The Downside Of Outsourcing

In today's hypercompetitive marketplace, outsourcing some functions, such as data processing, can seem like a simple decision. But new research by Federal Reserve Bank of Chicago economist Yukako Ono and Dartmouth's Tuck School of Business professor Victor Stango shows that outsourcing shouldn't necessarily be considered a permanent solution.

The researchers examined some 8,800 credit unions over a 10-year period ending in 2003. Their goal: to determine the roles of product diversity and size in the choice to outsource data processing. Up to a point, the more products the credit union offered, the more likely it was to outsource. However, once a bank offered more than six products beyond standard checking and savings accounts, outsourcing became less popular.

Only 17% of credit unions with two products (in addition to checking and savings accounts) chose to outsource their data processing, compared with some 41% of those that offered six additional products. But just 24% of credit unions with eight additional products chose to outsource.

As the credit unions became more complex, they wanted more control of their information, says Stango. They tried to bring the data in-house so that they could crunch the numbers themselves, then use that information to generate new business.

As the outsourcing contracts wore on, the credit unions discovered another danger to outsourcing: Multi-year contracts can end up locking a business into old technology. If a growing business requires extra services before a contract expires, vendors can ratchet up prices. In the case of credit unions, the cost was often an additional 20% to 30%, making outsourcing less cost-effective.

By James Mehring

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