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Title News - July/August 2005

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July/August 2005 - Volume 84 Number 4

Is Outsourcing the Right Decision for You?

by Julie D. McClellan

No doubt you have heard a lot about outsourcing and may wonder whether outsourcing is for you and your business. The answer to the question, as with most things, is "it depends."

The decision to outsource requires great consideration and is not a decision to be made lightly. How you come to that decision requires more than merely determining whether you can save money by outsourcing. This article is intended to help you identify the things that should be considered when making the decision to outsource and what to do once the decision to outsource has been made.

What is Outsourcing?
Outsourcing is a strategic use of outside resources to perform activities traditionally handled by internal staff and resources. Outsourcing differs from the more common use of outside contractors in that outsourcing involves the wholesale delegation of one or more of a company's core business functions to an outside vendor. In today's business environment, many functions are ripe for outsourcing including title searches, title production, accounting, human resources, technology development and management, facilities management, legal services, and marketing.

Pros and Cons
The first thing to do when making the decision to outsource is to weigh the pros and cons.

The Pros
Cost Reduction and Control. Cost reduction is the most frequently stated motivation for outsourcing. Outsourcing vendors often provide the same level of service and functionality as internal resources, but at a lower cost. Outsourcing vendors can offer cost reductions because, in addition to helping you minimize the expenses associated with having your own employees, they can take advantage of economies of scale; they have better access to lower cost labor pools (some offshore) and have more focused expertise.

Focus on Core Competencies. Outsourcing one or more functions of your business will allow you to focus your energies and resources on those functions that constitute your core competencies and have more strategic potential. If your business is real estate transaction services, is your company better served by spending scarce resources on additional closing staff or IT staff?

Cash Needs and Asset Management. An additional benefit of outsourcing is the opportunity to sell the assets associated with the function being outsourced, as well as the maintenance contracts associated with those assets. For instance, if you outsource your help desk network, you can sell the server it ran on to the vendor and cancel the maintenance contract as well. The net effect is an increase in cash and a decrease in assets on your balance sheet.

Increased Capabilities. Advances in technology have made many business functions easier to perform. However, technology advances quickly and is often obsolete before you have had an opportunity to receive a return on your investment. These rapid and often costly advances in technology may make it less feasible for a company to continue to make the investment in the capital and human resources necessary to maintain internal departments with optimal capabilities. Outsourcing vendors are able to take advantage of economies of scale to maintain advanced technology capabilities, and you reap the benefits.

Streamlined Cash Flow. Outsourcing helps companies with budgeting by offering a standard monthly or annual fee. These preset fees help companies avoid spikes in costs and project delays and better predict their monthly cash flow. For example if you use more bandwidth at the end of the month, using an outsourcer may allow you to obtain the bandwidth when you need it without having to pay the greater capacity for the entire billing period (including the times the greater bandwidth is not necessary).

The Cons

Unrealistic Cost Savings Expectations. While cost savings are certainly an advantage of outsourcing, large-scale cost savings are often not the result of the decision to outsource. The evidence suggests that those companies that pursue outsourcing based solely on the assumption that it will generate significant cost decreases are more likely to be disappointed by their results and face a greater risk of failure.

Confidentiality. Outsourcing any function of your business requires sharing critical internal company and customer information. This is information that if improperly disclosed could create a competitive disadvantage for you. Worse case, the disclosure of the information you share could result in the violation of one or more laws governing the confidentiality of personally identifying information or other customer or employee information. Regardless of who is handling the business function, you remain responsible for adhering to the confidentiality laws, and, for obvious reasons you do not want your business secrets shared.

Loss of Knowledge Sharing. By outsourcing one or more functions of your business, you run the risk of losing the internal knowledge, training, and skills development and management associated with that function. This could result in a lack of an internal knowledge base to address the basic operational issues or procedures.

Cultural Differences. Your outsourcing vendors may have a different internal culture and goals, or they may have actual cultural or geographic differences. These differences may create a tension between you and your outsourcing vendor that could potentially derail your primary objective.

Increased Oversight. Outsourcing does not mean that you no longer need to be concerned about the business function. You will still need to devote resources to maintain and manage the vendor relationship and to ensure that the business function is met in accordance with corporate policies and legal requirements.

Financial and Operational Risk. As a result of your outsourcing decision you will be placing critical internal company processes into the hands of a third-party provider. This means you will now become dependent upon the financial and operational performance of a company over which you have no control or input. Any risks taken by the outsourcer that impact its ability to function or perform will also impact the ability of your company to function or perform.

Decision-Making Process

Phase 1—Internal Analysis and Evaluation. One of the first things to do when considering whether to outsource is to examine the need for outsourcing and develop a strategy for the implementation of outsourcing. Clarify your organizational goals for outsourcing including identifying what area(s) within the company will be most effectively served by outsourcing. This will require you to evaluate the current return on investment as compared to the anticipated return the outsourcing vendor offers. The evaluation and analysis will also require you to develop a long-term strategy to manage the effect outsourcing will have on your business and current and future employees.

Phase 2—Needs Assessment and Vendor Selection. Phase Two is perhaps the most labor-intensive phase and may well require the most effort on your part. This is the research phase, when you need to gather detailed information about your organization and potential vendors and to identify your company's needs and learn what functions companies similar to yours have successfully outsourced. Write your business case for outsourcing and a proposal addressing what you expect to receive from an outsourcer. Evaluate and interview potential vendors to be sure that they have a clear understanding of your needs, are financially and operationally stable, have managed similar business processes for other companies, can integrate easily with your corporate culture, and have sufficient data security capabilities and a proven track record. The last part of this phase is the negotiation of your contract.

