Introduction
This article was first published in Quantum magazine.
The views of investment managers and management consultants about outsourcing, a market that is now worth $100 billion a year, swing wildly between admiration and scepticism, seemingly blowing hot and cold with economic fashion.
It can be a convenient way of reducing costs, sometimes by as much as 30%, but critics warn that it can also mean that a business loses touch with vital tasks and skills, possibly even to the point of being squeezed out of activities they had previously dominated. This means that investors and fund managers are now paying more attention than ever to the outsourcing strategies of quoted companies.
“We look for companies where you can see some kind of stability and profit stream,” says Philip Matthews, who manages the Growth and Income Fund of Jupiter Asset Management in the United Kingdom. “And we always try to price in associated risk—mainly by looking at the historic volatility of income streams for these kind of businesses, as this is one measure of risk. Outsourcing is one of the factors that can affect that volatility.”
Why Outsource?
Companies that do not outsource can find their overheads loaded with activities which are beyond their competence. Retail chains long ago realized that they cannot avoid taking a view on the property they use: should they own the freeholds, or effectively outsource their property skills by leasing or renting?
Matthews says: “Outsourcing has benefits in that it allows companies to both reduce costs and to use the services of specialist companies, but we are also mindful of companies that are becoming much more capital-intensive to generate the same level of profit.
“You tend to see businesses retain what they deem to be their key point of differentiation, while outsourcing what they can to cut costs or if there is a specialist service needed—but companies are always testing the boundaries. When and where there are major changes happening to the company, you need to be comfortable that they are not purely for the short term, to the detriment of the long-term future of the company.”
He cites the April 2010 BP oil spill in the Gulf of Mexico to illustrate the risks of outsourcing. “Businesses cannot absolve themselves of ultimate responsibility,” he says. “In other words, the parent company can lose control of the processes while potentially bearing the risk, which almost always rests with them.”
What Counts As Outsourcing?
But the BP case highlights a problem in assessing the use of outsourcing to a business: how should outsourcing be defined? Like many outside the oil industry, Philip Matthews believes that the rig suppliers and other companies working with BP in the Gulf of Mexico at the time of the Deepwater Horizon spill were providing outsourcing services.
BP, however, disagrees. “Drilling is not outsourcing. The entire (oil) industry uses (and has for many decades) specialist drilling contractors and specialist cement contractors (and other specialists) like these. As far as I know, no major oil company does its own drilling, or seismic surveying for instance,” says BP spokesman Robert Wine.
He defines outsourcing as “IT services, accounting, facilities management, HR, back office, etc. We have partially or wholly outsourced many of these for many years and it’s now just part and parcel of the business.”
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