Urban and Regional Innovation Research Unit Faculty of Engineering Aristotle University of Thessaloniki PRODUCT OUTSOURCING

Transcription

1 Urban and Regional Innovation Research Unit Faculty of Engineering Aristotle University of Thessaloniki PRODUCT OUTSOURCING IOANNIS KOMNINOS Electronic Engineer, B.Eng M.Sc.(Eng) Thessaloniki 2002

2 Product Outsourcing 2 CONTENTS 1. Introduction 3 2. Design of an outsourcing process Assessment of outsourcing need Establishment of the outsourcing relationship 5 3. Management of outsourcing Contracting Managing performance Documentation and resolution of outsourcing disputes and issues Key issues of managing outsourcing results Common outsourcing mistakes Outsourcer mistakes Ignoring the customers needs Ignoring the importance of leverage Avoiding accountability for the outsourcing process Using someone else to manage the outsourcing deal Company client mistakes Relying too much on executive contact Not letting the outsourcer lead the process Interfering with the process Signing an outsourcing deal with too long a term Improper process management Forgetting that the outsourcer is a business asset Benchmarking outsourcing: when and why Alternatives to outsourcing 15 Annex 1 Outsourcing strategy checklist 17 Annex 2 What to do and what don t for successful outsourcing 18 Annex 3 Popular types of outsourced services 19 Definitions Glossary 20 References 21

3 Product Outsourcing 3 1. INTRODUCTION Developing a new product or service requires additional time and resources that a company or an enterprise may not be able to commit. It may also require engineering tools or skills that it does not make sense for a company to purchase. In addition the cost to new software and hardware tools, and the amount of money spent in training staff could be too great. Also due to the progressive globalization and standardization of many products, manufacturing companies are forced with the task of currying more complex product development with limited and decreasingly time frames. To overcome all or some of the above problems more and more companies turn to Product Outsourcing i.e. hiring external contractors to develop a product for the company. Outsourcing means that a company can buy a product rather than produce it itself. It gives the work to someone that can do it more efficiently. It allows a company to share risks, reduce operating costs; free tied-up resources minimize hard to manage processes or functions, improve its market focus and keeps the company flexible. So Outsourcing is a tool for a cost effective service. As one its effectiveness and whether it can be successful or not depends on how it is designed, implemented and managed. One should note that companies have always hired contractors for particular types of work and have formed long-term relationships with firms whose capabilities complement or supplement their own. That is why sometimes outsourcing is mistaken with subcontracting. The difference between subcontracting and outsourcing is that the latter involves the most efficient reconstructing of particular business activities by utilizing external partnerships. 2. DESIGN OF AN OUTSOURCING PROCESS 2.1 ASSESSMENT OF OUTSOURCING NEED Before any action to be taken by a company to outsource a product, an assessment must be made of whether outsourcing is the appropriate route to take. This assessment

4 Product Outsourcing 4 allows a company to identify outsourcing opportunities and gather information about outsourcing so that to form appropriate strategies. The primary objective of such an assessment is to find out whether outsourcing is right for the company or not, whether outsourcing services will be better that the ones already existing into the company and what is the most appropriate outsourcing arrangement for the company. For the above questions to be answered first the company must be self educated on the use and applications of outsourcing. To do that one must gather information and collect other people s experiences. The company must then determine how committed senior management is to the idea of outsourcing and then identify the resources and expertise needed. At this point a comparison must be made to the company s resources and expertise so that a true decision of whether or not outsourcing is needed can be taken. Finally a strategic outsourcing plan to guide all outsourcing projects and each outsourcing decision must be formed. Using and completing such an assessment will enhance the company s view on outsourcing through assessment results as the ones described in Table 1 bellow. Table 1: Assessment objectives vs. results ASSESSMENT OBJECTIVES Identify outsourcing costs Determine service levels Check flexibility Investigate the form of penalties ASSESSMENT RESULTS Pint point unexpected costs that are not explicitly in the scope of outsourcing such as personnel related costs, costs of additional resources needed to manage an outsourcing process and costs due to confidential information leaks resulting in legal liability or competitive disadvantage. Define and agree to what is expected through each stage of the outsourcing process and set the level of commitment required by the outsourcer to perform such a process. Determine outsourcer flexibility and remove inflexible work practices mandated by e.g. labor unions. Pre set standards that an outsourcer must uphold and think about the size and form of penalties possibly imposed to the

