants` negative responses,” Deloitte’s study reports.

The study also reported that 57% of participants absorbed costs for services they believed were included in the contracts with vendors. Nearly half of the study participants identified hidden costs as the most common problem when managing outsourcing projects.

"There are fundamental differences between product outsourcing and the outsourcing of service functions, differences that were overlooked but have now come to the fore," says Ken Landis, a Senior Strategy Principal at Deloitte. "Outsourcing vendors and companies may have conflicting objectives, putting at risk clients` desire for innovation, cost savings, and quality. Moreover, the structural advantages envisioned do not always translate into cheaper, better, or faster services. As a result, larger companies are scrutinizing new outsourcing deals more closely, re-negotiating existing agreements, and bringing functions back in-house with increasing frequency."

“Participants originally engaged in outsourcing activities for a variety of reasons: cost savings, ease of execution, flexibility, and lack of in-house capability,” the study says. “However, instead of simplifying operations, many companies have found that outsourcing activities can introduce unexpected complexity, add cost and friction into the value chain, and require more senior management attention and deeper management skills than anticipated.”

Other findings:
• 62% of participants realized that they require more management
• efforts in comparison to the original estimates.
• 57% said they could not free up internal resources for other projects, leading to larger than anticipated deal management overhead.
• 52% ranked cost-related issues as the main risks of outsourcing.
• 81% have limited or no transparency to a vendor`s pricing and cost structure, resulting in increased chances of paying additional costs.
• 48% indicated that they do not have a standardized methodology to evaluate the business case for outsourcing.

For outsourcing vendors, companies are getting tougher in their negotiations:
• 83% of participants said they have renegotiated outsourcing deals due to pricing and to business, technology, and regulatory environment changes.
• 53% have moved from long-term contracts (six to ten years) to shorter contracts (up to five years) to increase flexibility and bargaining power.
• 73% are working with multiple vendors to reduce vendor dependency. Participants that had exclusive deals in the past warn that they are very risky, and they will not enter into them again.
• 45% say they are forced to include gain-sharing clauses in vendor contracts as motivation for innovation, highlighting continuing concern about vendor complacency.

"In the near term, outsourcing will become less appealing for large companies because it is not delivering the value as promised, and its appeal as a cost-savings strategy will also diminish as the economy recovers from recession and companies look for differentiated solutions to support their growth," says Landis. "However, outsourcing can still deliver value to companies that enter into outsourcing for the right reasons using a right model such as centralize-standardize-outsource, transform-operate-transfer, commodities outsourcing, risk transfer, and shifting fixed costs to variable, and have superb talent in-house to manage these deals from inception to execution."

Deloitte conducted the study in person during from October to December 2004 with senior executives from 25 major companies.


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