Combining strategic outsourcing and project management
the synergistic effect
With the coming of the millennium, organizations are continuously examining ways to gain a competitive edge and companies in every industry have begun to take a closer look at their support operations. Customers are demanding more when it comes to quality, value, timeliness of performance and price. To effectively compete in such a market, organizations must provide top-notch products, processes and services; remain focused; and have the ability to offer competitive pricing and quick response services. To do this, they must maintain the staff as well as the expertise. This can be a monumental task for any organization and, given the ongoing labor shortage, finding and keeping in-house experts can be expensive.
One increasing popular option for businesses striving to compete in an ever-changing marketplace is outsourcing one or more non-core activities. The successful outsourcing organization concentrates on key activities and hires “experts” to provide the rest. This does not decrease the ability to manage those functions; it simply allows organizations to be state of the art in all areas by partnering with professionals in non-core functions. This trend, predicted to continue into the next century, can be a cost-effective alternative that provides multiple benefits to employers. In addition, once seen as a high-risk strategy adopted only by companies in trouble, outsourcing is now being recognized as a powerful management tool not only to reduce operating cost but also provide strategic benefits to organizations.
Project management process and expertise have been in the market for sometimes. However, the transference of this body of knowledge to achieving outsourcing capabilities has not been documented fully. Furthermore the strategic importance of outsourcing is only beginning to gain recognition. The integration of project management process and outsourcing process must be guided in an iterative, self-correcting and step-by-step way to achieve success. As a result these two processes must act in tandem to leverage the maximum benefit that can be gained by the organization.
This presentation will examine the concept of outsourcing, the reasons for companies to outsource, and it will provide the framework of integrating Project Management into the Outsourcing Process that was applied to an organization. This framework will provide a step-by-step guide for implementing the Outsourcing Process using Project Management tools and techniques. The framework will cover three main headings of “Define and Organize Outsourcing,”“Plan the Outsource,” and “Measure and Manage Outsource Relationship.”
Concept of Outsourcing
Outsourcing is the strategic use of outside resources to perform activities traditionally handled by internal staff and resources. Outsourcing is a management strategy by which an organization outsources major, non-core functions to specialized, efficient service providers. Companies have always hired special contractors for particular types of work, or to level-off peaks and valleys in their workload. They have always partnered-formed long-term relationships with firms whose capabilities complement their own; companies have always contracted for shared access to resources that were beyond their individual reach—whether it be buildings, technology or people. But the difference with simply subcontracting and outsourcing is that outsourcing involves the wholesale restructuring of the corporation around core competencies and outside relationships. To further enhance this concept, the old outsourcing model and the new outsourcing model is given herewith to help differentiate the “mind-set” required to achieve a successful outsourcing strategy.
In the old outsourcing model, contracts are usually put together in haste. The outsourcer takes over a distressed situation in which service levels cannot easily be agreed upon. Consequently, very few meaningful service levels are defined. The outsourcer provides limited information to the customer in terms of its cost for providing services, and any inquires made by the customer are given the cold shoulder. The result is a poorly understood relationship in which both parties blame each other for increasing levels of nonperformance. These relationships historically result in a win/lose adversarial type of relationship where both parties seek to win at the loss of the other—the customer seeks to reduce the outsourcer’s profits, and the outsourcer seeks to maximize its profit structure in opposition with the customer.
In the new outsourcing model, the customer looks at the outsourcer as a long-term asset that is a source of ongoing value to the company. As an asset, time and resources are dedicated to managing the relationship and maximizing its value. The customer’s resources are held accountable for extracting value from the outsourcing relationship. The intent is to keep the relationship for as long as it brings value—understanding that over time new parties and alliances may need to be formed as technology and organizations change. Therefore, customers strive for long-term relationships and align the outsourcers motivation by developing appropriate incentives and penalties. They invest in tools that can objectively measure outsourcer performance and contribution as well as foster communication. There is an interdependency between the two organizations—change in one affects the other. Therefore, both parties must understand the cost drivers of the two infrastructures and coordinate changes so as not to drive additional costs into the process. Customer and outsourcer must behave as an integrated supply chain rather than win/lose adversaries.
A good example of this new outsourcing model is the relationship between Frito-Lay and Excel Logistics, which was created due to the revamp of supply chain strategy for third party set-up by Frito-Lay (Meachum, 1995). In 1993 Frito-Lay, a division of PepsiCo Foods, agreed to supply a line of foods to the Taco Bell chain. In-house logistics, however, offered no synergy. Frito-Lay promptly began to look for a third party. Requirements called for three-day cycle time from order placement to delivery. Excel Logistics was chosen because Frito-Lay required a quick entry into the marketplace and Excel had vast experience with the customer, providing shorter learning curve. Taco Bell customers call a telemarketing number that’s part of the Frito-Lay order center. Order are entered and electronically transmitted to Excel. Excel then processes, picks and loads the order in addition to selecting, dispatching and paying the carrier. They effectively become the operational arm of PepsiCo Foods.
