Functional Outsourcing – The Path to Business Growth

October 22, 2020

It has never been more important for organizations to stay nimble. Functional outsourcing is one method that helps companies scale without sacrificing agility.

In challenging times, agile operating models may hold the key to survival for many businesses. Fast-acting units have been shown to outperform their more sluggish counterparts – even when they were within the same organization. Industry analysts have highlighted three critical factors companies must emphasize to emerge stronger from any difficult period: cost, speed, and resilience. Agility at scale is the one essential corporate capability that can simultaneously move the needle on all three.

To obtain that agility at scale, firms are turning to one tried-and-tested method – outsourcing. Its popularity is reflected in market trends. According to Statista, the global outsourcing services market was valued at US$92.5 billion in 2019[1]. However, outsourcing is such a broad category that simply advising a business to follow this path is of little help. For outsourcing to add real value, a firm must first understand the type of approach best suited to its needs and clarify the specific objectives it wants to achieve.

The Scope for Change

The key difference between functional and other outsourcing models is scope. There are four broad groupings, and each varies by the degree of responsibility assigned to the outsourcing partner.

  1. Professional Employment Organizations (“PEO”): Typically offer payroll, HR, and compliance functions. PEOs act as a “co-employer”, meaning that recruitment decisions are left to the client. In other words, the scope of the PEO does not include hiring and selection.
  2. Staffing agencies: Significant overlap with PEOs with one crucial difference – increased scope. Staffing agencies are PEOs that also take responsibility for the recruitment process.
  3. Functional outsourcing: Functional outsourcing covers even more responsibility than staffing agencies. On top of doing everything a recruitment agency does, a functional outsourcing provider can handle a broader range of functions such as attendance management, operational performance management, onsite support, staff training, workforce planning, and even the creation of standard operating procedures. These are all functions that can fall under the range of a specific project that can be outsourced. However, responsibility for top-level strategic planning remains with the client.
  4. Total outsourcing: This is where the entire project itself is outsourced, instead of just specific functions. Here, the partner bears complete responsibility and is essentially the project owner. 

Minimal Resources, Multiple Benefits

Functional outsourcing enables businesses to run entire projects with minimal operational resources. While they must remain ultimately responsible for the project and top-level strategic planning, they can outsource all the other functions. This can lead to multiple benefits, including:

  • Improved cost efficiencies: The cost of keeping a full-time employee is greater than just their salary – actual costs would likely be 125% to 140% of base wages[2]. This also does not include initial hiring and onboarding costs. On the other hand, the salary costs of outsourced talent are often based on utilization, leading to significant cost efficiencies.
  • Quick scalability: Companies can confidently embark on more projects, knowing that most of the functions can be quickly and easily outsourced. It will allow them to scale without sacrificing agility.
  • Better quality control: Functional outsourcing partners are specialists, meaning they are more likely to have already invested in the best talent, tools, systems, and processes. The result is greater consistency and, in turn, superior quality control.

Potential Risks of Functional Outsourcing

Functional outsourcing does offer clear advantages, but there are also potential downsides. Before deciding to adopt this approach, firms must consider how they plan to mitigate such risks.

  • Damage to employee morale: The reality is that outsourcing can lead to employee redundancies. If the rationale behind outsourcing is not communicated well enough to staff, it may result in substantial damage to morale. Even if it does not lead to any redundancies (for instance, if it is used only for new projects), existing team members may still feel threatened. Careful communication is a must when undertaking any significant outsourcing.
  • Loss of control: No matter how tight a firm holds the reins of its partner, outsourcing still requires a delegation of authority. Fortunately, much of this risk can be mitigated by a rigorous selection process combined with policies and procedures to ensure smooth execution. The latter is also crucial for mitigating the chances of underperformance, which may stem from poor process flow.

Creating a Success Story

If a business has decided, after careful consideration, that functional outsourcing would be a net benefit, the next stage is to think about how it can be successfully implemented. This mainly comes down to establishing proper processes and procedures. There are several stages companies can follow to maximize their chances of success:

  • Sourcing the vendor: Beyond the obvious requirements, such as proven functional expertise, companies need to decide whether the vendor has disciplined business processes, financial viability, a willingness to partner (rather than dictate terms) and well-developed communication skills.
  • Setting the scope: Determining the exact scope of the outsourcing services being provided.
  • Transferring relevant knowledge: There will be a level of client knowledge that the outsourcing partner needs to possess to perform their jobs effectively.
  • Creating Standard Operating Procedures (“SOPs”): The insights provided by the client in the knowledge transfer should be used to craft SOPs (within the defined scope).
  • Forming the onsite team: Selection of the specific personnel who will be working onsite with the client.
  • Training the “backfill pool”: Turnover is to be expected and planned for. A certain number of excess personnel will be brought up to speed with the project to backfill any turnover that might happen throughout the project.
  • Performance monitoring: Establishing a system for the monitoring and tracking of the outsourcing provider.

A Competitive Advantage for the “Next Normal”

The pandemic has taught companies many lessons. A major one is just how dangerous bloated, rigid cost structures can be when circumstances take a sudden turn for the worse. Yet, businesses also cannot afford to hold back their growth out of this fear.

Functional outsourcing provides an elegant solution to both problems. As we move into the “next normal” more companies will likely turn to outsourcing as a way to confidently scale their operations – while also keeping their downside protected. 

[1] https://www.statista.com/statistics/189788/global-outsourcing-market-size/

[2] http://web.mit.edu/e-club/Archive/hadzima/how-much-does-an-employee-cost.html

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