Emily McHugh wishes she had done more homework before deciding to outsource. In 2004, McHugh, CEO of Casauri, which designs laptop cases and travel bags, moved her six-person company from New Jersey to Fort Pierce, Florida. Instead of hunting for real estate and setting up a warehouse, McHugh decided to save herself money and a lot of hassle by hiring an outside firm to manage her inventory and fulfill orders.
But McHugh soon found herself plagued with inventory shortfalls and shipping mistakes. Customers called with complaints that they had received the wrong color, the wrong style, or the wrong number of bags. Eventually, McHugh started looking into alternatives. After more research, she figured out that she could do the job in-house for about half of what she was paying. Now, instead of paying about $80,000 a year to the vendor, she spends $40,000 to lease warehouse space and pay a shipping clerk. "The funny thing is that if the outsourcer had done its job properly, I might never have realized that we could do it better and cheaper on our own," says McHugh.
In a gloomy economic climate, many business owners are looking for ways to slash expenses, and outsourcing is a popular option. But it may not always be the cost saver it appears. Like McHugh, some business owners fail to accurately calculate the costs. Often, when companies add up the savings they will gain by outsourcing, they forget to account for additional expenses that can make outsourcing a pricier option, says Rita Gunther McGrath, an associate professor at Columbia Business School and co-author of The Entrepreneurial Mindset. Before outsourcing to save money, consider these three often-overlooked costs that can run up the bill.
1. VETTING VENDORS Sometimes entrepreneurs underestimate the cost of researching vendors and vetting choices. The process can take weeks or even months and, depending on what is being outsourced, may require site visits and travel costs. And in times like these, entrepreneurs need to budget even more time to dig into each vendor's financial standing, says Paresh K. Shah, president of MindLeaf Technologies in Bedford, Massachusetts. Shah's company, which installs electronic records systems for hospitals, has outsourced several functions, including payroll and IT.
Two of the key questions Shah always makes sure to ask are "What is your current workload?" and "Are your clients paying on time?" He wants to hear that the company has a solid revenue stream and healthy cash flow. "As soon as you outsource part of your business, you are dependent on that vendor," he says. "You need to ask the kinds of questions that will allow you to sleep at night, knowing they won't go out of business the next day." Shah adds that it may be worth paying more to work with an established vendor rather than an upstart offering a lower price.
2. CONTRACT MISTAKES The easiest way to blow your budget on an outsourced project is to fail to define the details in your agreement, says Ken Koch, CEO of Business Resource Management, a business consultancy in Eagan, Minnesota. He says that when companies don't specify clear requirements, delivery deadlines, and budget limitations, it usually results in the vendor's spending more time and charging more money than the client expects.
Because it can be difficult to establish every guideline up front, some experts suggest starting out with a temporary agreement that can be renegotiated a few months later, once the parameters of the job are clearer. McGrath recommends engaging the help of an attorney to ensure that important details that can affect costs -- like specifying a fixed exchange rate if the vendor is overseas -- don't get overlooked.
Lisa Calhoun, founder and CEO of Write2Market, an Atlanta-based company that provides copywriting services, isn't afraid to push back on contract terms. When Calhoun -- who outsources payroll, IT, and several other functions -- signs an agreement with a new vendor, she often fights to include a clause that names her key contact with the vendor and gives her the option to cancel the contract if that person leaves the company.
3. KEEPING TABS "Many entrepreneurs fail to realize the importance of keeping the lines of communication open with their outsourced vendors," says Christine Bullen, a professor at the Stevens Institute of Technology in Hoboken, New Jersey, and the president of the Global Sourcing Council, an organization that studies outsourcing.
Yes, performing weekly or even daily check-ins to make sure outsourced tasks are on track can eat up employees' time; Calhoun of Write2Market says three of her staff members collectively spend about 10 hours a month managing the company's vendors. But the alternative can be even more costly, as Pedro Sostre discovered last year. To trim costs, his Web design firm, Sostre & Associates, which is based in Miami, outsourced part of a project to programmers in India. But Sostre failed to have one of his 10 employees manage the entire project. It was four days before the client's deadline when someone took a look at the work and realized it was a total mess. To make the deadline, Sostre had to take four of his full-time programmers off other projects and pay them to work through a weekend. Sostre ended up losing $15,000 on the project. He still outsources some of his programming, but now he adds an additional 20 percent to 30 percent to his budget to account for the cost of having an employee manage the vendors and fix mistakes.
Even after tallying these extra expenses, outsourcing still might be the cheaper way to go. Even Emily McHugh hasn't sworn off outsourcing completely -- she is using outside firms for graphic design and IT. But she is taking more time to analyze carefully the costs involved. "We never want to wonder again if we're getting our money's worth," she says.
DARREN DAHL is a contributing editor at Inc. Magazine, which he has written for since 2004. He also works as a collaborative writer and editor and has partnered with several high-profile authors. Dahl lives in Asheville, NC.