How To Outsource Strategically

How to Outsource Strategically

Leading companies, both large and small, are going beyond just outsourcing commodities to also outsourcing core/strategic parts and services. It often makes financial and operational sense for smaller firms with scarce resources to outsource non strategic parts and non core competency services. A commodity by definition is something that many suppliers exist for, and as a result of competition, can do it better, faster, and cheaper. However, our research and experience has demonstrated that outsourcing core parts can be done effectively if companies take a strategic long term results approach and avoid focusing on only short-term results. For example, some companies use techniques such as co-location and long-term contracts to better align with their suppliers and de-risk supply. Smaller companies in particular should establish joint ownership of all design and manufacturing capabilities developed during the outsourcing partnership. There was a time in industry when the school of thought was that every company needed a core competency and should focus all of its scarce resources on developing that competency. Having a core competency implied you could do something better, faster, and cheaper than anyone else and everyone came to you for it. However, from our experience, strategic outsourcing can in itself be developed into a core competency, especially for smaller companies that have fewer resources.

  • Strategy
    Commodities and core parts can both be outsourced, but the techniques used for outsourcing requires careful strategic evaluation, especially for a smaller company. Larger companies often have the resources to regroup if they ineffectively outsource something strategic, but smaller companies are more at risk because of a lack of resources to play catch up. For example, decades ago, IBM wanted to outsource the operating system and microprocessor for its personal computers and it was all about driving down costs. IBM failed to recognize that these two components of a PC were strategic and that perhaps cost was not the major driver. IBM quickly outsourced these parts to Microsoft and Intel. These two suppliers proceeded to widen their margins in the PC market as companies like IBM failed to establish joint ownership of design capabilities. IBM was large enough to regroup from these outsourcing decisions, but most smaller firms do not have this luxury.
  • Availability
    With core parts, those with special technical, quality, or strategic considerations, there might only be 1, 2, or 3 suppliers to choose from. After all, a few or no suppliers to choose from is what defines a core part. Also, if a part is core, chances are you need to go with one supplier because using more than one might be too complicated, sensitive, or costly. Suppliers with only one or two competitors are reluctant to work with customers that also work with their competition. Companies, especially smaller ones, should resist the temptation of using competitive bidding when they outsource core parts. Why? One, how do you use competitive bidding if there are only 1 or 2 suppliers to choose from? You cannot. Have you heard about the government awarding multi billion dollar contracts to suppliers with no bids? People often ask why don’t they use competitive bidding to get the best price. It is often because there is only one supplier that can give the government everything they need and want.
  • Process
    Price is usually not the most important evaluation criterion with core parts. Everyone of course cares about price, but how much does a smaller firm know about price with something as complicated as a core part? It is not a commodity like a widget. The buying organization should establish cost target goals and reward the supplier if they exceed those goals. Usually, strategic outsourcing of core parts is about performance (e.g., quality, service, and flexibility). Smaller firms should use negotiation to agree on the framework for interacting with a supplier for core parts post sourcing. Smaller firms should use inexperienced junior buyers for competitive bidding of commodities. However, smaller firms need to tap into the experience and skills sets of senior buyers that can negotiate the terms and conditions of a contract with suppliers for strategic core parts. If such skill sets do not exist internally, then external services should be leveraged.

In conclusion, smaller companies with limited resources can develop outsourcing as a core competency. One way to get there is through strategic sourcing and that includes commodities. For example, do not assume that you are getting the best price and cannot do better because it is a commodity. You might outsource steel pipes to a distributor and only pay $1.00 per piece because that distributor buys steel pipes from the steel mill in bulk. It would otherwise cost you $1.20 if you bought directly from the mill. That is strategic sourcing, and the approach works for both commodities and core parts. Raw material costs for all types of mills have been escalating at very rapid rates and these mills refuse to sell products at a loss which and go out of business. They are better managed today and have surcharges for cost increases that are out of their control such as raw materials. If a steel mill has a 15% surcharge that is passed onto a distributor and the distributor marks up the steel pipes by 15%, then your new cost will exceed $1.15. Strategic sourcing can address issues such as these through upfront negotiations and require that you only pay the distributor an increased amount above $1.00 that is exactly the rate of the surcharge. In other words, you will pay the 15% surcharge, but you will not let the distributor mark up the 15%. You could also shop around for mills that are more efficient and have a smaller surcharge or use a different distributor. Even commodities can be managed strategically and it might be required for smaller companies as they look for ways to widen margins with fewer resources. We hope the above aids your efforts in defining and refining your core competency and supporting outsourcing efforts.