On 14 September 2004, JP Morgan Chase & Co, the second largest bank in the US, announced the termination of a $5bn outsourcing contract with IBM. The announcement reversed what in December 2002 had been billed as the (then) largest outsourcing deal in the world: a seven-year contract to run the bank’s technology operations – data centres, voice networks, helpdesks and everything else. Some 4,000 former JP Morgan employees and contractors would be hired back after a two-year stint working for IBM.
Nor is the JP Morgan case an isolated instance. In June 2004, for example, RMC UK’s cement division, part of one of the world’s largest building materials and concrete suppliers, announced it was bringing its multimillion-pound logistics operation in-house from November. Outsourced to TNT since 2000, the operation employed 380 staff, operated 190 vehicles and moved 3.5 million tonnes of goods each year. “Going in-house will enable us to achieve better control, react more effectively in the market, and also make cost savings,” says RMC’s cement division’s supply chain director, Clive Oakley.
But how do such summary dislocations occur? How does an organisation go about bringing back in-house an activity that it has outsourced? How does it go from having no capacity to undertake a function one day to suddenly having a fleet of trucks or a large data centre to manage the next?
The prospect seems daunting, but the key is in managing it effectively. On a day-to-day basis, suddenly acquiring a new and complex operation to oversee – without any prior exposure to either it or the issues it faces – is a recipe for disaster, warns Alan Rodger, research analyst at the Butler Group.
“To bring an activity back in-house, it’s important to maintain an internal capability to perform it so you can actually bring it back. It’s quite common for companies not to do this, although more and more businesses are waking up to the risks of not doing so,” says Rodger. “The reaction of many companies is ‘outsource and forget’, when it ought to be ‘outsource and manage’.” Instead, says Rodger, companies should stay in touch with an outsourced function. Problems frequently stem from companies failing to do this, he adds, which is, of course, one common reason for outsourcing contracts ending in tears in the first place.
It’s one thing to review a monthly report saying how well a function is being managed, and quite another to possess the experience and insight to be able to tell if the wool is being pulled over your eyes. “If you don’t know enough to run it, then you don’t know enough to outsource it. And if you do decide to outsource it, expect to be shafted,” says Ian Gotts, CEO of Nimbus Partners, a process and performance management consultancy.
Tesco, for example, has long understood this, outsourcing just a portion of its transport and warehouse operations. Paul Bateman, the former head of its distribution operation, once argued: “Contractors have to be managed, and you can only manage something effectively if you’re in the game yourself. The minimum acceptable standard we look for is the standard we achieve ourselves.” And when the standard being delivered falls short of this level, management needs to either apply pressure to rectify the problem or terminate the outsourcing contract. Clearly, continuing to pay a third party to perform a task less effectively than a business can achieve itself makes no sense at all. Poor performance isn’t always the reason for bringing a function back in-house. Outsourcing contracts can be terminated for many reasons, among which is performance falling below expectations or specified service levels, but cost is also a huge factor.
“Plenty of companies that have outsourced in the expectation of cost reductions are instead finding that costs are going up,” warns Ed Ainsworth, a director of London-based procurement consultancy 4C Associates. “The outsourcing companies are charging extra for things that used to be included as part of the job, leading companies to conclude they might as well bring it back in-house because outsourcing is acting as a tax on everything they do.” And sometimes the business case underpinning an outsourcing contract just fades away. Accounting firm Deloitte & Touche LLP, for example, had outsourced the production of its printed documents for a number of years, totalling some £2.2m of printing each year. But innovations in printing technology meant the company could purchase high-volume colour press technology from Xerox and undertake its printing internally.
Some 36 people now work in Deloitte’s print and creative services operation, saving the firm £400,000 in work that would formerly have been outsourced. According to Peter Taylor, Deloitte’s print and creative services manager, the firm has also been tackling print jobs for its overseas offices, including the US, the Netherlands and Canada. Through such increased utilisation, annual savings are expected to rise to £600,000.
Outsourcing deals often end because bringing the function back in-house provides greater control. In 2002, for example, Karolinska Hospital in Stockholm recognised that too much of its IT infrastructure and hardware was in the hands of third parties – the result of a series of separate outsourcing deals negotiated over the years. Individually, each outsourcing deal had made sense: payroll, patient records, research programmes etc.
But the end result was fragmentation and diffusion of control: as the management phrase now in vogue to describe such situations put it, there wasn’t “a single throat to choke”. One by one, the hospital migrated them back, choosing to manage and run them from part of a 40,000 square foot data centre, operated by data centre provider TeleCity a few kilometres away. The physical aspect of the hospital’s IT infrastructure, such as power supply, security and environmental control, is the responsibility of a third party, but everything else is under its own control.
So how straightforward is terminating an outsourcing contract in practice? Martin Cotterill, a senior associate in the London outsourcing practice of law firm Latham & Watkins, says it is important to contemplate ending an outsourcing contract long before it is actually terminated. To transfer a function back in-house smoothly, the co-operation of the soon-to-be-fired outsourcer is important. “They are under no compulsion to do anything to help you, unless it’s written into the contract,” says Cotterill. “Getting the hand-over provision you want into a contract is all about maximising the leverage you’ve got, which is when you are drawing up the contract in a competitive tendering situation.”
And the precise nature of the help required depends on the particular nature of the outsourced function itself, he says. So seeking appropriate advice is important. But whether it is logistics, IT, or something else, the essence of the requirement placed on the outsourcing partner should be to effect a transition that all business will continue to be transacted, handing over all relevant documentation, records, computer systems and assets. And where chargeable costs are incurred, the basis of calculation should be specified. Another consideration, adds John Willmott, managing director of NelsonHall, a firm of analysts specialising in business process outsourcing, is that a sort of perverse logic operates and businesses need to be aware of its ramifications. “When taking operations back in-house, the key issue is how standalone the service is: does it have its own people, premises and equipment?”
If so, the transition will be much easier than if the facilities are shared between different companies to gain economies of scale, which is often the very basis of the lower cost base that outsourcing is meant to deliver. If a contract has been running for some time, he says, there can be nothing – or no one – left that was originally ‘yours’, he says. In such circumstances, bringing a function back in-house can be challenging.
Nevertheless, it can be done, as the experience of Kimberly-Clark shows. In mid 2000, explains European logistics director Peter Surtees, the company had outsourced some $30m a year of trucking contracts – namely its Europe-wide interplant and interdepot truck load movements. The company undertaking the outsourcing had promised savings of $1.75m a year which never materialised. According to Surtees, the company realised it could take advantage of a new pan-European service centre established to operate the contract, and that it could do so more efficiently than it had been able to do when the function was formerly in-house, thanks in part to Quick Quote, an internet-based price quote system from Freight Traders.
But all the people who had formerly managed the task had long since been reassigned to new roles, or had left the company. There was no one left to actually undertake the task of managing the movements internally again, so Surtees set about recruiting a senior manager to oversee the project. The new manager then set about recruiting transport planners: they might be French-speaking, German-speaking, Italian-speaking etc, but they would all be operating out of Brighton, working together as a team.
Within a year, says Surtees, the new team had delivered more savings than had been projected and far more than the former outsourcing partner had managed to achieve. So pleased was Kimberly-Clark with the results, explains Surtees, that in 2003 it assigned the team another $40m tranche of trucking contracts to manage, part-loads and ad-hoc movements that had been excluded from the original outsourcing deal. Bringing the function back in-house could have been a nightmare; instead, it turned out very profitably.