Combating the “Hidden” Costs of Managing Outsourcing

Industry media, especially over the past two years, often points out that a significantly high number of outsourcing arrangements do not deliver the promised cost savings due to “hidden” costs associated with managing the relationship. This is especially true, the reports state, in outsourcing relationships with an offshore delivery component, where administrative costs increase due to travel, communication workarounds, attrition, and other factors.

However, there are numerous industry studies also finding a high number of companies that are very satisfied with the results of their outsourcing arrangements, some even achieving greater return on investment (and higher cost savings) than anticipated.

Why the two drastically different outcomes? What makes the difference? What can buyers of outsourcing services do to boost their chances of achieving their desired objectives and eliminating or minimizing the “hidden” costs?

Outsourcing Center studied these questions in the context of 14 outsourcing relationships that each have been in existence for a minimum of eight years (and several for 12 years) and achieved more than they anticipated through outsourcing – including the level of cost savings.

The study found some commonalties in the way these outsourcing relationships were structured at the outset as well as how they were managed over the long term, which are major factors in overcoming “hidden” costs.

The study participants

Nine of the 14 relationships originated in 1998 or 1999, which is significant because the industry did not have as many widely recognized best practices and risk-mitigation factors back then. Also of note, four of the 14 buyers are government entities, significant because government outsourcing arrangements have some unique characteristics that usually create challenges in managing the relationship cost-effectively. Four have offshore components.

In addition to the public-sector relationships, the other buyers in the study represent the following industries: energy, telecommunications, healthcare providers (hospitals), pharmaceutical, banking, and insurance. They include multinational enterprises and midsize companies. The service providers in the study are Tier-1 and Tier-2 providers.  All 14 relationships were participants in the Outsourcing Center’s 2010 Outsourcing Excellence Awards program (

The processes outsourced in the studied relationships include

  • Finance and accounting
  • Data center / IT infrastructure
  • Real estate
  • Inbound/outbound mail processing and document management
  • HR benefits administration
  • Application development and testing

Provider selection matters

The first commonality the 14 relationships share is their criteria for selecting their service providers.

Other than “value proposition,” which was cited as the top criterion by almost all the buyers, “the provider’s superior processes and methodologies” was ranked most frequently as the #2 criterion. In describing how they manage or govern their relationships, several buyers pointed out they experienced fewer management challenges because of the provider’s superior expertise not only in performing the outsourced work but also because of its methodologies for managing through risks and issues that arise.

The study also revealed that, with the exception of the government deals, nearly all of the buyers included “the provider’s willingness to put skin in the game” among their criteria. With the exception of the government deals – which are bound by laws that usually prohibits the use financial incentives in services agreements – all of the relationships studied established either incentives tied to service level agreements (SLAs) or a gain-sharing initiative.

In each of these cases, the study participants cited the incentives as a significant factor in driving behavior in both companies. Particularly with gain-sharing mechanisms, the incentive plan is an influencer of how flexible the parties are and how openly and proactively they communicate – which then lessens the challenges that can cause a need for increased relationship management (and resultant costs).

The buyers in the study also described the kinds of information they sought (in the due-diligence phase) about a potential service provider in references from the provider’s clients or in the demonstrations of a partnering approach during the solutioning and negotiating process. These include such characteristics as the following:

  • Always looking for win-win solutions
  • Communicating early and often
  • Teaming, collaborative approach
  • Accountability

Governance assures desired behavior from both parties

The second commonality the 14 relationships share is a set of characteristics within the governance framework that each established to manage their relationship. These governance elements include the following:

  • An issue-resolution process that ensures both parties address challenges in real time and from a fact-based analysis
  • A communication structure that includes frequent (even daily), candid discussions about goals, visions, capabilities, solutions – especially around ways to save money – in addition to the more formal governance meetings
  • Access to both companies’ top management levels to assure timely provision of resources necessary to execute on the planned objectives, especially when exploring new ideas to respond to changing dynamics

Each of the 14 relationships established a framework for governance meetings that includes meetings to review the relationship itself separately from the operational issues and strategic objectives. Five of the relationships meet on a monthly basis to discuss strategic issues, one meets twice a year, and the others meet quarterly.

The study reveals a major finding regarding the participants’ belief about the value of checking the “health” of their relationship. One-half of the 14 have relationship governance meetings on a weekly basis. Of the remaining seven, five meet monthly and two meet quarterly. The extent and formality of the relationship governance meetings varies, but clearly the majority of them place high value on discussing their relationship frequently.

In addition, several of the studied relationships include team-building activities in their governance structure on at least a quarterly basis.

Factors producing cost savings

Each relationship in the study achieved a level of cost savings at or above their agreed-upon objectives. When asked to rank various contributing factors to the cost savings achieved, all 14 participants identified two factors as a driver yielding their cost-reduction:

  • Technology implementation
  • Standardization and/or centralization of process and resources

The four relationships with offshore components cited “offshore labor arbitrage” as one of their top two drivers. It is important to note that all four faced the potential for greater “hidden costs” eroding their cost savings because of the characteristics of managing an offshore relationship, but they successfully addressed those hidden factors.

However, the study revealed that the way a buyer manages the relationship has a major impact on a provider’s ability to deliver cost-effective services and cost savings.

Service providers participating in the study described several characteristics of their customers’ relationship management characteristics that enabled the providers to produce the desired cost savings. These include:

  • “We have a seat at the table of many of their planning and development meetings. This is particularly important for our ability to ensure continuous cost-reduction activities are effective and quick and will not be encumbered by internal stakeholders’ concerns or ‘pre-outsourcing’ thinking.”
  • “They are rational and thoughtful in their management of our services, keeping mutual end goals in mind.”
  • “Their trust in our capabilities and their faith in our relationship give them the ability to listen confidently to the ideas we bring to the table as value-added thinking. Their confidence impacts decision making, which impacts our ability to drive results through cost savings and productivity initiatives.”

Win-win results from effective relationship management

When companies manage their outsourcing relationships effectively (and structure them for success at the outset), both the customer and the provider win. And that’s the case in these 14 relationships.

The study question asked the buyers to rank nine factors as to their importance in how the outsourcing relationship helped the company achieve its business objectives. The benefit factors include the following, ranked in order of how many buyers achieved that benefit. Findings are as follows:

  • Reduced costs (13 buyers)
  • Increased ability to focus on core business (12 buyers)
  • Improved productivity (10 buyers)
  • Automation of manual processes (8 buyers)
  • Access to IT skills not available or affordable in-house (5 buyers)
  • Avoided capital expenditure (4 buyers)
  • Enabled taking advantage of new market opportunities (3 buyers)
  • Reduced process cycle time (1 buyer)
  • Improved time to market (1 buyer)

The buyers cited cost reduction most frequently. However, it is important to note  they ranked increasing the ability to focus on their core business more often as the most important factor in driving value from outsourcing.

As to the providers’ wins, customers in most of the 14 studied relationships extended their contracts prior to contract-expiration date (and some did so several times). Most increased the scope of services more than once over the years. Several stated that they did so partly as a way to enhance or strengthen the relationship.

In addition, a significant finding in the study reveals that scope expansion went further than just functions related to the outsourced work and the initial business unit outsourcing its functions. In one-third of the relationships, the customer helped the service provider gain inroads to other departments or business units in the customer organization.

In describing the importance of governing the relationship and managing for successful outcomes, one buyer described it as “vital to helping our relationship flourish.” That’s an apt description of these 14 long-term relationships that the buyer and service provided managed so effectively that the companies minimized the “hidden” costs that could have eroded their cost savings and other value from outsourcing.


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