Measuring the ROI of outsourcing

How can firms know whether outsourcing is really delivering value for money? 

Any outsourcing programme is put in place with specific objectives in mind. However, once the programme is up and running, companies do not always determine whether the expected benefits have actually been delivered.

“A lot of time and energy is spent on building a business case and working out the savings, but I don’t think people always go back and ask whether they have achieved their goals,” says Matt Bennett, a partner at law firm Olswang.

When companies do ask the question, all too often they find that their outsourcing arrangement has not delivered the expected benefits. In a recent outsourcing survey by Deloitte, for example, over half of respondents reported lower than expected cost-savings. And research by MooD International found that on average respondents believe outsourcers deliver 85 per cent of the financial return promised.

Understanding the return on investment (ROI) is becoming even more central as companies’ outsourcing strategies evolve. Paul Cash, managing director of Fruition Partners UK, says where IT outsourcing is concerned, there is a growing trend for businesses to use a number of niche outsourced services rather than one large outsourced contractor for all their IT services.

ROI Guide

“As such, a failure of one outsourced function can result in a serious knock-on effect for the rest of the IT ecosystem,” he says. “Businesses, therefore, must approach outsourcing as an end-to-end process that requires considerable attention.”

One fundamental obstacle is that the benefits of outsourcing can be difficult to quantify. Cost savings themselves are unlikely to pose a challenge as comparing the actual and expected financial savings delivered should be straightforward. But other benefits, such as risk mitigation and the freeing up of in-house staff to focus on value-adding activities, can be less easy to measure.

Digital marketing agency Kurve, for example, uses an international network of freelance workers. The value of these outsourced staff is calculated by looking at not only the hourly rate paid to staff, but also the company’s time investment in identifying, training and managing workers. “The ROI for us is defined as how many extra man hours we are able to create for our senior-level staff by using outsourcing to do the low-skill level work instead,” says managing director Oren Greenberg.

In practice, the way in which ROI is calculated will depend on decisions taken at the beginning of the outsourcing relationship. First and foremost, companies need to understand the status of their existing processes before they begin tendering for an outsourcing project.

“How can you ask a supplier for a precision bid without a detailed articulation of the current service delivery model?” asks Jim Reed, director of procurement at the University of Nottingham. Without a clear understanding of the current service delivery model, he adds, companies will not have the information they need to predict and agree an ROI, let alone know whether it has been achieved further down the line.

COST-BENEFIT ANALYSIS

Before activities are outsourced, a cost-benefit analysis should also be carried out on the proposed arrangement to understand the expected ROI. On the cost side, companies should be aware of certain factors which are often overlooked. Tom Mulvaney, managing director at managed services firm Networks First, says companies need to confirm whether any quote they receive from an outsourcer is an all-inclusive price or whether other costs may be added on later.

“Another specific area often overlooked is the inclusion of retail price index increases and how they are calculated,” he adds. Companies should also determine how the pricing on longer-term outsourcing arrangements will change depending on how the company’s business expands or indeed contracts.

Qualitative factors may be harder to measure than quantitative metrics, but these may be the factors that ultimately determine the success of the outsourcing arrangement

Companies will then need to calculate the value of the benefits and subtract these from the costs to calculate the overall value of the arrangement. Mr Mulvaney says that areas to focus on include the ability to control capital costs by converting fixed costs to variable costs, any reduction in overheads and the freeing up of internal resources to focus on core competencies. In addition, he says, outsourcing can create a more level playing field by enabling firms to access the same high-level expertise that big companies can retain on their staff.

The next step is to agree how the benefits will be measured. Qualitative factors may be harder to measure than quantitative metrics, but these may be the factors that ultimately determine the success of the outsourcing arrangement. Mr Reed points out that ROI is not just a financial number. “It should take into account value delivered, management hassle removed, innovation delivered and a view on any competitive advantage, or IP gained or relinquished,” he says.

QUALITY OF SERVICE

These qualitative factors can make or break a relationship. Some 48 per cent of respondents to the Deloitte survey said that while vendors may have met contractual obligations where costs and service levels are concerned, the overall quality of service still suffered.

Oliver Colling, chief financial officer services lead at consulting firm North Highland, cites the example of a social housing provider that had outsourced its maintenance provision to a third-party provider. “On paper, the financial performance was spectacular and showed a huge saving on in-house provision, but the service received by tenants was substandard,” he says. The relationship was terminated as a result, even though the provider had met their financial performance requirements.

With the expected benefits pinned down, companies need to check whether their outsourcing arrangement actually delivers the deal by carrying out a regular ROI audit; an annual review should suffice. Working with accurate and complete data is essential.

“Very often, partial data is used to audit the financial benefits. The total cost of ownership pre and post-deal need to be considered to get an accurate view of savings delivered against the plan,” says Antonio Russo from Deloitte shared services and business process outsourcing advisory. “Of course, the quality of the data and level of granularity are key to provide the best outcome.”

Finally, while ROI auditing provides clear benefits to companies which use outsourced services, companies should bear in mind that this type of exercise can also benefit the providers themselves. “It’s in the supplier’s interest to encourage an annual review of the benefits of the relationship,” concludes Olswang’s Mr Bennett. “The cost-savings are realised when the contract is signed, but three years later people may have forgotten what the original and ongoing benefits are.”