The Deloitte report found that a quarter of the 25 companies surveyed (which has IT, spends in excess of $50 billion) brought back functions in-house after realizing that they could be addressed more successfully or at a lower cost internally, while 44 percent failed to see cost savings materializing as a result of outsourcing.

The report also found that seven out of 10 firms surveyed have had negative experience with outsourcing projects. It concluded that customers who face more than five problems with the providers are likely to take the insourcing route.

Paul Schwefer, CIO, Continental Group says about his experience while working with IBM “Large companies are so metrics-driven and inflexible that they cannot innovate.” Whereas managing the IT infrastructure requires both commodity services and a good amount of customization. He scrapped the deal and brought back operations in-house to regain control of the program.

The moment customization comes in the picture, costs escalates. Even though the customer pays a maintenance and support fee, each time there is a software upgrade you have to pay for customization. And, customization increases the dependency on the provider. All this leads to a vicious cycle in the relationship.

What added to the disillusionment was that customers had no way of knowing the value they had derived from the outsourcing relation because they could not measure its benefit. The problem is so widespread that about half of the participants in the Deloitte survey (48 percent) admitted that they did not have standardized methodology to evaluate the business case for outsourcing. If only they had instituted more controls and governance in place before outsourcing!

The Changing Economic and Regulatory Environment

The dynamic nature of the business environment calls for constant review of business decisions. What was acceptable during the economic downturn does not hold true during boom times. The imperative of cost cutting pales in comparison for the urgency to achieve scale and growth. As the economy looks up, the need is for stable integration of IT into business processes to achieve competitive edge. Therefore there is a need for tighter control and deeper understanding of processes. The imperative is not costs, but domain knowledge and how technology can be integrated to bring business benefits.

The way Wal-Mart has deployed technology to overhaul its supply chain and gain strategic advantage over competition is an outstanding example of how business vision can be aligned with technology. The moment a Wal-Mart customer picks up any product from the shelf and scans it at the counter, it automatically generates a signal, which updates the inventory, sends a pop-up message on its provider’s screen so that he can immediately make another of that item and ship it to Wal-Mart via the supply chain to keep its shelves well stocked. Not only that, it allows Wal-Mart executives or any of its providers to know exactly which products are moving at what rate and stock accordingly.

That calls for in-depth understanding of the organization’s business processes and goals, which cannot be expected from an outsourcing vendor. It is best to bring back such processes in-house and leave commoditized services to outsourcing providers.

Outsourcing vendors will not be able to bring the kind of commitment that an in-house team can and therefore bringing certain operations in-house with the changing economic environment becomes justified. With the regulatory environment changing everyday and with new regulations like SOX compliance coming in, customers feels more comfortable in bringing back certain processes in-house to exercise greater control over their security processes.

Reality Check: A Peaceful Co-existence

Clearly the hype cycle of the outsourcing fad is over. No longer will a company outsource just because it is the ‘in’ thing to do. Deloitte says outsourcing will lose its “holy grail” status. Cost will continue to be an important factor but companies will ask tougher questions about the benefits of outsourcing. The bulk of the outsourcing activity will be seen in the commodity processes or organization will outsource temporarily to transform functions and run it for a short- term period.

But make no mistake that outsourcing is here to stay. A report last month from Gartner said the worldwide outsourcing market is expected to grow from $293.4 billion in 2003 to $429.2 billion in 2008, an annual growth of 7.9 percent.

At the same time, the increasing complexity associated with outsouring will drive many organizations to resort to insourcing, if not all processes, at least partly. But insourcing has its own set of challenges and pin points which organizations would like to avoid.

Outsourcing is not the end all and be all, but neither is in-house staffing. The best path is to take an analytical approach with a trusted partner and work in a collaborative manner with benchmarks in place. Organizations will have to tread a fine path between insourcing and outsourcing and take individual calls according to business imperatives.