5 Product Outsourcing 5 outsourcer in case of substandard performance by the outsourcer. Source: Australian Queensland Government 2.2 ESTABLISHMENT OF THE OUTSOURCING RELATIONSHIP To establish an outsourcing relationship five tasks must be completed. Those and their outputs are described briefly in table 2. Table 2: Tasks and outputs to be completed in an outsourcing relationship Task Get ready Lay the foundation Plan approach Plan evaluation Pick the outsourcer Output Plan project and communications. Prepare the agreement documents. Decide how to manage the process. Decide hoe to evaluate the outsourcer. Do the outsourcer evaluation and decide on the best one for the job. Source: Australian Queensland Government The first task addresses the action to be taken for the planning of the outsourcing project and identifies the most efficient form of the communications between the company and the outsourcer. The project plan details the outsourcing process structure, requirements, approaches and milestones. The form of communications details the person or persons that the company will be communicating with, when these communications will take place and how these will be done. (For example will the communications take place on a managerial level or a lower level? Will they have the form of weekly / monthly / bimonthly meetings or the form of mail, phone and ?). The second task faces the action to be taken for the preparation all the necessary documents needed to an outsourcing partnership. Contracts, service level agreements,

6 Product Outsourcing 6 and procedure manuals provide an explicit basis of what the outsourcing agreement will be about, the legal framework behind it and the obligations of both company and outsourcer. Refinement of these can be made during negotiations or during the process itself. Task three compromises of the decisions required so that the outsourcing process is well managed. The managerial team is picked and their duties are defined. Task five answers the question of evaluation of the outsourcer once the outsourcing process has began. All the evaluation criteria and the mandatory outsourcer obligations are decided. Also the levels of the standards during the outsourcing process are picked. When all first four tasks are completed, then according to the decisions taken during those tasks, an evaluation of the outsourcer and its proposal is made. A summary of the evaluation findings for each outsourcer candidate is formed and the decision on which will take the job is taken. 3. MANAGEMENT OF OUTSOURCING The essence of product outsourcing is that it shifts a company s focus from managing resources in managing results. So outsourcing demands a more advanced approach to performance management, one that ensures that the desired results are defined clearly and reflect the company s true requirements. Also an outsourcing management approach makes certain that the outsourcing results are reported regularly and quickly adjusted as needed. 3.1 CONTRACTING A rewarding outsourcing relationship begins with clearly defined expectations that can be easily understood from both the company and the outsourcer and allow a more shift and smooth outsourcing management process.

7 Product Outsourcing 7 The desired contract terms need to be introduced as easily as possible in the contract and should include the scope of service, the resources required, the change in the relationship management, the pricing structure and fees, the intellectual properties, the termination options, the rights and restrictions of both outsourcer and company and the liabilities. They also must include Service Level Agreements (SLA s) whenever this is feasible. It is very important that all outsourcing contracts have terms for both termination of cause and termination of convenience. Some exit considerations may be centered on people, equipment and intellectual properties. Contract elements are necessary to cover all aspects and specifications of the project and the involvement of attorneys in the beginning of the process helps identify weak points that would probably interfere with the management process later on. 3.2 MANAGING PERFORMANCE One way that a company can manage outsourcing performance is through a management tool called scoreboard The scoreboard must be put in place before the services are delivered and measures the performance of both the outsourcer and the end result. It must be clear, complete and contain measurable terms. It should contain an appropriate list of criteria, agreed from both the company and the outsourcer, that will provide a complete picture of the outsourcing performance. The first step in creating a scoreboard is the definition of categories. These categories are all the aspects of the outsourcing process that the outsourcer will be judged. Secondly one or more attributes must be set. These attributes are unique to the services being provided and the company s business objectives. Next step is the selection of a way to measure attributes. This measurement method must be metric and must be supported by one or more tools used to collect data. Finally the scores of the attributes and the categories must be rated against a desired outcome. The following table is an example of how a scoreboard should look like (taken from a telephone company that provides call center services to another company).

8 Product Outsourcing 8 Table 3: Management scoreboard CATEGORY ATTRIBUTE METRIC Quality Timeliness Customer satisfaction Effectiveness Compliance Cycle time Abandon rate % rating of excellent or very good call processing % rating or rep s performance % of calls handled according to company s policy % of calls answered within 20 mins % of calls abandoned by caller prior to response Financial Unit cost Total operating costs divided by call volume Productivity Average handling time Total number of seconds divided by total calls Source: Corbett M. F. Some categories or criteria that such a scoreboard could be formed of are given bellow. One should note that in cases that the outsourcing process or end result is complicated sub categories or criteria should be set. Table 4: Criteria and Sub criteria of Outsourcing Evaluation CRITERIA OF OUTSOURCING QUALITY EVALUATION Experience Communication Contract uphold Efficiency SUB CRITERIA Specialized knowledge Technology know-how Good presentations during development Frequent update of company customer Right questions on details problems On time delivery Budget keep Contract terms uphold Completion on schedule High quality end - product Goal achievement

