By outsourcing, you can be kept up to date with the latest methods via the vendor as opposed to having to update an in-house staff (training costs). If you outsource several functions to a single vendor you gain economy of scale. Also, the size of in-house support functions such as HR and training can be reduced since there is less in-house staff. In other terms, the company gets to focus on the core work (unless the wrong vendor is selected). By changing to a vendor, you generally can reduce the labour cost overall, especially if you have legacy employees who have a high rate due to raises over the years.
There are some disadvantages; however, if the company is not prepared to maximise the capabilities of a vendor. For instance, the organisation should consider what performance levels (service level agreements), what measurements are suitable, etc. The organisation needs someone who can tell a bad job from a good one – sort of like a local in-house subject matter expert – to oversee the work (belongs to purchasing or is a “technical representative” of purchasing). If there are too many vendors on site then it gets confusing who has what responsibility, you lose the advantage of economy of scale, and you can get vendors in-fighting for scope.
Sub-vendors may compete between themselves to the point of unprofessional behaviour to gain favour in the eyes of the prime-vendor or end-client. The cost of the conflict impacts the level of trust between the end-client and the prime-vendor not to mention the potential of missed expectations.
Vendors who self-perform the majority of the work may offer the client the best of all options in reducing costs and minimizing risk. Most of the advantages of the self-perform model emanate from concepts described in “agency theory” – how one group, the agent, performs duties for the principle, or client. The concepts generally focused on the following:
Clients generally possess imperfect information on the vendor allowing the vendor to potentially overstate capabilities and over-promise performance.
- Each party (client and vendors) focuses on self-interests which may compete.
- The impact of the cost to change relates to the commitment of the client to resolve goal differences with the vendors.
- Vendors require a high level of monitoring until the vendors establish a trusting relationship with the client.
Additionally, the level of risk driven by self-interest multiplies for each additional vendor or sub-vendor. Performance may also suffer for the end-client if sub-vendors have competing self-interests. For example, one sub-vendor may possess the capability to perform tasks delegated to another sub-vendor. In this instance, sub-vendors may compete between themselves to the point of unprofessional behaviour to gain favour in the eyes of the prime-vendor or end-client. The cost of the conflict impacts the level of trust between the end-client and the prime-vendor not to mention the potential of missed expectations.
The self-performance model decreases the cost of the overall contract by lessening the amount of pass-through costs. For example, in a highly sub-contracted model each vendor adds overhead costs and profit to billed work. The prime-vendor typically adds overhead costs and profit to the sub-contracted work as well. In effect, sub-contracting the work adds a multiplier effect to the overall cost of the operation. Conversely, a self-performed operation minimizes the amount of billed overhead and profit.
Overall, it can work well if it’s set up appropriately and runs like a team.
(an original article first published in Clean India Journal, March 21, 2012)