Archive for the ‘Outsourcing’ Tag

The dangers of outsourcing

Conventional wisdom says companies should outsource manufacturing and operations to take advantage of lower wages and faster operational scalability. Aside from the question of whether this strategy (particularly when it involves offshoring) always delivers the promised benefits, you may also wonder whether outsourcing makes long-term strategic sense. The demise of Kodak, the iconic U.S. photography company, suggests organizations need to be wary of outsourcing strategic business activities. Outsourcing has been occurring for decades, based on the idea that moving labour-intensive work offshore would significantly reduce cost, without jeopardizing a firm’s competitiveness.

Kodak’s fall shows this is a dangerous assumption. Companies can unknowingly reduce their competitiveness when strategic work such as manufacturing and product design is outsourced. In other words, they stand a good chance of loosing the secret sauce that drives meaningful differentiation. Moreover, outsourcing accelerates the diffusion of knowledge and talent to outsiders thereby lowering barriers to entry. The result is higher levels of competition and a lower return on invested capital.In addition, many operations that were once performed more economically offshore can now be in-sourced at a similar cost and much lower risk.

Founded in 1893, Kodak was the dominant player in the camera, film and processing business with a strong reputation for product and manufacturing innovation. Ironically, Kodak developed the world’s first digital camera in 1975, yet was never able to leverage that early success to take advantage of the market shift to digital photography. Instead, the way Kodak expanded its digital business sowed the seeds of its demise. In 2013 the firm declared bankruptcy.

Harvard Business School Professor Willy Shih had a front row seat, having served as president of Kodak’s Digital & Applied Imaging business through the turn of the 21st century. “Much of the camera technology was invented in the United States, but U.S. companies gave it all up,” Shih said. He contends that when Kodak moved pieces of their operations overseas many years before, they lost technical expertise, product innovation and manufacturing skills. When digital cameras became the rage, Kodak had lost the ability to put together a compelling digital camera solution. As a result, they were unable to compete in this rapidly growing market. Coincidentally or not, other companies such as Dell, Blackberry/RIM and HP saw their fortunes decline during the same time they aggressively offshored major parts of their value chain.

From a strategic perspective, manufacturing a product can trigger new ideas that lead to improved operational efficiencies and product innovation, especially when there is close contact between users and designers at the production level. Maintaining key operations also allows companies to retain vital research and development, support and manufacturing knowledge, which are key to producing next-generation products. These long-term spillover effects can explain why successful consumer technology companies such as Apple and Google limit outsourcing to manufacturing, and keep product design, branding and customer support in-house.

Outsourcing need not be a risky strategy. The following are three things leaders should consider in deciding which activities are performed internally and which can be left to others:

Focus on what’s important

Many of the managers we speak with do not know what makes their organizations tick. Leaders need to know the key capabilities (e.g., assets, brands, people, knowledge, and resources) that deliver their unique value proposition so they can safeguard them.

They also need to understand what new capabilities (e.g., digital competencies) are required to generate growth three to five years out.

Double down on the core

Continue or increase investment in your differentiating, core capabilities that drive your market position and return on assets. These areas would include innovation, brand building, customer service or employee training.

Take steps to in-source strategic activities (those that are needed for growth) from external vendors.

Optimize existing relationships

For the foreseeable future, outsourcing is here to stay. It is unrealistic for companies to do everything in-house. In other cases, it is essential to unwind outsourcing arrangements or build up internal capabilities.

For these ‘sticky’ deals, managers should review and optimize their existing relationships to: Insist on and enable providers to deliver continuous improvement in terms of innovation, service levels or cost savings; ensure the company has mechanisms to capture the same learnings in areas such as product manufacturability and process efficiencies as their outsourcer; consider a dual outsourcing and in-house strategy for some activities to maintain flexibility and knowledge accumulation.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

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Offshoring’s burn victims

RBC’s recent imbroglio over its Indian IT outsourcing practices illuminated the pitfalls of dealing with offshore providers.  Unfortunately, the Bank’s experience is not unique.  Contrary to conventional wisdom, IT offshoring has not been a boon for every North American firm pursuing that strategy.   Quality and service have struggled to meet stricter North American performance and service standards. Moreover, India’s labour cost advantage is declining for a variety of macro economic reasons. Finally, pervasive business and brand risks remain.  Leaders need to relook their existing offshore relationships to ensure they still make business sense and consider new compelling, ‘Made-in-Canada’ alternatives.