The result—in less than two years, Frito-Lay has assumed the No. 2 position in the Mexican food niche they have chosen. Cost levels are in line with what had been anticipated from the beginning and customer service levels is better than Frito-Lay as a whole, hitting the 90-plus percent mark. From Excel’s point of view the arrangement is more of a joint venture and risk sharing as Excel’s success was directly linked to Frito-Lay’s success. Sharing risks could have led to trepidation, but Excel did not have a fear factor going into the venture because, as Joe Puleo, Director of Business Development said, “Frito-Lay had a vision and they (Excel) shared that vision so we could complement it. And that’s not always the case.” Other clients, he said, often leave his firm “stabbing in the dark.”
Reasons for Outsourcing
The potential benefits of outsourcing for a company are enormous. Outsourcing allows a company to lower its cost, turn a fixed cost into variable cost, release capital investment for use in other areas, avoid future investments, and generally refocus management on the bottom line. Some of the top reasons for companies to outsource are identified as follows:
• Accelerate reengineering benefits
• Access to world-class capabilities
• Cash infusion
• Free resources for other purposes
• Function difficult to manage or out of control
• Improve company focus
• Make capital funds available
• Reduce operating costs
• Reduce risk
• Resources not available internally.
A key benefit of outsourcing is substantial cost reduction of the outsourced commodity. In some cases, these costs are reduced by 20–40%. A related benefit of outsourcing is the variable nature of unit-priced outsourcing, which in effect translates a fixed cost infrastructure into a pay-as-you-use variable cost infrastructure. For example, if a warehouse with steady operating cost is outsourced on a unit-cost basis (cost per item in the warehouse), the warehouse service becomes variable. This allows the company to match its expenses to its revenues.
This is especially beneficial in the case of seasonal business or cyclical business down turns. The customer is also able to avoid the ongoing reinvestment required by infrastructures such as new equipment or facilities upgrade, because the outsourcer provides that investment as part of its cost. In addition, when selling the assets or transferring the people, the customer realizes a positive cash in-flow and releases assets for redeployment elsewhere. This, in turn, lowers the invested intensity of the business.
Perhaps the greatest benefit of outsourcing is that it allows management to focus its attention on strategic parts of the business, and allows the outsourcer to focus on improving the professionalism of the service such as the warehouse or data processing infrastructure. Another good example is Motorola and UPS Worldwide Logistics tie up to provide time-definite delivery under “Rapid Net DirectShip” program. Emphasis is on reducing shipping time by using a single carrier to minimize in-transit problems. Motorola’s vision was to modify semiconductor products to customer specification and make delivery within one week, “168” hours. A final benefit of outsourcing is that the outsourcing organization may be able to more closely align these services by allocating them to the consuming processes or departments on an activity basis to achieve a more effective alignment between the consuming departments and the outsourced infrastructure.
The history of long-term outsourcing has not always been glorious. Unfortunately, too many outsourced customers experience problems over the life of the outsourced relationship such as data control issues, inflexibility with changing business needs, deflating components that don’t equal less cost, poor communication, over dependence on the outsourcer, internal resistance, and competition between outsourcers and others. Typically, these problems do not surface until the middle of the second year when a company’s management has turned its attention elsewhere in the organization.
Outsourcing Process Model
The Outsourcing Process Model (OPM) developed is shown in Exhibit 1. This model uses the Planning and Managing Project process as a guide for its implementation. The model has three phases. The first phase is Define and Organize Outsourcing. The second phase is Plan the Outsource and the third phase is Measure and Manage Outsource Relationship.
Define and Organize Outsourcing
Establish Outsourcing Team
Company has to identify teams for its various outsourcing projects.
Conduct Strategic Analysis
Outsourcing is fundamentally a tool for organizational change. To be effective, any outsourcing effort must be based on a clear strategic direction. The work involved organizational implications, and risks of an outsourcing decision are too great to be implemented as an unthinking reaction to a short-term situation. The key to successful outsourcing for any company is clear understanding of the organization’s core competencies and its business goals.
Organizations outsource because they want to accomplish something. In many cases, the goal is to reduce and control costs while meeting or improving service levels, quality and other performance objectives. Sometimes it is for better allocation of capital dollars—to make sure that it has only productive assets on its books. Whatever the reasons the problem is that too often organizations do not understand these goals at the outset. The goals drive the actions. There is no right or wrong, but there is effective and ineffective within the context of what the organization is trying to accomplish.
Identify the “Best Candidates”
Once the organization understands why outsourcing, it then turns its attention to the critical question of what functional areas represent the best candidates for outsourcing. Picking the wrong areas is often a source of failure.
