Following decades of businesses outsourcing IT functions and business processes to external suppliers, a recent trend is for some of these functions and processes to be brought back in-house, i.e. insourced. A recent IT sourcing study reports that more than a fifth of the top IT spending organisations in the UK are planning to 'outsource less and insource more'.
Drivers for insourcing
Insourcing is sometimes intended to enable businesses to regain or improve their control over critical functions and processes. Whereas a particular function may have once been perceived as low level and part of operations, rather than strategic, in fact that function and the decisions it takes can have far reaching impact on a business. One such example would be a function such as IT architecture, which affects IT policy, strategy, and security.
Insourcing is also perceived to bring benefits by way of increased flexibility. Outsourcing agreements do accommodate change on an ongoing basis, however they typically prescribe a structured change process which requires direct engagement with the outsourced provider, and a cost impact for the customer depending on the nature of the change. Whereas change which is primarily an internal business function activity is perceived to allow a greater degree of control in determining the nature of the change, and potentially limiting the cost impact.
It is worth mentioning that the simplified purchasing route for available technologies, with the increasing prevalence of 'as a service' and cloud offerings, has increasingly allowed businesses to retake activities which previously would have relied upon legacy technology and infrastructure and, therefore, the outsourcing suppliers.
Cost reduction is another common reason for insourcing. Insourcing removes the supplier margin and labour arbitrage, often a driver of outsourcing, is losing its appeal with increasing costs in outsourcing centres, along with the rise of automation and robotics which is reducing the labour component of certain activities and functions.
An insourcing will potentially require some or all of recruitment and training of personnel, or transfer of personnel; amendments to processes; data transfers, systems reconfiguration, user access modification; IT licences reviewed and assured; updated governance; new reporting, and so on.
Operationally, the risk to a business predominantly relates to the new operating model that will be implemented post the insourcing. Clearly understanding and documenting the scope of the new, insourced activity, and how that activity will align internally within the business and with ongoing third party providers, is essential. Not only is there a risk that the new operating model might create deficiencies in operations, the transition from outsourced to insourced may have a detrimental business impact itself.
Insourcing typically, though not always, will require a partial, rather than complete, insource of an outsourced activity. The extraction of a part of a particular function or activity has attendant challenges. From a contractual perspective, if insourcing is taking place during the lifetime of an outsourcing agreement, while these agreements typically anticipate partial termination they are not always prescriptive in terms of what can be terminated and moved elsewhere. Even if the customer is granted complete flexibility by the agreement to terminate portions of the service, the practical implementation of a partial termination in terms of cost allocation and impact on remaining services often means that there is a meaningful barrier to insourcing.
Outsourcing agreements are evolving to reflect a greater trend towards insourcing. Businesses themselves are increasingly focused on the potential future structure and operating model design, and are writing in to agreements specific, potential changes. A greater flexibility is also being achieved by agreements being split, or modularised to reflect individual components of service, for example within an IT infrastructure arrangement having separate terms and conditions stretching from legacy, dedicated IT components, through to public cloud, via infrastructure as a service or platform as a service.
A key consideration will be the extent to which key employees, knowledge and skills are able to be transferred back to the business – this will clearly be more of an issue in relation to outsourced functions which involve significant employee support. An insourcing is likely to be a transfer for the purposes of TUPE, but this is very much an issue to be considered on a transaction by transaction basis. It may be possible to structure the insourcing so as to determine the application (or not) of TUPE, depending upon the outcome required by the business, although this of itself may be subject to negotiations.
The impact of the existing outsourcing contract will need to be taken into account. Even where TUPE does apply so as to transfer the assigned employees back in-house, there is a risk that employees could decide not to transfer by opting-out of the transfer. This is particularly a risk for senior or key employees who are likely to be more in demand in the wider market place. The fact of the transfer effectively gives an employee an opportunity to resign on the date of the transfer without having to give notice of termination – this may be an attractive option for some, but clearly could have a detrimental impact on the future provision of the relevant function or process.
And where employees do transfer under TUPE, the regulations protect their terms and conditions of employment, giving the business little scope to make changes to these at the point of transfer or for an undetermined period following the transfer. This is a significant restriction on the business, but one which may be subject to change in the future following the vote in favour of Brexit.
The current trend of insourcing is probably best seen as another phase in the outsourcing/procurement cycle. Indeed, despite an increase in insourcing, outsourcing is still on the rise globally. As business needs evolve, so will their requirements to outsource functions to dedicated suppliers or insource functions for some of the drivers set out above. The key for organisations will be to have the contractual flexibility to make these changes, and a clear operational understanding of the related delivery models and risk.
Mike Pierides, Partner, and Caron Gosling, Counsel, Pillsbury Winthrop Shaw Pittman