Offshoring IT operations have always been difficult and risky; the RBC/iGATE flap is merely the public tip of the iceberg.   Alex Rodov, CEO of a leading Canadian IT testing firm QA Consultants, has seen the damage of these arrangements first hand:  “Offshoring is no longer the bargain it once was.  It is not uncommon to see higher – not lower – costs, more hassles, delayed time to market and compromised quality.”

Our research uncovered the following example of an offshoring ‘burn victim:’

Financial Services project is “A Bridge Too Far”

A leading financial services company was looking to launch a major, new online offering.  The firm did not have the internal capabilities to build this platform themselves.  They chose to outsource the initiative to a large Indian IT services provider.  This is where the problems began. The Indian firm underpriced the project to get the deal.  They also took the client’s business and technical requirements ‘as is’ without vetting its feasibility.

Ultra low cost pricing is a common strategy for offshore providers to gain market share.  In this case, unfortunately, it did not leave them much margin room to validate the client requirements or assign enough experienced staff.  As a result, the provider missed gaps in the software architecture and did not fully understand the client’s needs and expectations.  Not surprisingly, each version of the delivered code did not meet quality expectations.  Furthermore, the cultural, time and language differences hampered alignment around expectations and trouble-shooting. The provider tried to redress the quality issues by throwing more staff at the problem – and then tried to get the client to pay for them.  Not only did this generate more friction in the relationship but it also failed to address the root cause of the problem namely misaligned goals, poor Indian staff quality and an unbridgeable cultural and linguistic divide.

This is not a case of a single deal gone bad but rather one example of the real difficulties commissioning knowledge-based work thousands of miles away.  This story did not end well.  The initiative had a target budget and delivery of $3.2 million and 7 months respectively.  It eventually was delivered in 22 months for a total cost exceeding $65 million.

Declining India…

Blaming one party or another is too simplistic.  Failure has many fathers.  Business conditions have fundamentally changed – and not in India’s favour.  For one thing, India is losing its luster as the lowest cost place to undertake IT activities. According to 2010 U.S. Bureau of Labour Statistics, India’s average per hour cost advantage has shrunk to only 6-7x U.S. rates (versus a 20x times advantage 10 years earlier).  Furthermore, the quality of the Indian workforce has never lived up to expectations.  The Wall Street Journal has reported that 75% of technical graduates are unemployable by their IT sector. Finally, bridging the relationship/cultural divide has proven to be more challenging and pervasive than anticipated.   In all its forms, distance really does matter.

…Emerging Canada

At the same time, Canadian IT service companies have become more competitive, taking advantage of moderating Canadian wage rates, a steadily increasing, educated (and stable) workforce and a growing sentiment that we need to cultivate strong local businesses. The emergence of globally competitive Canadian IT services firms is giving North American companies more choice, not to mention highlighting the value of good old fashion Canadian innovation and hard work.  To wit, QA Consultant’s roster of blue chip clients such as Loblaw, Bank of America, Praxair and Canadian Tire, demonstrates that leading North American firms recognize the business and reputational advantage of staying closer to home when outsourcing key processes.

Most likely, the optimal outsourcing strategy will include a mixture of local and offshore operations, with the ultimate decision based on an assessment of total delivered cost, the importance of local control and predictability and; a prudent evaluation of brand and intellectual property risk.  Managers should approach these decisions objectively and not be afraid to challenge conventional wisdom that lower cost and higher performance can only be found offshore.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

Retaining employee expertise

 

It’s an organizational fact of life that talented and experienced people will move on — whether through headcount reductions, promotions or leaving for a better job. The knowledge that departs is often vital to a firm’s capabilities and a key source of best practices. This flight often ends up weakening the company, increasing costs and boosting risks.  To preempt this outcome, leaders should develop talent plans for key employees that capture organizational history, best practices and customer insights.

Many kinds of knowledge are at risk of disappearing with key employee turnover.  This expertise could be around key business relationships, customer insights, or having an implicit understanding of how the organization really operates or how a product has been designed.  Information risk is especially acute under times of business distress or when circumstances (e.g., a merger) overwhelm deliberate thinking.  Outside of risk mitigation, documenting and sharing expertise in a timely fashion is a great way of driving continuous improvement and minimizing costs.

