The evolution of outsourcing

Evolution of outsourcing

Since outsourcing emerged during the mid-20th century, there have been a number of shifts in the ways in which it has been approached and how it has benefitted organisations. With significant shifts in customer demands, technological advancements and evolutions in business needs, outsourcing has provided a means for organisations to drive efficiencies and cut costs. In this article, we’ll delve into how outsourcing has developed over time.

First generation deals tend to be more characteristic of the early stages of the outsourcing industry, namely more transactional. First generation deals are focused on obtaining lower costs or better service from the in-house operation or engaging a third-party service provider to outsource discrete business functions or processes. Given the higher risks with an initial outsource, the contract is often focused on control, limiting the supplier’s ability to innovate, and the KPIs (key performance indicators) are often focused on mirroring what was done internally. These deals often lack a significant focus on strategic alignment and advanced technology integration seen in later generations of outsourcing.

First generation outsourcing deals are therefore mainly characterised by:

  • Limited scope: First generation outsourcing deals usually focus on non-core, back-office functions, such as data entry, payroll processing, customer support, or IT support services, with core business functions more often being retained in-house.
  • Cost-driven: The primary motivation for these deals is often cost reduction. Organisations seek to leverage the cost advantages of outsourcing, particularly by offshoring to countries with lower labour costs.
  • Long-term contracts: First-generation outsourcing deals often involve long-term contracts, with organisations looking to secure cost savings over the duration of the contract.
  • Transactional nature: These deals tend to be more transactional in nature. The emphasis is on the efficient delivery of specific processes, and there may be limited focus on strategic alignment or technology integration.
  • Concerns about quality and security: Quality of service and data security are often key concerns when it comes to outsourcing, particularly in offshore partnerships.

Second generation outsourcing deals represent an evolution from the early, first generation outsourcing arrangements, and are characterised by a shift towards more strategic and collaborative partnerships between organisations and their service providers. By the time the initial contract from the first stage of outsourcing is expiring, the customer is likely to be a more mature buyer. Having learnt the lessons from their initial decision to outsource, they are ready to have a richer discussion on the potential for a more transformational approach. The fear and uncertainty when initially outsourcing will have passed and setting out the strategy for the second generation deal is likely to include:

  • Gainshare in the commercial model: This is where the outsource provider shares in some of the benefits from the outcomes of their efforts. For example, improving first contact resolution reduces demand, so in an outdated contract, this would penalise the partner who is paid to provide capacity. In a model that includes gainshare, the supplier is incentivised to drive the right outcomes for the client and their customers.
  • Greater control sitting with the supplier: This development, often seen in second or third generation deals, is about empowering the supplier to take greater ownership of the outcome and often includes an increased scope, where previously retained parts of the operation are now outsourced.
  • Strategic partnerships: Rather than purely transactional relationships, there is a greater focus on aligning outsourcing initiatives with the organisation's long-term business goals.
  • Outcome-based agreements: These deals may include performance-based or outcome-based agreements, where service providers are incentivised to meet specific KPIs or achieve desired business outcomes.
  • Technology integration: Organisations and service providers increasingly collaborate on technology integration and innovation. This includes the adoption of emerging technologies, like artificial intelligence, automation, cloud-based infrastructure, and analytics to enhance operational efficiency and competitiveness.
  • Flexible contract terms: While first-generation outsourcing contracts were often long-term, second-generation deals may have more flexibility in terms of contract duration. This allows organisations to adapt to changing business needs and market conditions.
  • Risk sharing: This is often perceived as greater in this evolution and can involve shared investment in technology infrastructure or sharing risks associated with achieving business outcomes.
  • Focus on quality and compliance: Quality of service and compliance with industry regulations and standards are given more attention in second generation outsourcing. Service providers are expected to meet high standards of quality and ensure data security and compliance.
  • Global delivery model: Many second generation outsourcing deals continue to leverage the advantages of a global delivery model, combining onshore, nearshore, and offshore resources to provide a balanced approach to service delivery.

Third generation outsourcing deals are characterised by a greater focus on digital transformation and business value creation. This generation is known for a rise in the integration of advanced technologies and a more profound transformation of business processes. This involves comprehensive, end-to-end solutions and partnerships that go beyond cost reduction to drive innovation, competitive advantage, and customer-centricity. Some of the key characteristics of this evolution are:

  • Digital transformation: Third-generation outsourcing is closely tied to digital transformation initiatives. Organisations seek to leverage emerging technologies, such as artificial intelligence (AI), machine learning, robotic process automation (RPA), blockchain, and the Internet of Things (IoT), to drive efficiency, innovation, and competitiveness.
  • Integrated solutions: Unlike earlier generations of outsourcing that often focused on individual processes or functions, third generation deals emphasise integrated solutions. Service providers work closely with clients to re-engineer and streamline end-to-end business processes, resulting in comprehensive and transformative solutions.
  • Business value focus: These deals prioritise the delivery of business value beyond cost savings. Organisations are less concerned with simply reducing labour costs and instead, are more interested in achieving strategic goals, such as improving customer experience, accelerating time-to-market, or enhancing product and service offerings.
  • Advanced analytics and insights: Third generation outsourcing leverages advanced analytics and data-driven insights to make informed business decisions. Service providers collect and analyse data to identify trends, optimise operations, and provide clients with actionable insights.
  • Cloud computing and agile infrastructure: Cloud computing and agile infrastructure are central to third generation outsourcing. Service providers help clients migrate to the cloud, enabling greater flexibility, scalability, and cost-efficiency. This is crucial for supporting digital initiatives and remote work.
  • Customer-centric approaches: Customer-centricity is a key focus. Organisations seek to enhance customer experiences by leveraging technologies like AI-driven chatbots, personalisation, and omni-channel support. Service providers help implement and manage these customer-centric solutions.
  • Security and compliance: As organisations rely on outsourcing partners to manage critical business processes and data, security and compliance are of paramount importance. Third-generation deals involve rigorous security measures and compliance with industry regulations.
  • Shorter, flexible contracts: Contracts in third generation outsourcing deals may be shorter and more flexible. Organisations recognise the need for agility in a rapidly changing business environment and aim to adapt quickly to new technologies and market conditions.
  • Innovation partnerships: Organisations and service providers often enter into innovation partnerships, collaborating on research and development, experimentation with emerging technologies, and co-investment in digital initiatives.
  • Environmental and sustainability considerations: Sustainability is an increasing concern, and third generation outsourcing deals may include environmental and sustainability considerations, such as reducing the carbon footprint of operations and supporting corporate social responsibility (CSR) objectives.

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