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Farm It Out

Posted on Thursday, September 1st, 2005 by

Farm It Out

Time is money. Intelligent outsourcing can save your business a bundle of both.

You didn’t go into business to spend hours administering payrolls, wading through changing tax rules and maintaining fickle computer systems—but when your server went down one Thursday morning there was no one else to fix it but you and, before you knew it, you had spent the entire day getting the problem solved. With a critical business meeting scheduled for nine on Friday morning you had no choice but to get up in the middle of the night to do the work in preparation for the meeting that you should have been doing the previous day. By the time the meeting rolled around, you were so exhausted you could barely focus on the issues at hand. Is this any way to run a business? Does it make sense to be spending so much time on relatively minor operational tasks that you have little or no time for the work that is central to your long-term goals? And while you could hire and train full-time employees to manage those tasks, wouldn’t that be both expensive and time-consuming?

Outsourcing offers an infinitely better solution. Increasing numbers of small businesses are freeing up time and saving money by farming out non-core functions such as information technology, payroll, human resources, and accounting. Small businesses plan to increase their use of outsourcing by 8% during 2005, considerably faster than large firms, according to the Outsourcing Institute, a professional organization based in Jericho, New York that tracks outsourcing trends.

“Outsourcing can be especially helpful for small firms,” says John McClendon, a professor at Temple University’s Fox School of Business in Philadelphia. “It can provide them with some of the advantages larger firms enjoy, such as economies of scale and specialized expertise.”

Outsourcing does pose some potential risks. Pitfalls, including vendor incompetence, poor communication, culture conflicts, and misuse of your firm’s proprietary information sometimes make outsourcing less productive. Fortunately, you can avoid most of those problems with a methodical, carefully planned approach to the outsourcing process.

The promise of outsourcing

“Outsourcing” became a largely misunderstood household word during the 2004 presidential campaign. Politicians and pundits used the term to describe the practice of hiring cheap labor in developing countries—a practice more accurately called “off-shoring.” The true definition of outsourcing is both more mundane, and, to small businesses, more useful. “The bottom line is that outsourcing involves using an outside vendor to do something you’ve traditionally done in-house,” says McClendon.

Outsourcing often makes intuitive sense. You hire an accountant to do your taxes, because it’s not worth your time to familiarize yourself with the tax laws. Likewise, a technology consultant can upgrade your computer systems far more efficiently than you could do the job.

What’s more, there is considerable empirical data suggesting that outsourcing can help small businesses. Robert Brown, small-business outsourcing analyst for consulting firm Gartner Group in Stamford, Connecticut, has done extensive research into the benefits of outsourcing. Brown and other experts report the following benefits:

ACCESS TO EXPERTISE. Outsourcing allows small businesses to draw upon expertise that would be far too expensive to develop and maintain in-house. Such expertise might include familiarity with regulations, technologies and industry practices—the sort of up-to-date knowledge that requires significant experience as well as ongoing education. That know-how can provide a host of other benefits, such as the ability to spot developing opportunities or keep your businesses compliant with changing laws. For example, a technology consultant might help make your business more efficient by identifying ways to automate your supply chain. Similarly, a payroll vendor might keep you on the right side of new payroll-tax regulations.

TIME TO FOCUS ON YOUR CORE BUSINESS. When you outsource time-consuming but peripheral tasks, you and your employees can focus on what consultants like to call your “core competencies.” A doctor can spend more time with patients; a consultant can devote more hours to working with new and old clients; a designer can save his energy for his designs. The extra hours you and your employees devote to your firm’s core business could make a real difference to its bottom line—even after you take into account the money you spend on outsourcing. It’s no surprise that “improving focus” was the number-one reason small businesses gave for outsourcing business functions in The Outsourcing Institute’s 2004 Outsourcing Index.

IMPROVED MORALE. Employees generally are happiest doing what they do best. They often hate being distracted by tasks that have nothing to do with their essential functions. Just ask William Dailey, an accountant and controller for Trans-County Title Agency, a 25-employee title-insurance firm in New Brunswick, New Jersey. He handled the firm’s human resources for years—he estimates HR duties took up 20% of his time—before the company’s owners hired a dedicated HR firm. “I wasn’t qualified for that job,” he says. “I never went to school for HR, and I don’t have the personality for it. The company hired me for my ability to count money, and now I have the time to do that properly.”

LOWER COSTS. Economies of scale allow outside vendors to perform many business tasks far more efficiently than small businesses could do that jobs themselves—and that translates into cost savings. “Small businesses can get access to experts for a much lower cost by outsourcing than by hiring,” says Brian Klaas, professor of management at the University of South Carolina’s Moore College of Business. “Essentially, outsourcing means that a number of businesses can share the cost of an expert’s training and resources.”

Outsourcing allowed Dupriest to
offer a competitive benefits package to his employees.