Two of our previous client engagements illustrate the hazards of not retaining wisdom:

Product firm outsources key activities

This company decided to outsource an important business process, making the operational team redundant.  Despite a long implementation period, little attention was paid to retaining the team’s institutional knowledge. This was a fateful omission.  The firm no longer had the expertise to effectively manage the outsourcer, resulting in higher costs and reduced operational performance.  Furthermore, the lack of know-how prevented the company from exploiting new innovations that could have improved consumer satisfaction.

IT company is acquired

A rapidly growing software firm was purchased by a large IT services company.  As buyers are apt to do, they quickly brought in their own teams and processes, and rationalized many of the functions including sales and product development.  This process was handled clumsily.  Incoming managers spent too little time understanding the informal works practices used to get their jobs done.  Moreover, they did little to preempt expertise gaps through knowledge transfer or retaining key people as consultants.  These omissions created significant problems around client retention, customer service and software upgrades.

In both cases, outcomes would have been better if these companies codified and managed their expertise, had timely knowledge transfer and archived important historical information in accessible places. The reality for many organizations, unfortunately, is the opposite.  The proficiency of a small team or even a single person can be a challenge to re-accumulate when needed.  Vital know-how (especially implicit knowledge that is never written down) is often spread over many people or buried in IT silos. In fact, losing implicit data may represent the biggest danger because managers may not even know it existed in the first place.

How can firms avoid these pitfalls?

First, recognize this issue is not about better severance packages or employee engagement.  Key people will leave; you just have to manage the risk, and work on better documenting and sharing their expertise.  Catherine McIntyre, SVP Strategy and Development at LoyaltyOne, believes capturing institutional knowledge is crucial.   “My experience at LoyaltyOne and P&G shows it’s essential to do and it definitely pays out in many ways. Like most leadership tasks, it takes planning and showing we truly supported the work by participating in some meaningful way.”

This can be achieved by exploring three key questions:

Which employees have risks, opportunities?

Who are your experts in the key roles?  Usually, they will be long serving employees who manage customer relationships or design products.  These people may not always be high in the organization or be the ones with the most seniority.

What do we need to learn from them?

What are best practices, indispensable skills or work habits needed for important tasks?  You will often need to go deep to understand the “art” of the job.  In key accounts, for example, who are the decision makers, barriers and influencers?  Or, what “pitch” seems to work best?

How will we get this knowledge, in a sensible way?

High performance companies bake information sharing into every employee’s job description and performance plans. We also recommend regular team and department debriefs, as well as 1:1 mentoring with those workers most likely to graduate to key roles.  McIntyre takes a comprehensive approach to talent management. “I’ve used a variety of approaches, appropriate for the type of knowledge to be captured and the existing culture. This included special functional training as groups of people were promoted into new levels, job shadowing for those being groomed for next roles, and case study competitions to encourage documenting the most current knowledge.” Companies looking to be more strategic in their approach may want to develop apprentice programs, encourage more inter-department job mobility and look to create internships with key suppliers, especially outsourcers.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

 

Supply chain strategy gone wild

When it comes to best practice supply chain strategy, conventional wisdom is shifting.  Historically, companies – particularly automotive, electronics and telecom original equipment manufacturers (OEMs) – have outsourced most of their non-core operations.  Some firms outsource so much of their operations that they do almost nothing themselves except for design and quality control. This approach, however, has not delivered the hoped for benefits. Many supply chain leaders are now rethinking how they craft and manage outsourcing relationships and whether these continue to be aligned with their core business strategy. 

Inspired by the Japanese, virtually every North American OEM aggressively shifted to an outsourced and tiered supply chain so that they could reduce costs, minimize capital and focus on their core competencies.   As part of this strategy, managers reduced the number of suppliers a firm directly deals with; gave these tier 1 suppliers the mandate to design, produce and deliver major components and; off-loaded the responsibility of managing lower tier vendors to their tier 1 suppliers.

These blanket outsourcing deals, according to supply chain experts Thomas Choi and Tom Linton, are problematic.  Costs rarely fall significantly, and will often rise.  Moreover, firms may also experience declining competitiveness due to reduced access to emerging innovations and vital market information.  How does this happen? 

Less control over bill of material costs

When the OEM delegate’s control over a product’s BOM, the total delivered cost of the product (including items like inventory management and logistics) become opaque and difficult to manage.  This lack of visibility makes it difficult for the OEM to leverage further volume discounts and to switch suppliers to get better pricing.

