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Strategic Frameworks for Outsourcing Decisions Part Three

Vivek Sood continues to explain how to strategically outsource in the final part of a three part report

First stage of Outsourcing: Preparation


As the cliché goes – failing to plan is planning to fail, and in case of outsourcing this could not be truer. Outsourcing creates a long lasting relationship with the supplier, which calls for serious and rigorous preparation before committing the company for an extended period. Long-term contracts need long-term strategic thinking.

While in retrospect, preparation looks like an obvious and important step, in practice a majority of companies do not pay enough attention. They move too fast into the next stages and overlook many important points in the preparation process. This oversight explain the unexpected costs that often occur during the implementation.

The company must have a good reason for outsourcing, such as focusing on core services, gaining access to specific skills, reducing the costs, gaining more flexibility in service delivery, improving service quality or access to technology. All this internal information must be rigorously collected and analysed in order to know if outsourcing is indeed the best solution to achieve a business model transformation, and what is the best way of outsourcing. The point is to have a clear, holistic view of a working business model and how outsourcing fits strategically within that model.

The analysis is not only done internally but also covers the customer and product segmentation to outline the marketing strategy of the company. This outside-in view of the company further ensures a strategic fit of outsourcing with the overall corporate strategy.

A lack of preparation will often result into an underestimation of costs (often forgetting the cost of complexity) or also an overestimation of ROI. Other issues to consider at this stage are legal issues, problems of confidentiality and security of the internal data, means of information sharing and preparation of disengagement possibilities.


Second stage of outsourcing: Market Engagement


After a thorough preparation in the first stage, it is time to create a fit-for-purpose market engagement strategy. This could include very formal tenders or RFQs (Request for Quotations) through to RFPs (Requests for Proposals) to semi-formal RFIs (Requests for Information) or even informal discussions with the potential suppliers. In fact there is a whole continuum of market engagement strategies that can be used ranging from very rigid on one end to totally flexible on the other end. The right market engagement strategy will depend on contingent elements that should have been established during the primary stage, such as:

1.      Services to be outsourced, and type of outsourcing arrangement envisaged

2.      Industry dynamics – structure, conduct and performance of competitors in the suppliers’ industry

3.      Company culture

4.      Key objectives and business transformations sought

5.      Amount of co-operation required from the suppliers beyond supply of commodity services

6.      Current supplier relationships

For this reason market dynamics in the supplier market must be thoroughly known and understood. Moreover, precise service requirements must be established and the service delivery process agreed upon before a market engagement document such as RFP, RFQ or RFI is finalized.

The buyer has to carefully analyze the cost of the supplier to know the negotiation margin and establish valid price responses. Moreover, if the price is too low and the supplier is not making enough margin on the contract, the deal is likely to be reneged or marred by underservicing. At the same time, the company should be open to consider all potential suppliers around the world and not only the ones it already has former relationships.

Utilizing information about the suppliers is key in the market engagement stage of outsourcing since it allows companies to have a clear picture of the future total cost of ownership. Indeed the cost of purchase is not always the best proxy to know the efficiency of an outsourcing project. Besides the initial purchase cost, a company has to pay more for future changes, in case of implementation problems. For example the cost of consulting in the implementation of an IT project is much higher than the cost of the software at the beginning. Knowing about the supplier’s practices and history makes it possible to calculate future complementary costs of the outsourcing project.


Third stage of outsourcing: Vendor Selection


A wise colleague quipped that it is ironic that before the outsourcing contract is signed, the vendor is focused on communicating value while the buyer is focused on understanding the costs, while as soon as the contract is signed the roles reverse with the buyer focused on getting value, and the vendor focused on controlling his/her costs.

The key questions at this stage are:

·         How many stages in the selection process?

·         What criteria should be used for each stage to filter the vendors? Is a weighting system appropriate?

·         What is the composition of the selection group?

·         What process should be deployed to form the short list of vendors?

  • How do we ensure that the selection is driven by business objectives rather than unimportant details?

  • How can we incorporates the next stages - integration and relationship management (RM) capabilities – in the selection process itself?

  • How do we ensure that the right penalties and rewards have been incorporated in the contract adequately?

  • How to get an agreement on a rapid integration timetable enabling on-going relationship management with the vendor?

Several methods are used to select the most suitable supplier. The elimination method involves using the predetermined criteria to eliminate gradually the supplier and the winner of the tender is the last company standing. Using another method, the company establishes minimum critical requirements and eliminates any vendor that does not meet them.

Negotiation is a crucial part of the vendor selection process. Multiple rounds of discussions, call-for-responses and other commercial arrangements may be utilized.

