Whenever outsourcing enters the conversation, the topic of cost naturally takes center stage. Yet, it’s surrounded by widespread misconceptions that can mislead customers, leading to poor decisions and, ultimately, to outsourcing endeavours that fall short of expectations.
Although many facets contribute to a successful outsourcing strategy, this article hones in on seven critical aspects of cost that warrant your attention. Recognizing the value of your time, I’ve distilled these points into concise, actionable insights, enabling busy decision-makers to swiftly assimilate the crucial information needed to steer clear of the pitfalls and pave the way for a successful outsourcing partnership.
The seven principles I present are rooted in decision science research, crafted to guide you through and counter common cognitive biases. With a clear path to better decision-making, these seven principles will safeguard you against the pitfalls that often result in clients getting their fingers burnt:
- The Anchoring Effect: Why going on-site is my number 1 tip for outsourcing success
- Beware of Homer Simpson Logic: Did he really build in 6 weeks what required 6 months?
- Barking up the Wrong Tree: What everyone has got wrong about outsourcing
- ‘Penny Wise, Pound Foolish’: Why narrow vs. broad framing changes everything?
- Goodharts Law: When a measure becomes a target, it ceases to be a good measure
- Contradictory Behaviour: Why our actions and attitudes don’t align
- Comparing Apples to Oranges: Are you looking for the best talent locally but the cheapest ‘quote’ offshore?
1. The Anchoring Effect
Many clients are driven to work with rogue vendors, influenced by the belief that reputed vendors charge unjustifiable margins.
This impression is partly due to the Anchoring Effect and Arbitrary Coherence, two cognitive biases that significantly influence how people perceive and judge prices and value.
The Anchoring Effect is a cognitive bias where initial information heavily influences subsequent decisions. In a notable experiment by psychologists Amos Tversky and Daniel Kahneman, participants spun a wheel with numbers 10 or 65, then estimated the percentage of African countries in the United Nations. Those who spun 10 gave lower estimates, and those who spun 65 gave higher ones, despite the irrelevance of the wheel number. This demonstrates how subconsciously we use arbitrary information as a baseline, affecting our judgments even when we think we’re not influenced by it.
In pricing, the first price seen often becomes the anchor, affecting perceptions of later prices. Higher prices, compared to a low anchor, may seem unjustifiably expensive, even if they’re more reflective of the true market value. This is compounded by Arbitrary Coherence, a concept suggesting that once an anchor is set, people view other prices as reasonable relative to it, even if the anchor was set arbitrarily. In other words, this effect can persist even in the face of evidence suggesting that the higher price is reasonable due to the arbitrary coherence of the initial anchor. These biases lead customers to undervalue higher-priced (and potentially higher-quality) options, as their perception of value is distorted by the initial anchor.
In the context of outsourcing, where clients indiscriminately fish for quotes and the incompetence of rogue vendors is veiled due to distance and a lack of scrutiny and willingness on behalf of clients to communicate, it is now easy to see why quotes from reputed firms can feel highly unreasonable.
The most effective countermeasure to these cognitive biases, therefore, is an on-site visit to vendors (and my number one tip for outsourcing). The entities to whom clients are willing to outsource remotely are often those they would never consider if assessed in person. The lack of substance in such ‘entities’ becomes glaringly apparent upon a physical visit, and the perceived reasonableness of their rates quickly loses credibility. Seeing first-hand how these ‘bare bones’ operations function exposes their inadequacies.
Where an on-site visit may not be feasible, it is important for clients to understand that profit margins for staff augmentation firms are modest, typically between 6-8%. Experienced entrepreneurs and executives know that overhead costs are like icebergs. To offer robust and comprehensive outsourcing services, firms incur significant hidden costs such as compliance, support functions (like customer support, HR, legal, and service delivery), infrastructure, transportation, and the cost of bench resources. Thus, the apparent profit margin can be misleading.