Reduced OEM control can also lead to decreased supplier compliance.  When working with an automotive manufacturer, we discovered that tier 1 suppliers often veered from the approved vendor list (of the companies from which top-tier suppliers are supposed to buy parts and materials) when it served their interests.  This was most common with standardized materials and where they could keep most if not all of the cost savings.  Better management of tier 1 suppliers is possible, but it is a challenging and potentially confrontational exercise.

Restricted access to market and technology information

Paying no attention to lower-tier suppliers who serve multiple industries shut the OEM out of potentially important technology and market developments. For example, without close supplier relationships at the raw material level, companies may miss opportunities to adjust orders and lock in favorable prices as well as gain access to the newest technologies. Tight collaboration with lower tier suppliers has enabled companies like Apple and LG Electronics to incorporate the newest chip designs into their products before their rivals do, and to secure these technologies at advantageous prices.

Tier 1 suppliers should be the conduit of market information and innovation.  However, they often don’t have the inclination or time to monitor the technology landscape below them. Furthermore, tier 1 suppliers may pursue a different strategic agenda than the OEM.  For example, tier 1 suppliers could knowingly withhold market information in order to improve their bargaining position with their customers or to use the information to sell to other business prospects.

There are ways to get more out of your supply chain while reducing risk.  For example:

  1. Retain purchasing and technical control over items that have the most significant impact on the total cost of goods sold.  For many products such as a mobile phone, TV or a PC, a few inputs could make up more than 50% of its total BOM cost. Just a 1% reduction in the price of such items translates into considerable savings.
  2. Get more visibility into your supplier networks. Innovative firms like Apple play close attention to what is going on in their entire supply chain’s R&D pipeline.  Five years ago, Apple understood that HMI (human machine interface) technologies would play a strategic role in future products, so it maintained close relationships with companies in that space. The move paid off.  Apple now has excellent visibility into a sub-system that accounts for more than 40% of the iPad 2’s total cost and is crucial to Apple’s goal of delivering meaningful product differentiation.
  3. Pay close attention to lower tier vendors that serve multiple industries.  Some suppliers, particularly in the technology, services and commodity sectors, provide inputs to multiple industries.  These firms can provide early warning signals around technology, pricing and regulatory changes. To lock-in preferential supply arrangements, our automotive client secured contracts with strategic lower-tier vendors.  The OEM then stipulated that their tier 1 suppliers use those vendors exclusively and execute the strict terms on their behalf.

To drive supply chain performance and reduce risk, firms must optimize their outsourcing partnerships.  Our experience shows that many tier 1 suppliers and their vendors are amenable to closer collaboration if given the chance and presented with tangible business benefits. Where outsourcing ends up being too problematic or inconsistent with long term corporate goals, CEOs may want to consider vertical integration as a more appropriate business strategy.  Many companies have, with impressive results.

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

Maximizing the Potential of Outsourcing Engineering Work

Few companies today would hesitate to outsource routine operations like IT services and call centers, but farming out engineering and product development is another story.  And for good reason.  Many companies have failed to achieve the same results outsourcing core engineering and product work as they have with back office operations.  In other cases, firms are reluctant to lose direct and visible control over mission-critical activities versus non-core operations.

Engineering and product development are expensive activities, making up between 3% and 10% of revenues depending on the sector.  There are compelling reasons to outsource this kind of work to centers like Bangalore, Shanghai and Budapest.  For one thing, potential cost savings are significant considering that offshore engineers earn a fraction of their North American or European counterparts. Secondly, most foreign engineers (particularly in IT) are trained in the latest tools and methodologies as opposed to many North American engineers who have only been exposed to older techniques.  Thirdly, for firms operating under strict time constraints the ability to conduct round-the-clock development over different geographies is very appealing. 

Outsourcing engineering has been difficult for many firms. For one thing, this kind of work is complex, expensive and risky, challenging even under the best of circumstances.  Secondly, these undertakings require a high level of internal collaboration as well as regular interactions with customers and suppliers. This level of engagement is not always feasible when key activities are offshore.   Engineering work also relies on all parties possessing a sophisticated grasp of the English language, something that is not always easy to find outside of English-speaking countries.  Finally, ensuring good project management and governance is always difficult but even more so when your team is 10 time zones away.

