1. Deciding what to outsource
Deciding what to outsource does not have to be a complicated exercise. The key is to understand how you will approach the exercise and what your outcomes are expected to be. The more clearly you understand the motivation for outsourcing an area, the more able you will be to explain this to potential suppliers. One of the main factors in successful outsourcing is ensuring that your outsourcing partner understands what you need from the project and that they are confident that they can meet these expectations.
Outsourcing Aligned to Competitive Advantage
The first thing that comes to mind when we consider competitive advantage is cost savings. However, there are many other areas in which competitive advantage can be gained. Speed to market is obvious. If you have a new product that you’re going to manufacture and only limited facilities to manufacture them in – then outsourcing might be the way to gain a strong hold on the market without enormous investment in training, human resources, machinery, new buildings, etc.
The product may be marginally more expensive than one produced solely in house. However, the advantage of gaining a stranglehold on a new market before your competitors can bring their own resources to bear may more than compensate for a fractional increase in production costs.
Competitive advantage might also be found in rapid scaling of capacity. For example, a marketing team intends to run a brief but intensive campaign on a particular mass market product. The campaign will only last a month. Bringing on new sales people to support the conversion process for the campaign, or new warehousing and distribution staff to support the supply of the product might not be feasible with the operational resources you have. The competitive advantage can be retained by outsourcing this capacity on a temporary basis. This capacity might be more costly than the equivalent in-house resources but again if profitability can be proven – it’s worth the investment.
However, cost-savings do drive some outsourcing agreements – the offshoring of call centre operations is a very straightforward example of attempting to achieve the same results with a lower level of cost.
Outsourcing aligned to Internal Capability
This area of consideration can be politically sensitive. However, if a business understands its core competencies it can begin to consider outsourcing those areas in which it lacks capability. Those areas which lie outside of the core business can be outsourced on a long-term basis without major impact on the company itself. For example, a distribution company may decide to outsource its payroll functionality because the function lies outside its core capabilities and there’s no need to develop it further within the business. Payroll can be outsourced at competitive rates with the minimum of fuss.
Those which lie inside of the core business can be outsourced on a short to medium term basis and the contract can be used to build internal capability. For example; a high-tech company which prides itself on its service releases a new product which is an unprecedented and overnight success. The company finds itself with a low level of capability to manage the massive new demand for support as its previous customer base numbered in the hundreds and the new base numbers in the millions. It outsources the support function to a call centre provider locally; it takes advantage of the opportunity to train up its own management team and chooses to contract with the outsourcers on a basis that allows for the function to be in-sourced at a future date.
Outsourcing for capability is an extremely sensible business practice. It’s important for supply chain managers to approach this topic gently. Outsourcing certain areas of business may mean redundancies etc. and it’s important to understand the depth of the transition before agreeing to proceed.
Develop a Thorough Understanding of the Impact
Understanding which processes you want to outsource is the start of the decision making process for outsourcing. The next part of the process is to understand which dependant processes are linked to the areas you will outsource and how the transition may affect them.
For example; if you outsource the support function (the contact centre) how much impact does this have on your sales process? In many organizations there’s a fuzzy area between the two functions and call centre agents often close business – how will this work when the area is outsourced? How will targets for the sales department be affected? You can’t outsource an area without fully appreciating how it will affect the larger business.
Understand the Outsourcing Opportunities Available
This might sound obvious but it’s vital that prior to outsourcing the supply chain management team evaluate all the outsourcing opportunities available. That means looking at potential suppliers and determining a rough fit. If a company decides to outsource its manufacturing for rapid growth it needs to know if there’s a potential partner (or ideally more than one) that is capable of handling its requirements in the time frame stipulated. This might be simple if the manufacturing process is simple assembly of components, it might be much more difficult if the supplier is required to have ultra-specialist plant for production of components.
Alternatively, you might be examining outsourcing payroll but want to be certain that in the future you can outsource all of the HR function. This will place (necessary) limits on the numbers of suppliers that you want to consider for payroll outsourcing as payroll only specialists won’t be able to handle the additional requirements if or when they arise.
A Focus on Supplier Collaboration rather than Abandonment
If you want your outsourcing to be highly effective it’s key to understand that outsourcing is a collaborative venture. While the supplier will be responsible for much of the day-to-day management of the project/process, their ability to deliver consistent results will depend on input from your company.
The initial evaluation of potential outsourcers must include a focus on their compatibility with your own values, ethics, etc.