Every non-core business function is a candidate for outsourcing. The best candidates are those with the greatest contribution to the business goals at the lowest risk. The scope of services selected to be outsourced is critical. Set too large, the results may not be definable. Set too narrowly, the desired results may not be obtainable because of continuing internal dependencies.
Identification of best candidates requires an analysis of current costs, operational strengths and weaknesses, provider capabilities and short-and long-term anticipated changes in the company’s environment. In addition, the pros and cons of integrated versus a selective approach to vendor selection must be carefully weighed.
Plan the Outsource Contract
Here the team identify the length of the contract, clarify expectations and set performance metric. The contract must also define service level requirements and escalation process. If the legal department in the organization gave a standard contract, then the team may incorporate the above and customize the contract.
Plan the Outsourcing
Define and Develop the Outsource Work Requirements Structure
Defining requirements in clear, complete, and measurable terms is one of the most difficult, yet most important, parts of the outsourcing process. A clear definition of accountability is essential to success. The challenge for any company lies in developing a relationship that clearly defines roles and responsibilities, especially when there are shared responsibilities.
Enhancing one’s performance measurements (service levels) is an effective way of addressing accountability issues. Since outsourcing represents a long-term relationship with another firm, it is critical to define not only the desired results but also the type of relationship needed for ongoing success. Having well defined service levels will reduce ambiguity in the agreement and assist in creating a more positive working relationship.
Providers must be selected based on their total capabilities and cultural fit. A careful balance of relationship building and a competitive, methodical approach must be struck throughout the provider selection process.
Once the provider is selected, final agreement must be crafted to describe in detail the scope and nature of services; provide performance guarantees with both incentives and penalties; and describe how the relationship will be managed. This framework includes the rights to review and approve important personnel, how the transition will be managed—especially in the critical area of people, and how the right level of flexibility will be built into the relationship.
Conduct Risk Management
The standard, isolate, analyze risk process as in project management can be used with the risk assessment matrix. A detailed risk management plan needs to be developed.
Transition to Management
Focusing on human resources and internal and external communications are critical during the transition to the outsourced environment. This is in addition to the natural attention to the operational details of moving to the new environment. Early successes must be promoted and problems must be quickly identified, escalated if needed and resolved.
An organization’s outsource relationship must be surrounded by a cohesive management system. This system should create organizational links between the buyer and it’s suppliers at the operational, tactical and strategic levels. Change must be expected and the process for dealing with change understood by all.
Technology has become a powerful tool for managing the relationship between the organizations. Video-conferencing, advanced teleconferencing, e-mail, collaborative online tools, intranets, extranets, and Internet can all be used. Technology enables outsourcing; it also enables its management.
Measure and Manage the Outsource Relationship
Take Adaptive Actions
Close out and External Bench mark
Collect status, analyze variance, take adaptive actions and report status are recurring tasks. Once a solid foundation has been set and in operation, the next most common set of problems can be in the way the relationship is structured. Measurement is inherent to good structuring. Organizations can only achieve what they can measure.
Many organizations have reported significant difficulty in measuring and reporting the things that matter most—the quality of the services they are receiving, continuous improvement, comparison to industry standards, and the actual business value realized. They even report some difficulty in measuring the more basic aspects of the services—quantity, costs and customer satisfaction. Other problems created during the formulation of the relationship are:
• Over promising, both internally and by the provider, which naturally leads to unrealistic expectations
• Failure to budget and allocate sufficient resources for the ongoing management of the relationship
• An over reliance on penalty clauses, especially contract termination, as sole vehicle for ensuring shared interests between the organizations.
Unresolved differences in culture and management styles among organizations are common problems. Too often, no management system for the relationship is put in place until after problems surface. Similarly, direct personality conflicts between individuals with different organizational backgrounds can easily occur. Even a lack of employee training on the workings of the new environment can cause serious problems.
Frequently, managers do not have the experience needed to manage outside relationships. The traditional skills that made managers successful—technical skills within their field, operational planning and oversight, resource allocation—are not the skills needed for success in managing an outsourcing contract. Establishing results-based goals, communications and negotiations are what are needed. Dr. Michael Useem at Wharton refers to this as “lateral leadership”—leading out instead of managing down.
The good news is that none of these problems undermine the essential value proposition for outsourcing. But, they do suggest that the anticipated benefits are not automatic and that organizations—both customers and providers—need to do a better job of applying sound management principles to this rapidly expanding business approach.
Managing a long-term outsourcing relationship is no easy task. Some of the common contributing factors to give rise to a dysfunctional or unsatisfactory outsourcing relationships are:
• Pricing and service levels are established at the start of the contract and usually contain no meaningful mechanism for continuous improvement.
