Last week I was part of a get together of technology managers, analysts and influencers. One of the topics was outsourcing failures. What was interesting was that the consensus opinion was that it was generally failing miserably and that much of this failure was currently being covered up by managers who didn’t want investors to know they had screwed up. However, if you were to look at the companies from the outside, you would see that they were increasingly bringing out late products of lower and lower quality, their valuations were dropping, and their financial performance had been dropping even before the downturn. I can’t divulge the companies we were talking about as it would get too many of these people in trouble, but the belief is that since we were seeing it in all the companies, we were touching it may be a universal problem. Let’s talk about why this isn’t being reported and the cause of the problem.

Concealing Problems

With the financial collapse, there should be no doubt in anyone’s mind that things that should be disclosed about companies’ performance aren’t being disclosed in a timely manner. And if this is a problem in one of the most heavily controlled industries, banking and finance, it is likely a bigger problem in industries that don’t have these controls.

Outsourcing is a high-profile action. It shifts jobs from the local economy overseas and is really not very popular with politicians. If it actually doesn’t work, the effort is likely a career ender for the folks who made the decision. And, because there is a widely held, possibly false, belief that it actually works, individual failures look unique, thus increasing dramatically the personal exposure. In addition, the problems that show up aren’t financial, they are operational. These problems can generally be blamed on a lot of things and without people who are independent doing detailed analysis of the problems, the cause can be blamed almost indefinitely on a lot of things. That protects the decision maker but leaves the company at risk. So there is substantial risk to reporting the problem accurately, to properly associate the problem with outsourcing requires deep analysis, and the people who are most at risk generally have to approve this analysis so it doesn’t get done. That is why we don’t see these failures reported very often.

Why Outsourcing Fails

This isn’t to say that all outsourcing does fail, but from the limited sample we had, the vast majority we could see were failing. The reason why has less to do with the cultural differences and physical distances involved and more to do with the dependencies that firms take for granted and don’t realize are critical to the successful operation of the company.

When a function is internal, multiple official and unofficial communications channels drive work through a particular function. The agility of the firm is generally tied not so much to the official communications channels but the unofficial relationships that exist around an effort. As most of us learned in school, people don’t communicate very well and this existence of a matrix of unofficial communications channels helps assure that the requirements for a task are accurately conveyed. But, generally, when something is outsourced, be it locally or overseas, all of these unofficial relationships are severed. Now all communication has to flow through relatively few authorized channels and, in some cases, that may be the one executive who is running the outsourced unit. The end result is that instead of having people constantly interfacing with others who better understand them, directions are passed down a chain of people who increasingly don’t have the skills to understand them. The result is costly mistakes. The more complex the web of unofficial communications is, the bigger the adverse impact of outsourcing the related unit will be. Given how critical IT is to so much of what is actually done in a company, outsourcing it would seem to be suicidal.

Wrapping Up

Outsourcing has a very obvious benefit of saving costs, but the downsides aren’t as obvious. That typically results in bad decisions where the benefits aren’t properly weighed against the very real risks. In addition, with the benefits coming quickly and the problems developing over time, there is the very real issue that these bad decisions won’t be reversed, crippling the related companies. Before outsourcing, take stock of what the impact will be if the function becomes vastly less responsive and requires more effort. You may find, as we evidently did, that the vast majority of times you’ll decide that the short-term benefits simply don’t come close to overcoming the long-term risks.