2. Developing an RFP for outsourcing
Once you’ve determined what to outsource and you’ve fully understood the business implications and your list of potential partners it’s time to develop an RFP (Request for Proposal) to invite partners to bid on your project.
The specifics of an RFP will vary from project to project. The more competence you have in-house in an area the more you will be able to develop a detailed RFP which outlines the full end-to-end process expectations. It is acceptable in areas which you lack knowledge to develop an RFP which solicits this knowledge from potential suppliers, in fact this is a good way to better understand an area and assess the capabilities of suppliers to add value in that specific area.
There are several things to consider when developing your RFP:
Fixed Price Outsourcing
A fixed price contract may either be fixed for the duration of the contract for example; $1 million per month for x number of months, or it might be fixed per deliverable for example; $50 per sale made.
Fixed price outsourcing works best when the deliverables are highly specific and easy to measure. The advantage of developing an RFP that focuses on fixed price contracting is that the company can then take the price into account in long-term budget forecasts.
In general terms these contracts are used when the company doing the outsourcing understands the cost per task of doing the work in-house and is looking to maintain that competitive edge during the tendering process. For example; a logistics team might know the average cost per delivery made to a household. If they were to outsource the delivery service they would expect to maintain or reduce this cost.
The process might be open, in that the target cost is included in the RFP. Alternatively it might be closed and while suppliers are informed the project is to be delivered on a fixed cost basis – they are left to provide their own figures. This strategy works well if the company believes there are substantial cost savings to be made during the outsourcing process.
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Time and Materials Outsourcing
In other instances a fixed price contract is not going to work. For example; a manufacturer decides to outsource its onsite servicing arm. Call lengths are not fixed, the travel costs aren’t fixed, and the requirements of each visit might range from changing a plug to recalibrating complex machinery and replacing a wide variety of parts.
In cases like these the RFP needs to be developed to focus on the costs regarding time and materials expended by the outsourcer. This allows for all eventualities when delivering the service, though it is sensible to set trigger points after which the supplier must seek authorisation for further work.
Business process outsourcing is becoming increasingly common. It enables companies to concentrate on their core offering. The RFP in this instance needs to examine the other processes dependant on the outsourced process and ensure that there is adequate provision for communication and information exchange so that internal processes aren’t harmed through the act of outsourcing.
One-off projects need to be carefully defined in the RFP with either an end-date specified or another cut off measure (for example volumes produced) specified. Careful consideration needs to be given to handover measures at the end of the project.
Long-term projects require greater flexibility in the contract. The RFP needs to consider annual reviews (or more regular interviews) for re-negotiating terms. It’s also vital to consider how early termination of the agreement will be handled.
3. Examining Cultural Fit
Throughout the management of an outsourcing project one key consideration is cultural fit. That means examining the outsourcer for more than their ability to deliver a project. The objective is to ensure that the supplier’s business approach matches or is close to your own company’s.
In many instances you will want the outsourced team to feel like a part of your own business. That is much easier to achieve if there’s a common philosophy between you and your outsourcing partner.
You’ll want to assess this throughout the RFP process. Questions like; “Do their team behave like a high-performing unit and are you meeting a broad section of the team? (Or are they all sales people?)”.
You might also want to consider a client visit to a supplier’s clients. How they handle this may give you unique insight into their ability to manage the relationship. Do they choose a client with a similar scale of needs to your own and similar objectives? If not, why not?
4. Bid Management for Outsourcing
Once the RFP has been sent out and responses received it’s then time to enter the evaluation phase for the project.
It is essential to determine how you will evaluate each supplier on an equitable basis. Many businesses develop scoring frameworks for a bid. Individual criteria might include; cost, flexibility, compatibility, timescales, etc. It is quite normal to use weighting for the criteria to emphasise areas of important. For example if cost is critical it might be given 3 times the significance that timescales are given.
The grading structure should be simple and clearly understood by the whole team engaged in evaluating the proposals. The purpose is to identify the suppliers which can most ably deliver a working solution to the area to be outsourced.
During the evaluation stage you may find that additional issues arise and these should be communicated back to all suppliers and they should be given additional time to address these issues.
Negotiating agreements is a core part of the supply chain management function. It’s vital that during the outsourcing process that a focus is kept on win-win arrangements. Outsourcing contracts that are awarded solely on a price basis often tend to fail. An understanding that the supplier needs to make a profit and understanding what that profit objective is can allow for more rational negotiations.
