Wednesday, February 22, 2012

Looking at Outsourcing from the angle of risk

In the last blog, we looked at outsourcing from the ability of the organization to leverage the resources for the better. In today's blog we look at the concept of outsourcing from the aspect of risk.

To understand this, let’s begin with a small example. Let us assume a bank decides to set up a small team towards building a system to handle all the banking related tasks that could be automated. The estimated time for the project for a team of 100 people was 20 months. Around 6 months after starting off the project, there is a huge banking slump and the bank now has issues which threaten its very existence. The project of computerization of its activities invariably would take the back seat. If the software system being developed was done by a larger software company - the risk of the banking slump wouldn’t be too high for the software company. The software company possibly has a larger portfolio of clients and would be able to manage these sorts of risks better than the bank that took up the project of developing the software system in house!

To summarize the learning - a supplier aggregates demand from multiple customers and therefore can diversify risk better than the customer can on their own - creating higher value for the customers. The supplier's ability to aggregate demand across businesses and industries would have to be a set of uncorrelated risk profiles. This uncorrelated risk profiles of the suppliers create a portfolio of companies which resemble in many ways to a mutual fund. The fund mitigates the unsystematic risk of an organization or an industry by associating it with customer-portfolio diversification.

An organization would have to think if would increase its risk by keeping the function in house or would be better off by outsourcing the function.

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