What Is Transformational Outsourcing?

As I said earlier, transformational outsourcing is a special variety of outsourcing. It involves outsourcing ongoing services that are critical to the performance of the business. So ‘‘what’’ is outsourced matters, and ‘‘how’’ the initiative is structured is also important. But what matters more is the purpose of the initiative—the ‘‘why’’ of outsourcing (see Exhibit 2.1). Transformational outsourcing is defined most clearly by the objective of the initiative. Transformational outsourcing is:

Using outsourcing to achieve a rapid, sustainable, step-change improvement in enterprise-level performance.

Exhibit 2.1: Transformational outsourcing defined by the ‘‘why’’ of the initiative.

Let’s pull this apart and examine its parts in detail. First, we say ‘‘using outsourcing.’’ Outsourcing, or for that matter any other management tool, does not create an impact by itself. It changes a company’s trajectory, it is hoped in the intended direction, when executives deliberately use it for their ends. In other words, tools don’t make change happen; people make change happen.

Transformation implies a rapid, step-change improvement in performance. We would not call a program transformational if it took decades for the effects to become apparent. Nor would we put it in this category if it had only a small impact. Transformation means big change fast. Of course, all change is relative. We consider an initiative transformational when it achieves larger, faster, and more lasting impacts than we might reasonably expect. For example, Bill Parcells has a reputation for transforming football teams. He has taken three separate professional teams from sustained losses to playoff slots within two years of taking over as coach of each one. For a coach to have this kind of impact on a team’s performance is extremely rare, hence transformational. Most would credit

Lou Gerstner for transforming IBM’s notoriously self-absorbed and inbred culture of the 1990s, even though even he would say it’s still a work in progress.^[2] What about that transformation was fast? Not much, but its speed still exceeded expectations because most of us would have called it impossible.

Making a big impact on enterprise-level performance means changing the things that really matter. Companies undertake no end of minor change initiatives every day. They improve their staffs through training; they adjust compensation to more closely align with corporate goals; they focus resources on higher-growth markets. These activities are all useful, but not transformational. Their impacts are imperceptible at the bottom line except over a very long time. A transformational initiative, in contrast, can noticeably double a company’s stock price, shift its market share, or drive its profitability.

The target of transformational outsourcing has to be an entire operating unit. That’s why we say enterprise-level performance, not organizational performance. If the impact cannot be felt at the bottom line, it’s not truly transformational.

And finally, if the benefits were only temporary, we would not say that the enterprise has actually been transformed. Achieving a sustainable change in performance means that the organization has been set on an entirely new track. Nothing in business lasts forever, but a true transformation should provide benefits for an entire management generation— five to seven years.

Transformational outsourcing has gained some currency right now. As a result, many outsourcing vendors are touting their work as transformational. In most cases, it is not. And this media hype just confuses executives about exactly what the concept means and how it works. Just put the words transformational outsourcing in an Internet search engine, and you’ll find that Compaq, Cognizant, Schlumberger, IBM global services, Alltel, Collaboratech, Cap Gemini Ernst & Young, and others all claim they can transform their clients’ businesses through outsourcing by implementing new technologies. This isn’t it. Transformational outsourcing often requires that new technologies are implemented, but the defining factor isn’t the new technology. It’s the purposeful use of outsourcing to achieve dramatic enterprise-level change.

A few examples might help to bring our definition to life. National Savings and Investments isn’t the only example of transformational out-sourcing, but it’s a good place to start. The executive team of National Savings deliberately used outsourcing to achieve the changes the organization needed. The agenda certainly reflected big change fast: the CEO’s aspiration was to go from near last in the industry to on a par with the leaders in three years. And the impact showed up clearly at the bottom line of the enterprise.

A company we’ll call Archer Financial Group, a multinational financial services company, paints a similar picture in the private sector. In 1997, the company was facing demutualization and exposure to the scrutiny of public ownership. The board determined that the company had steadily slipped from a dominant market position to middle of the pack, and nimble new entrants were circling to take their share of the company’s juicy customer base. It brought in a new CEO to lead a turnaround, with a mandate to pull it off within three years. After taking a thorough look at the organization and its resources, the CEO framed a broad vision about overall direction. He also recognized that the company lacked the culture, IT capabilities, and management bench-strength to execute the transformation.

