Apples and Oranges: Outsourcing vs. Internal Function

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In business practice we are quite used to outsourcing cleaning, security, delivery and catering functions. Decisions on outsourcing are made without long disputes. All the above services are non-core and non-critical for the business. That is why they are first candidates for outsourcing.

European and American economies moved further in outsourcing habits and actively outsource functions, which are non-core, but critical. Such functions include accounting, HR administration, supply chain management, claims administration, etc. Penetration of the outsourcing of non-core, but critical functions in Europe in various industries exceeds 60-70 percent. In Russia this parameter is below 1 percent, but we will move inevitably in the direction of business specialization via outsourcing.

I will not speak here about the reasons why non-core, but critical functions have to be outsourced, as this subject is worth a separate publication. I will just assume that there are fundamental benefits of doing things in a most efficient way, which outsourcing can help to realize. In more detail I would like to outline here the comparison framework of the internal function and outsourcing.

The way the business function is organized internally and with participation of the external provider is very different, and these differences do not allow us to compare the internal function and outsourcing on an apple-to-apple basis. To make such comparison we should identify common grounds and assess indirect effects of the outsourcing decision.

For adequate comparison of both options the following stages have to be accomplished:

First, we have to grade relative importance of the four main criteria: effect of the cost of the function on the bottom line financial result, impact of the quality of the function on the client's business success, materiality of the assets dedicated to the internal function and integral improvement of the manageability of the company in case of successful outsourcing (can be measured as a percentage of time the management will save for the core business after successful transfer to the outsourcing model). Such grading will allow us to determine a relative weighting of each criterion in total evaluation.

Secondly, we assess the extent to which the current function meets business and legal requirements. The comparison should be made in relation to the service provider's proposal, which presumably should be structured to meet 100 percent of legal and business requirements of the client.

Finally, we have to calculate direct and indirect expenses under both scenarios.

The following direct costs have to be considered: salary and bonuses, payroll taxes, personnel insurance, various benefits, cost of replacement for the vacation and sickness time, cost of context retention in case of the employee replacement, training, office rent, depreciation of the equipment and furniture.

In addition to the direct costs we should take into account the share of the indirect expenses: office maintenance costs, telecommunication, legal database, consultations, IT and accounting system support, software license, and the managers' time. Indirect costs can be assessed as a share of the overall administrative and management costs proportionate to the head count.

Combination of the total cost of the function with the coefficient obtained at the second stage will give us the money value of the internal function. So, we compare this value with alternative outsourcing propositions taking into consideration the weighted criteria defined at the first stage.

The approach outlined here allows comparison of the apples and oranges -- very different business solutions- by bringing them to the common frame of reference.