The Outsourcing Decision
By: Scott S. Tibbo and Roberta J. Duffy Printed in: Inside Supply Management
Who's in and who's out? That is the question. There are many factors that go into the decision about whether or not to outsource a particular business activity or function. Professionals take into account costs, processes, human resources, expertise, company culture, innovation, and overall feasibility. But who is ultimately making the decision? Given the criteria above, it's easy to see how the outsourcing decision might be a natural fit for supply management. After all, evaluating making determinations about best-value processes, operational costs, and the availability of supplier expertise are all core competencies for the leading-edge supply manager.
However, many will say that historically, the actual decision about whether or not to outsource a particular function or activity has often been made elsewhere within the organization. It might be made at the highest executive level and while the reasoning might include the aforementioned criteria, it might also include a political agenda, personal preference, or a disproportionate amount of influence from various business units.
How much more effective will outsourcing decisions be if supply managers are involved from the beginning? There are several advantages - from using market intelligence in order to make the "right" decision, to laying the groundwork for healthy supplier relationship years down the road. To become part of the outsourcing decision and realize these (and many more) benefits, supply management must first, be viewed as a strategic player on the organization's executive team - one whose expertise is valued, and second, be able to deliver on that charge.
The Supply Management Fit
For those professionals looking to make a move into a strategic position on the executive team, there is evidence to support your case. The research firm A.T. Kearney recently published its white paper, "Assessment on Excellence in Procurement," and in it, provided clear data about supply management's value.
Of the upper echelon (the "leaders") of the companies surveyed, over two-thirds use procurement in strategic goal setting, including outsourcing. Compare this to less than one-third of the "followers" using this strategy. "There is a definite correlation between a firm's success and the role of supply management," says William J. Markham, EDS Fellow and principal in the operations practice for A.T. Kearny in Chicago. "The CPO is bringing the supply market perspective and helping to determine what is core and what is not core." In addition, the white paper says that 74 percent of CEOs indicated there was "high" relevance of procurement to shareholder value, compared to 33 percent in 1998 and 15 percent in 1995.
Markham says that the core decision about outsourcing needs to begin with the company understanding what exactly it is trying to achieve through outsourcing. "For most, it's about getting rid of something you don't want or don't need to do in-house, or getting a product or service that you aren't able to do in-house. How does a firm know that it doesn't want or need something? Well, that has to go into the equation." And the elements of that equation are data points that the supply manager can furnish.
Cost factors: Through total cost analysis and activity-based costing, a supply manager can benchmark and determine if costs are too high, particularly compared to what is available in the market.
Service factors: Being market savvy and familiar with possibilities, the supply manager can identify if value-added services could be increased, ultimately decreasing costs or increasing value. Process improvement factors: Process mapping or a reengineering effort often leads to the discovery that some processes are inefficient. It may be determined that outsourcing can alleviate these inefficiencies.
Potential innovation: A supply manager has the ability to identify suppliers in the industry who are leading-edge, with the potential for innovation or new technologies. Particularly in a case where the company may lack its own resources, outsourcing and aligning with an outsourcer for the long term can be the vehicle for realizing these benefits.
In addition to contributing this tangible data, there are further arguments for involving supply management from the beginning in the outsourcing decision process. Because the supply management function is often the charged with contracting, managing, and ultimately building the relationship with the outsourcer, it can be advantageous to have a supply management contact as part of the outsourcing decision team from the onset.
- The supply manager will have a hands-on understanding of the objective and desired result of the outsourcing relationship, meaning that as supplier management issues arise, he or she will have a foundation on which to make those judgments.
- The supply manager will have a better sense of ownership of the outsourcing contract and relationship if involved in the initial decision. This will be advantageous as he or she facilitates the transition and manages changes among internal customers and any business units affected.
- Finally, as is the case in many business models, personalities and a genuine compatibility between contacts can be just as important as any specification, measurement, or contract. If the individual that is going to manage the outsourcer plays a role in the initial decision-making, it will give everyone an opportunity to determine if there is a good "fit" of working personalities.
Stretching
These assessments fall naturally into the realm of supply management activities. However, there are other factors that the firm must consider - requiring information from top executives and other business units. The prudent supply manager will be familiar with many of these through his or her exposure to overall company objectives, but seeking out more in-depth knowledge about these factors is one way of demonstrating a desire and ability to play a larger role in the outsourcing decision. Questions to investigate include:
- What is the firm's comfort level in terms of risk related to intellectual property?
- What are the political issues that may affect the decision?
- What personnel resource issues will arise if outsourcing is implemented? Do those changes align with company objectives?