• Differences in buyer and supplier cultures often cause misunderstanding and distrust. Even if the cultures are compatible, the two parties still have fundamentally different goals and objectives that are frequently difficult to harmonize.
• All outsourcing contracts are based on key assumptions regarding technologies, business conditions, personnel, and other relevant issues. As soon as the contract is signed, these assumptions begin to change. However detailed the contract or favorable the terms, most contracts cannot anticipate the changes in an evolving environment. This phenomenon tends to ensure that one, if not both of the parties will be become disenchanted with the relationship. Longer-term contracts that lack flexibility tend to increase the likelihood of dissatisfaction.
• Once the contract is in force, there is a great temptation for both parties to sub-optimize the relationship and attempt to better their lot at the expense of the other. The inflexible nature of the contract usually favors the supplier.
• Buyers frequently underestimate the time and attention required to manage an outsourcing relationship, or worse, they hand over management responsibility to the vendor. The outsourcer begins to operate in a priority vacuum, and service levels tend to deteriorate because the outsourcer’s agenda is not in sync with the buyer’s business objectives.
• Lack of management oversight is usually the result of two factors:
• The team that negotiated the contract often does not stay engaged in contract management. A new team that may or may not understand the contract’s intentions is given responsibility for managing the relationship.
• Employees that understood the pre-outsourced environment have been transferred to the outsourcer’s team. This disruption in continuity can have significant adverse effects on the outsourcing relationship
In a recent PA’s research, the most successful outsourcers were able to manage their relationship better, Tarsh (1997) identify that the successful outsourcers invest in building the relationship right from the very start. They have very strong relationship with their suppliers, hold high-level strategic reviews, and have an effective process for continual improvement that is underpinned by performance measures and end user satisfaction measures. When organizations follow these steps, they achieve higher levels of benefit and greater cost savings than those who follow more traditional approach. Tarsh further identified four guidelines for a more successful relationship management:
• Create a shared vision for the outsourcing. Reflect this vision in the contractual arrangements.
• Include effective performance measures that motivate the contractor to ensure that its actions serve the client’s business objectives.
• Establish clear communication mechanism.
• Develop a clear contingency plan and exit strategy.
According to Yudkowsky (1998), unanimously, what matters most is that the end result of the outsourcing works. From both vendor and user perspective this happens by developing a trusting relationship that allows the outsourcer to be a true business partner. This relationship developed by the outsource vendor learning the customer’s business and understanding what would and what would not benefit the customer by being outsourced. Customers usually should not be outsourcing their core competencies.
Exhibit 2 shows the summary of the above in a simplified step-by-step guide.
Bendor-Samuel (1998) developed a value model to redefine outsourcing. It takes into account the customer looking at the outsourcer as a long-term asset that is a source of ongoing value to the company. An example to explain the adding value is the Volvo GM and FedEx relationship. As distributors are realizing that they do not have the capability to completely serve their customers in all situations, innovative managers have started to view their distribution channels as “webs of capabilities embedded in an extended enterprise.” They have come to recognize that by sharing their resources with others in their channel they can take advantage of profit-making opportunities. This concept of a flexible and responsive channel of distribution is being termed “adaptive channel” (Narus & Anderson, 1996). To illustrate the utilization of adaptive channel is Volvo GM. Volvo was having problems getting replacement parts where needed for emergency roadside repairs, even though their inventory levels were quite high. They outsourced and united with FedEx Logistics to overcome this problem. When a dealer needs a part, they call a toll-free number for FedEx and the parts are shipped and usually arrive the same evening. This arrangement has eliminated three warehouses for Volvo GM and has decreased its inventory levels by 15%.
Buy, build or outsource? It’s the 2000s twist on a classic question. You may not find it in a hardcover dictionary yet, but outsourcing is part of the everyday vocabulary of businesses around the world. Often it is intoned to make it sound like a blessing or an epithet, and it can be either or both. As Peter Drucker the project management guru predicts that almost every business function without pathway to top management will be outsourced. Outsourcing is more than simply a popular word. It has become a leveraging tool for companies.
Bendor-Samuel, P. (1998). Redefining outsourcing: The value model. Everest White Paper, Infoserver Magazine.
Meachum, M. (1995). Concentration on the customer’s customer leads to success in logistics outsourcing. Traffic World Magazine, Nov 13.
Narus, J.A., & Anderson, J.C. (1996). Rethinking distribution.Harvard Business Review, July/August, pp. 112–120.
Tarsh, S. (1998). Managing outsourced relationship: A shared vision produces greater rewards. Trends in Outsourcing, The Outsourcing Institute.
Yudkowsky, C. (1998, May 25). Using vendors wisely is critical outsourcing issue. The Business Journal.
Proceedings of the Project Management Institute Annual Seminars & Symposium
September 7–16, 2000 • Houston, Texas, USA