The supply chain industry is constantly in a state of flux, with nothing ever seeming to stay the same for very long. Globalisation, ever-changing customer needs, and other market forces serve to maintain a state of liquidity, requiring companies to re-evaluate strategies and business models on a regular basis.
Perhaps for that reason, companies that outsource logistics and other activities, sometimes recognize the need to bring competencies back in-house. That’s no bad thing of course, provided the reasoning behind the decision is sound and the consequences thoroughly evaluated.
Why Take Logistics Back In-House?
So what might drive companies to return to insourcing, especially after the painstaking exercise of finding an outsourcing partner, drawing up complex contracts and service level agreements and building a relationship which at the outset, is foreseen as a long-term partnership?…
You’ll find eight of the most common reasons outlined below.
Of course, many of the issues described can manifest at some stage in an outsourcing partnership, and none of them has to result in a return to internal operations, but when a company does decide to stop outsourcing, it’s more often than not due to one or more of these factors.
1. Expected Cost Savings Not Realised
One of the primary reasons to outsource is to achieve cost savings. Some companies enter into an outsourcing partnership in the (sometimes-misguided) belief that a third-party provider can perform its function at less cost than the client company could achieve. If the expected cost reductions fail to materialize, or if the costs of outsourcing increase over time, the client may bring the outsourced activities back in-house.
Very often, the client is as much to blame for this particular issue as the provider, because for outsourcing to be a successful cost-saving strategy, bilateral transparency is essential from the outset.
Unfortunately, some client companies though, fail to enable the required transparency, typically citing confidentiality as a necessity, but this is seldom a fruitful approach. To be a cost-saver, an outsourcing venture really requires the full collaboration of client and provider, sharing information freely as trusted partners.
Then again, even given a high level of transparency and information sharing, cost savings associated with outsourcing are commonly less than anticipated. The reasons for this can include:
- The costs of partner selection and onboarding, which may be far higher than expected;
- The length of time/amount of resources required to hand over operations to the 3PL partner;
- The cost of staff severance/redundancy payouts.
Of all the situations prompting a company to bring outsourced processes back in-house, this is one of the most avoidable. What’s the best way to avoid it?… Don’t outsource with the sole objective of saving money.
2. Service Levels Not Met by Provider
This is another common reason why companies bring outsourced processes in-house. When a well-informed client company decides to outsource, it will draw up a comprehensive service level agreement, sometimes with the involvement of its customers, which will bind the third-party provider to comply with specific, agreed standards.
A service level agreement will often contain a termination clause, providing for the client to exit the outsourcing relationship if the provider consistently or frequently fails to meet the service levels.
Even without an exit clause, companies will sometimes shoulder the expense incurred by bringing services back in-house, if the provider cannot maintain standards above cited service-level KPIs.
In the majority of cases though, terminating the outsourcing partnership should be a last resort, rather than the go-to course of action. For example, in the case of logistics outsourcing, a good first step to take in the event of 3PL underperformance is to order an independent audit of the outsourcing contract.
The Value of an Independent Outsourcing Contract Audit
Whether a 3PL’s performance has eroded gradually or taken a sudden turn for the worse, there is an underlying reason somewhere (or perhaps a number of underlying reasons) and an audit should unearth the causal issues. Ideally, an audit will cover the following aspects of the contract and client/3PL relationship:
- The commercial agreements between client and 3PL;
- The content and provisions of the 3PL contract;
- Cost and service performance of the 3PL;
- The processes being performed by the contractor;
- The IT solutions being used to manage the 3PL operation;
- The relationship between the client and the logistics service provider.
Sometimes the very fact that an audit has been commissioned is sufficient to shake up those responsible for managing the partnership and prompt improvement action. If not, at least the audit results should highlight the key issues and enable a decision as to whether performance can be improved or if reverting to in-house operations is really the best solution.
3. Customer Dissatisfaction/Pressure
As in just about every industry, the customer is master of the supply chain arena. Even if a third-party provider is meeting service level expectations, there are times when one or more customers of the client company become dissatisfied with an outsourcing arrangement.