Phase 3—Implementing and Management. This is the long-term phase of your outsourcing relationship. You need to monitor and evaluate the performance of your outsourcing vendor on an ongoing basis. Establish procedures so that you can identify and communicate issues early and resolve them quickly and fairly. You also need to help your existing and future employees adapt to the organizational changes.

Contract Considerations
Most of the potential problems surrounding outsourcing can be addressed by negotiating a contract that covers all the possible issues. Contract negotiations are often complex and company specific and should involve your legal counsel. However, your goals and those of the outsourcing vendor should be the same:

  • Negotiate a reasonable price,
  • Define service levels and consequences if the levels are not met,
  • Identify what happens to your current employees,
  • Establish ongoing monitoring, and
  • Establish an exit strategy.

Negotiate a Reasonable Price. The research and assessment of your company should help you establish an internal cost baseline for the business functions you are outsourcing. You should consider all potential internal cost-saving opportunities, including utility pricing to pay for services only when you need them. You want to thoughtfully examine your outsourcing vendor's proposed costs to identify potential cost savings, such as ways to minimize vendor transition costs, obtaining cost reductions as the price of technology becomes cheaper, and the option for periodic review of the contract to renegotiate price. Of course unless both you and the vendor remain satisfied with the financial deal, the arrangement will fail. More importantly, the ability of the vendor to achieve some sort of reasonable profit will impact the ability of the vendor to provide consistent service quality and service delivery.

Service Levels. Your contract needs to clearly and concisely define minimum service levels and identify any ancillary services to be provided. You want to try and identify any contingent scenarios and establish a response to those scenarios. In defining the service levels, you want to address precise expectations and priorities and include quantifiable guidelines. You also want to establish noncompliance penalties that are large enough to motivate the outsourcing vendor to meet the service levels.

Current Employees. The decision to outsource can wreak havoc among your employees. There are two areas of concern regarding your employees. First, your current employees are the ones with the most knowledge of your business process and the function being outsourced. They know the ebb and flow of your business process, and so you want to maintain as much continuity as possible to make the outsourcing transition as painless as possible. You want to be sure that your outsourcing vendor takes some of your employees into its employ to add to a seamless transition. You want these employees to remain assigned by the outsourcing vendor to your account for as long as possible, you want to be sure the vendor provides these employees with career development opportunities, and you want to have a first right of refusal to take these employees back into your employ as part of your exit strategy.

The other personnel concern is the effect the outsourcing decision has on your remaining employees. In addition to the employees whose job performance is being outsourced, you may need to address the concerns of the employees remaining, including the very real fear that their jobs may be next to be outsourced. One way to handle this is to make every effort to protect the employees whose jobs are being outsourced by ensuring comparable placement for as many of them as possible with your outsourcing vendor.

OnGoing Monitoring. Research shows that the first six months of an outsourcing vendor relationship will include significant problems as the parties adjust. Thus, in your contract negotiations, you want to make it easy to monitor the outsourcing relationship. You want to benchmark your vendor's performance against industry standards. Make sure to audit the fees you are being charged. Identify problems early and communicate them in order to come to a resolution. You want to continually assess the financial stability of your outsourcing vendor and, especially in the case of a smaller vendor, you want your contract to include a requirement that the vendor provide you with periodic financial statements. In order to effectively monitor the relationship, be sure to assign adequate resources to manage the arrangement and to communicate between the parties. The most important thing is to be flexible. Be prepared to reexamine the service levels and stated expectations, including renegotiating portions of the contract if necessary.

Exit Strategy. When delegating the responsibility of vital business functions to an outsourcer, you need to be realistic and recognize that the outsourcing vendor relationship may not work. You may not recognize the costs savings you anticipated, the vendor may fail to meet the stated service levels, or there may be other reasons you decide to pull the business function back in-house. Thus, you need to be sure that you have an exit strategy to ensure a smooth exit from the vendor relationship. You want to be sure that the contract provides you with many opportunities to terminate the relationship while ensuring that there are fewer opportunities for the vendor to terminate the agreement. The most important provision is the ability to terminate the agreement if the vendor fails to meet the service levels or if the vendor engages in repeated breaches of certain provisions of the agreement. The contract should include a provision that will require the vendor to help you transition to a new outsourcing vendor or transition the business function back in-house upon termination of the agreement. Include language in the agreement that will result in a return of the assets you transferred to the vendor when the relationship began, including any key employees with specific knowledge of your business and the business function handled by the outsourcing vendor.

Conclusion

The decision to outsource is dependent upon a number of factors. Many companies have rushed into outsourcing lured by the promise of big savings, only to realize that the savings never materialized or the other problems attendant to outsourcing far outweighed the cost savings. Outsourcing may or may not be the correct decision for your business. However, the key is to make an informed decision based on a complete and thorough analysis of your business needs, goals, and objectives.

Julie D. McClellan, Esq., is currently an IT legal technology consultant. Previously, she was a technology attorney for a national underwriter. This article is an excerpt of her presentation at the 2005 ALTA® Tech Forum. She can be reached at Julie_mcclellan@msn.com.


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