Finally, this stage ends when a tailored contract on which the supplier and the customer agree has been created and signed. Along with the general aspects of the relationship, the specific clauses have to be negotiated. The delicate act is in balancing the benefits of both parties and protecting everyone from future dissent, which is the key to long-term relationships.


Fourth stage of outsourcing: Integration


Integration is the most accurate word to describe the next stage that comes after vendor selection – although many call it implementation, deployment or even kick-off.

Why? Because, in effect, the supplier is an outside element which is going to take part in a series of processes within a company. The supplier has to get access to the critical internal information and infrastructure of the company – this aspect carries its own risks. That is why collaboration needs to be based on mutual trust and backed by sound risk management practices.

As the vendor list becomes more global, the supply chains of multinational companies morph into complex business networks with the end customer as the centre of all attention. This customer-centric approach of the network equips the company for fast changing realities. Integration of the new supplier implies integration with all the other stakeholders in the business network.

The key questions at this stage are:

•      How do we jointly create a mechanism that will deliver the envisaged services in an effective and efficient manner?

•      How do we get past formulaic implementation into the real business objectives of this particular relationship and make sure those objectives are continually achieved through the course of the entire relationship?

•      Do we have key performance indicators (KPIs) designed to monitor and report on business objectives with firm views of end goals of the business?

•      How do we make sure that no superfluous data, information or communication distracts from the key objectives of the outsourcing?

•      What meetings are necessary for ongoing relationship management?

-          When, how often?

-          Who? What agenda?

•      What procedures do we need to put in place so that service shortfalls are detected, reported and corrected systematically?

•      How do we make sure that the penalties and rewards will be systematically administered?


Final stage of outsourcing: Value Creation


If all the other stages have been properly executed without shortcuts taken, value should flow out of the arrangement easily and gracefully for both parties. Most companies that blame outsourcing or the vendor should examine carefully where they were less than adequate in the previous four stages.

Outsourcing has been seen, since the beginning, as a tool to reduce costs for a company. However, it is more than just cost saving. Outsourcing is also capable of yielding far more important results: it is a way to produce more value. Using an external supplier’s expertise reduces the time to market, and improves the quality of the products or services.

Every company has a specific set of experience, expertise, capabilities and its own network. Choosing a partner gives a company access to all these external assets. Instead of developing resources with internal capabilities, outsourcing allows companies to leapfrog this costly time consuming process.  .

Outsourcing brings speed, flexibility and expertise - the key power of the business network, the opportunity for a company to be part of a leading team of companies. Complementary business partners create synergies in the value creation process. The supply chain binding the companies together, has the final customer at its core. Intel’s unprecedented decision to make chips for rival companies is an example of value creation. On one hand, companies such as Samsung, Nvidia and Qualcomm can gain access to Intel’s production expertise, on the other hand Intel can utilize its idle production chain and generate revenues.

Amid the globalized competitive landscape, companies are increasingly joining hands and multiply their strategic alliances. The number of partnerships has more than doubled in the last decade and will continue to thrive in the future. If companies can overcome the difficulties in the first phase of collaboration and learn to work together, time will give them the sweetest fruits.

Another way in which a company can benefit from its supplier is that a supply gather insights by providing the same product or service to a large number of customers. You can benefit from this expertise and should take into account their advice. Moreover, they can also have a broader vision of the task. A global supplier provides services in different markets and countries, making its knowledge of the different trends and the specific application of the product or service desirable.

As the business network grows, adding to the number of stakeholders and complexity, it is imperative to have effective project management. Also, companies need to monitor and assess the value creation of its outsourcing project. This can be done by comparing results with predetermined benchmarks, whether against competitors or past performance. Steady evaluation not only helps in translating strategy implementation into a competitive advantage, but also in improving the processes by identifying dysfunctions and bottlenecks. This lays an important step for planning in the future.


Four critical lessons from the leaders who outsource well:


  1. Business network strategies are increasingly important – something which could never be outsourced to your service provider or a contract manufacturing outsourcer.

  2. Great companies are marvellously adept in their ability to unravel the packaged bundles of services presented to them, pick and choose the components that suit them the best, and put together a best-of-breed customized bundle.

  3. Modularization makes it easier to homogenize and hence commoditize a market. Hence, whether it is the market for systems, or for processes, or for physical infrastructure or for services – these are increasingly commoditized going forward. Companies who do well prepare for this coming commoditization and stay on the leading edge of the curve.

  4. Modularization has changed the face of global businesses. All tasks are carried out where it is most cost effective to do so. You can expect service factories to be the norm, working in unison with physical factories in different locations.