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Outsourcing or ‘Out of sight, out of mind?’

I was having a lunch meeting with a project manager, and the topic of outsourcing came up. Specifically, outsourcing the manufacture of a particular machine that would form part of a larger vehicle system. I asked him why he was doing this, particularly when for many years the predecessor to this machine was very successfully manufactured in-house. His answer was simple.

It was to transfer risk to a supplier.

There are many problems with this answer (and no - there weren’t too many more layers to his response). His organization was trying to drive down (perceived) internal project risk by transferring (perceived) risk to a supplier - all through making them responsible for creating said machine. If the supplier didn’t meet deadlines, then there were compensatory clauses in the contract that would effectively mean that the supplier would be fined substantial amounts of money.

There are all manners of problems with this approach, not least of which is that my project manager’s organization would still be faced with the risk of not providing customers the vehicle system on time and on budget. The customer doesn’t care that you are ‘fining’ a supplier for not meeting a deadline. And the adversarial environment this creates often has disastrous impacts on the quality of the goods being provided.

So when should you outsource? My rule of thumb is something like this:

Outsource when this creates something good or valuable.

Don’t outsource simply to avoid something bad.

This is all about mindset.

There are plenty of thoughts on this topic. Many entrepreneurs will talk about outsourcing to free up time for innovation or more ‘core’ functions. They also talk about how outsourcing provides access to specialized talent to help you create something amazing. And in some cases, outsourcing allows you to keep pace with higher-than-expected scaling (which is a good thing!). You can see in all these examples that there is a clear ‘thing’ being gained by outsourcing.

But sometimes it gets a little murky. And that starts when we talk about time and money (and nothing else). A simple view on when to outsource is to do a cost and time calculation of doing something in-house versus through an outsourced service provider. However, even this approach needs to have some critical, strategic thinking. Even if the math says ‘yes,’ what capability or opportunity do you miss by having someone else do it? If the answer is … not much … then outsource away!

When we boil the decision down to a numbers game based on time, money, risk metrics et cetera, you almost certainly lose long term. For example, multiple studies (like this one and this one) show that when local government functions were outsourced, many of the cost savings were absorbed by more ‘managerial’ positions.

And here is one of the main problems with outsourcing for the wrong reasons. When we outsource for any other reason to gain organizational stakeholder benefit, we are essentially changing the way we do business for internal personal or cultural reasons. Perhaps it is a military that is not focused on generating its own engineering capability. Perhaps it is a vehicle manufacturer that is quickly trying to generate the ‘façade’ of short-term savings by outsourcing … because this means they only pay for parts after they are built. This is not generating long-term value for our organization’s beneficiaries.

This quickly leads to weird and disastrous phenomena, like a mutant marketplace where prospective vendors focus on winning contracts and not delivering results. Like this one where a prospective vendor worked out that to simply ‘tender effectively’ for a military customer, his business needs to spend $ 2.3 million to get the security clearances and otherwise ‘qualify’ for consideration.

The one common thread to all outsourcing success stories – particularly for militaries and governments – is competition or the threat of competition. So if you have to pay $ 2.3 million just to enter the market, pretty soon the only vendors that are left are bloated ‘big prime’ companies full of professional contract winners (where the $ 2.3 million overhead is but a mere trifle). And when these vendors win the contract, they subcontract to the poor old businesses who couldn’t afford that $ 2.3 million entry fee. And this subcontracting is usually based on existing relationships of the cheapest cost (not competition). The big company takes a hefty cut, passes the cost onto the customer, and otherwise prepares their team for winning the next contract.

And this is before we delve into the inefficiencies and lost direction by creating even more contractual barriers between the customer and the 23-year-old graduate engineer who will actually do the hard work.

In the end, the customer who doesn’t really know why they outsource and then goes on to make the marketplace difficult to get into pays lots of money to lots of ‘non-value adders’ for no reason.

So when you consider outsourcing, ask yourself what value or goodness will be created as a result. If you are outsourcing because a spreadsheet says this drives downtime, money and risk … think a little deeper. Reducing time, money and risk is great – but what does this allow you to do? Are there any long-term costs for outsourcing? Do you hollow out your expertise? Does your organization become entirely reliant on supplier organization to the extent that if they decide to focus on another customer (which happens a lot) then you can’t produce your product anymore?

The answers to these questions still might mean outsourcing is the right thing to do. You just need to ask.


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