This article was co-authored by Chris Eastham, a technology partner at Fieldfisher.

The UK labour market is going through significant turbulence. Inflationary pressure on wages is being compounded by labour and skills shortages and waves of industrial action.

Tech companies are having a particularly hard time finding the specialist skills and experience they need.

For organisations struggling to find the right candidates to fill roles, and facing difficult pay discussions and retention issues, outsourcing back-office functions may provide a useful opportunity to manage costs and risk, and access economies of scale and talent.

Not all businesses have extensive experience in complex or business-critical outsourcing, and many are considering this option for the first time.

Before plunging into the world of outsourcing, organisations need to think carefully about how to integrate this way of working into their business model. If not managed correctly, outsourcing can fail to solve immediate staffing problems and even be disruptive and create additional commercial and legal risk.

Recent trends in outsourcing

Outsourcing is a well-established practice in a number of sectors, particularly technology. In a nutshell, in an outsourcing arrangement, the customer organisation will transfer responsibility for delivering certain business functions (or part of them) to a supplier in a strategic medium- to long-term partnership.

While outsourcing can be used to deliver or support almost any type of business function, it is most often used in relation to back-office or support functions, rather than customer-facing functions.

Typical examples of functions that are outsourced include IT and cybersecurity, finance, HR, pensions and employee benefits, warehousing and logistics, or physical premises support (such as front-of-house, security, or cleaning).

In the past, drivers for outsourcing particular service lines have included cost management and accessing talent pools in other geographies.

Pre-pandemic, some business commentators felt that outsourcing (and in particular offshoring) was in decline for a number of reasons, including the increased availability of automated and Software-as-a-service (SaaS) solutions.

Traditional offshoring models do seem to have become less popular, although there was an observable uptick in offshoring transactions during the Covid-19 pandemic. In general, however, the outsourcing market is evolving to adapt to new technologies and more complex business needs.

There still appears to be a gap between smaller and larger corporates in their appetite to take advantage of outsourced services, with larger and more sophisticated companies significantly more likely to use outsourcing as part of their service delivery model.

This may be a missed opportunity for smaller companies, as they could potentially achieve significant benefits from the cost certainty and expertise that outsourcing can bring.

Why consider outsourcing now?

Historically, outsourcing transactions have been driven by a combination of the following:

1. Desire to focus on core business activities. While necessary for day-to-day operation, support functions can be a distraction to the core revenue generating activities of the business. Outsourcing can assist organisations to focus on their raison d'etre, delivering value for their customers and stakeholders.
2. Flexibility in staffing and service capacity. Depending on pricing models, businesses can create flexibility in their costs according to their needs. This will be particularly valuable for businesses who suffer from significant fluctuation in demand or with a seasonal element, and will help organisations to respond to wage pressure in a more agile way.
3. Quality. Outsourcing providers will generally bring more expertise in their service line, and their staff will be better able to deliver best practice, to support improvements in service quality.
4. Cost management/reduction. This may or not be a factor, depending on the function being outsourced and the commercial model. Businesses should not assume that outsourcing will automatically reduce cost—in many cases, access to a highly skilled workforce and latest technology may significantly enhance capability and deliver better value for money, but may not represent a saving compared to an in-house function. It may however be used to deliver a degree of cost certainty, or to de-risk certain unknowns.

While the above are traditional reasons for businesses to outsource, new drivers are emerging in the current economic climate, most of which centre around different types of business risk.

Outsourcing enables businesses to shift risk to a third party provider, which will have a number of benefits, including the ability to manage:

1. Supply chain resilience. Outsourcing providers are often in a better position to manage certain supply chain risks, because delivery of the outsourced function is their core business. Providers will generally be better able to provide for business continuity for when the unexpected happens. Third party providers will also tend to be able to draw on economies of scale and potentially be in a stronger bargaining position with upstream suppliers than individual businesses.
2. Inflationary pressures on wages. Outsourcing providers will manage these in the first instance, and it may be possible for businesses to agree fixed risk premiums in pricing, in return for certainty over the future cost of providing services, which can be extremely valuable in navigating uncertainty.
3. Labour shortages and industrial action. These risks will be managed by the outsourcing providers, who are often better able to address issues and guarantee service continuity as they will usually have a deeper bench to draw on.

Where to start?

It is important to think through carefully—at the outset—what you are looking for from outsourcing to ensure your business gets the value it needs. Organisations should ask themselves:

What exactly is being outsourced?

Organisations really need to understand the function they intend to outsource, and the role it plays in their business. This involves mapping out:

• What the service currently delivers, and how;
• What staff are engaged in delivery; and
• How the part of the business that delivers the service is organised.

You should consider your business needs and drivers, how the business is going to evolve, and how the service would best be organised in future to fit with your core operations.

This is an opportunity for 'blue sky' thinking about future service delivery, and may later lead to further analysis of whether a single service provider, multi-sourcing or a service integration and management (SIAM) solution might be best placed to meet your requirements.

Businesses can also think about whether there is scope for the service to be improved through automation and other technology solutions.

When done properly, a formal tender process introduces a competitive element into the discussion, and helps customers and providers to understand the context of the deal from the outset—often leading to a better solution in the end.

What are the people implications?

Outsourcing will almost always affect some employees in the business, so organisations need to identify who those people are.

Once it is known whose jobs will be affected and how, the Transfer of Undertakings (Protection of Employment) or 'TUPE' implications must be considered, and the business should take advice if there is any uncertainty about what these may be.

Getting this right from the outset is key to running a successful tendering exercise where there will be a people impact, as it will allow the parties to deal with people aspects in designing the service and price modelling.

It will also allow the business to manage what can be an unsettling process for affected employees, without causing undue disruption.

Organisations need to think about whether there are likely to be redundancies because of the outsourcing (and consider and plan for potential reputational and employee relations implications).

Finally, attention should to be given to how the interface between outsourced and internal teams will be managed. Co-sourcing, with outsourced teams working alongside internal staff, is becoming more popular and can deliver significant value, but does require some thinking through.

Are there any other legal issues?

In addition to complex contractual negotiations, there are a multitude of legal issues that can arise from outsourcing depending on the sector in which the business operates, and what type of service is being outsourced.