There could be a number of possible reasons for customers to object to outsourcing. For example:
- Customer expects higher service levels than those agreed between client and provider
- Customer’s supplier policy no longer supports supplier outsourcing
- Customer perceives that third-party provider is not effectively supporting products or services
- Customer negotiates new SLAs to which the third-party provider is unable to commit.
When any of these or other reasons cause an outsourcing agreement to conflict with customer needs, the client may find it necessary to bring the outsourced processes back in-house. If a continued business relationship with a valued customer is at stake, there may indeed be little choice but to do so.
4. Politics and Public Relations
In some cases, political pressure or public relations issues might persuade a client company to yield and bring outsourced processes or services back in-house. Political influences in particular, which may be direct or indirect, can be very powerful indeed.
The current trade war between the USA and China, for example, is making life difficult for US companies that brokered deals with Chinese manufacturers to take advantage of low-cost labour.
It remains to be seen how these organisations will respond as trade tariffs start to bite. Some firms may shift manufacturing operations to other low-cost countries, like Vietnam, while others might decide to reach out to domestic contract manufacturers.
The boldest enterprises may even exploit the diminishing costs of automation and industrial robotics to bring manufacturing back in-house. If there’s one thing that is certain though, it’s that President Trump wants US manufacturing back on US soil, and is prepared to use political muscle to achieve that aim.
5. Forces in the Outsourcing Marketplace
Another offshoring issue that might ultimately force a company to return to insourcing is the impact of changing pressures in the overseas marketplace. Wage inflation in particular, can create staffing challenges for outsourcing providers.
This, in turn, can lead providers to take cost-cutting action in relation to the workforce, with a resultant downturn in service quality. When these marketplace pressures begin to destabilize the outsourcing partnership or impact customer service, the client may revert to in-house control of the previously outsourced activity.
6. Breakdown of Outsourcing Relationship
Outsourcing partnerships are very much like marriages. In order to survive, both parties must prove themselves trustworthy, communication must be continuous and effective and a fully collaborative approach must be taken to problem-solving. However, just like marriages, relationships between clients and providers sometimes break down.
When an outsourcing arrangement disintegrates—typically because of poor management by one or both parties—the client has little choice but to look for a new partner. In such a situation though, some companies may prefer to bring the expertise and processes back in-house.
7. IT Integration Issues
Business information systems are playing an ever more pervasive part in relationships between suppliers, partners, and customers. In some cases, the inability to align and integrate IT solutions can result in a company’s decision to take back their outsourced business activities.
This situation is most likely to occur when a client and service provider has systems that can conceivably be integrated, but at a cost that provides prohibitive for one or both parties.
Fortunately, as information technology continues to develop, it’s becoming easier to align systems in an interoperable, if not fully integrated way, meaning technology is becoming less of a limiting factor in outsourcing arrangements.
8. Concerns about Provider Security
Occasionally, in logistics especially, a client company’s management may feel it has no option but to bring outsourced work back in-house because of security problems within the provider’s operation.
For example, if a third-party logistics provider repeatedly suffers theft, damage, spoilage, or tampering of a client’s products and appears to be unable to get control of the situation, the client may decide that returning to an in-sourced operation is a more secure solution.
Better to Have Loved and Lost?
Happily, there are plenty of examples of outsourcing partnerships, which—through careful planning and competent management—are flourishing, and will add value to the client companies’ businesses for a lengthy and indefinite term.
Nevertheless, sometimes even the best relationships have to dissolve, so parting company with outsourcing partners and taking back direct control of logistics or other business processes is not necessarily an indication of failure.
Indeed, continuing to outsource when customer retention, competitiveness, profit or even corporate image are at stake, would be a far more regrettable folly.
If you are ever in the situation where you need to bring your employer’s business operation back in-house, consider the experience one from which your company can grow. It’s better to have tried a venture and found it wanting, than to forever wonder if outsourcing might be the perfect way to strengthen your supply chain strategy.
This post was originally published in June 2015 under the title “8 Reasons Companies Bring Outsourced Processes Back In-house”. It has now been revamped and updated with more comprehensive and current information.