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Volume 9, Issue 15;   April 15, 2009: Mitigating Outsourcing Risks: I

Mitigating Outsourcing Risks: I

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Outsourcing internal processes modifies the usual risk configuration of those processes, but it also creates a special class of risks that are peculiar to the outsourcing relationship. What are some of those risks and what can we do about them?

When we outsource internal processes, we create risk. It's no surprise that the risk created varies with the kind of services outsourced. For instance, outsourcing cubicle maintenance creates risks that differ from those created by outsourcing IT, software testing, or product development. When the risks of outsourcing create threats to the enterprise, we mitigate them — if we fully appreciate the risks.

Gut bacteria

Gut bacteria. The human gut, like the guts of most animals, is populated by hundreds of species of microorganisms. They perform dozens of useful functions for their hosts, many of which are no doubt essential. Without the microbiota, the host species would probably require additional organs to perform these functions. That might be one reason why biologists consider the gut microbiota to be a "virtual organ." In some sense, the host has "outsourced" these functions to the microbiota of the gut. Read more about the gut. Image by Janice Carr, Centers for Disease Control and Prevention, courtesy National Institutes of Health.

Since some risks associated with outsourcing are inherent to outsourcing, many decision makers haven't encountered them before. Some of these risks are intuitively clear, or have been widely discussed. For example, outsourcing a customer relationship software maintenance task entails some risk of exposure of proprietary information.

But there are other outsourcing risks that are a little less obvious. In the descriptions below, "customer" refers to the organization that decided to outsource some activity, and "vendor" refers to the organization that carries out the outsourced activity.

Part II explores risks associated with the evolution of the processes that are outsourced. In this Part I, I describe risks related to the migration of knowledge to the customers' competitors.

Knowledge of the outsourcing process
Knowledge of and experience with the process of outsourcing itself is a customer asset. An example of valuable knowledge: contractual artifacts for managing outsourcing risk. As the customer engages with a vendor, it inevitably transfers that knowledge to the vendor, and from there, the knowledge can migrate to competitors of either party.
Customers can mitigate this risk by taking care not to reveal intentions during the initial negotiation. Vendors who understand this customer concern can gain trust and loyalty by promising to treat — and then actually treating — contractual terms as if they were the intellectual property of the customer. Often, in effect, they are.
Improving competitors' processes
Outsourcing elements Outsourcing elements of internal
processes inevitably transfers
internal knowledge to the vendor
of internal processes inevitably transfers internal knowledge to the vendor. When the customer outsources, the vendor necessarily acquires knowledge that previously had been internal to the customer. For instance, the customer might have developed an automated tool for transferring data from one commercial customer relationship management system to another — a tool that isnøt available commercially. That knowledge might then propagate to arrangements between the vendor and other customers. Nor is such propagation limited to that one vendor, because its employees carry that knowledge with them when they move to other vendors.
Vendors who accept business only from selected customers who do not compete with each other provide some mitigation of this risk. Customers can mitigate this risk by favoring vendors who don't serve competitors.

The significance of any risk related to outsourcing depends upon the importance of the outsourced process in differentiating the customers' offerings from the offerings of competitors. The more significant a differentiator the outsourced process is, the greater the risk incurred by outsourcing it.  Next in this series Go to top Top  Next issue: Mitigating Outsourcing Risks: II  Next Issue

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