Michael G. Patton
Michael G. Patton, President & CEO, Corporate Strategic Services, Inc. Columbus, OH 43235, 614-760-9280, Pattonmg@aol.com.
Outsourcing has been with us for years in one form or another. A common form of outsourcing that has existed in manufacturing since Henry Ford's days has been whether a company should make vs. buy components of products they are building and selling. There are many myths, distortions and exaggerations which surround outsourcing both in the positive and negative. The one indisputable fact is that the use of outsourcing for acquiring non-core products and services is growing rapidly in both the manufacturing and service sectors. Additionally, outsourcing is now moving into many non-traditional areas that in the past would never have been outsourced as companies are striving to be more competitive in both the domestic and international market.
Issues cover by this paper include:
Outsourcing Today. The outsourcing phenomenon that is currently occurring today is transforming many managers from providers, to brokers and facilitators of required services, products and functions. In the purchasing profession, we are evolving from buyers and contract administrators to sourcing managers and administrators. Today every commodity, service and function that has been traditionally purchased or provided by an internal function could be and is being outsourced. A 1996 survey conducted by Arthur Andersen and The Economist Intelligence Unit found the following:
Outsourcing is being used in a variety of ways by different industries. In the service sector, such as banking and insurance there is push to focus on their core competetcies and use outsourcing for many functions from outsourcing the entire IT function, couriers, mail services, security and many more. Other companies are outsourcing functions to alliance partners, where both companies eliminate non-core functions, but gain additional volume by performing work for their alliance partners. The common reasons companies are using outsourcing in addition to cutting costs is that they wish to focus more of their energy, resources and capital on their core competencies and by turning fixed costs into variable costs.
Benefits Achieved by Outsourcing. What are the perceived benefits provided to any organization that decides to initiate an outsourcing program? Listed below are just a few of the benefits to outsourcing which are offered as justification and rationalization to outsource:
Risks in Outsourcing. There are risks to using outsourcing as a tool that should be considered prior to making a decision to outsource. Many outsourcing contracts are so complex that companies have hired consultants to evaluate proposals. Another problem is that some companies are now locked into long-term contracts with outside suppliers that are no longer competitive. Some of the more common and relevant issues to consider are listed below:
Checklist of Supplier Selection Issues. In establishing an outsourcing program the single most key element is obviously the selection of the outsourcing company that will be providing those services, products or functions to your company. It is a very critical decision as once you have entered an outsourcing agreement and implemented the process, it can be extremely difficult and painful to extricate yourself from an outsourcing contract that fails. Listed below are several of the factors you should consider when selecting a supplier to bid on outsourcing, but the three most important factors in choosing potential outsourcers are reputation, existing relationships, and references.
Skills and Tools Required. When evaluating how, why, and when you should consider using outsourcing as a strategic tool, first inventory the skills you need to effectively develop, manage, implement, and sustain this type of program. What skills are necessary? The following list represents the "typical" skills required for most outsourcing programs:
Tools. As important as the skills which are required to effectively make outsourcing decisions, the tools that purchasers can use when making these decisions are equally important and readily available. There are many tools one can use to help in this process which range from NAPM videos, satellite seminars, and publications to articles published in journals, Web sites, expenditure analysis, consultants, third-party training programs, and sourcing companies. However, the most beneficial tool to use is Expenditure Analysis.
Expenditure analysis will help you determine what potential opportunities exist for achieving cost savings by outsourcing. Use of this tool in conjunction with process mapping will provide you with the information you need to obtain prior to launching your outsourcing program. The process of considering all costs, tasks and functions associated directly with the outsourcing of a product and/or service is critical, as knowing this information will allow you to accurately structure your RFP, contract and any service level agreements (SLA) to ensure your success. Use of expenditure and process flow analysis will detail the following:
Development and Implementation of Outsourcing Programs. Laying the groundwork for any outsourcing program begins long before any supplier is ever contacted. Success in outsourcing depends on having a clear vision, a defined corporate strategy, knowledge of what it currently takes to deliver the outsourced commodity, what service levels must be met and what it costs to meet them. Once you have identified the commodity or process to be outsourced, take the following actions:
1. Select your team. If you are outsourcing a complex product or service you should form a cross-functional team. The team leader is the key to the success of the project and normally this individual would come from the purchasing function. The other members of the team would be individuals that represent the product/service being outsourced and/or those affected by the product/service being outsourced.
2. Understand your cost structure. Using some of the tools mentioned previously, such as expenditure analysis and process mapping, will detail the costs involved in providing this product/service. Make a complete and detailed inventory of the various personnel, licenses, equipment, leases, facilities, and any other resources, assets, and contracts that are currently required to produce the item or perform the function which is going to be outsourced. Use metrics, benchmarks, and other tools to evaluate existing capabilities and costs of the function being outsourced. Be certain to include all conversion costs that will be associated with this function being outsourced.
3. Develop Service Level Agreements. The service level agreement (SLA) defines the level or amount of service to be performed. Meet with the internal clients that had provided this function and develop SLA's that define the nature of the services as well as performance measurements, quality levels, and other relevant metrics or key performance indicators (KPIs) and any transfer pricing. These results, when completed, will be incorporated into the Statement of Work. Include baseline performance measures and the formula for measurement.
4. Determine the length of the outsourcing contract. It's in the interest of the purchaser to negotiate a shorter-term contract that provides ample flexibility. Whatever the length of the contract, you should provide a reasonable exit of convenience in case the relationship becomes unmanageable.
5. Develop a Statement of Work. This is the most critical portion of any outsourcing agreement as it defines how the program will work, required SLAs, quality levels, hours of operation and performance, working conditions, services to be provided, performance measurements, and budgets. This document should specify exactly what, when, where, how, why, and by whom this function will be performed and the manner in which this performance will be measured.