Given the potential benefits, it is likely more firms will dip their toe into outsourcing sooner rather than later.  According to Booz & Co., engineering outsourcing is currently a $30B market but it is expected to grow to $150B a year by 2020. To improve a company’s chances of achieving outsourcing success, Booz has come up with five key success drivers:

1. Choose the Right Project

Initially, choose projects with the best risk/reward profile, where lessons can be leveraged into future projects and where a business case can be defined. 

2. Identify the Appropriate Business Model

Unlike a typical vendor-run or captive arrangement, firms should consider other forms of outsourcing business models that ensure sufficient control, IP protection and shared risk & rewards.  Examples include Joint Ventures and Build-Operate-Transfer arrangements.  

3. Team Up with the Right Vendors

Firms must thoroughly identify, analyze and vet only qualified vendors using criteria that go beyond price and reputation.  These other factors could include engineering talent audits, capabilities assessment and employee attrition analysis. 

4. Create Iron-Clad Performance Metrics

Given the important of the work, both parties must jointly choose and track key performance metrics through comprehensive and well articulated Service Level Agreements (SLAs).  Outsourcers must be able to identify SLA variances quickly and enforce corrective actions as needed.

5. Establish a Strong Governance Structure

A strong and aligned governance structure encompassing both parties and based on clear reporting lines & roles is the most important success driver in any outsourcing relationship.  Projects require senior,  head-office accountability and ownership as well as empowered vendor leadership who have the authority to solve problems quickly and effectively.  

For more information on our services and work, please visit the Quanta Consulting Inc. web site.

Back to the Future – The Revival of Vertical Integration

Is vertical integration as a business strategy back in vogue?  Perhaps if you see some recent corporate moves as the beginning of a trend. A number of bellwether firms have reversed outsourcing mandates and begun to  take key operations in house.  Two recent examples are Oracle’s purchase of hardware vendor Sun Microsystems  and PepSico’s acquisition of two of its bottling operations. PepSico and Oracle join other industry leaders such as ExxonMobil, Apple, Reliance Industries, American Apparel and Google who leverage vertical integration to drive competitive advantage. 

Obviously, a small number of corporate decisions do not portend a global trend.  And, there are still many firms that will continue to focus on core competencies and outsource non-core activities.  Yet, there are sound reasons to reconsider vertical integration as a core business strategy, especially when the firm has strong cash flows and ready access to capital.  Some of these reasons include:

Drive cost reduction

A difficult climate is forcing companies to challenge conventional wisdom around outsourcing and creatively think about how to cut costs and reduce complexity.  In many cases, outsourcing has not delivered target cost objectives and has too often led to significantly higher  indirect costs in areas like relationship management and travel.  Properly executed, vertical integration enables firms to deliver significant cost reduction by achieving higher scale economies and recapturing economic rent (i.e. the outsourcer’s profit).  Where some operations are outsourced as well as provided internally, vertical integration helps ensure suppliers deliver services at the lowest possible cost and highest quality. 

Improve supply chain responsiveness

Working with outsourcing partners has many benefits but high speed, flexibility and control do not rank near the top.  Redesigning outsourced operations, particularly fragmented and global ones, is nigh impossible in the short to medium term, especially under conditions of rapidly changing client tastes and fluctuating demand. Furthermore, once long term, fixed cost outsourcing deals are signed, the outsourcer often has little inclination or incentive to pass along efficiency improvements or innovation to their client.  

Enhance the customer experience

Improving your customer experience is one of the few areas that firms can generate sustainable differentiation.  To build a winning experience, companies need a high degree of control over their delivery model including a common vision, stable operating processes plus feedback mechanisms. Unfortunately, this is very tough to achieve when disparate firms are involved in the value chain.  As well, troubleshooting is often a challenge due to outsourcer process complexity and hidden employee turnover.

Reduce business risk

In dynamic markets, there usually is no problem in securing access to raw materials and specialized labour.  However, when economic or political turmoil occurs or markets become less competitive, companies run the risk of losing access to key inputs or operations.  Vertical integration can reduce business risk by ensuring these critical ingredients are available to the organization as needed.

It remains to be seen whether the actions of a few firms reverses 30 years of corporate orthodoxy around outsourcing’s superiority.  However, a number of trends may be creating a ripe environment for vertical integration including ever-shortening product lead times, continued economic turmoil and insecurity around access to specialized materials or skills. Should current economic conditions continue, we will likely witness  more firms seeking to control their value chain through vertical integration.

For more information on our services and work, please visit us at Quanta Consulting Inc.