The decision to outsource a business function remains a major one for any organisation.

Key among pre-sourcing issues is the reason behind the outsourcing: what exactly is the organisation hoping to achieve and are those aims reasonable? Common drivers include the desire to reduce or control costs, and/or improve service quality. Assessing the potential for improvement, however, requires an understanding of the current position. This may involve benchmarking the function in question against industry peers to judge whether significant performance improvements could be anticipated. Assessing potential savings may require some cost-allocation work if the function uses assets that are shared with other parts of the business. Only when armed with this knowledge does it become possible to make an informed decision about the service and benefits you might seek from an outsourcer.

Another driver behind outsourcing may be the need to support strategic development plans that require extra resources. In British Waterways' case the decision to consider outsourcing was initially triggered by the organisation's strategic development plans. 'We were just launching into quite an aggressive ten-year plan which involved a fair amount of diversification of the business,' says Mark Smith, finance director. 'That had implications for the IT infrastructure of the business and we didn't believe that this strategy could be delivered with what we had got. We needed to implement SAP and do some work around our hardware infrastructure.' Following an assessment of its IT needs and potential outsourcing solutions, British Waterways appointed Logica in 2002 to implement and operate a mySAP.com IT solution over a ten-year period. 'Logica will host the SAP software for us and maintain it for ten years, having also been the implementation partner,' says Smith. 'We thought it was important to lock in the implementation partner into a long-term agreement. It is to their advantage to do the best possible implementation because they will be the host for the next 10 years.'

Another attraction of outsourcing can be its potential to drive through benefits following one or more acquisitions. 'When an organisation is acquisitive it rarely gets the benefits out that it told the market it was aiming for,' says Robert Morgan, chief executive of specialist sourcing and outsourcing consultancy Morgan Chambers. 'One of the problems is the internal politics. But you can use outsourcing as the executive tool to force through the implementation of structural changes and cost-savings which formed the logic behind why you bought your competitors.'

The possible benefits of financial reengineering are also worth considering. Outsourcing contracts offer the potential for balance sheet restructuring – removing the assets that are transferred to the outsourcer – as well as for improving operating profits. If the organisation would benefit from an immediate cost-reduction, outsourcing contracts can be back-end loaded so that the first few years are delivered free of charge, with higher charges kicking in later on.

Throughout the pre-sourcing process the question of what exactly should be outsourced must be addressed – a whole function or only part of its activities? The scope may depend on how the organisation perceives its immediate and future needs and capabilities. British Waterways considered a range of outsourcing options and Smith notes that careful management of personnel is required during this stage, particularly if those gathering the information may be directly affected by the outsourcing decision – potentially being transferred to the outsourcer. 'If you are talking about outsourcing IT you definitely need technical input from your IT people,' he says. 'We did some intensive management of people's expectations and tried to get them to see it in a dispassionate way. The guys responded extremely well. I am sure there were worries and concerns, but they didn't knock the thing off course.'

Defining the scope is only part of the presourcing challenge. 'You need to define clearly what you want to get from outsourcing – the output benefits,' says Bob Fawthrop, marketing manager at Logica. 'There are service levels that are nice to have, like having a computer working 99% of the time, but that's irrelevant if all the other things associated with what you need to do as a business don't work. You need to focus on the key performance indicators, as well as service levels.'

A pre-sourcing risk assessment should be conducted to compare the relative risks of retaining the function in-house and of outsourcing it. Risk of retaining may include potential difficulties in finding sufficient qualified personnel to provide the kind of service required. Risks of outsourcing clearly include the potential collapse of the supplier and loss of service. Some of the risks identified can subsequently be mitigated in the contract negotiations, as where the outsourcer pays penalties for sub-standard service.

Outsourcing by its very nature involves the transfer of some risks from the client organisationto the outsourcer. The lower the risks transferred, the lower should be the cost of the outsourcing contract. 'You might look to your outsourcer to rationalise your workforce,' says Damon Rosamond-Lanzetta, a senior associate at solicitors Stephenson Harwood. 'If you transfer over 100 and they only need 80, there's an issue. If you hand over 80 because you have been able to manage a voluntary redundancy or retirement programme, you are going to hand over a smaller risk and you will pay a lot less for it. So the earlier you identify the risks and manage them down, the better the outsourcing solution you will get.'

Some of the pre-sourcing analysis and preparatory work may prove too time-consuming for staff to complete efficiently in addition to their normal work. If so, bringing in extra temporary resources in the form of experienced interim managers may be worth considering. 'We have the capability to help organisations address risk assessment and HR issues, for example' says Chris Beer, joint managing director of Resources Connection UK, an interim management provider. Similarly, interim managers may be able to deliver performance and efficiency improvements in a function prior to it being outsourced. This may be worthwhile where cost-savings are a key driver. 'One of the risks in outsourcing is that the buyer gives away to the outsourcer the benefits that can be obtained from improving efficiencies,' says Bob Leach, Resources Connection's joint MD. 'There are some efficiencies the outsourcer can bring that the company can't get by itself but many of the benefits of reengineering the buyer could probably get for himself if he had the time.' Removing obvious inefficiencies in the function's processes before outsourcing will save money.

One of the final issues to consider when considering whether outsourcing is the right option should actually be whether the organisation could become an outsourcer itself. It may be that the organisation could increase shareholder value more significantly in the long-term by investing in its own functions and then providing selected services to other organisations. 'If you have intimacy of your market and of who might be interested in these services you could take a cost centre and turn it into a revenue centre,' says Morgan. This could be a highly appealing idea for finance directors and management teams with real strategic vision.

In November 2002 Group Lotus, the quality automotive manufacturer, appointed Logica to provide on-going consultancy and IT support and procurement for Lotus' operations in the UK, Malaysia and the USA. Having the potential to access leading-edge IT skills and use them as a tool to advance Lotus' engineering business was a key driver behind the decision. 'By bringing in Logica we could tap into their expertise and all of a sudden, rather than being an IT department of 35 or 40 people in Norfolk, we were connected into a significantly larger IT base with world class knowledge,' says financial director James Stronach.

Secondly, having access to an organisation with greater IT resources was also considered a better risk management option than maintaining more limited resources inhouse. 'The third issue was general quality of service,' says Stronach.

'We believed that the single-minded focus that Logica would bring would get us more out of this business area than we could ourselves. We would do our best, but we are not experts in IT.'

Although cost issues were not paramount, Stronach says Lotus has agreed a competitive deal with Logica. 'It has taken the lump factors out of the spend,' he says. 'I now have a smooth charge over five years. I can budget accordingly for that and we are able to have much greater visibility of IT costs throughout the business.'

During the pre-agreement process, however, Stronach discovered how difficult it is to define actual and desired service levels. 'A huge amount of effort went in there,' he says. 'It's very difficult and a lot of work has to go into quantifying current service levels.'