Coping with the Hidden Costs of Outsourcing

Written by Vandana Mohanchandran

Recurring hidden costs pose one of the greatest challenges of risk management when it comes to outsourcing of services. Outsourcing (offshore and nearshore) is known to save, in some instances, up to 80% of costs; however, this is seldom the case. There are six key hidden costs when it comes to outsourcing. The knowledge of these costs will assist in managing potential risks arising from under budgeting. Knowing and planning for the risks will help business leaders achieve cost efficiency when outsourcing. Most costs can be managed by addressing three key factors: selecting the right vendor, choosing the right outsourcing model, and building solid internal processes.

Selecting a Vendor

Costs incurred while selecting a vendor are usually substantial, and cannot be under-budgeted. Business leaders will be required to dedicate time and workforce to the process. Additionally, there will be costs for request for proposals (RFP) and evaluation, as well as toward the actual contract writing. Further investment is required in examining outsourcing models that different vendors offer. Closely evaluate the vendor’s proposition and their capacity to build a quick infrastructure. Select an experienced vendor who knows how to write reliable contracts and wants to form a successful partnership. It is seen that companies may incur an additional 1-10% cost of their whole outsourcing venture on the initial cycle of selecting a vendor. An initial up-front investment is necessary to help cut costs in the long run.

Building a Relationship

Another necessary cost that should not be underestimated is the cost of transition. When beginning an outsourcing relationship, it will require an initial investment in training and establishing business processes. It is projected that corporations spend a supplementary 2-3% on transition costs, but this can be avoided by choosing a service provider with a responsive outsourcing model and experienced staff that requires little software development training and can begin work immediately. The time of transition may vary from vendor to vendor, but the time and cost of the adjustment period must be accounted for.

Cultural and Organizational Differences

Depending on the location to which a business is being outsourced, whether it is to Eastern Europe, India, the Philippines, or the Far East, there are some costs involved to solve cultural and organizational differences when operating in different regions. On average, it is believed that these costs can add an additional 3-27% to the total outsourcing costs. It is important to clearly understand a vendor’s culture while selecting an outsourcing location, especially taking into account the cultural proximity to minimize miscommunication.

Lag in Productivity

It is estimated that approximately 20% of organizations that go offshore experience a lag in productivity. This can be avoided by selecting vendors that have the right qualifications and remote staff. By doing so, the technical aspects of the business tend to suffer less as the goals are aligned. Attrition can cost an extra 1-2%, so it is essential to have a supplier that can guarantee that the hired employees remain till the completion of the project. Picking an accurate outsourcing model, such as Remote In-sourcing will assist in addressing issues of employee turnover.

Improving Processes

Costs associated with improving the internal team by providing additional training can incur an additional 1-10% of the total cost. The supplier may require adding more employees to the project, which may not be cost-effective in the long run. Business leaders must ensure that the supplier offers knowledge transfer and related training for internal staff to be able to manage the processes for the deal.

Managing the Outsourcing Deal

Documents such as contracts, data sheets, and invoices, must be managed accurately during an outsourcing venture. As a result, the cost of managing the outsourcing relationship is a critical cost and can contribute between 6 and 10% to the total outsourcing costs of any venture. You also have to make sure that there is a project manager who can manage the whole outsourcing process and make sure projects are moving forward.

Several of these costs will have to be borne regardless of whether the venture is an outsourced one or not. However, it is essential to keep related costs in mind when following through with an outsourcing contract. It is critical to ensure that clear objectives have been set, the right vendor has been chosen, and managing risks effectively.

To know more about risk management related to managing costs when starting an outsourcing venture, please reach out to a NeoGroup advisor for assistance. NeoGroup has been objectively advising clients about the costs and benefits of outsourcing since 1999. Please click here to submit a risk free inquiry about your advisory needs.

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