Chapter 4: Transformational Outsourcing Meets Strategy

Transformational outsourcing isn’t right for every company. It represents a major strategic commitment. As we discussed in Chapter 2, most companies will get better results from relentless incremental change than from expensive, lurching transformations. However, in some situations, transformation is the only viable alternative. Let’s start from the position that your organization has established its strategy and clearly understands its strategic imperatives, and transformation is on the agenda.

What Benefits Does Outsourcing Offer?

Executives use transformational outsourcing to achieve a clear strategic purpose. Outsourcing is not the only tool that executives wield to accomplish their goal; it is part of a concerted program to effect dramatic change. It is, however, a very important part of the agenda.

The single biggest reason for failure in outsourcing of any sort is that executives lose sight of their objectives. Some fail to clarify them in the first place. Others stop short of a complete picture by failing to consider all the important stakeholders. Still others start off with a good under- standing of what they want to accomplish, but lose their grip on it in the press of contract negotiations, rocky transitions, or subsequent business changes. Transformational outsourcing initiatives rarely fail, but when they do, they fail for errors of strategy, not execution. In other words, executives and their outsourcing providers implement what they intend to implement, but this just does not produce competitive success. Leaders will want to get their strategy in focus, then be perfectly clear about the contributions they want from their outsourcing provider. Of course each company’s strategic imperatives will be highly unique and are outside the scope of this book. I want to focus here on the distinctive benefits companies can derive by using outsourcing.

First, the outsourcing provider can bring top-drawer skills and capabilities to help your company execute its strategic agenda. Ideally, these are capabilities your company needs in order to be successful at the new strategy, but does not possess itself. For example, National Savings and Investments did not have the technology expertise to develop the new information system–based products and services it needed to remain competitive. Its outsourcing partner had a worldwide reputation for excellence in IT.

Access to skills extends beyond the obvious mastery of the operational details of the area that is outsourced. The right partner can also bring deeper and broader expertise in strategy and business processes. The outsourcing provider adds its management team to yours, and it can tap its knowledge of other companies and industries to bring good, new ideas to your table. For example, the large multinational outsourcing provider of Universal Leven, the Netherlands insurance start-up, offers new product innovation as well as policy processing services as part of its value proposition. NS&I has staff responsible for new product development, but it works intimately with its partner to get a lead on technology innovations that offer promising new opportunities.

Outsourcing can offer the benefit of speed. Through focus as well as expertise, an outsourcing provider is frequently able to implement diffi-cult changes in a fraction of the time it would take an in-house team. A start-up gains speed to market through operations that are gassed up and ready to fly. A Thomas Cook executive explained, ‘‘We could have raised a team to implement SAP and reengineer our financial, HR administration, and IT processes. It would have taken our best people full time, and I don’t know who would have been running the business in their absence. And they still would have taken longer than the experienced team our provider put on the ground.’’

Outsourcing delivers an organizational wake-up call. Better than any other approach to dramatic change, outsourcing sends a message that shakes an organization out of its lethargy. Why? Because it represents one-way action. No matter what happens afterwards, the organization will never be the same. Leaders have taken a bold step. Employees are affected. Even those who are not directly affected hear an incontrovertible signal that their world has changed.

Outsourcing can reduce costs. Many, but not all, outsourcing initiatives involve some kind of cost reduction in the value equation. Frequently cost reductions in some areas are necessary to free up resources to invest in growth opportunities. And most cost-reduction objectives involve both streamlining the existing operation and putting in controls to reduce the internal demand for that operation. For example, when a transportation services company outsourced its IT function, its provider implemented a disciplined process for making new IT requests. The business managers who had previously just picked up the phone to get their friendly IT representative to change a report format or run a special information request now had to write a justification memo and submit it for approval through the manager of change control. Needless to say, the utilization of IT resources for trivial changes dropped radically, and the company was better able to direct its IT efforts toward high-payoff activities.

Companies that create their own high-performing service units before they outsource are likely to get smaller improvements from transitioning to an external provider at that point. But low-wage-rate areas like India, central Europe, China, and the Philippines offer substantial cost-reduction potential over operations in areas like western Europe, the United States, Japan, and Singapore.

