How to Measure the ROI of Outsourcing

Outsourcing is the practice of using outside firms to handle work normally performed within a company and is a familiar concept to many entrepreneurs. The main resources available to any business are money and time. In order to save both, many business owners and executives around the nation are choosing to outsource many tasks that they have traditionally performed in house. Outsourcing is an excellent option for small and medium-sized businesses that are looking for cost savings while reaping the benefits of expert knowledge

Return on investment, or ROI, is one of the most recognized of all the financial measurements and ratios in the world of business finances and accounting. It’s the standard that’s used by business owners and entrepreneurs to determine how they will utilize their limited resources in order to maximize their business opportunities and profits. Understanding the return on investment (ROI) is becoming even more crucial as companies’ outsourcing strategies evolve.

One fundamental obstacle is that the benefits of outsourcing can be difficult to quantify. Cost savings themselves are unlikely to pose a challenge as comparing the actual and expected financial savings delivered should be straightforward. But other benefits, such as risk mitigation and the freeing up of in-house staff to focus on value-adding activities, are not as easy to measure.

Perform a Cost-Benefit Analysis

Before activities are outsourced, a cost-benefit analysis should also be carried out on the proposed arrangement to understand the expected ROI. On the cost side, companies should be aware that certain factors may be overlooked. If your small business is considering outsourcing, confirm whether the quote you receive is an all-inclusive price or whether other costs may be added on later.

Next, it is essential you calculate the value of benefits and subtract these from the costs to calculate the overall value of the agreement. Areas you may want to focus on include ability to control capital costs by converting fixed costs to variable costs, any reduction in overheads and the freeing up of internal resources to focus on core competencies.

Finally, your team must agree on how the benefits will be measured. Qualitative measures are usually harder to measure than quantitative measures, but these factors should be carefully considered because they could ultimately determine the success of the outsourcing arrangement. The financial value should not be the only thing considered when performing a cost-benefit analysis, and value delivered, management hassle removed, innovation delivered, and a view on competitive advantage should be some factors your small business should consider.

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Quantify the Anticipated Benefits

On the other side of the ROI equation, your business should determine the benefits that you expect the outsourcing agreement to bring your firm. These are not limited to but may include:

Greater cost control- With outsourcing, your small business has the ability to control capital and convert fixed costs to variable costs. By freeing up capital, you have more money to invest in other productive areas of your business.

Lower overhead- Comparing the cost of outsourcing with the cost of performing the work internally will tell you if outsourcing will reduce your costs. Doing everything internally requires resources such as space, office supplies salaries, benefits, etc. This can drive the overhead costs up compared to outsourcing non-core functions.

A focus on core competencies- While difficult to quantify, this may be the biggest outsourcing benefit of all. Core competencies distinguish a company from its competitors. Determine what makes you different from your competitors and apply the resources to those areas that you free up by outsourcing. The value of focusing on core competencies can be measured through faster growth and increased profitability.

Staffing flexibility- Does your company experience cyclical or seasonal fluctuations in sales and workflow? Outsourcing can be especially beneficial to companies that do, by tapping into external resources when needed without committing to them on an ongoing basis. Additionally, an added benefit is that internal staff has the ability to learn new skill sets by working alongside outsourced service providers that they can put into practice.

Higher efficiency- Trying to do everything internally often can come at a steep price. Most small and medium-sized companies don’t have the structure or scale to perform tasks as efficiently and effectively as an outsourced team can provide.

A more level playing field- When your business outsources, you have access to the same high-level expertise that big companies can retain and experience in their internal staff. While a large firm has the expertise of a full-time CFO which comes at a large price, for example, a small firm can tap into the expertise of an outsourced part-time CFO at a fraction of the cost of hiring a full-time CFO with a six-figure salary and benefits.

Innovation- Bringing in outside experts creates the ability for inefficiencies to be spotted which otherwise would not have been. Once you outsource, you may even discover something you believed to be your core competencies is not. If your management team and staff truly focus on core competencies, they will find new and better ways to outsource those tasks that are distractions and add value to those tasks that remain within the organization. What is a new idea worth to your small business?

Final Thoughts

Finally, while ROI auditing provides clear benefits to companies which use outsourced services, companies should bear in mind that this type of exercise can also benefit the providers themselves.

It is an excellent idea for small businesses to measure the ROI on their outsourcing agreements. This type of exercise can also benefit the providers themselves and set clear expectations of what is expected. When you’re comparing costs and benefits, make sure you’re doing a fair comparison that takes into account both everything you’re spending and everything you’re getting, or not getting. The health of your organization, and of your own credibility, depends on it.

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