Outsourcing — A RUNAWAY TRAIN

Internal Auditor, June, 2000 by Jonathan Figg

Transferring a process to an outside vendor can derail even the most steadfast organization. A smart, proactive internal audit shop can help to mitigate the risks and keep the outsourcing strategy on track.

ALMOST EVERY INDUSTRY HAS BEEN TURNED ON to the benefits of outsourcing. According to a recent survey by The Outsourcing Institute--a global network of researchers and professionals in the field of outsourcing--the top reasons behind this trend include reducing and controlling operating costs, improving company focus, and gaining access to world-class capabilities. It's not surprising that businesses worldwide are jumping on the outsourcing bandwagon.

While every organization is looking for efficient, more costeffective strategies, some companies might ignore the potential problems that outsourcing poses. Internal auditing can represent a formidable line of defense against those risks. In recent discussions with a number of seasoned auditors and outsourcing experts, Internal Auditor learned how audit shops can add significant value in every phase of the outsourcing process, from helping with decision-making to maintaining a long and healthy relationship with the outsourcing provider.

THE DECISION TO OUTSOURCE

The allure of outsourcing as a quick fix to budgetary woes or organizational inefficiencies may blind management to the potential dangers of shifting an internal process to third-party contractors. One of the first risks to consider, according to Peter Bendor-Samuel, CEO of the Outsourcing Center, is whether the business process is too complicated or sensitive to be controlled outside the organization. He suggests that the following questions be asked: "Can the scope of the relationship with the outsourcer be defined? Can the results be measured? Can an equitable agreement be established?"

Experts also suggest investigating whether or not a hasty outsourcing decision could open an intellectual drain or create a loyalty rift in the organization. Talented staff who are displaced following a shift in process ownership might take with them innovative ideas and work approaches that would have benefited the future direction of the company. Perhaps even more dangerous is the potential of outsourcing to raise staff loyalty issues. "Employees might be waiting for the other shoe to drop after a process is outsourced," maintains Al Marcella, author of Outsourcing, Downsizing, and Reengineering--Internal Control Implications, published by The IIA. "If staff perceives that the organization doesn't care about its personnel, employees won't waste their loyalty on the business," he says. "They'll update their resumes and start hunting for new jobs."

John Morgan, director of internal audit services at Deloitte & Touche in Dallas, warns that some outsourcing decisions get the green light from individuals who know that their tenure at the organization is limited. "They may be heroes for making momentary reductions in operating and management costs, but someone else will eventually be responsible for any problems that may arise after the decision-makers leave," he says.

Internal auditing can support the decision-making process by evaluating the organization's rationale for outsourcing a function and determining whether or not outsourcing can deliver the quality and cost improvements that have been purported. "While we don't initiate the deal or make the decision," says Jerry Gardner, vice president of audit services at Integris Health Systems, "we will advise management as to the viability of outsourcing a process."

Morgan stresses the importance of having an independent function, such as internal auditing, perform business case reviews of the suggested outsourcing scenario. "Internal auditing can provide an independent assessment of the assumptions that management has made with regard to proposed benefits of outsourcing," notes Morgan. "Specific areas that the internal auditor can address include whether or not (a) the arrangement will be short-term or long-term, (b) the costs have been proven, and (c) the evidence and calculations supporting the decision to outsource have been verified."

EARLY INVOLVEMENT

Once the organization has determined that the evidence to outsource a given business process is positive and well-supported, top internal audit shops typically take an active role by assisting in the due diligence of potential outsourcing firms and alerting management to areas of concern. "Internal auditing's involvement early on in the outsourcing process is a best practice," says Steve Goepfert, chief audit executive for Continental Airlines. "From vendor selection through contract negotiation, internal auditing has a role to play."

When the organization is negotiating deals with outsourcing providers, Gardner's staff conducts a detailed internal audit before management makes the final selection. Gardner warns that external audits fail to adequately address the controls and systems that might prove problematic in an entity on which his organization will rely.