Many executives fear a loss of control from outsourcing, but in the event, they find that operational visibility actually improves. By making responsibilities and information flows more clear—both of which are required as a matter of course during the process of handing an operation over to an outsourcing provider—the organization will develop solid, detailed information about how its operation works. It can then use this information to make better decisions about how to improve both costs and revenues. We will hear more about the Thomas Cook story in Chapter 6, but its finance director’s comment about this type of benefit is particularly apropos:

Cosourcing makes visible the costs and implications of decisions. [When you have this information] it may lead you to make different decisions about what you offer to customers. For example, now that I can see all the costs associated with doing a particular type of business, I may decide I no longer want to offer it. I anticipated getting this kind of benefit from our cosourcing initiative, but I did not know how powerful it would be. Previously, people had no way to under- stand the implications of their actions, and now they do.

For growth-oriented companies, outsourcing offers access to instant capacity as the business expands. We’re not talking about utility computing here, although computing infrastructure is far from irrelevant. What growing companies really need is access to processes that work. Whether this involves supply chain capability, phone-ready call center staff, or an administrative center that knows how to integrate a new acquisition, an outsourcing partner can offer just-in-time sips of process capacity that would normally come in fire-hose quantities.

Outsourcing gives a company financial flexibility. Transformation is expensive; it means new computer systems, moving expenses, redundancy payments, training, investments in new products, services, and markets, and a whole host of other kinds of cash obligations. In fact, the companies most in need of transformation are often the least able to afford its upfront costs. You and your partner can work out a funding dynamic that takes advantage of the financial strengths of both companies. Through innovative financial solutions, which are entirely legal and unimpeachable, an outsourcing provider can help smooth out these costs. For example, providers often buy a company’s existing assets—computers, facilities, equipment, and the like that are associated with the operation it will take over. The company gets a cash infusion as well as lower recurring costs—for immediate positive impact on both its balance sheet and its income statement. Of course, this immediate benefit is paid off over time as the provider keeps a larger and larger share of the operational cost improvement it generates. It the transformation is successful, though, growing profits more than cover these costs.

Even when the outsourcing provider does not pay up front for physical assets, it can use its own capital to fund new technologies, facilities, staff, training, and a wide variety of investments that generate a stream of benefits. The company pays for services rendered, either with fixed fees or ‘‘by the drink’’ payments that are geared to service volumes. In the early years of a relationship, the provider pays the difference between total investment and the service fees. In later years, with the benefit of planned improvements in operations, the service fees more than cover costs and give the provider a reasonable margin.

For example, many organizations have more difficulty securing capital funding than annual budgets. Family Christian Stores could never have afforded the investment it made in new information systems. By working with its outsourcing provider, it was able to pay for these over time with profits from growing sales. Public-sector organizations frequently rely on outsourcing partners to provide capital investment in technology, which the government then pays for ‘‘by the drink’’ with its annual budgets. In one Accenture study, converting capital into expense was the most frequently mentioned objective for business process outsourcing. Fifty-eight percent of the organizations in the study counted it as either their primary or secondary goal.^[1]

Finally, partners can bring third-party funding into an outsourcing initiative. This makes sense when the outsourcing provider has such a solid track record that it reduces the perceived risk for the initiative. As a result, the cost of borrowing can be lower than it would be for the company on its own. The company must ultimately pay off the debt, but it can do this with the savings it generates from the transformational initiative. Accenture’s work with a major grocery chain illustrates this approach. The initiative involved Accenture’s taking over the chain’s entire IT operation, including infrastructure and applications, with an intention to reduce the cost of maintaining so-called legacy systems and invest in new IT capabilities that would drive its business transformation. As Exhibit 4.1 illustrates, Accenture purchased the IT assets, giving the company a cash infusion on day one. Accenture also set about reducing its information technology cost base. This freed up resources that could be put to more strategic uses. Accenture also guaranteed that the chain’s ongoing IT cost would be lower than its historical spending, and that that rate of spending would grow more slowly than before. Accenture was paid for its efforts by a third-party financing company, so Accenture did not have to invest its own scarce capital. The grocery chain will repay the loan over time with its improved profits.

Exhibit 4.1: Creative financing opens a whole range of new options.

Bankers are not known for their risk-taking. In the case of the grocery chain’s initiative, the reputations of the two partner companies helped convince the financing company of the merits of the deal. In the Family Christian Stores example, it was the provider’s reputation alone that attracted a financial partner to the deal, making it affordable for the small company.

Outsourcing providers can bring all these benefits to the table. As we have seen above, executives need different things from outsourcing to achieve different purposes. The successful executive teams explicitly set down what purpose they are trying to achieve and what specific benefits they are after. They rank these in priority order, and they keep this ranking in mind as they set out to craft an outsourcing initiative to transform their enterprise. When things change, as they inevitably will, they review their objectives as the starting point for correcting their course.

^[1]Some details of this example have been changed to protect the identity of the firm.