6. Identify potential suppliers. Identify and conduct preliminary due diligence on all prospective suppliers before determining if you are going to outsource. Determine how many companies can provide the function you are planning to outsource, where they are located, and the geographic area they can support.
7. Identify internal resources. Identify all critical internal resources that will stay with your company after the function has been outsourced and who will help manage and administer the outsourced function.
8. Develop a strategic plan. Identify the long-term needs of your company for the function being outsourced and incorporate these projected needs into any outsourcing agreement. The need for developing a detailed strategic plan will vary based upon the spend and the critical nature of the products and services which are involved.
9. Determine which outsourcing strategy fits best. There exists a multitude of strategies and options, which range from "out-tasking" a single function such as PC Maintenance to turning multiple functions over to a sourcing company. It is important to review and consider which option(s) fit best for your current environment and will meet your long-range goals.
10. Develop a pre-qualification process. During this time, develop a pre-qualification form and have all potential suppliers complete it prior to determining your candidate list. This form should provide relevant information regarding the capabilities of any potential company to provide outsourcing services to your organization.
11. Facility inspections. Facility inspections of potential providers of outsourcing services should occur after your analysis of the pre-qualification forms has been completed. On-site inspections of their clients where the outsourcing company is providing functions should also occur, if allowed.
Upon completing all steps involved in the pre-selection and pre-qualification process, begin developing the request for proposal (RFP) for outsourcing this function. Your goal should be to create an RFP that is well structured and clearly defines what you wish to achieve. Developing a detailed, thorough, and formatted RFP will result in supplier responses that allow for comparisons from multiple suppliers.
Receive, Analyze, and Rank the Proposals. Your team should review and rank the proposals from the suppliers. The importance or weight of these issues will vary based upon the contract and your company's position. However the order of these items listed below are ranked based upon "typical" issues for these types of contracts. Construct a comparison chart or table to evaluate and compare responses on these key issues:
Upon completion of the evaluation of the aforementioned items and subsequent ranking, develop and determine your negotiating plan and strategy for each potential supplier.
Negotiating. In negotiations, be sure to address the worst-case scenario: terminating the contract prior to its scheduled completion. Terminating a contract is the worst condition that can occur and is never easy, regardless of the product, service, or function involved. Your contract must define intermediate consequences for both parties so that terminating the contract is not an issue when minor problems occur in the relationship and in the supplier's performance of their responsibilities. To ensure this relationship is mutually beneficial when consummated, focus on the key issues detailed in the previous section, as these will impact the success of your program.
Measurement and Enforcement. What are the factors involved in successfully managing and sustaining your outsourcing program? The contract and statement of work specify the required service levels, performance expectations, penalties for non-performance, and termination clauses. Listed below are tips for success commonly suggested by organizations and trade groups such as the Outsourcing Institute.
Possible Pitfalls. As you progress into the relationship, this will be a question that is commonly asked by yourself and others who have been involved with or affected by the decision to outsource. Depending on how well you have or have not structured your outsourcing program, you may be suffering any one of the following problems:
How can you minimize these problems? There are many things you can do to successfully manage the outsourced relationship. Some of these suggestions are detailed below:
Coordination. Coordination often determines the value of the relationship and needs to be done early on. To ensure successful coordination between your organization and the outsource provider, both parties should coordinate standards such as software, network protocols, and business processes such as procurement and customer service, shipping schedules, warehousing processes, inventory, and lead-times.
Single point of contact. Although the cross-functional team will move on to other projects, this does not mean that they are done managing the outsourced process. The contract administrator should become the point of contact that is responsible for coordinating with the supplier throughout the course of this agreement. It's essential that the contract administrator be available to manage this long-term commitment and should have adequate resources provided.
Accountability. Detailed Service Level Agreements and other performance measurements and indicators are critical to the success of the relationship. Outsourcing relationships should be dynamic in nature, allowing for the addition of performance indicators during the course of the contract, which reflect changing business requirements and therefore changing service levels. The documentation of the lines of accountability involved in the managing and coordination of the outsourced function are rarely done before the contracts are signed.
Continuous process improvement. At a minimum, you should have the same flexibility when a function is outsourced as you had when you performed this function internally. It's essential to have a continuous process improvement model included in your agreement to ensure the function's continued flexibility to respond to changes. One way to address the continuous improvement issue is to start benchmarking where you are today with respect to cost, performance, productivity, utilization of resources and other key metrics.
Post contract management. Issues range from holding someone on the staff accountable for overseeing contracts with outside suppliers, to integrating into the outsourcing company employees who may have lost their jobs because of the transition. Stated and included in this agreement are provisions for some sort of escalation process that clearly defines how problems will be handled and the process that will be used to resolve these issues.
Double outsourcing. One common event that should be understood and addressed with your outsourcing supplier is the practice of "double sourcing." This is common in some functions that are typically outsourced such as the IT function. Double outsourcing is when subcontractors are employed by companies providing outsourcing to you.
Evaluation and Measurement. The need for post-outsourcing contract evaluation and measurement is imperative. Some commonly used methods of evaluation and measurement are:
SUMMARY. What conclusions can one draw from the information contained in this article on Outsourcing? First, its obvious those companies are more frequently making the decision to outsource functions that were traditionally performed internally. The reasons for outsourcing are strategic in nature and outsourcing is viewed by companies as one more solution for gaining a competitive edge. Finally, understanding where, when and how to successfully outsource will be one of the most important business skills needed for the future not only for purchasing professionals but for all managers that are challenged to do more with less.