9 Product Outsourcing 9 Source: Avlonitis G. The above categories - criteria some times are the same that are used in the selection of the outsourcer and failure of the outsourcer to comply with any of these (i.e. the metric value is low or outside the set range), result in customer discontent and dissatisfaction. The main reasons that a customer will not be satisfied with the outsourcer performance are given bellow. Table 5: Reasons of customer dissatisfaction Main reasons Customer need misunderstood Communication Contract uphold End Result Outsourcer actions No personal interest Seem to want to avoid long term relationship Not receptive to questions and suggestions Unstable communication Limited cooperation Unpleasant during communication Late delivery Over-spending Not explaining reasons for delays or high costs Not achieving goals set Low quality end product Not done what was promised Source: Avlonitis G. 3.3 DOCUMENTATION AND RESOLUTION OF OUTSOURCING DISPUTES AND ISSUES When an outsourcing process is set in motion, a lot of issues come to light that need immediate attention so that the process will not deteriorate. The use of the Scoreboard discussed earlier can not be helpful in this case since it only examines the performance of the outsourcer and the end result. A company should form a mechanism of identifying and resolving outsourcing issues and disputes. A team of managers charged with the quick review and resolution of

10 Product Outsourcing 10 such issues. It is imperative that the team consists of the right people in the right places and with the authority to effect change. For instance a sales manager will have little or no effect in an issue involving say the change of specifications of a high-tech outsourcing product, and a product or a R&D manager will have little or no effect in an issue involving an outsourced economic service such as payroll. 3.4 KEY ISSUES OF MANAGING OUTSOURCING RESULTS The following issues represent some of the best practices for managing the many aspects of outsourcing relationships. A company should adopt these practices so that the intended results are achieved with the greatest possible benefits. One should consider how to measure results and how to manage the arrangement before contracting. The measurements should be introduced in the negotiations and in the agreement. If already under contract one should work with the provider to agree upon metrics and objective ways of obtaining them. The formal organization, that will promote teamwork and provide communications and decisions, should be defined. Organizational effectiveness and refinement of organizational structure are key points for good communications and decision making during the outsourcing process. Teamwork and positive relationship between one s providers and one s staff should be encouraged. An environment of mutual respect should be set and the attitude of us vs. them should be discarded. A process for the perpetuation of the knowledge and intent of an outsourcing agreement should be created. Usually the initial team that have negotiated and signed an outsourcing agreement is replaced and another is set to manage the agreement. The later team of managers, frequently do not have the knowledge of the small details of the agreement and sometimes are inclined not to follow them. As a result the agreement is broken and the outsourcing process is destroyed.

11 Product Outsourcing 11 Providers should be included in planning. A provider can be very helpful in project planning once he knows what the company strategy is and where the company is headed. Incentives should be used to increase benefits. If the providers are motivated, they can be stretched even further to meat outsourcing objectives and thus more benefits for the company. 4. COMMON OUTSOURCING MISTAKES An outsourcing agreement is sometimes like a marriage. Neither of both parties knows what to expect. Especially a company client, that has never before outsourced a product or a part of a product, frequently stumble into pitfalls. Some of the mistakes that can pop up into a company outsourcer relationship are given bellow. 4.1 OUTSOURCER MISTAKES IGNORING THE CUSTOMERS NEEDS Sales people usually mistakenly view the sales process as a game that must be won or lost. With this in mind the sales team of an outsourcing company usually focus on the game of sales itself rather than the needs of their customer i.e. the client company. They tend to get lost in this game and forget that their customer just needs an effective and cheaper way to manufacture a product. Sometimes they worry about the size of their outsourcing company and their possible lack of global reach, which in the eye of the customer gives the impression of insecurity. Having in mind the fact that most of the times, the customer already feels insecure about the whole process of outsourcing, the above attitude results in the disqualification of their outsourcing proposal by the customer IGNORING THE IMPORTANCE OF LEVERAGE

12 Product Outsourcing 12 One of the biggest advantages of outsourcing is the ability to use leverage. Leverage is when the outsourcer creates value for the company client and thus becomes needed. For an outsourcing company this means: access to scare materials, the ability to substitute expensive resources by cheaper ones, the possession of expertise and access to capital. So a client feels most satisfied and regards the outsourcing company valuable when the outsourcer can provide all or some of the above AVOIDING ACCOUNTABILITY FOR THE OUTSOURCING PROCESS An outsourcer must always be responsible and accountable for its outsourcing process. Not always this is the case. Outsourcers tend to avoid accountability since this results in greater risks. Greater risks simply mean that the outsourcers are responsible for everything that can go wrong in an outsourcing process. So they do whatever they can so that they can legally remove the risk. But by doing so the risk moves to the client, which now has the ability and the right to intervene to an outsourcing process, something that always leads to disaster USING SOMEONE ELSE TO MANAGE THE OUTSOURCING DEAL Outsourcing as mentioned before is like a marriage. So the relationship between the outsourcer and the company client is very intimate. One cannot manage such a relationship by using a third party. Usually a managerial team, different from the outsourcing team and sometimes hired to do this job, take over the outsourcing relationship as soon as the outsourcing deal is signed. This results in dissatisfaction and disappointment of the customer since he cannot get in touch with the outsourcing team. 4.2 COMPANY CLIENT MISTAKES RELYING TOO MUCH ON EXECUTIVE CONTACT

