Average Outsourcing Contract Delivers 15 Percent Net Savings, New Study Reveals

Actual cost reductions belie hype due to costs of procurement and contract management, but savings still significant and market interest continues to grow, TPI says

Actual cost reductions belie hype due to costs of procurement and contract management, but savings still significant and market interest continues to grow, TPI says

The Woodlands, TX  April 19, 2006  Outsourcing contracts deliver an average of 15 percent savings, despite widespread market claims that outsourcing can reduce costs by over 60 percent, according to a new research by sourcing advisory firm TPI.

The study by TPI examined outsourcing contracts awarded between 2003 and 2005 and found that, net of professional fees, severance pay and governance costs, savings range between 10 percent at the bottom end and 39 percent at the top, with 15 percent being the average level of savings anticipated when contracts are first let.

"Opinions vary widely about the cost savings to be gained from outsourcing," said Duncan Aitchison, managing director of TPI. "This research proves that the promise of massive operational savings is unrealistic when you take into account the costs of procurement and ongoing contract management."

Cost Reduction Focus

Aitchison said that, in TPI's experience, outsourcing arrangements that focus solely on delivering huge savings often fail to meet client expectations, but he noted that 15 percent is not only a realistic estimate of savings but also a significant one.

TPI's research, published in the firm's quarterly TPI Index, shows that cost reduction remains the primary motivation in current outsourcing contracts. However, an increasing number of companies are outsourcing primarily in order to improve quality, up from 11 percent in 2004 to 21 percent today.

"Although clients continue to view outsourcing as a means of achieving cost savings, they are also increasingly concerned with improving the quality of their services," Aitchison said. "We are seeing an ever-growing number of clients using outsourcing as a way of introducing innovation into their business, and the number of TPI-led deals with a 'transformational element' has never been higher."

Strong Rise on Restructurings

According to TPI, 2006 to date has seen the largest number of outsourcing contracts ever signed in the first quarter of the year. So far this year, 83 contracts have been signed valued at over $22 billion, compared with 76 deals valued at just over $16 billion at this point last year. Excluding restructurings, 64 contracts valued at $14.9 billion have been signed so far this year, compared with 61 contracts valued at $13.3 billion a year ago.

"This strong quarter is due in part to the rise in the number of contracts being restructured," Aitchison said. "However, even when we exclude restructurings, the number of contract signed so far this year is still a first quarter record."

IBM, EDS and T-Systems were the main beneficiaries of the contracts let in the first quarter of 2006, winning total contract values of $4.6 billion, $4.4 billion and $1.6 billion respectively. Meanwhile, the pipeline of deals on which TPI is currently advising is led by EDS, IBM and CSC, which are competing for deals totaling $7.9 billion, $7.4 billion and $4.9 billion respectively.

Incumbents Hold Advantage

Nineteen restructuring contracts totaling $7.4 billion have been signed so far this year. This represents a third of the total value of contracts signed to date  more than double the historical average of 15 percent. TPI has identified a further 141 contracts totaling almost $40.7 billion due for restructuring during the remainder of 2006.

Examination of deals on which TPI has advised reveals that the majority (66 percent) of restructurings occurred as a result of first generation contracts coming to the end of their term rather than due to any unhappiness with the provider. Indeed, TPI research shows that the incumbent provider tends to be retained when contracts are restructured, although the percentage retained has fallen marginally over the last two years, from 86 percent in 2004 to 79 percent so far this year.

"Although historically, most outsourcing restructurings have been renegotiated with the incumbent service provider, it can no longer be taken as read that the existing provider will retain all or even part of the original deal through a restructuring," Aitchison noted. "Client retention will increasingly depend on an incumbent's ability to offer a competitive proposition for every facet of the service and this will often require significant changes in price, contractual terms, scope and delivery approach from the original agreement."

Additional Articles of Interest

 All that glitters may not be gold when it comes to outsourcing manufacturing productions to China. First, weigh the costs and learn the facts with this helpful guide. Read "China or Bust: Recognizing the True Costs of Outsourcing" on SDCExec.com.

 Visibility and product quality are key to maintaining a competitive edge in the market. So how can a company successfully achieve those objectives while also outsourcing its manufacturing? Read "Quality Management in Outsourced Manufacturing," an SDCExec.com In Depth exclusive.

 For five steps to help your company decide whether or not outsourcing is the right move, read the SDCExec.com exclusive "Strategic Sourcing  Not Just Procurement Anymore."