Contracts need to be both secure (in terms of protecting your business) and fair. While the key understanding of the objectives and how the service will be provided need to made clear there needs to be a level of flexibility granted to the supplier in terms of the day-to-day management of the outsourcing contract. It is vital to ensure that reporting on progress and attainment is specified in the contract.
Relationship Management for Outsourcing
Once the contract is in place there is a need for continued management of the relationship. This is perhaps the most critical area for ensuring the success of any outsourced project or process.
The bid team are likely to take control of managing the performance of the contract. If the appropriate measures for reporting have been established the focus of this will be to correct issues in delivery. Whilst the contract should have established any punitive measures for non-delivery the team should be working in a constructive way (rather than a disciplinary one) to rectify the problems. This may mean additional investment in resource for large contracts to ensure that communication is constant and meaningful.
The longer a contract runs for the more likely it is that at some point additional negotiations may be necessary. These may reflect changes in market conditions, or increases in service volumes, etc. These negotiations need to be structured to deliver business value without alienating the partner currently providing the work.
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Finally, it’s worth noting that no matter how well written a contract there will often be areas which arise which weren’t anticipated. In some cases the supplier will need to make a decision that hasn’t been mandated. In these situations the management approach should be around clarification. What is the issue? How to best address that issue? What should be done in future? It’s vital that once an issue has been clarified that it is documented properly and fed back into the contracting process for future negotiation.
The outsourcing approach is a simple one; decide what to outsource, develop an RFP, identify potential partners, evaluate their responses to the RFP, negotiate the right contract, and then manage the contract effectively. The complexity of each of these steps will be dictated by the function being outsourced and the company which is doing the outsourcing.
Logistics Outsourcing Seminar
If you have an interest in this subject we are running a Logistics Outsourcing Secrets seminar in Sydney, Brisbane and Melbourne. Click here to go to the registration page: Outsourcing Success Secrets
P.S. Is there anything you would add to the article? Do you have any questions about the article? Ask me personally in the comment box below. I answer all comments myself.
I am a PhD student on this subject from Victoria University. I have spent more than two decades in outsourcing and selling outsourcing of logistics and supply chain solutions. I am still learning from peers like you. Great article, my supervisor Dr Himanshu suggested that I should read the article and I have enjoyed reading your thoughts on outsourcing.
I felt two points could add value to the above article. One is governance process which includes collaborative approach of outsourcing. Many believe that outsourcing means job given to outsider and it is the responsibility of the outside agency to get things done within time and cost agreed. This means they are trying to transfer accountability to the third party. In my opinion we are only transferring activity but not accountability and responsibility for the outcome. Hence, I believe collaborative approach and governance process is critical to achieve targeted goals. This paves way to more innovative pricing models such as open book method, activity based cost model, cost plus model, and gain share model.
Secondly, we see many contracts fail within six months as the whole process goes through, courtship, hardship, battleship and relationship. Majority of the projects that fail show signs of disconnect in the hardship phase and get terminated in the battleship phase. Hence, in my opinion, it is critical to have Plan B which is exit strategy. This is critical because organisation performance should not impact due to outsourcing failures.
I firmly believe that Core Competency strategy of the organisation should lead to outsourcing decision. I appreciate your thoughts and advise which could be critical for my PhD study. Thanks for the opportunity to comment. Thanks once again.
Hi. Am doing an MD on this subject would you know what the approaches of logistics outsourcing are?
You will find a lot more information on the Blog here and our YouTube Channel: https://www.youtube.com/c/robobyrne/
You make a couple of really good points Vijay!
Far too many organisations see Logistics Outsourcing as passing a problem to someone else, the 3PL, and then complain when things go wrong. It takes a degree of commercial maturity to understand that a great deal of responsibility and accountability still rests with the client, to manage the outsourced relationship effectively.
Regarding Plan B, I would always enter into a Logistics Outsourcing relationship with a very open, positive and thorough approach, thereby almost eliminating any chance of failure. But having a Plan B, or more realistically a clear exit strategy does of course make absolute commercial sense and should form part of any outsourcing plan.
Good luck with the rest of your studies and maybe we can catch up for a coffee some time.
Some nice points there Rob,
We have done outsourcing for couple years now, but I must admit that we haven’t done it properly. Some of the points mentioned above point out to our problems.
Thanks for the great post.
Have a nice day.
You’ll find plenty more on Outsourcing here Oskars. If there is something more you want to know about, just let me know.