Optimizing Outsourcing Relationships for Today's Market Realities

Changes in outsourcing services, terms and delivery models have given manufacturers new tools for dealing with new market conditions.

Outsourcing R&D and product engineering sounds like heresy to many manufacturers, but it has become common practice at others. As manufacturers leave no stone unturned in their search for ways to streamline operations and reduce costs, they are rethinking nearly everything about outsourcing, including:

  • What can be outsourced?
  • How can services be delivered?
  • How should service provider relationships be managed?
  • Are existing contract terms and performance metrics enough to drive desired business outcomes?

The answers to these questions have likely changed since you signed your last outsourcing contract and will shape the scope, scale and success of future engagements. By understanding how conditions are changing, you can work the changes to your favor.

Market Momentum

At the start of 2009 manufacturers faced serious questions about how they could succeed in an environment marked by unprecedented global competition, little liquidity and the modern recession. As 2009 went on, they increasingly found the answer in outsourcing. Manufacturers signed contracts to outsource more than $10.4 billion worth of IT and business process services in the last six months of 2009, nearly double the amount of the first half. The trend was mirrored in other industries -- there were more outsourcing contracts signed globally between September and December 2009 than during any other quarter in history.

All signs point to even more outsourcing in 2010, and manufacturing is expected to be a leading segment. There are $15 billion worth of existing information technology outsourcing (ITO) and business process outsourcing (BPO) contracts due to expire this year, a 41% increase from 2009, so outsourcing service providers have a lot at stake. They're dealing with the recession, too, (despite the second-half surge, 2009 was a down year for outsourcing), and will work harder and more creatively to win your business.

It's All on the Table

Not only are manufacturers expanding their outsourcing activity, but renegotiation of existing contracts is also on the rise. There were a number of large, global outsourcing contracts signed over the past 10 years that brought promises of significant savings, improved service and increased flexibility. During the past year, however, there been a significant movement toward reevaluating and renegotiating these contracts.

Service providers are accustomed to going back to the table to discuss how additional cost savings or service performance can be improved and are prepared to make practical suggestions. Here are some of the trends and new thinking that are driving outsourcing engagements in manufacturing today.

Scope of Services

Outside of contract manufacturing sourcing, which is beyond the scope of this article, IT services accounts for a high percentage of outsourcing by manufacturers, followed by common business process functions. Engineering, product development and R&D represent only a sliver of the back-office outsourcing done by manufacturers, but the fact we've seen an uptick in this activity illustrates the lengths companies are willing to go in search of cost savings and efficiency gains. Outsourcing elements of the product development life cycle has provided manufacturers significant benefits through labor arbitrage and variable resource capacity. As demand for resources fluctuates, access to skilled resources in key areas of design and engineering can provide tremendous flexibility.

While these developments merit watching, other changes in manufacturer outsourcing behavior have become more visible. For example, companies today often look to global service providers to solve significant remote support problems, especially for maintenance and repair, desk-side support and plant operations. Companies who already source these services should monitor performance closely -- while global service providers have the potential to support client operations worldwide, servicing small facilities in remote locations is a challenge for them as well.

Delivery Models

Companies are more accepting of how outsourced services can be performed, and providers have become more competent and creative. Cloud computing is currently driving a lot of discussion and innovation. We suspect that initially, manufacturers will want service providers to provide access to infrastructure and networks to support customized, proprietary client applications. Data security concerns initially may limit outsourcing opportunities for some cloud-based solutions. Market pressure will eventually drive clients to rethink how they leverage standardized software solutions, especially supply chain and plant operations. This change will take time, but companies that fail to leverage these new industry trends will certainly be at a disadvantage.

Service delivery innovation is also occurring outside the cloud. For example, remote support is increasingly being used for higher-level support functions, and some service providers willingly seek to collaborate with others, rather than compete against them, to offer services to clients.

Contract Structures

The average length of outsourcing contracts has fallen eight out of the past 10 years, which has held down contract values. One reason contracts are smaller is that companies are much more likely to split them among multiple service providers. Multi-sourcing, as this is known, is one of the strongest trends in outsourcing. It is done to leverage the abilities of niche service providers and in hopes of capturing more up-front cost savings. Multi-sourcing is also a sign of outsourcing maturity - as manufacturers gain experience with outsourcing, they increase confidence in their ability to manage multiple service providers. This confidence may be misplaced, though, as governance shortcomings are an all-too-common component of outsourcing relationships.

Metrics

More actively monitoring service provider performance often isn't enough -- service level agreements (SLAs) themselves and contract terms need to be updated for the current business climate. We have seen several instances where service providers are in complete compliance with the contract but are not providing the intended beneficial effect. To remedy this, there is a movement toward creating contract terms and performance metrics that align with business outcomes rather than technical performance. Such contracts may reward incremental cost savings, performance gains and transformational results. Some SLA terms may be relaxed and others tightened.

For example, we often see service levels that are measured too broadly across an enterprise. Service level performance that is measured on an aggregate level may not identify business-critical outages or failures at an individual plant or regional facility. Sometimes measuring fewer service levels that directly impact business operations is more desirable than measuring many different technical metrics.

Manufacturers can't change the economy, but they can change how they structure their businesses to thrive in it. Changes in outsourcing services, terms and delivery models have given manufacturers new tools for dealing with new market conditions. You can take advantage of these developments to gain flexibility at a time when it's needed most.

Tim Barry is Associate Partner & Managing Director, Consumer Products and Manufacturing Services at TPI which is a unit of Information Services Group, Inc. (ISG). The firm advises in the areas of insourcing, offshoring, shared services and outsourcing.


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