Advantages of Outsourcing

OUTSOURCING AS A COMPETITIVE ADVANTAGE IN THE GLOBAL WORLD Harish Kumar Singla (Reader- Finance) Maharishi Arvind Institute of Science and Management, Jaipur FDP-IIM AHMEDABAD Vijay Sharma (Faculty- Marketing) Maharishi Arvind Institute of Science and Management, Jaipur What is competitive advantage? When a firm sustains profits that exceed the average for its industry, the firm is said to possess a competitive advantage over its rivals. A competitive advantage exists when the firm is able to deliver the same benefits as competitors but at a lower cost (cost advantage), or deliver benefits that exceed those of competing products (differentiation advantage). Thus, a competitive advantage enables the firm to create superior value for its customers and superior profits for itself. Famous strategist Michael Porter identified two basic types of competitive advantage:   Cost advantage Differentiation advantage Cost and differentiation advantages are known as positional advantages since they describe the firm's position in the industry as a leader in either cost or differentiation. Resources and Capabilities According to the resource-based view, in order to develop a competitive advantage the firm must have resources and capabilities that are superior to those of its competitors. Without this superiority, the competitors simply could replicate what the firm was doing and any advantage quickly would disappear. Resources are the firm-specific assets useful for creating a cost or differentiation advantage and that few competitors can acquire easily. The following are some examples of such resources:      Patents and trademarks Proprietary know-how (technological skills) Installed customer base Reputation of the firm Brand equity Capabilities refer to the firm's ability to utilize its resources effectively. An example of a capability is the ability to bring a product to market faster than competitors. Such capabilities are embedded in the routines of the organization and are not easily documented as procedures and thus are difficult for competitors to replicate. The firm's resources and capabilities together form its distinctive competencies. These competencies enable innovation, efficiency, quality, and customer responsiveness, all of which can be leveraged to create a cost advantage or a differentiation advantage. How to create Competitive Advantage? Winning companies aren't successful by accident, though often it may seem that way. A closer look usually reveals that most have sized up their target markets and zeroed in on a unique approach to meet their customers' needs, values and expectations. Through important considerations like location, product, services and product features, they have somehow found a fresh spin, a new way to offer buying incentives that similar companies either can't or don't offer. Once the company has developed a competitive edge, maintaining it will be a daily challenge. It will require it to look into its crystal ball and attempt to forecast where the trends and changes in it‟s‟ industry will come from, and what the company can do to stay ahead of the game. It will demand that company continuously track its competitors and their future plans. It will also need to recognize that through the course of time its customers' needs may change due to a variety of circumstances. The company must be flexible and willing to change as well. The following questions are designed to help an entrepreneur to determine whether his company has a competitive edge:          Have I clearly defined my company and its target market? Who are my competitors? What is my company's clear-cut strategy and plan for success? Do I regularly track my competitors' moves? Do I take advantage of my competitors' weaknesses? What have I learned from my competitors' mistakes? What have I learned from my competitors' strengths? Do I take advantage of competitive opportunities? Does my company possess a uniqueness that easily separates it from my competitors?         Would I pay money to use my own product or service? How do my prices compare with the rest of my industry? Who are my customers? Do I have a loyal customer base? Am I sensitive to my customers' needs and requests? Are my employees trained in customer service? What trends do I see for my industry in the future? Do I have the capabilities and resources to compete in the market five to 10 years from now?  What is my vision for my company five to 10 years from now? Achieving High Performance through Outsourcing Research finds that outsourcing is no longer used as just a cost-cutting tool; it also offers a host of high performance benefits to companies. Once viewed solely as a tool for cost-cutting, outsourcing is now recognized as a strategic tool that can boost performance by encouraging innovation and new approaches to conducting business. Outsourcing serves two main functions: First, it can serve as an accelerator to achieve high performance in missioncritical areas, enabling a company to quickly build scale and best-in-class processes. Second, it allows a third-party to take responsibility for the less critical areas, thus enabling companies to focus on those capabilities that will have the greatest impact on their business. One of the fastest growing areas of outsourcing is finance and accounting given the many benefits it affords. In addition to realizing baseline savings, companies are also finding that outsourcing finance and accounting processes can increase operational control. By creating shared-services operations for finance and “inheriting” the highly defined processes and controls brought through outsourcing, the ability to better enforce internal controls and comply with audit requirements undergoes a step change. And, leveraging the best-in-class credit and collection capabilities of an outsourcing provider directly impacts day‟s sales outstanding, past-due receivables and can significantly improve working capital. Outsourcing Objectives Outsourcing arrangements are not typical purchaser/vendor relationships. When examining the potential value that outsourcing can deliver, it‟s equally essential that the objectives and success criteria for