Minimizing Risks of Outsourcing Failure

As the challenge on CFOs and other business leaders to do more with less continue to increase, we have witnessed an increase in the number of outsourcing arrangements across all industries.

Most organizations, led by their CFOs have outsourced selected projects, functions and delegated the day-to-day management of these activities to third-party organizations.

Many at times, the reasons for outsourcing include but are not limited to – outsource to achieve significant cost savings, focus management on core activities, improve quality, achieve higher activity levels, improve customer service(s) and improve financial control.

Whether CFOs and their organizations achieve these intended outcomes is a debate for another day as some research findings have proved otherwise.

When outsourcing certain business activities, it is imperative that CFOs do not succumb to “herd mentality”. Just because everyone is doing something doesn’t necessarily mean you have to follow suit.

When the decision has been made to outsource, it is critical for CFOs and the other business leaders to thoroughly understand the risks inherent therein and devise intelligent means of managing and monitoring these.

Unfortunately, outsourcing risk is poorly managed in a considerable number of outsourcing arrangements.

What business leaders need to be clearly understand is that, if improperly managed, outsourcing risk can be fatal to their organizations.

Simply outsourcing a selected part of your business does not mean all your problems are over. You can never outsource responsibility, nor can you outsource reputation risk.

By handing over critical parts of your organization to a third party and delegating their day-to-day management to a third-party organization, you are to a certain degree, losing degree of control over operations and quality.

However, you still maintain ultimate responsibility of the partnership performance and results. It is therefore important to remember that when something goes wrong, your customers, employees, vendors and other key stakeholders will come knocking at your door for answers.

They do not care much who the outsourcing company is.

Thus, having an effective enterprise risk management (ERM) framework can help CFOs monitor and manage a wide array of risks in outsourcing arrangements.

Lack of preparation and improper decision making are what causes a large percentage of outsourcing arrangements to fail. CFOs and business leaders need to know and understand the critical units that are absolutely essential to the functionality of the core business processes.

In other words, the decision to outsource should be made on good business grounds, looking at the overall value outsourcing can bring, and not solely on grounds of cutting costs or improving ROI.

Having clearly defined goals and objectives from the outset is key to identifying risks to the project and minimizing failure. If clear objectives are not defined, it makes it difficult to assess all the risks with potential of derailing the outsourcing arrangement.

What CFOs need to understand is that outsourcing risks go beyond the planning stage. They are found at each stage of the outsourcing arrangement.

Once the agreement has been entered into, risks will continue to creep in along the way.

How are you going to respond if service delivery fails to meet your expectations, confidentiality and security are breached, there are management changes at the outsourcing company, the contract is too rigid to accommodate change or the outsourcing company goes out of business?

These are some of the risks CFOs must keep an eye on and ensure there are adequate plans and controls in place to monitor and manage these.

As mentioned earlier on that poor planning and decision making are what causes a large number of outsourcing arrangements to fail, selecting the wrong partner is one of the worst risks.

Selecting the provider to deal with should not be based on whoever provides the cheapest deal but also on other factors such as capability and competence, supplier pricing transparency, data and information security, third-party dependency risk, compatibility with your organization’s culture and vision and the supplier’s governance structure and internal management practices.

By having various perspectives of the supplier CFOs will be able to manage the process effectively.

Another area of risk concern lies within the SLA, the contract which governs the buyer-supplier relationship. Although SLAs are partly standard for any type of outsourced arrangement, they must be properly designed to your specific business.

Bad SLAs can hide unacceptable problems in the business and this has a high potential of backfiring in the long run. Thus, when negotiating the SLA, it is critical to take a risk-based view of the contract development.

In addition to containing details of what needs to be done, division of responsibilities, activities that will impact the arrangement and critical deadlines that must be met, performance review process, reporting of performance, issue escalation process, confidentiality expectations, change control protocols and the exit strategy, the SLA should also act as a fundamental risk control.

Risk profiles should be developed for each outsourced function, service or activity to allow for appropriate oversight. These risk profiles must be aligned to the desired process outcomes and the risk metrics developed accordingly so that they can be monitored logically.

Designing risk profiles helps CFOs and other business leaders evaluate the performance of the outsourcing partner and determine whether the desired outcomes are being achieved or not.

The risks metrics designed to monitor the arrangement should tie into the SLAs that have been established for the service provider. Furthermore, they must be properly focused and the means of producing and reporting them must be real time and near time.

Lack of appropriate outcome-focused metrics and the right measurement criteria is a key failure point in outsourcing arrangements. The problem with many arrangements is that too often unrealistic expectations are placed on the provider by the client.

CFOs and their executive management team should be reasonable and realistic and try to ensure there are no surprises. Good communication ensures that management’s expectations are managed and also acts as a prudent risk control mechanism.

The exit strategy must be laid bare from the outset. Although there are various reasons why the contract should come to an end, failure by the provider to deliver on expectations or poor quality are some of the reasons. When negotiating SLAs, CFOs must think about their exit strategy.

There should be clarity about the circumstances under which the agreement may be terminated, how the service or function can be brought back in-house or passed on to a third-party, who owns what assets and when compensation is due.

Failure to do so can result in the organization becoming dependent on the provider or losing its negotiating power making it difficult to transition elsewhere.

It is important for CFOs to understand that an outsourcing arrangement is a partnership that must be nurtured and managed effectively on a collaboration basis to achieve the desired outcomes.

Getting it right from the start is key to minimizing failure and maximizing performance.