Tag Archives: outsourcing

Outsourcing trends and project management

The internet is changing the trade-off between outsourcing and doing work in-house. It is important for project managers to be aware of this trend. Previously, there were many reasons to do work in-house and only outsource in a very limited set of situations, but now a number of the problems of outsourcing have been either reduced or eliminated by the internet. Project managers should reevaluate when they want to outsource, as there are now many more opportunities than even 5 years ago, primarily driven by technological changes.

The Nature of the Firm

In 1937, Ronald Course, first published his seminal article on the Nature of the Firm and the debate has being ongoing within the field of economics ever since. Basically, there is debate over why firms exist and what efficiencies (if any) they provide over having everyone just work individually on a freelance basis. Some of the reasons for firms to exist include:

  • Reputation – firms have brands and reputation that would be costly for individuals to create and maintain.
  • Search costs – its pretty expensive to launch a Request For Proposal process every time you need make a legal decision, and having an in-house legal team might be more efficient.
  • Friction causes by external contracting – every time you contract with someone outside the firm there are legal costs and a risk that the contract may not be executed as expected. Whereas, within the firm the process is likely to be much smoother.

The impact of technology on outsourcing

The internet is changing this. All of the problems above that justify the existence of firms are starting to be solved by the internet. Reputation used to be relatively hard and costly to measure, but now sites like Amazon can provide informative product reviews, whilst sites like Yelp  in the US, do the same for businesses. Search costs are reducing as sites like Google and Bing make it much easier to find anything. Friction costs haven’t gone away, contracts still exist, but intermediaries now offer services that make this process easier – Mechanical Turk, Elance and Seed are all example of this. Mechanical Turk is Amazon’s tool for having individuals do low level work, such as checking if a photo is correctly titled and getting paid $0.02 per photo. Elance offers outsourcing of larger tasks like preparing a PowerPoint presentation. Seed is AOL’s effort to outsource content creation, Seed submits the description of what sort of news article or photograph is required, for example an article on ‘When Following Warren Buffett is a Mistake’ and anyone can then submit that article and receive a share of the advertising revenue it generates. In all of these cases, the technology is prompting greater outsourcing:

Solution Benefit Previous Solution
Mechanical Turk Outsource low-level analytics Hire the capability in-house
Elance Outsource discrete pieces of work Hire the capability in-house
Seed Outsource writing of online articles Hire the capability in-house

There are still barriers to outsourcing, notably that the quality of what is delivered remains hard to measure objectively in many cases, but there are significantly less blockers than previously and project managers should (re)consider the new opportunities in this area. 

AIG And Outsourcing Portfolio Strategy

The government bailout recipient AIG recently dismissed McKinsey, management consultants who were undertaking work called ‘Project Destiny’ to layout a roadmap for the business. Some details are here. The rationale was apparently to take the work in house in order to reduce costs.

It raises some interesting questions about to what extent strategy can be outsourced, and whether the cost of this outsouring outweigh the benefits. In this case, internal politics may also be at play as the new CEO looks to impose his own agenda.

An interesting principle behind this is the cost of information. For example, if I stood to win $5 on a coin flip, and had to call heads or tails. Then the expected value of that wager to me is $2.50 ([$5 x 50%] + [$0 x 50%]). But if I had a way of knowing exactly what the outcome of the coin flip would be with certainty I would be willing to pay up to an incremental $2.49 for that information (if accurate) because I would be certain to get $5, rather than the expected value of $2.50 if I had no knowledge on whether it would be heads or tails.

This is to some extent the situation AIG is in, they have tremendous uncertainty around their business, it is not clear how the value of their assets and liabilities might change over time.  Their market cap has been fluctating in approximately $1-5B range so far this year, suggesting the market isn’t sure either. How much should AIG pay to improve their knowledge? That question is itself a large consulting project.

They have clearly decided that the incremental gain from the information McKinsey could provide is too great. In reality, cashflow issues might have impeded, what could have been an otherwise financially desirable decision.

Topics such as portfolio outsourcing as discussed in more detail in my book on Strategic Project Portfolio Management.