outsourcing be clearly understood within the organization. Those goals and criteria must be communicated to potential vendors early in the process to ensure an accurate common view. Any outsourcing arrangement must be tailored to create a win/win deal that balances potential risk between the client and the vendor and creates an incentive for the vendor to work with the customer organization. It‟s becoming increasingly common for outsourcing arrangements to be structured for „gainsharing‟: once targeted benefits are achieved, benefits beyond the target are shared. Arrangements such as these promote a true partnership. Many companies are wary of long-term, full-service outsourcing contracts, because they understand that one of the few constants in a long-term relationship is change—in technology, in the competitive and regulatory environment, in the needs of the business, and in the business value expected from the outsourcing relationship. Outsourcing Value Chain Activities A firm may specialize in one or more value chain activities and outsource the rest. The extent to which a firm performs upstream and downstream activities is described by its degree of vertical integration. A thorough value chain analysis can illuminate the business system to facilitate outsourcing decisions. To decide which activities to outsource, managers must understand the firm's strengths and weaknesses in each activity, both in terms of cost and ability to differentiate. Managers may consider the following when selecting activities to outsource:   Whether the activity can be performed cheaper or better by suppliers. Whether the activity is one of the firm's core competencies from which stems a cost advantage or product differentiation.  The risk of performing the activity in-house. If the activity relies on fastchanging technology or the product is sold in a rapidly changing market, it may be advantageous to outsource the activity in order to maintain flexibility and avoid the risk of investing in specialized assets.  Whether the outsourcing of an activity can result in business process improvements such as reduced lead-time, higher flexibility, reduced inventory, etc. The strategic advantage Outsourcing allows companies to create a single point of contact—and a competitive advantage—for solving invoice discrepancies and other financial service related issues and thus enables companies to strengthen the relationship with their customers. In the ever-changing landscape of the industry, where companies move geographic locations or take over new businesses, the ability to operate finance and accounting independently can serve as a strategic asset. With processes and systems standardized in the financial area, changes create less disruption to service—and can be accommodated more readily. Other advantages of outsourcing finance and accounting is a rapid return on investment without a hit to the P&L, and service level increases that are built into the outsourcing contract. All affect the bottom line and enable companies to reinvest savings in areas that have the greatest impact on the business. Finally, outsourcing can prove an invaluable tool in corporate efforts to institute change. Outsourcing acts as a catalyst to break down entrenched habits and prompt a re-evaluation of established processes. Companies often find it difficult to stimulate internal changes because employees so closely identify the process they perform with their own jobs. The role of outsourcing is broadening for companies. Previously viewed as a cost-savings measure, outsourcing‟s role continues to expand, as companies look to the additional benefits of increased innovation, greater control and support in strategic change. In addition, the outsourcing provider becomes a business partner and enables the companies to focus on the areas that will yield the greatest impact. The math behind finance and accounting outsourcing is simple: greater levels of control and innovation at lower costs help companies achieve high performance—and nets a winning proposition for players. There can be no doubt that either by outsourcing or by developing these offshore subsidiaries companies can make substantial savings. Both British Airways and Bell Canada report savings in the tens of millions of dollar ranges. However, if we look at the industries both of these two companies operate, they both face major competition from new entrants. It may be suspected that both will find that continuing to simply squeeze cost out of what might be seen as a flawed business model will merely slow down the speed of their demise, rather than lead them to gaining competitive advantage. What to outsource? In any given market we will see dominant and established players looking to survive in the face of “disruptive” change from new entrants. They will nearly always struggle to compete with these new entrants due to a general “incremental” change mindset. In today‟s competitive environment this is not enough. At the very least companies must strive to ensure that they are making “step” changes and thus ensuring that competitors and new entrants find it harder to keep up. The other thing that the outsourcing stories have in common is that they all seem to actually be about outsourcing functions. They seem to be yet another way to avoid having to deal with the issues of business processes. It doesn‟t demean the success of these organizations but It questions whether they could have achieved more had they Undertaken value chain and business process analysis first. It may be again suspected that they may have chosen different paths had they done so. They might have (at least in some cases) found that some of the aspects they outsourced should have stayed in-house and some of the other inhouse activities might have been better outsourced The rapid moves towards outsourcing are no doubt bringing forward the day when more and more corporations are “virtual” and merely involve a small core of people with an idea “orchestrating” a business using partners. However, where the new wave of “virtual” organization will win out over the “traditional” companies is that they will not outsource anything that might create competitive