Outsourcing: Avoiding Hidden Risks

David BovetPartnerNorbridge, Inc.24 April 2008

Contact: dbovet@norbridgeinc.com+1.978.831.1121

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Outsourcing has its risks

Lou Dobbs: Here’s Why You’re WRONG!

Send Jobs to India? U.S. CompaniesSay It’s Not Always Best

Errors Costly in Offshore Rush

OUTSOURCING, ON HOLD

Offshore “Hiccups in an Irreversible Trend”

Unhappy with Outsourcing

Outsourcing is no Panacea“Just Another Fad” – Michael Porter

2

Much of the supply chain is outsourced …

Buy Make Move

Buying AgentAggregator

Quality Inspection

Co-PackersContract Manufacturers

Private Label

3PLsCarriers

Warehouse Operators

2007 Logistics Survey:

65% outsourced in Europe

47% outsourced in NorthAmerica

3

… As well as the rest of the company

Buy Make Move

ConsultantsMarket ResearchersSoftware Providers

Call CentersReturn Centers

PlanCustSvce

IT: Help Desk, Applic Developmt Finance: Accntg, Payables

R&D: ODMs, Engrg, QA HR: Benefits, Admin, Support

4

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Why do companies outsource?

Contain cost

– Reduce labor and facility costs

– Variabilize cost structure

– Leverage provider’s economies of scale

– Free up capital

Drive strategy

– Offer new customer options

– Focus on core activities

– Simplify management attention

Improve service levels

– Access specialized skills

– Raise process quality

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Traditionally, outsourcing was lower risk

Outsource

Core to the business

Organized by expertise

Opportunity/decisionintensive

High process risk

Low

High

Low High

Non-differentiating

Basic know-how transfer

Transactionintensive

Low processrisk

Traditional View of Appropriate Approaches

Economies of scale

Valueadded

In-house

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But outsourcing risks are rising

Strategic risks are rising

Emerging

Mature

Low

Switching costs

Providercapability

High

Complexity ofoutsourced activities

High

Performance manager Strategic

CarefulchoiceTactical

Critical,highervalue-added

Transactions,back-officeprocesses

Softwaredevelopment,Help desk

Call centers,employeeservices,IT support

Low

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Types of outsourcing risk

Strategic

Loss of control

Brand damage

New competition

Arrested evolution

Operational

Poor service, quality

Weak governance

Staff resistance

Process disconnects

Lack of visibility

Financial

Revenue hits

Unforeseen costs

Regulatory risks

– Governance

– Financial

– Data privacy

Provider bankruptcy

Hazard

Natural disasters

Political risk

Strikes

Cyber risk

Business interruption

Insurance gaps

Let’s look at a few examples …

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Loss of strategic control

Major IT outsourcing dealDec 2002

Aug 2004

Merger with Bank One

Contract cancelled

Moves IT back in-house

4,000 IT people

Back toJP Morgan

Deciding what is “strategic”

Jul 2004

Jan 2005

Planning “backsourcing”

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Brand damage

Lead paint toys recall

First flagged in Europe Recall of 2.7M toys in 2007 Negative brand impact Mattel had to apologize Now – more testing and

cost, by Mattel, retailersand product licensors Increasing regulation

Effective oversight is essential

Quality responsibility remains

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Arrested evolution

Low-cost airline

Company begins operating with a few aircraft Selects local firm for aircraft maintenance Airline grows exponentially Adds dozens of planes

Lacks partner management capabilities Relationship hits a roadblock How to obtain “world class” services?

Choosing provider for the long term

Building relationship mgmt capability

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Operational disconnects

Global networkorchestration

787 Dreamliner 892 orders Unique global

supply network 44 int’l partners Outsourcing unique for Boeing Parts shortages, pre-assembly delays Plan B lacked detailed sequence planning

Upfront contingency planning

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0%

10%

20%

30%

40%

50%

60%

70%

100 200 300 400

Volume (Orders + Backlog), Index

Operational and revenue hits

Global contract manufacturing transition

Q1

Q2

Q3

Q4

Q5

Q6Q7

Q8

DeliveryPerformance,

%

Active management, process integration

CM delivery performanceworsens as volume rises

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3PL Phase-in

97%

84%

70%

80%

90%

100%

Ap

r

Ju

n

Au

g

Oc

t

De

c

Fe

b

Ap

r

Ju

n

Au

g

Oc

t

On-Time Delivery Performance

Target Performance = 97%

Year 1 Year 2

On-TimeDeliveries %

Service quality decline

Transportation outsourcing

Service performance did not meet expectations

Provider due diligence and aligned incentives

In-house Service deterioration

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Why does outsourcing go wrong?

Wrong expectations

Inadequate planning

Poor communications

Incompatible cultures

Conflicting objectives

Misguided incentives

Lack of attention

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Making outsourcing work

Choose best partnerand launch the deal

Manage andimproveperformance

Decide whether andwhat to outsource

LaunchPartnerselection andimplementation

ManagementOngoing controlandimprovement

StrategyOpportunityassessment andbusiness case

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Phase 1: Strategy

Define objectivesand potentialoptions

Target activitycharacteristics

Desired outcomes

Value drivers

Identify internaland externaloptions

1. Strategy

Assess options

Process maturity

Suppliercapabilities

Value / economics

Quality and servicelevels

Risks andmitigation

Recommendoption and buildbusiness case

Cross-functionalvalidation

Scenarios andmilestones

Rightsourcingbusiness case

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Internal resistance to outsourcing

Outsourcing initiativesare abandoned due to:

What's going tohappen to me?

Why does ithave to change?

When are thingsgoing to move for

me?

What is init for me?

What arewe going tobecome?

Lack of leadership andmotivation for change

Cultural inability to change

Lack of time commitment

Inadequate communication

Employee resistance

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Phase 2: Launch

Conduct partnerselection

Define process

Develop criteria

Identify potentialpartners

Model outcomes

Review processesjointly

2. Launch

Plan launch

Negotiate SLA

Set KPIs

Design governancemodel

Transfer risks

Plan transition

Set exit strategy

Execute transition

Transition team

Phased cutover

Milestone checks

Revise as needed

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Modeling proposed value

Supplierevaluationanalysis

Detailedpartneringnegotiations

KPI andincentiveprograms

Requiredsupplier effort /scope

Requiredsupplierperformance

: Inputs

: Modules

: Outputs

Key

SupplierRFP forms(templates)

Suppliercosts & risks

Supplierperformance/outputs

Client valueanalysis

Value model

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Phase 3: Management

Managerelationship

Strategic guidance

Governance

Key processes

KPIs

Pricing, incentives

Team alignment

3. Management

Linkoperations

Processintegration

Forecast sharing

Visibility

IT flexibility

Risk mitigation

Re-evaluateapproach

Change strategy

Extend scope

Back-source

Re-bid

Spin off

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Outsourcing risk best practices

Make a right-sourcing decision based on strategic goals

Invest in a robust selection process

Retain domain knowledge

Communicate fully with employees

Build joint company-supplier transition teams

Design and staff relationship management

Define appropriate performance measures

Provide the right incentives

Design an exit / back-sourcing strategy

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Conclusion: Outsourcing is here to stay

Positive contributions

Spend the time upfront

Don’t underestimate the transition

Design and maintain strong governance

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