LAST month Network Rail announced that it was bringing all its pounds 1.3 billion annual maintenance business in-house and restructuring itself around its main routes – that is, to fit with its operating company customers. A total of 18,500 people will be transferred from the private engineering companies to the track operator in the biggest shake-up since rail privatisation in the mid-1990s. The move is also unusual. Insourcing of any kind runs so counter to trends that it is worth stopping to ponder what it means.

Conventional wisdom of the past 20 years is that the more companies can outsource routine tasks to specialist providers, the better. ‘Outsource everything except your soul!’ exhorted Tom Peters. What started with catering, security and other low-level tasks now embraces training, logistics, IT and even HR. IT outsourcing particularly is now a massive business.

The argument for outsourcing is that it imports market discipline. ‘You can see what the service costs and change the provider if you aren’t satisfied,’ says Iayn Clark of International Strategic Management, a provider of specialist services for ad hoc assignments – due diligence for banks and high-level training, for example – for which organisations cannot cost-effectively maintain full-time teams. In theory, too, specialised providers of ‘commodity’ services should be able to do it more cheaply through focus, economies of scale and access to the latest technologies.

But, as ever, the reality is more complicated. Even a cursory look at the literature reveals that at least half of all outsourcing projects fail to live up to expectations. Only a few save substantial amounts, and even outsourcing providers suggest cost-cutting is not the place to start. Once the profit margin of the provider and cost of managing the contract – anything from 4.5 to 10 per cent of the fee – are taken into account, the figures look a lot less attractive.

Experience also shows, counterintuitively, that it is rash to outsource something you do badly or don’t know much about. Faced with a supplier whose core competence is negotiating contracts and knowing what the costs really are, you’ll end up locked in and paying too much in the long term if not in the short. This is the paradox of outsourcing: to do it properly you have to know as much about the function as the provider, in which case why not do it yourself.

But why would you want to do routine stuff in-house? Back to Network Rail. In this case, what suffered was not cost (at least not directly) but quality. Faced with declining payments to take account of anticipated efficiency savings, the companies protected shareholders and prof its by cutting costs at the sharp end, with unfortunate results for the operation as a whole, to say the least.

Network Rail’s predecessor, Railtrack, was also fatally split, with the needs of shareholders fighting for priority with those of the network. Boundaries between companies are shifting all the time. There will always be a flow of work in and out. But it should be guided by principle, not fashion.

And what happened to the rail network is a classic example of outsourcing for the wrong reason: the fashionable fallacy of treating companies as if they were markets. The idea was that by contracting in the market, and managing those contracts, Railtrack (as it then was) would be able to use its maintenance resources more efficiently. And not just for maintenance: there was so much outsourcing going on at one stage, according to one employee, that the company had outsourced the outsourcing process.

But companies aren’t markets. They obey different operating logic and have different roles. Markets evolve blindly, guided by the invisible hand towards the most efficient short-term use of resources. Unfortunately, although Railtrack didn’t realise it, there is no guarantee that short-term efficiency coincides with the larger purpose of the company. For companies do have purpose. That is their point. They are intentional entities. They can choose to sacrifice some short-term efficiencies for the sake of innovation that increases their store of resources in the long term.

Ironically, it is only now that it is no longer a private-sector company in the normal sense that Network Rail can develop that long-term dynamic efficiency by focusing on the things it should be doing: hence the reorganisation. ‘Our focus is now on engineering: rebuilding and maintaining the railway,’ says a spokesperson.

Having already taken one contract back in-house, precisely to get a hands-on feel for how maintenance was being managed and costed, Network Rail believes it can save pounds 200 million to pounds 300m from the overall bill – and do it better.

But even if it weren’t cheaper in the short term, if Network Rail is to build its organisational vocation as a great engineering company – which it must do for long-term efficiency – then maintenance has to be in-house.

Renewal stays outside (as it was in the days of British Rail), but understanding maintenance will enable it to make more informed and timely decisions about rebuilding, Network Rail believes. Maintenance is its soul, and has to be treated with due reverence.

The Observer, 30 November 2003