NEW PERSPECTIVES. Outsourcing can provide ongoing input from an outside expert to help you improve your business. For example, an outside accountant or financial-consulting firm will provide regular financial reports, produced and examined by an advisor with years of experience working with companies similar to yours. Gene Polley, a business advisor with small-business consulting firm Fiducial, recently showed a client who owns an auto-parts store that the prices he charged hadn’t kept up with the industry average. “The next month, the client made an extra $5,000 in profit just from marking those items up to the going rates,” he says.

IMPROVED RECRUITING. Outsourcing certain functions also can help you attract and retain high-quality employees. “The marketplace for good people is very competitive,” says Darren Dupriest, owner of background-checking firm Clarence M. Kelley and Associates in Shawnee, Kansas. “Outsourcing HR and payroll allows us to offer a well-designed package of benefits, and our eleven employees know their paychecks will be handled professionally. We can make our employees happy without having to sweat the details.”

Making the most of outsourcing opportunities

Outsourcing doesn’t always work as planned. A recent study by consulting firm Dun & Bradstreet found that between 20% and 25% of outsourcing relationships fail in any given two-year period, and half fail within five years. Reasons for those failures include unexpected costs, poor service, culture conflicts, and a lack of flexibility to address changes.

The following tips can help you reap outsourcing’s benefits while avoiding its potential pitfalls.

DETERMINE WHETHER IT MAKES SENSE TO OUTSOURCE A PARTICULAR TASK. Outsourcing works best for jobs and systems that are similar at many firms, such as payroll, accounting, human resources, or technology. An outside vendor may have trouble with processes that are unique to your firm.

For example, many airlines save money by outsourcing new-employee training—but Southwest Airlines keeps that process in-house. “Southwest views employee training as a crucial, unique element of its corporate culture—so the company doesn’t believe in using outside vendors for that task,” says John McClendon. “They spend more resources on training than their competitors, but they feel that it’s worth it.”

FIGURE OUT THE COST OF KEEPING THE PROCESS IN-HOUSE. Calculate how much the job costs you now and how much it is likely to cost going forward. Include the costs of labor and materials, as well as the opportunity cost associated with diverting employees’ time from their primary duties. That information will help you decide whether to keep doing it yourself or look for someone to take it off your hands.

DEFINE YOUR GOALS. Before shopping for vendors, figure out exactly what you want them to accomplish: whether it is to implement a particular technology, handle administrative functions to free up employees, provide a package of affordable benefits, or meet other goals. Also consider whether you’re looking only for a vendor to administer a given businesses function, such as payroll, or if you want to consult the vendor about a wider range of business practices.

START SMALL. “Don’t outsource everything, especially at first,” says Gartner analyst Robert Brown. “Some companies overdo it, and run into trouble managing all their vendor relationships.” Start by farming out one or two relatively simple, discrete tasks.

USE REFERENCES TO FIND THE RIGHT VENDORS. “Get out and talk to other businesspeople,” advises Gene Polley. “Referrals offer the best way to get good vendors.” Look for a firm with a reputation for integrity and experience serving companies similar to yours. Interview several candidates before hiring a firm.

EVALUATE PRICES. Brown notes that small businesses often pay proportionately much more than larger firms for similar services, in part because they are less vigilant about negotiating cost. Remember that economies of scale should allow vendors to perform the relevant tasks more cheaply than you can yourself. And don’t allow vendors to sell you services you don’t need.

CONSIDER YOUR PERSONAL RELATIONSHIP WITH THE VENDOR. Avoid vendors who make you feel uncomfortable, no matter how good their reputation. Consider whether you really want to work with a person, and whether you trust the vendor with sensitive information. “The relationship is number one,” says Kelly and Associates’ Dupriest. “Can you relate to the people you deal with, and do they understand you and your business?”

DEMAND FLEXIBILITY. Consider the ways your relationship with the vendor might change in the future—perhaps based on your firm’s potential for growth. If you expect revenues to double during the coming year, will the vendor be able to keep up? If you expect flat or declining business, make sure your contract won’t force you to pay for a higher level of service than you’re receiving.

MEASURE RESULTS AND EVALUATE THE RELATIONSHIP. “Adequate measurements keep both parties honest and engender trust,” says Brown. Sara Cullen of Australian outsourcing consultant ABIE Source recommends measuring the following four components: service quality; financial results measured against previous periods, the cost of doing the task yourself, and market rates; the quality of the relationship; and the degree to which your reasons for outsourcing are being met, and whether the vendor has introduced better business practices. With those measurements in hand, you’ll have a sound basis for judging the relationship. Reevaluate every one to three years, and use the opportunity to adjust the arrangement as needed.