Two key points need to be emphasized:
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- Offering cheap rates is the simplest strategy, but running a reputable business is far more complex than operating a fly-by-night service. Often, the cheapest vendors are merely ‘companies’ in name only, with their low quotes being their sole value proposition, which is precisely why they are the cheapest. Due to the remote nature of offshoring, clients often get a limited view of the actual operations, which can be advantageous for rogue vendors offering minimal service delivery, expertise, or infrastructure support. These vendors charge less because they offer and know less, making direct comparisons with rates of reputable firms illogical and unjustified.
I’ve encountered numerous clients who, upon visiting India, were dismayed at the reality of vendors on their shortlist. A bare-bones service is easy to run, and the distance conceals their lack of substance.
- Offering cheap rates is the simplest strategy, but running a reputable business is far more complex than operating a fly-by-night service. Often, the cheapest vendors are merely ‘companies’ in name only, with their low quotes being their sole value proposition, which is precisely why they are the cheapest. Due to the remote nature of offshoring, clients often get a limited view of the actual operations, which can be advantageous for rogue vendors offering minimal service delivery, expertise, or infrastructure support. These vendors charge less because they offer and know less, making direct comparisons with rates of reputable firms illogical and unjustified.
- Ironically, these rogue firms, while charging less, have lower overheads, resulting in higher profit margins. In short, if you’re hesitant to partner with an established outsourcing company due to a perception of unjustified margins, remember that when you don’t cut corners it always costs more. Ironically, it may be the seemingly cheapest providers who are actually earning higher profit margins at your expense.
The primary concern for clients should be about getting the job done right and focusing on the bigger picture —achieving substantial cost savings, as much as 50-70%—rather than fixating on vendor margins. This mentality, reminiscent of being ‘penny wise and pound foolish,’ contributes to clients being complicit in their own outsourcing failures. They focus on the wrong priorities, a classic case of cutting one’s nose off to spite one’s face.
2. Beware of ‘Homer Simpson’ Logic
Opting for a service that’s half the price but takes three times as long to deliver is not a saving. Surprisingly, many customers fall into this ‘Homer Simpson’ trap, lured by the immediate appeal of low costs.
Many clients neglect to consider what a quote omits. As Peter Drucker, the renowned management consultant, pointed out, “There is nothing worse than doing the wrong thing well.”
It may sound straightforward now, but the truth is that numerous customers dismiss vendors based solely on their quotes. This approach is akin to booking the cheapest holiday package without knowing the destination—undeniably a ‘d’oh!’ moment.
While every project is unique, the intangible costs, potential collateral damage, and opportunity costs for technical projects are usually substantial. Particularly in technical domains, the solution’s design has a significant influence on cost efficiency. Knowing what to do and how long it takes a professional are critical factors that are too often underestimated and ignored.
Consider these immense time and cost savers:
I. The number of times you’ve resolved similar challenges.
II. The breadth and relevance of your work portfolio.
III. Depth of industry knowledge.
IV. Comprehensive understanding of the business case.
V. The broader ecosystem in which the project operates, such as having experienced seniors to guide through unforeseen challenges—a value beyond mere price.
If this seems overstated, take it from Andrew Mills, Chief Technology Officer at CommonSense Monitoring Solutions in the UK. In the video below, he details how a software project he estimated would take him six months was accomplished by his Virtual Employee, Maneesh, in just six weeks—a double advantage!
In essence, it’s all too easy for busy decision-makers to confuse efficiency with effectiveness. We’ve all been there at some point, juggling too many tasks and succumbing to decision fatigue and inattentional blindness. When we are juggling too many tasks it’s easy to forget that our goal is not merely cost, but cost-saving. The two are not the same, and the former is, in fact, a very poor and overly relied-upon heuristic for the latter.
In Part 2 of this 3-part blog, we will talk about the next three principles: Barking up the wrong tree: What everyone has got wrong about outsourcing; Penny Wise, Pound Foolish: Why narrow vs. broad framing changes everything?; and Goodharts Law: When a measure becomes a target, it ceases to be a good measure.
