Outsourcing has held management's attention through the 1990s, longer than any other weight-loss regimen. The urge to contract-out, as tracked by an index from The Outsourcing Institute and Dun & Bradstreet, is now a $100-plus billion market in the United States alone-and growing at over 35 percent per year. While downsizing and reengineering quickly showed their limitations in improving corporate performance, outsourcing endures.
But cracks are showing in the cosmic egg that reflects outsourcing as a universe without boundaries. Momentum can mask the change in the environment, changes that should cause bank CEOs to rethink what is still a new way of life. Outsourcing, applied successfully in manufacturing sectors, is undergoing a severe test in the financial services sector.
Having viewed hundreds of requests-for-proposals and supplier responses, I see the ground starting to shift. Consolidation and restructuring are now impacting all contract service industries. So the glory days of cutting costs by double-digit percentages through massive outsourcing are over in the United States.
RISKY BUSINESS. And the goal of sharpening strategic focus, separating core from non-core functions, is becoming riskier. Consider an investment firm that outsourced technology and is now forced to compete against those who retained the capacity to innovate in-house. Or a bank that formed a back-office processing alliance at significant cost and disturbance only to unwind the effort after a couple of years. Or a securities firm that experienced poor quality results after outsourcing an already streamlined distribution function. Seemingly severable tasks often prove otherwise when tested by volatility, time and inability of the work force to cope.
Senior managers need to become more expert in the discipline of sourcing, an approach that gives equal weight to internal, external and hybrid alternatives. This means staying on top of performance standards, costs, volume details, practical alternatives and limitations of the marketplace despite vendors claims. Even more, putting some resources back into those internal corporate services and technology organizations that were pummeled this decade by twin peaks-first cost-cutting and now ballistic growth.
Competence is the ultimate discriminator. Sometimes outsiders have the edge, particularly in one-time projects employing specialized skills and where external energy is needed to undo the mental ossification that occurs in mature organizations. But in a time of economic growth and skills scarcity, vendors have great difficulty attracting and retaining the people that make outsourcing a viable alternative. Outsourcers' teams today are populated with new employees, all climbing several learning curves simultaneously.
Cost remains one of the top priorities.Outsourcers will have trouble meeting customers' expectations for efficiency going forward. While revenues are exploding across the outsourcing industry, profit margins are thin and have declined at some of the major players. Further subcontracting for specific skills, which equates to stacking profit margins, is also having an effect on the economics. International Data Corp., a market research firm, finds an average of 36 percent of an outsourcing contract and 25 percent of a systems integration contract involves subcontractors. And labor costs are starting to escalate beyond inflation. For many services, it's unclear how the future cost of outsourcing could possibly remain below that which a corporation could achieve in-house. CONSOLIDATION PRESSURE. Complexity and continuity are also areas for concern. The promise of outsourcing has always been that qualified contractors will manage the appointed tasks, develop a keen understanding of customer culture plus free-up large amounts of customer management time and other resources. This worked in a headcount-focused and low-growth period like the early 1990s. But what about now? Over 10,100 merger-and-acquisition deals were announced in 1996, according to Securities Data Co. With business volatility at an historic high, complexity and continuity risks escalate with big-ticket outsourcing, especially when contract service firms are also experiencing consolidation pressure.
Outsourcing is now embedded in world commerce. The financial and strategic benefits have been profound in manufacturing sectors; some of the same benefits can be captured in financial services. Good news for shareholders so far. But the "Big Buffalo" are just about gone in in the United States and contract service providers face enormous challenges. Aggressive customer commitments are already booked. Competition. Shareholders' scrutiny of profitability and growth. GLOBALIZATION PRESSURE. Financial services competitors that have the will to manage their own infrastructure with modest external reliance can still break out of the pack. Outsourcing is a path to competitive parity, not innovation, unless the strategy is superbly executed. And innovation is what's needed to change the genetic code of business.