10 Top Reasons Companies Outsource
Improve company focus
Reduce and control operating costs
Free resources for other purposes
Gain access to world-class capabilities
Resources not available internally
Accelerate reengineering benefits
Reduce time to market
Share risks
Take advantage of offshore capabilities
Function difficult to manage or out of control
55%
54%
38%
38%
25%
20%
18%
12%
12%
10%
NOTE: Numbers don’t add up to 100% since respondents selected more than one answer.
Source: Outsourcing Institute’s 2004 Outsourcing Index

 

READ ANY OUTSOURCING CONTRACT CAREFULLY. Make sure it spells out the following: minimum service levels required; conflict resolution provisions; an escape clause; who owns the work produced; and incentives for good performance, where appropriate.

Prime candidates for outsourcing:

information technology. Out- sourcing IT is a no-brainer for many businesses, given the complicated nature of information technology and the speed with which it changes. It’s essential to define precisely what business results you want to achieve before entering an IT-outsourcing relationship. Consider whether you’re looking to fix specific problems or seize particular opportunities—or if you want to determine how new technologies might help in ways you haven’t considered.

Referrals from other people in your industry are the best way to find a good vendor. Affiliations with the Association of Computing Machinery and the Institute of Electrical and Electronics Engineers are good signs, as are certifications from leading vendors of hardware and software systems, especially for the products your company uses.

Ask the consultant for help achieving your business goals, rather than for a particular technology (unless there’s a clear, compelling reason to do so). The consultant should be able to propose a solution in a way that you can understand—be wary of technology consultants whose jargon leaves you confused. Be prepared to spend between $600 and $1,200 a day or more, depending on the complexity of the work.

Avoid getting stuck in an open-ended project. Divide each project into discrete steps, each with a deadline and budget. Ask the consultant for written reports as the job progresses—that will make it easier to maintain and upgrade the system in the future.

ACCOUNTING. Most small businesses already outsource end-of-year income-tax preparation—but consultants contend that they shouldn’t stop there. The duties your firm might outsource range from bookkeeping to more complex tasks such as business valuation and auditing. A seasoned accountant also can apprise you of the tax implications of business decisions you make throughout the year, helping stave off unpleasant surprises come April 15. What’s more, he or she might act as a business owner’s point-person in crafting financially sound succession strategies or doing other financial planning. Rates depend on the complexity of your books and the tasks you outsource. You might begin your relationship paying an hourly rate, until the accountant understands your business well enough to quote a flat fee.

Keep in mind that outsourcing your firm’s books does not mean washing your hands of them. Meet regularly with your accountant and make sure you understand where your business’ money is and why you’re undertaking particular financial strategies.

PAYROLL AND HUMAN RESOURCES. Outsourcing payroll can remove a gorilla from the back of many small business employees, and can protect firms from costly errors. The IRS reports that 40% of small businesses are fined for filing payroll taxes late or incorrectly, to the average tune of $845 per year; some fines are far worse. “Payroll tax rules change every year,” says Fiducial advisor Gene Polley. “If you’re not careful you can get into a boatload of trouble.” A number of large firms offer payroll processing to small businesses. Among the industry leaders are Paychex, ADP (Automatic Data Processing), and, most recently, Sure Payroll, an innovator in the development of affordable online payroll processing. One potential benefit is a simplified accounting process since some payroll services provide direct integration with back office accounting and hence eliminate the need for duplicate data entry. Other advantages include uptime guarantees that are typically better than you would get from running your own system and protection from penalties. The range of services vary as does the price—it’s worth taking the time to compare the offerings to find the provider that offers you the balance of cost and service that’s right for you.

Businesses looking for more consultative, personalized relationships might want to look into professional employer organizations (PEOs). These firms officially become co-employers of small businesses’ employees, making the PEOs legally liable for any errors in payroll-tax filings or other mistakes. Controller William Dailey turned his payroll over to a PEO: “The cost of the PEO is only barely more than what we were paying for payroll taxes anyway,” he says. “It’s clearly worth it.”

PEOs also can handle a wide range of human resources functions, from offering comprehensive and affordable benefits packages to writing employee manuals to helping craft strategic compensation plans. Business professors John McClendon, Brian Klaas, and Thomas Gainey conducted a survey designed to gauge client satisfaction with PEOs. They found that 89% of respondents saved time, while 68% saved significant money. They also found that the more firms outsourced to PEOs, the more satisfied they were. “There’s no reason why a small business-person should have to handle all of their company’s HR duties by themselves,” concludes Klaas.

The Web site of the National Association of Professional Employer Organizations (napeo.org) can help you locate a member PEO in your area.

You’re in business to make money doing work you enjoy. Outsourcing tasks for which your firm is not well suited can help you achieve both of those goals. “Small businesspeople have enough headaches without trying to be the expert at everything,” says Dailey. “If you’re overworked or putting important work aside just to…”

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