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Outsourcing Your Back Office

Posted on Sunday, May 24th 2009

By Guest Authors Richard Hooker and Steve Monas

[Richard and Steve wrap up their series of excerpts from their book “Shoestring Venture: The Startup Bible” with a post on the advantages and concerns of outsourcing the many tasks that any business’s back office takes care of.]

A business’ internal capabilities are the stuff that strategy is made of, so outsourcing many — if not nearly all — of a business’ critical functions seems to create dangerous dependencies. Forgivable, perhaps, in a startup, but risky in a growth-oriented company, no? In this excerpt, we weigh the pros and cons of outsourcing a sizable chunk of the critical back office functions rather than developing the capabilities in-house.

So, why outsource your back office? Isn’t it easier just to do it yourself? Or hire other people and develop the internal capabilities.

The answer is both yes and no. In many ways, it is simpler to do it yourself, but it requires a huge amount of work even at the very beginning of your venture. If you can’t do all that work, hiring your own staff has many advantages. You can deal directly with your employees, you can judge the quality of their work, and you can have some control over the security of your business’s information. These are not minor advantages.

But doing the work yourself or hiring employees have their disadvantages, the most significant of which are the limitations they place on your business’s growth. Your back office must ramp up as your business grows. That’s not as easy as it sounds. Today you have a bookkeeper and a receptionist. Tomorrow you require a bank of phone operators, a bookkeeper, payroll expert, accountant, and a human resources department to handle all those employees.

Outsourcing from the very beginning gives you three distinct advantages over hiring staff: scalability, cost savings, and avoiding the general headaches that having a staff entails.

The most significant factor limiting your business’s growth, in general, is your ability to scale up your staff to meet greater market demand. You may have the best product in the world, and lots of people want to buy it. However, the more they buy, the more your organization and your back office needs to grow. Believe it or not, many small businesses fail when they succeed; they can’t scale relative to the market demand. I worked for a small business that had a thirty-year growth history that looked like an  eight-year frequency sine curve: every four years they’d grow to about forty to fifty employees and within four years they’d shrink to about four employees. The principals could not manage the larger organizations market success required—the sure sign that they were going to fail was when they succeeded.

The right outsourcing vendors can greatly increase a business’s capacity to grow and reach new markets. The vendors devote all their expertise to the back office functions and ramp up (or down) to meet your needs; all you need to do is worry about getting your product made and selling it. You don’t have to master the intricacies of managing a complex organization with widely disparate departments and functions.

Outsourcing solves many of these problems but saddles you with other headaches. If you outsource your back office functions, you never really meet your employees. You can’t evaluate them individually and guide the improvement of their performance. You can only evaluate the performance of your outsourcing partner. In addition, “your” employees at the outsource company often work for more than one business. As a result, they don’t really get to know your business very well and rarely care about it. That does matter. For instance, you may want customer service to be your business’s defining character. With a direct hire, you can train them in customer service and monitor how well they perform. More importantly, you can hire and nurture an employee to care about your business and customers. You do not have that luxury with an outsource partner. Typically, you never even talk to “your” employees; instead, you spend all your time with a manager or account executive. That makes it even more difficult to ensure the highest quality work, dedication, and service.

On the other hand, you don’t have to handle payroll. There are no income taxes to deduct. No W-2 forms to prepare at the end of the year. No health insurance. No unemployment insurance. No laws to keep up on. No performance reviews. No write-ups. You pay your bill to the contractor every month and you’re done with it.

In addition, outsource office support is also typically much cheaper than an employee—as low as 15% (if you offshore) of what an employee would cost in wages, infrastructure, and additional compensation. You still have to worry about paying your outsource bill, which can be either variable or fixed, but it’s typically a lot less than a staff would cost. So, just like payroll, you need healthy cash flow to pay your bill on a regular basis. But if you manage to get your back office services at a significantly lower price than direct hires, you’re more likely to sleep at night.

There is an additional advantage. Because many outsource providers have a large number of clients, they are able to take advantage of economies of scale to offer services you could never afford on your own. For instance, if you want a phone receptionist available twenty-four hours a day—because somewhere between 50% and 80% of all callers who reach a phone machine never leave a message—you would have to hire three full-time employees to work around-the-clock. You can get the same twenty-four hour reception service from an outsource provider for little more than it would cost you for eight hours of daily phone reception.

And finally, outsourced “ virtual” employees do not require physical infrastructure. Your deal with the outsource vendor means that they provide the desk, the chair, the computer, the software, the phone system, the computer system, the rest room facilities, and every other piece of “overhead” that comes with employees. Taking advantage of economies of scale, this means that “your” employees at the outsource location are able to use sophisticated, state-of-the-art technologies that you could never afford; bringing an outsource vendor on board often means bringing the best technologies on board, as well. The vendor does pass these costs on to you, to be sure, but the costs are spread across a large number of clients.

Outsourcing has one additional benefit. If you set up the right contract with an outsource provider, it’s exponentially easier to dismiss an underperforming contractor than an employee. If you’re unhappy with the bookkeeping service you’ve hired, fire them. Hire a new one. It’s usually that simple. And here’s something that’s genuinely cool. If you don’t like your vendor’s performance and tell them about it, they usually make an effort to improve! Try that with an employee!

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With the context of “Shoestring Venture”, I am not sure how much you can attract the vendors for outsourcing the back office of 2 people’s worth of work and how much attention you will get from an offshore vendor for such a small work. If this is something which is a highend work like product development outsourcing or outsourcing your QA and QC need I have seen it working very well with even a small team of 2 – 4 people (A quick disclaimer: I belong to a software development and testing global delivery company ) but for back office work I am not sure. The business dynamics for the vendor may not work unless you put a long term contract or lock in period from both sides which could be a challenge for the companies in context.

Santanu Monday, May 25, 2009 at 10:51 AM PT