Outsourcing deals crumbling due to cost reduction focus

Contracts priced to show an immediate cost reduction, says research

Outsourcing deals are failing before they run their full course

Outsourcing deals are hitting the rocks because of many businesses' short term focus on cost reduction, according to industry experts.

Research by Compass Management Consulting reveals 65 per cent of all outsourcing contracts worth over £20m unravel before running their full term.

Typically the fallout is precipitated by a vendor trying to claw back money further into the contract after losing out during year one and two to meet an initial intense focus on slashing costs.

Compass says contracts are priced to show an immediate savings of up to 18 per cent below the in-house operation it replaces on day one, only to rise to more than 36 per cent above comparable top quartile internal operations by year three.

Analysis by Compass of 240 contracts over 24 months showed that most tier one outsourcing vendors are charging an average of 30 per cent and sometimes as high as 45 per cent - above the comparable internal market rate in the final years of the contract.

Simon Scarrott, head of business development at Compass, said: ‘Often a measure of success is cost reduction in year one, but the vendor is financing that and must recoup money in years two, three and four.'

'Within two or three years independent arbitrators are often brought in to value the contract as it is not delivering what it intended to deliver and because contracts tend to be constructed with no flexibility,' he said.

However the Compass findings are balanced by TPI’s Quarterly Index report that shows the value of outsourcing contracts in Europe rose in the first quarter of 2007 by 67 per cent to 7.7bn euros (£5.2bn) compared with the same period last year.

Scarrott says the figures just focus on brand new deals and that the mid life crisis suffered by many big contracts will continue unless contracts are constructed to respond to changing business requirements.

‘Clients should do their due diligence better pre-contract and contacts should reflect that change is a given and build on it,’ said Scarrott.

Martyn Hart, chairman of the National Outsourcing Association, said: ‘Prices have dropped over the last five years, so it makes sense to negotiate some benchmarking within a contract that takes account of movements in the market, but to say that outsourcing contracts don’t save money is ludicrous. However if you try and grind a supplier down to cost you will pay for it.’