Outsourcing Point/Counterpoint

Jan. 8, 2010
Outsourcing may not always be a sure-fire, can't miss strategy for improving bottom line performance.

Anyone who has been monitoring the business press and industry trends in the past 18 months or so will have noticed that outsourcing may not always be a sure-fire, can't miss strategy for improving bottom line performance.

Some examples that highlight the doubts that are being raised are:

  • Numerous surveys indicate that anywhere from 17% to 53% of customers have not realized business value / return on investment from offshore outsourcing. (CIO, 2008)
  • "58% of organizations surveyed could not confirm that outsourcing had clearly improved financial performance. 90% of customer organizations didn't accurately understand the opportunity costs of the selection process and 79% of such organizations couldn't accurately identify the internal financial cost of the sourcing selection process. ( KPMG, 2008)

These and similar findings / comments are becoming increasingly common. Many are beginning to question the value of outsourcing as a strategy and there is a growing sentiment for bringing activities back in house. We believe that is faulty thinking. Outsourcing, done well, is a powerful tool, especially for manufacturing companies. The key is to avoid two critical errors that frequently result in value leakage across the entire portfolio of outsourced good and services.

Those errors are:

  • Fire, Aim, Ready Decision Making -- Companies that would otherwise go slowly to carefully assess the overall value proposition for outsourcing fall into the trap of assuming that the answer will always be Outsourcing = Competitive Advantage because so many of other companies are doing it and are reporting significant benefits as a result. For companies just getting into outsourcing, this is often compounded by the fear that they are late to the party and have to run to catch up.
  • Don't Confuse Me With Facts Decision Making -- In companies where outsourcing is pushed as the optimal strategy, there is a danger that management may reject any analysis that does not conclude that outsourcing will be successful. Knowing what results are expected, assumptions, data collection, analysis, and conclusions may be skewed to support a recommendation to proceed. For companies with experience in outsourcing, this is compounded by the creation of internal structures whose growth and rewards depend on expansion of the outsourced portfolio.

The key to making successful decisions lies in understanding some of the key factors that influence the outsourcing process. While there are many nuances and each situation requires careful scrutiny, there are several choices that need to be fully understood by all who are involved with the outsourcing decision. Here are three of the most critical ones.

Specific vs. General Competencies

It is extremely difficult to create maximum value without detailed knowledge of the markets from which outsourced goods and services will be obtained. At the same time, companies need to recognize that long-term value is created by developing and maintaining outsourcing competencies, and not by developing and maintaining country or regional (Chinese, Brazilian, Eastern European) outsourcing expertise. The answer to the question, "Where to outsource?" is constantly changing. In general, by the time your organization develops real depth and breadth of expertise focused on a particularly attractive region, that region may no longer be the optimum locale from which to obtain goods and services. The answer is to develop general outsourcing competencies that include quickly identifying partners who can provide the detailed country-specific knowledge and competency necessary to ensure that value is created and risk is minimized.

Leading vs. Following

The earlier you enter a market, the greater are the potential rewards. That also means that the risks are substantially higher as well. Risk is substantially reduced by letting others blaze the trail. The problem is that, if you wait too long, you may find that the cost benefit equation no longer clearly supports your outsourcing decision. The best approach is to take a balanced perspective that looks at short term and long term risks and opportunities. For example, the long term value of getting into an emerging market very early may more than offset the risk if you are sourcing a non-strategic category and you are sure that, in the event of need, you can quickly shift to less risky sources. On the other hand, the risk to the business if you were to be the first one into a new market as you outsourced a strategic component for which there are few fall backs would be far too great, regardless of the possible value for doing so.

Total Cost of Ownership vs. Fully Loaded Costs

In many cases, the justification for a proposed outsourcing venture focuses on the traditional components of a Total Cost of Ownership (TCO) analysis. While this is a valuable component in establishing the business case for outsourcing, it frequently overlooks many indirect costs that can have a significant impact on the overall value that can be gained from outsourcing. This is why many companies find that reduced cost of ownership does not necessarily equate to improved financial performance.

Essentially, the cost savings for the components and / or activities that are outsourced are frequently offset by hidden costs that have not been allocated to the outsourcing effort. One frequent cost that is often overlooked is the creation of an outsourcing competency center within the customer's organization. The salaries, benefits, equipment, travel, etc. associated with such a center should be spread across all outsourced goods and services on a reasonable and equitable basis, a step that is seldom included when building the business case for any single outsourcing decision.

Cost Arbitrage vs. Value Arbitrage

Traditionally, the advantage of outsourcing lies in taking advantage of difference in cost, most specifically, labor cost, between two different markets. Today, outsourcing decisions that are based solely on differences in cost are missing a major driver of value in the outsourcing arena. Before committing to outsource to a particular locale, it is absolutely critical that future market potential in that locale be included in the equation. The so called Optimal Zone, where cost savings are high and local market potential is high, should be the long-term goal of any outsourcing strategy. Focusing on cost alone insures that any competitive advantage will be relatively short-lived.

Each of these challenges inevitably confronts any organization when outsourcing is the topic. When the company is looking to send its goods and / or services to providers who are also off-shore, they present even greater challenges. The key is to recognize that there are tremendous opportunities in outsourcing and that high risk always accompanies high rewards. To insure that the risks are identified and minimized and that the rewards far outweigh those risks, companies should take the time to do their homework and should always base their decisions on objective analyses.

Dr. Lowell Yarusso is Vice President and Talent Manager ,of The Mpower Group which provides specialized services in management consulting, strategic sourcing and training. www.thempowergroup.com

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