Apr 05, 2022

One common fear that clients have about outsourcing is that the promised savings won’t materialize. Operations managers worry that they will navigate the challenges of implementation only to find themselves tied to a service provider that underperforms and costs more than expected. And no one wants to look foolish by paying more for getting less.

Too often, operations managers do not consider their current hidden costs and end up having overly optimistic cost projections. Operations teams are often underfunded, typically focus on saving any penny that can go to the bottom line, and team members continually work to be incrementally more efficient. From a risk perspective, rather than receiving new systems and tools, team members may make do with complicated spreadsheet solutions, which often include inherently risky manual processes, and knowledge of how these spreadsheets operate may be limited to a few staff members.

In a prior blog post, I wrote about the loss of control as the top fear among operations leaders. In this post, I’ll dive into a fear I hear about almost as much as the loss of control ─ that cost savings will not be achieved.

Understand Your Real Costs

If you have identified a target operating model that includes outsourcing some functions, you’ve likely based your decision on several factors. You might be looking to increase the regions you operate in or invest in new types of assets. But no matter the business rationale, all internal parties will be focused on how outsourcing will impact the bottom line.

The best advice I can provide is to take time to understand your current cost structure so you can get a fair apples-to-apples cost comparison between your current costs and costs from using a provider. Create a true picture of your current costs by acting as a detective and uncovering all of the unrealized and assumed costs in your current operations. By identifying your true current costs, you can then calculate the actual incremental cost of moving to your new target operating model, including using outsourcing providers. Managers too often overlook their actual current costs of providing services, resulting in the price of outsourcing seeming surprisingly high.

Assess Your Real Costs

Analyze your cost of services at both the functional and sub-functional levels. Ensure you fully understand your current cost model so you have a full accounting of your current costs. By understanding your cost model, you’ll better understand the commercial costs for services better positioning your firm to negotiate with a service provider. Developing a realistic understanding of your internal costs allows you to better manage them going forward. Some things to consider include the following:

  • Fixed costs, including staff, infrastructure, vendor licenses, and managed service costs
  • Hidden costs, which may be more difficult to quantify, but include staff overtime, potential compensation claims from trade errors or other operational errors, or the impact of ongoing initiatives that have stalled or were put on hold due to capacity constraints

You should also consider future cost avoidance since in some cases you will not have to worry about upgrades and implementations. And sometimes these costs are greater than your transferable costs or the fixed costs that you will immediately transfer to the provider.

Make the Business Case

Once you have accounted for these costs, create realistic project costs. Develop an accurate cost basis to demonstrate the expected payback timeline, internal project costs, license renewals, and staffing costs. Consider implementation costs for functions not provided by the service provider as well as internal project costs such as the cost to backfill staff during implementation. Also account for the cost to decommission existing systems and license renewal schedules.

Reduce the number of cost unknowns. Perform scenario planning to model different situations as you move to a more variable cost basis. Account for their impact on current and target operating model costs. Stress-test your cost models in different business environments. For example, what are costs like if AUM/FUM change dramatically, if you acquire additional businesses (or become acquired), or in bear/bull markets, etc.?

Identify outsourcing benefits that may be difficult to quantify but provide the following real business value to your firm:

  • Opportunity cost ─ new products, regions, and client opportunities can be constrained by your current business model.
  • Business agility ─ improving how quickly you can bring new products to market or enter new regions adds a value that may be difficult to quantify but has clear value to your colleagues.
  • Reduced operational risk ─ improving operational methods, such as reducing manual processes and internal email instructions, lessening operational risk.

Determining the true cost of outsourcing is a complex endeavor, with many variables to consider, but your firm can achieve significant savings if it’s implemented correctly.

Want Some Help?

Cutter can help you develop or audit your cost of services and, more importantly, assist you in identifying your target operating model. Learn more here.