advantage. They already know that anything you can outsource, so can your competition. Where to go? Independent research, commissioned by international law firm Baker & McKenzie, involved 51 in-depth interviews with FTSE 500 directors across a wide range of sectors, questioning them about the Brazil, Russia, India and China markets. Among its findings was the revelation that almost two-thirds of companies believe that outsourcing can brings real competitive and strategic advantage. India was singled out for its expertise in services provision. One respondent commented that India is "hi-tech, it's well educated so it's a good place to base centers of excellence". Referring to Russia, another respondent said they are using "a fantastic research institute [with] a lot of well trained scientists and engineers that have surprising technology". China is seen as a manufacturing hotbed. However, direct investment in the country remains difficult. As one respondent said, "I have no problem with outsourcing to China to exploit its manufacturing base but I think it's very difficult to invest in directly." However, the research also highlighted environmental inhibitors to moving into these markets. These inhibitors included corruption and political and economic volatility, which were mentioned in relation to Russia and Brazil. Human rights were of greater concern in India and China. Leveraging outsourcing as Strategical Tool Theirs is more than a simple outsourcing strategy, however. The leverage comes in analyzing all the services that comprise the company, discovering which actually give or could give the firm its edge over competitors, concentrating on doing a world class job in delivering these strategic services internally and acting to "eliminate, limit, or outsource" the rest. Instead of analyzing market share, Quinn, Doorley, and Paquette urge managers to analyze the strength of the service components of their business relative to its competitors. The indirect benefits of outsourcing may be the most important. By outsourcing non-strategic activities, organizations can devote more time and attention to the core activities that give them competitive advantage. Outsourcing can reduce the size of the organization and make it less hierarchical, allowing it to focus on obtaining, developing, and motivating the people who create value. It can also allow a shift in management attention toward strategy, coordination, and the skills that promote competitive success (Quinn, Doorley, and Paquette, 1990b). These views of competitive advantage represent a shift in management thinking and open the door to what some call: "The Virtual Corporation." The virtual corporation produces world-class products and delivers world-class services by organizing suppliers and vendors to do many of the activities in the value chain or many of its business processes. The virtual corporation performs the services and processes that give it the edge and outsource the rest to a host of vendors. The critics of outsourcing often rest their case on assumptions that internal functions should be able to do what vendors do if they only applied good management practices and worked smart. Sometimes this is true, but in other instances it is not. Consider the ways in which vendors could hold an edge:  Multiple clients allow a vendor to operate at a scale unattainable by any single organization  A large vendor can buy and fully utilize large, powerful, and more efficient equipment than clients who operate at a smaller scale.  A large-scale vendor has considerable advantage in negotiating price and service with providers of equipment and software.  Large-scale vendors can maintain a bench of technical experts with greater range and depth than any of their clients because the vendor can utilize the expertise efficiently and effectively when spread over multiple clients on a flexible, as needed basis.  Large-scale vendor management can specialize, focus, and gain repeated experience with management of tasks that would only come around once in the careers of many IT managers. Vendor management may be more skilled and experienced, as a result. Because of the variety of clients and circumstances vendors encounter, vendors have a depth and range of experience that individual clients can't match. Vendors can go through multiple restructuring and conversions that could only happen once in the experience of your in-house personnel. Just as the best surgeons tend to be those who do many operations of the same type, day-in and day-out, so too vendors who do the same difficult tasks repeatedly gain an advantage over those who do them infrequently or only once. The ability to specialize in skills also extends to experience with new technologies. Your people will only encounter conversion to a new operating system or client-server architecture once, but through experiences with multiple clients, vendor personnel can have this experience numerous times and gain a real advantage in knowledge, speed, and efficiency. Being on the cutting edge in technology and methods is a big attraction to hiring and retraining the most talented people. Vendors can often offer these experiences on a more consistent basis to its personnel than can the typical IT department. For this reason, vendors often have very good people with the latest experience, something difficult to reproduce in other organizations. Trends that Favor Outsourcing Clark, Zmud, and McCray (1995) identify factors in information systems technology change, technology management, and business change that favor outsourcing. Information Systems Technology Factors Technological change expands options and enables outsourcing in the sense that:  Many information products and services have become commodities as computer technology and its use matures. "A product or service can be considered a commodity when a common functionality exists across customers and/or clients, particularly firms within a specific industry, and when reliable, high-quality performance levels are widely available at competitive prices." The commoditization of information technology and systems has fostered economies of scale in their delivery and clear identification of their status as non-strategic or utilities. Vendors who compete on both price and quality of service can often reach the scale necessary for minimum cost, and the non-strategic status of many information system functions allows them to be outsourced.  