- What is the company culture as it pertains to outsourcing a core competency? Oftentimes, for indirect goods and services, the concern is not as great, but a core competency may be more intricately fused with a history, brand, or image.
- Is there a risk of creating another competitor in the marketplace if your outsource partner ultimately decided to expand its business?
"It's quite a balancing act," says Markham. On one hand, you want the best-value product or service, but if you outsource something critical, what value are you still adding to the process? It's gets to issues of understanding how you want to manage your intellectual property.
Even under the umbrella of evaluating a particular potential supplier, there will be elements (beyond cost, quality, or technology) that will require the supply manager to partner with other subject matter experts. Legal, finance, human resources, and even marketing may be involved to dissect environmental, labor, contracting, asset allocation, promotional, or future competitive issues.
Holistic Approach
Since the emergence of outsourcing as a business model, the trend has been an increase in its use. However, the most forward thinking supply managers have shifted their thinking and the "outsourcing decision" has become more of a "total business decision." In other words, it's just as much a decision about insourcing as it is about outsourcing. The broader assessment is of the total value chain and from there, it can be ascertained where the activity should lie.
Robert M. Monczka, Ph.D., director of Project 10X for CAPS Research and distinguished research professor of supply chain management at Arizona State University, identifies other trends related to outsourcing. He says that historically, the outsourcing evaluation has been limited to decisions about a particular firm or outsourcer. For example, organizations ask, "Should we outsource this activity to Company XYZ?" Monczka says that a more holistic approach is required. The question should be, "In looking at the entire supply chain, who should be doing what?" This can ultimately lead to activities and responsibilities being housed where they can be accomplished to create value, as opposed to each outsourcing possibility being assess in terms of a single outsourcer. Furthermore, he says that the insourcing/outsourcing decisions will be made on a more cross-enterprise basis; assets will be shared and transferred across the entire value chain; and there may even be nontraditional asset ownership.
Interestingly, there is more research to support the broader view that organizations are continuing to take. Another recent A.T. Kearney white paper entitled "A.T. Kearney's Perspectives on Operations Excellence" provided results from the 2001 Global Excellence in Operations Awards Program. A.T. Kearney's Markham says there is no clear trend whether the outsourcing of manufacturing operations is growing or not. However, there is speculation as to reasons why a firm might choose to keep a noncritical function in-house. One hypothesis is that firms are applying expert manufacturing process - key value-add philosophies - to some non-critical processes and realizing benefits. In other words, all else being equal, it can be advantageous to apply internal collective knowledge across functions to hone processes. Though this model has immense benefits in terms of risk reduction, there are a few caveats: a) most likely, it is only applicable in a small number or organizations, because the "best practice" process must be of the highest degree to realize any benefit; and b) where it has succeeded, it's most likely not been a conscious effort on the part of the company, just an emerging phenomenon as individuals move across functions.
Because so many aspects of outsourcing align with the activities and core competencies of supply management, organizations that do not involve the function in initial discussions are not taking full advantage of internal expertise.
Being involved in such business decisions, such as the outsourcing of a critical function or one that falls outside the "traditional" realm of supply management, give supply managers an opportunity to shine. Collecting information and demonstrating the analytical skills required to make an educated decision that affects the broad organizational goals might open the door for even further interaction and responsibility at the executive level.
Delivering the Goods
The degree to which supply managers are involved at the highest strategic level when it comes to outsourcing decisions may be varied. All the above claims are solid arguments for why and how supply management can take an aggressive role, but the test will be in a supply manager's ability. To gain the respect and responsibility is to be able to demonstrate that they can, in fact, get the job done. They must use the proper decision-making tools and show that their expertise in this area will add value to the outsourcing decision.
Below is one tool that can be used prior to outsourcing to assess the current supply environment and determine baseline costs.
Considering Outsourcing? Establish the Baseline First
By Scott S. Tibbo, CFM
Common Problems
Outsourced functions run the gamut, from facilities management, real estate, architecture and engineering, food services, or mail services, to name a few. And the driving motivation can be just as varied. These services can be awarded through a competitive bid process, or negotiated directly between an owner and a pre-qualified service provider. The form of contract can range from a fixed fee arrangement, to a cost-plus and management fee basis, to a guaranteed maximum price scenario.
Yet, regardless of what is being outsourced, why its being outsourced, or what methods will eventually be used to select and contract with the provider, over the past 10 years, many outsourcing initiatives have either failed or experienced strained relationships due to owner dissatisfaction with the performance of the service provider and/or an inability to effectively control costs of the work being performed. The most common root causes of these problems are typically poorly defined customer expectations, inaccurate workload projections, and inadequate scope definitions as defined by the client. The presence of any of these can result in a misalignment between the client's expectations and the service provider's initial price proposal.
