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The saying that one person’s trash is another’s treasure was never so true as during the heyday of outsourcing information-technology departments. The idea in the 1990s was that you should figure out what you are not good at (or don’t want to do) and find someone to take the work off your hands. “We aren’t in the I/T business,” many chief executives reasoned, “so let’s outsource I/T to someone who is.” Outsourcing is hot again, in a much broader way, precisely because of the information technology that executives were so eager to get rid of. The Internet, and the rich communication platform it creates among companies, has allowed for new alliances and relationships that companies are starting to experiment with. For instance, Internet retailer Amazon.com Inc. (www.amazon.com) and electronics retailer Circuit City Stores Inc. (www.circuitcity.com) struck a deal before the past holiday season that allowed a customer to log on to Amazon, purchase a digital camera, and pick it up at the Circuit City in his neighborhood. If the camera was dropped in the punch bowl at a holiday party, the customer could take it back to Circuit City to have it replaced. Amazon simply outsourced fulfillment and customer service to Circuit City. As the Amazon/Circuit City arrangement shows, outsourcing now goes beyond turning over to another company the operation of an entire department, such as I/T. Instead, business processes that cross departmental lines—such as logistics or manufacturing or even research—are being turned over to outside companies. Research firm Gartner Group estimates business-process outsourcing will grow 23% a year and be a $300 billion business worldwide in 2004. Is this a good thing? In many instances, yes. But executives need to learn from the many errors committed in the first go-round, with I/T outsourcing, and from the mistakes that have been made by pioneers in this new round. Executives should be asking themselves these questions: WHAT IS OFF-LIMITS BECAUSE IT IS CORE TO THE BUSINESS? This is a complex question. Some companies see almost nothing as off-limits. Bayer AG, the German drug giant (www.bayer.com), has even outsourced about 30% of an area that could make or break the company: its long-term research-and-development efforts. Throughout the pharmaceutical industry, some 20% of drug development is now outsourced, and research firm Frost & Sullivan predicts that by 2004 nearly 42% of all pharmaceutical drug development expenditures ($38.4 billion) will be spent on outsourcing to alliance partners. Still, companies can make mistakes if they evaluate corporate capabilities individually and don’t consider how much one process or department affects another. As Wall Street firms evaluated I/T outsourcing, they saw that they would get clear efficiencies, but they also realized that they couldn’t view those efficiencies in isolation, and that the people who design their complex financial instruments would lose some agility. Because these firms depend so much on their ability to quickly design and bring financial products to market, they correctly decided to pass up the efficiencies that would have come from outsourcing. WHAT IS THE COMPETITIVE LANDSCAPE? Telefon AB L.M. Ericsson, the Swedish electronics company (www.ericsson.com), recently decided that cost-cutting was paramount in its industry. So it outsourced the manufacturing of its mobile phones to Flextronics Corp., a company based in Singapore (www.flextronics.com). Ericsson avoids capital investment in equipment and technology that grows obsolete rapidly. Flextronics, which also produces mobile phones for Motorola Inc., hand-helds for Palm Inc., printers for Hewlett-Packard Co., and the hot new Xbox videogame player for Microsoft Corp., gains better purchasing and production economics than Ericsson could generate on its own. Still, Cisco Systems Inc. (www.cisco.com) hurt itself through a similar deal with contract manufacturers when it misjudged the landscape. The manufacturers want predictability in orders, so they can operate as efficiently as possible, and Cisco locked itself into long-term contracts just as the bottom was dropping out of the market for networking equipment. Cisco had to write off $2.5 billion of inventory in early 2001, basically because it thought its competitive environment demanded efficiency when it really required nimbleness. HOW IMPORTANT IS FLEXIBILITY? I/T outsourcing proved to be an often-brittle arrangement. Many a company has been surprised to learn that information technologies that it sees as crucial to its future are “out of scope” of the outsourcing contract. This happened in droves when the Internet rapidly emerged, and companies wanted their outsourcers to create Web sites and internal intranets using the new capabilities. For instance, Mutual of New York (www.mony.com) and Computer Sciences Corp. (www.csc.com) had to go to arbitration just two years into a seven-year outsourcing contract because of a dispute over the scope of their arrangement. Companies considering business-process outsourcing need to make sure there is the right amount of flexibility in their contracts so they can adapt as times change. HOW MUCH MANAGEMENT BANDWIDTH IS NEEDED? Outsourcing is often sold based on the idea that it will reduce the need for supervision by senior managers. In fact, outsourcing may just be trading one kind of managerial headache for another. For example, insurance companies have tried for a long time to outsource to large brokers the underwriting of specialty products, such as professional liability insurance for law firms, where the brokers understand the risk better than the insurance companies do. In the process, the insurance companies get rid of a lot of operational headaches. But they increase the general-management headaches because they must still find ways to limit the amount of risk they take on, even though they have delegated the evaluation of risk to another company’s employees. It’s important to gauge in advance just how much time, if any, management will save by outsourcing a business function. WILL PRODUCT QUALITY BE COMPROMISED? Cummins Diesel (www.cummins.com) found it could outsource manufacturing for most engine parts but learned that, to maintain quality, it needed to make certain critical “wear” components itself. In a down economy, it only makes sense to eliminate as many costs as possible, and that can mean a renewed look at outsourcing. But as Cummins, Cisco, the insurance companies, and many other firms have learned—or will learn, usually the hard way—you can take this trend only so far.
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