Technology Change also allows the separation of management, operation, and delivery of information services that expands the choices available for outsourcing and reduces the risks of outsourcing. Technological change also enhances the demand for outsourcing.  The incredible increase in the performance-to-price ratio of information technology in the last 50 years has led to widespread and innovative use of information technology in all aspects of businesses. However, the same rapid technological change quickly makes older hardware and software obsolete. Organizations are, therefore, on a constant treadmill with an abundance of equipment and staff skills that are always becoming obsolete and a shortage of critical cutting edge skills and hardware. Outsourcing provides an avenue for reducing the human and equipment resources that don't fit the strategic direction and for meeting the latest needs with up-to-date resources. Technology Management Factors Changes in the management of information technology also foster outsourcing:  Information systems budgets have grown along with the growth in the use of computer equipment and automated systems. It is often difficult to measure the benefit and justify the use of information technology. Senior managers are attracted to outsourcing as a way of making costs predictable and assuring that the organization is paying the "market price" for information systems services.  Chief information officers often have business backgrounds as strong as or stronger than their technology backgrounds. They are taking a business view, rather than a technology view, of outsourcing alternatives.  Information systems control has been decentralized and dispersed in many organizations. What remains of the old corporate or centralized IT function often has excess capacity and resources that makes some of its functions possible targets for outsourcing. Industry-level Factors Industry-level changes may also promote outsourcing:  Rapid technological change often creates over capacity in certain functions in information intensive industries that leads to opportunities for outsourcing, resulting consolidation, and economies of scale. Clark, Zmud, and McCray give the example of routine data processing functions in banking that have been widely outsourced to third parties (sometimes other banks) as a way of achieving lower costs.  The number and quality of outsourcing vendors offering price competitive and high-quality services has increased. Barriers to entry are low, and technological change creates discontinuities in needs that vendors can exploit. As new vendors enter the marketplace, competition increases and further reduces the price and increases the quality of service.  Vendors are experiencing rapid growth in the demand for their services and can afford to snap up, reward, and promote some of the best technical talent in the industry, further enhancing their potential and the attractiveness of outsourcing. Firm-level Factors  The corporate imperative to run "lean and mean" and cut costs has favored outsourcing for the same reasons already mentioned above.  Globalization of business in combination with technological change creates new needs for capabilities to address problems related to distance, size, and rapid change. The new needs may be better met through reliance on vendors with these capabilities. Conclusive remarks The best conclusions we can draw are that outsourcing is beneficial if the organizations have identified that what they will outsource are non-core and noncompetitive advantage activities. The money saved here needs to be re-invested into the core activities and more particularly in activities that raise the bar and make it harder for competitors or new market entrants to catch up with the company. Finally, whilst it may make sense for businessman to outsource the activities, one should not outsource the Business Processes; these are the competitive edge of the company and the very key to survival. References Black, J. A., and Edwards, S. 2000. „Emergence of virtual or network organizations: fad or feature‟. Journal of Organization Change Management, 13 (6): 567-576. Boyson, S., Corsi, T., and Dresner, M. 1999. „Managing effective third party logistics relationships: What does it take?‟ Journal of Business Logistics, 20 (1): 73-98. Burdon, S., Clegg, S., and Weiss, R. 2004. „Competitive Advantage from Best Practice Outsourcing: The Untold Success Story.‟ Report, University of Technology Sydney, Sydney. Clark, Thomas D., Zmud, Robert W., and McCray, Gordon E. "The outsourcing of information services: transforming the nature of business in the information industry," Journal of Information Technology, 10 (1995) 221-237. David Switzer, Application Outsourcing: A Competitive Advantage Tool, Application Management Services, CTG Domberger, S. 1998. The Contracting Organization. A Strategic Guide to Outsourcing. Oxford University Press: Oxford. Drucker, P. F. 2002. „They‟re not employees, they‟re people.‟ Harvard Business Review, 80 (2): 70-78. Dun & Bradstreet 2001. The Dun & Bradstreet Barometer of Outsourcing (2001). Available at: http://www.dnb.com.au/rmo/barom2001 Goolsby, K. (2001) „Getting a Handle on the Purse Strings‟, Outsourcing Journal, February 2001 Hilmer, F. and J Quinn (1994) Strategic Outsourcing, Sloan Management Review, Summer Jones, Wendell, (2001) CEO Outsourcing Advisers, Outsourcing Summit Feeny, D; Willcocks, L and Lacity, M (2003), “Business Process Outsourcing: The Promise of the „Enterprise Partnership‟ Model”, Templeton Executive Briefing, Templeton College, University of Oxford, UK Quinn, J. B., and Hilmer, F. G. 1994. „Strategic outsourcing.‟ Sloan Management Review, (Summer): 43-55 Robinson M., and Kalakota, R. 2004. Offshore Outsourcing: Business Models, ROI and Best Practices. New York: Mivar Press. Shy O., and Stenbacka, R. 2003. „Strategic outsourcing.‟ Journal of Economic Behavior & Organization, 50: 203-224.