An equally significant and common challenge of outsourcing is that many internal managers have not been able to accurately determine (or report to senior management) actual cost savings or operating cost reductions that have been captured post-outsourcing. This may be because "baseline" costs and service provisions were not defined prior to outsourcing the activity. As a result, the owner could not accurately quantify their actual cost of operation relative to the financial bid offered by the outsource provider. It may also be due to the aggregation of services within the owners scope of work (SOW) preventing the ability to price each service separately. As a result, owners may need to make the financial decision to outsource based only on high-level, aggregated pricing.
The Proposed Solution
The proposed solution means establishing a baseline assessment - prior to pursuing outsourcing. It can be used as an analysis of the current environment and will establish a clear understanding of the current service level expectations, work volumes and baseline costs. Insufficient resources, or a lack of expertise for how to collect, analyze and document the findings, are not good reasons to avoid this critical step. Following is a brief overview of the concepts and basic process one can follow to establish their baseline assessment.
Step One: Start at the Top
Even though the long-term goal may be to fully outsource the services currently provided by a department, it is still essential that the scope definitions and service level expectations are aligned with the critical business drivers of the company. Therefore, when documenting the scope of work and defining the service level agreements (SLAs) against which the outsource provider will be measured, it is recommended that the SLA be reviewed with key representatives from the major customers/users within the company for their input. Make sure to align the range of services, scope of work and SLAs with the long-term needs of the company and its key operating units.
Step Two: Data Gathering
After defining all of the services to be included within the outsourced scope of work, compile specific data such as internal staffing allocations, cost of salary and fringe benefits, allocations of corporate overhead costs, materials and supplies, contracted services, as well as annual volumes specifically related to each of the services under consideration. Build a financial model to capture all of this data and calculate a true "total cost" for each service on an annual, activity, or unit cost basis, whichever is most appropriate. Validate that the totals cost within the model tie back to the operating statements and/or general ledger reports. This financial information will serve as a "baseline" comparison for the outsourcing bids as well as the foundation for measurement of the selected provider on a prospective basis.
Some specific examples of the level of detail in which baseline information could be categorized for different operations are as follows:
Facilities management: Breakdown all operating expenses (cleaning, repairs and maintenance, utilities, grounds and security, administrative costs, and fixed costs) into separate cost categories on a building by building basis.
Facility services: Breakdown all cost associated with support of the customer/users (project management, space planning, conference room set-ups, tenant construction, move/add/change, etc.) into separate cost categories by service.
Real estate: Breakdown all cost associated with managing the real estate portfolio (transaction management, lease administration, architectural services, space management, strategic planning, etc.) into separate cost categories by service.
Mail services: Breakdown all cost associated with receiving, sorting and distributing the mail into separate activity costs per transaction (average cost per piece of incoming mail, outgoing mail, accountable mail, presorting and fulfillment, etc.).
Step Three: Benchmarking
Prior to going to bid it is advisable to gather current benchmark data on average costs for each of the services that are being considered for outsourcing. This step will help evaluate where current (baseline) costs are in relation to the market prior to investing in the RFP development/bid process and also predict potential cost reduction opportunities. In some instances, published industry benchmarks are available (such as BOMA and IFMA for building operating costs), however, in other cases such as average unit costs for project management, design services, or mail services, published industry benchmarks do not exist. Therefore, this information can be obtained by contacting peer organizations or using other resources such as suppliers and consultants. If done accurately, this information is also helpful to establish a business case for outsourcing - or not, depending upon the results of the analysis.
Next Steps
Now that the scope of work, SLAs and baseline financials have been accurately established, this information can be used as the foundation to prepare a clear and concise request for proposal. It is essential that the information conveyed through the RFP accurately articulates the firm's service expectations, projected volumes, and measurement criteria so the bidding organizations can adequately determine how to approach, staff and price their services. It is equally important to provide a detailed set of pricing models within the RFP that will allow the bidders to submit pricing for the various services at the same level of detail in which the baseline costs were captured. This will allow a comparison of the financial aspects of each proposal in detail between multiple bidders, as well as against the baseline costs. Having detailed information is critical to analyze outsourcing bids, negotiate financial proposals, and establish pricing models with the selected provider.
Elimination of ambiguity, clarity of specifications, and a realistic context will contribute significantly to a healthy and successful outsourcing relationship. There are many different outsourcing structures that work, many good providers and a great deal of opportunities to reduce costs. But without knowing where you are trying to go, it's hard to know if you ever got there.
