Outsourcing: Savings Are Just The Start

If the fit is right, contractors can goose profits-and creative freedom. But that's a big `if'

Janet Wittes wasn't trying to jump on the latest management bandwagon. When she founded Washington-based Statistics Collaborative Inc. in 1993 to analyze the clinical trials of drug companies, her son handled her company's financial matters. But as demand for her company's services grew--and her son went off to become a journalist--Wittes knew she needed outside help. "I realized how little I knew--like not even knowing how to bill clients or set salaries," said Wittes.

To get the support she needed, Wittes turned her books over to a local firm called BusinessMatters Inc. The firm took care of her basic accounting needs, but it also told her something that shocked her. She was consistently underestimating--sometimes by as much as 75%--the cost of each job, both in terms of the hours worked and overhead. Three years later, BusinessMatters is not only keeping Wittes' books, it is also offering help with taxes and personnel. Wittes says her profits have doubled since she started the relationship.

Call it outsourcing, Round 2. By now, everyone knows what outsourcing is. And some have even saved money by contracting out services they used to perform in-house. But the really smart business owners have figured out how to use outsourcing as a strategic tool. Instead of simply looking for savings, they seek an alliance with someone who will deliver the ancillary services they need--at a higher quality than they probably could have provided themselves--while giving them the freedom to focus on their core business.

Indeed, when the Outsourcing Institute, a professional group in New York City, recently asked executives at some 30 large and small businesses to list the reasons why they outsourced, "reducing costs" ranked third, while "improving company focus" and "accessing world-class capabilities" ranked first and second.

Of course, it doesn't always work out that way. Good partners can be hard to find. And companies that outsource too much can lose touch with their customers--and lose their ability to respond quickly and creatively to the marketplace.

Still, outsourcing can be a boon. At Ballymeade Country Club in North Falmouth, Mass., General Manager Jody Shaw outsourced many of his club's business functions to Paychex Inc. in Rochester, N.Y. The company not only handles the payroll for Shaw's employees--who number about 50 in the summer--it also administers the company's 401(k) plan and provides manuals, documentation, and occasional legal advice. "If we didn't have Paychex or a similar company, we'd have to pay $12,000 to $15,000 a year to hire a person to work part-time," says Shaw. "As it is now, we pay less than $5,000 a year."

SATISFIED. How typical is Shaw's cost-savings experience? The most recent evidence seems to be a 1993 survey by Coopers & Lybrand. It queried some 400 fast-growing companies with revenues of $1 million to $50 million and found that the half that used outsourcing reported cost savings averaging 7.8% over the cost of providing the same services in-house. (A third said they broke even, and 4% reported losing money.) However, companies that outsourced also reported revenues 22% greater than those that didn't, not to mention fatter margins and healthier cash flows.

All the more reason why interest has grown in "post-contract management." Here, issues range from holding someone on the staff accountable for overseeing contracts with outside suppliers to integrating into the outsourcing company employees who may have lost their jobs after work is farmed out.

Companies are also focusing a lot of attention on benchmarking, says Michael F. Corbett, the Outsourcing Institute's director of research. "Even if an outsourcing deal is providing an obvious benefit, companies want to be able to compare it to world-class standards for the service, as well as to what other companies pay for the same service." Corbett says companies are also trying to find ways to ensure that an outsourcer keeps providing improvements after the contract has been signed.

In response to that kind of competitive pressure, some outsourcers have begun sharing their savings with customers. Take Symmetrix, an information systems provider in Lexington, Mass. It guarantees that clients will save more money with its computer system than the fee it charges; if they don't, it will waive the fee.

Clients, in turn, are demanding that outsourcers live up to clear performance criteria that translate into improved service. An outsourcer might agree to halve the number of clerical workers required, for instance, or to reduce the days it takes to fill orders from three to one.

WISH LIST. No matter how familiar a company becomes with outsourcing, one of the thorniest problems is finding the right partner. Because their needs can be so specific, small companies have to spend more time articulating what they want, says Donald F. Blumberg, who runs an outsourcing consulting firm in Fort Washington, Pa. "And small businesses typically don't know what they want because they don't know what's available," he says.

Davis Weinstock is one small-business owner who knows how hard finding a partner can be. When Weinstock, a New York communications consultant, tried to find an outsourcer seven years ago to handle his company's basic accounting functions, the experience was distinctly unpleasant. "Like Goldilocks, we went to small, medium, and big firms, but we felt so ill-served and neglected with all of them," says Weinstock of his 20-person company. "We even encountered outright mistakes. I remember thinking that the firms basically sent their best people out on their potentially most lucrative accounts, leaving small firms with the dullards."

Despite having been thrice-burned, Weinstock decided to take one more stab at outsourcing three years ago, when he was referred to Ayco Co., an Albany (N.Y.) financial-consulting firm. Weinstock was so impressed with Ayco that he now has the company handling essentially all of his firm's financial tasks, such as invoices, paying 90% of the bills, and managing the firm's pension plans. The result: Weinstock and his colleagues get to focus on their clients instead of their bank balance.

In the past few years, the range of tasks that companies can turn to outsourcers for has swelled. The most common are the standbys: payroll processing, accounting, legal, recruiting, and computer services. However, some companies are experimenting with areas such as inventory and pension management, sales--even customer service.

If anything, the danger is in taking outsourcing too far. Some consultants think customer service, for one, is too integral to a company's business to be handled by outsiders. Others worry that if too many aspects of production, marketing, or distribution are handled outside the company, its ability to respond to changes in the marketplace could be undermined. "Contrary to what many people think, outsourcing alliances-- especially when they involve core products or services within rapidly growing, intensely competitive industries--may actually impede the speed of bringing products to market," says Philip H. Birnbaum-More, a management professor at the University of Southern California.

Then there are the legal risks. Businesses with more than 15 employees have to make sure they provide employees who lose their jobs as a result of outsourcing with adequate notice and severance--a minimum of two months' pay. Grover N. Wray, director of human resources for Arthur Andersen & Co.'s contract-services business, notes that lawsuits involving outsourcing are still rare. But he advises employers to seek legal counsel as soon as a bid for outsourcing help is put out.

EXIT HELP. Consulting with a lawyer early in the process can also help later on if a relationship sours. Few companies think ahead about how to exit an outsourcing arrangement as painlessly as possible. "With these deals, it is often difficult to disengage because the vendor has so much power, and it might take 6 to 12 months either to bring the project in-house or to bring in another vendor," says attorney Richard Raysman, whose Manhattan firm specializes in outsourcing issues. Raysman recommends specifying in the contract that the vendor be obliged to cooperate for up to a year while a contract is being terminated.

As more and more companies are finding out, outsourcing is really just an opportunity. To get the most out of it, you have to find the right partner and be attentive. Not unlike most relationships.

Before it's here, it's on the Bloomberg Terminal.