#1 – Penny Wise and Pound Foolish

Inherent flaws in the outsourcing business model are analogous to a poison that spreads throughout the system leading to a serious ailment. In some cases, the ailment can simply cause negative side effects such as metrics that are misreported, under reported or poorly understood by both parties. In these cases, companies or outsource providers live openly with these infections and often battle the effects daily, simply learning how to live with them.

In other cases, the ailment lies hidden deeply within the relationship – and neither the company outsourcing nor the service provider knows it’s there. At first, no physical signs of the ailment may be evident, but left unchecked it may fester into something bigger. In the worst cases, the problem can become so endemic that it eventually causes the death of the relationship, which leads the company to bring the outsourced services back in house or induces it to switch suppliers.

Our research and experience have exposed the 10 most common problems in outsourcing agreements. We regard these as ailments that can plague and potentially destroy an outsourcing relationship.

Let’s start with the first and the easiest ailment to identify. The one that materializes when a company outsources based purely on costs. We’ve all heard the warning against being “Penny Wise and Pound Foolish.” Unfortunately, many procurement professionals are still in the dark ages. Too many companies profess to have an outsource “partnership” while behind the scenes they focus solely on beating up their service providers on price.

When outsourcing, you need to think beyond the short-term bottom line. The danger in focusing on the cheapest offer is like anything else – you make trade offs in quality, service or both. Unfortunately, many executives view outsourcing as a “quick fix” solution to resolving balance sheet problems. Often companies suffering from a case of “Penny Wise and Pound Foolish” tactics fall into a loop of frequent bidding of their work to the lowest price provider and making the transition to reliance on that supplier. This tendency can lead to a vicious cycle of bid and transition, bid and transition, bid and transition. Companies that become caught in this cycle typically end up with unintended disadvantageous consequences such as these.

Outsource providers that work with the company eventually will refuse to work with the company again. They become tired of getting beat up on price, only to have their efforts rewarded by losing the work the next time around. Ultimately, they choose to pursue revenue from more productive outsourcing relationships. In one extreme example we witnessed a company re-bid their transportation services every three months. In this case the company had recklessly churned through nearly all of the top 20 suppliers during a five-year period, and consequently was forced to work with suppliers of lesser quality.

Outsource providers bid such low prices in order to work with a company that they go out of business; the outsourcing company consequently struggles to find a new outsource provider. One company, as an example, was described by its suppliers as an “800-pound gorilla.” This company dabbled with outsourcing in manufacturing and had some successes. As a result, company executives decided to outsource all manufacturing to allow the business to focus on core competencies – s strategy that usually is a smart move. The book of business was worth roughly $100 million in revenue for the winner. In this case, three contract manufacturers had the experience and scale to manage the outsourcing company’s work volume. The “800-pound gorilla” strained its relationships with its vendors, however, by putting them through several rounds of extreme negotiations to save the last possible dime on the multimillion dollar outsourcing deal. Following the grueling negotiations, the company awarded the work to a $1 billion outsource provider, which achieved an estimated 10 percent increase in revenue as a result of the transaction. The problem? The outsource provider “bought” the business, and eventually could not sustain the losses of profit. The overwhelmed vendor gave the “800-pound gorilla” a 30-day notice that it would no longer manufacture the outsourcing company’s products and went into bankruptcy – eventually tanking what was once a successful and profitable $1 billion firm.

Organizations that engage in this spendthrift ailment give outsourcing a bad name – and should not be outsourcing in the first place. Their myopic focus might pay off in the short term, but this approach has proved time and time again that being Penny Wise and Pound Foolish does not pencil out for vendors – or for outsourcing companies.