He decided to position information technology as the engine of transformation for his business. Despite the fact that most of us would consider information technology a critical and high-priority activity in a financial services company, the CEO’s push marked a big change for the role of IT in the organization. At the outset of the initiative, the IT infrastructure was weak, relationships with business leaders were passive, costs were high, and the function actually reinforced organizational silos instead of cutting across them.

Archer outsourced its entire IT operation to a global management consulting and technology services company. The CEO correctly under- stood that if he forced change in the company’s systems, he would disrupt the complacent attitudes and power dynamics among his senior team. He used this wedge to cause the organization to completely rethink its market strategy, value propositions, product lines, and incentives and compensation. In short, he drove top to bottom change in the organization by using outsourcing.

With its outsourcing partner, Archer created a separate IT business unit to house a shared service center. They started with the basics: They drove duplicative applications out of the processing network and streamlined work flows. Then the CEO and the provider’s leadership kicked off technology-enabled change programs designed to cut down the dysfunctional organizational silos and change the company’s focus from protecting turf to performance. They also implemented a report card that measured contribution to strategic goals.

The results? In three years, operating margins increased from $151million to $370 million, market share grew from 19.1 percent to 28.1 percent, assets under management increased 64 percent, and share price doubled. As these two examples demonstrate, outsourcing offers a viable approach for executing dramatic business transformations.

Transformational outsourcing is very different from conventional outsourcing.

Transformational and conventional outsourcing have very little in common (see Exhibit 2.2 for a comparison). To be totally frank, outsourcing initiatives are extremely diverse. They don’t fall neatly into one or two buckets. But these two ways of using outsourcing are so different that it’s useful to describe them as archetypes.

Exhibit 2.2: Different outsourcing relationships meet different objectives.

Pick up any article or book about outsourcing and you will veryquickly hit the idea of core and noncore competencies as the line of demarcation for outsourcing. The conventional wisdom goes something like this: To achieve excellent performance, any organization—let’s call ours Flambo—must focus on doing a few things well. No organization can be good at everything, and Flambo is no exception. The first step in achieving excellence, therefore, is for Flambo’s executive team to identify the organization’s uniquely valuable collective learning and coordination skills that stand behind its core product and service lines—in other words, its so-called core competencies. ^[3] Everything else people in Flambo might do—the noncore activities—distract them from the highest and best use of their time.

To optimize focus and performance, Flambo should contract with other companies to take over these noncore functions and processes. As a result, their executives will be able to pay more attention to the important, core contributions. In addition, what is noncore to Flambo may well be core to an outsourcing provider; hence, they can be counted on to perform those activities efficiently and effectively. The advertised benefits from this conventional form of outsourcing include:

• Cost reductions of 25 to 30 percent

• Service improvements, like more responsive call centers and faster problem resolution in noncore functions

• Improved executive focus on core competencies, which theoretically leads to improved performance

• Access to superior—and continually improving—skills and expertise of the outsourcing provider

When managers are following the conventional wisdom, they use outsourcing to contract out functions and processes that require their scarce management attention, but don’t offer any opportunity for competitive distinction. Their objective is not to change much of anything except their expense line and the way they use their own time. And the organizational- level impacts are expected to be positive, but minor. Even if the cafeteria becomes much more efficient through outsourcing, for example, no one would expect this improvement to have a noticeable effect on the bottom line. A search-engine company provides a good example of conventional outsourcing (see Exhibit 2.3). It outsources the process for responding to e-mailed customer requests for support to India. ‘‘The reason for outsourcing is to save money,’’ an executive summarizes. The process is well structured and well understood on both sides. The company provides templates, and the outsourcing provider’s staff use them to respond to e-mails about navigation problems or requests to link to the company’s site. The manager in charge of the relationship communicates with the provider largely through e-mail. This conventional view of outsourcing holds that:

Exhibit 2.3: Conventional and transformational outsourcing have little in common.

1. Outsourcing is appropriate only for noncore activities.

2. The primary benefit of outsourcing is reduced cost.

3. When executives outsource a function or process, they can turn their attention to more strategic matters.

^[2]Lou Gerstner, Who Says Elephants Can’t Dance? Inside IBM’s Historic Turnaround (New York: HarperBusiness, 2002), p. 242.

^[3]C. K. Prahalad and G. Hamel, ‘‘The Core Competence of the Corporation,’’ Harvard Business Review, May/June 1990, pp. 79–92.