13 Product Outsourcing 13 Once a company has decided to outsource, usually hurry s up to get the outsourcing deal done and put the transaction on a fast track. To do that, executives from the company and the outsourcer, meet, agree and let the next level of management to sort out all the details of such a relationship. Since an outsourcing process is a complicated one, it sis advisable that various elements of a company must be involved in the original meetings and have a say to the agreement. Top-level executives are rarely enough to review such a process NOT LETTING THE OUTSOURCER LEAD THE PROCESS The essence of outsourcing is that a company transfers the process of product making to the outsourcer and then buys the results of that process. The quickest and most certain way to destroy an outsourcing process is to let the company client dictate how this process is done. When a company tells the outsourcer what to do, removes from the outsourcer the ability to add value to the process and produce a cheap product INTERFERING WITH THE PROCESS Many companies willingly do not transfer the ownership of the outsourcing process to the outsourcer and keep the process under control. When the company assigns someone to look over the process this person becomes overwhelmed and incompetent to manage something that has very little knowledge about. As a result the outsourcing process fails SIGNING AN OUTSOURCING DEAL WITH TOO LONG A TERM It frankly impossible to create boundaries or service level agreements, for an unknown process as outsourcing. One must construct a contract that will last a long time but will allow the service terms agreements to change during short periods of time. (For example some companies are willing to sign up to five years outsourcing contracts regarding web hosting, although no one can tell or predict what the internet will look like after five years). So it is preferable for a company to develop a close relationship

14 Product Outsourcing 14 with an outsourcing company, but sign short term contracts that can be easily negotiated and if necessary renegotiated or even broken IMPROPER PROCESS MANAGEMENT Companies new to the outsourcing process often do not assign the right people to manage the process. They often assume that since all the details of an outsourcing contract are discussed and the contract is signed, that do not have to worry about the outsourcing process any longer. The right person for the job should be someone that understands the process and be able to focus and interpret the results in terms of the best interest of the company. He should have a different way of thinking in respect to most business managers and the oversight to recognize any problems or mishaps before those are surfaced FORGETTING THAT THE OUTSOURCER IS A BUSINESS ASSET Far too often the company forgets that the outsourcer is a business asset and must be treated as such. The outsourcer can be from the person that manufactures a new product or a part of a new product for the company, to the person that keeps the books, to the one that prepares the payroll or hosts an application. All these are vital parts of a successful and prosperous business. If the outsourcer is treated differently, for example like one of many suppliers or one of many customers, then the one thing that the outsourcer adds to a company will be lost. Its ability to make things easier and more effective for the company. 5. BENCHMARKING OUTSOURCING: WHEN AND WHY Most companies when they decide to outsource a product are confident enough that this action will save them money in respect that is cheaper than producing the product themselves. The most common mistake in this line of thinking is that the company is usually under the impression, that its receiving a fair deal, simply because the outsourcers cost s are lower that their own. Typically outsourcers propose 15-20% less than a company s current cost. But many times this difference in costs results in

15 Product Outsourcing 15 poor quality products. So benchmarking is required to provide a baseline of costs and service levels. A company can use it to compare results delivered by the outsourcer against the same or similar results throughout the industry or market and consequently negotiate or renegotiate the outsourcing deal. During negotiations benchmarking knowledge is critical to setting the right expectations for cost, performance and service levels. Any negotiation position is reinforced by external validation of one s requirements. Also when a company has decided to outsource, with very little investigation, and wants to move fast through the negotiation process, can use benchmarking data as a guide. When an outsourcing deal is signed and the process has been set in motion, benchmarking can be used for contract refinement. Most of outsourcing deals are renegotiated within two years of being signed and during the process of outsourcing. Usually dissatisfaction over pricing and service levels are the main drivers for renegotiation. Benchmarking plays a key role in renegotiations since the company client need access to industry performance parameters in order to make a case with the outsourcer. Usually the requirement for benchmarking should and sometimes is, drafted into the final terms of an outsourcing agreement. 6. ALTERNATIVES TO OUTSOURCING Sometimes outsourcing is not suitable for a company after reviewing the pros and cons of such a process. In a case like this, other in-house alternative management and marketing strategies exist. Some of them are given bellow. Inaction: Do nothing. The company does not need to outsource a new product, part of a new product or a service. Cut projects: A company can cut down some projects that are resource wasteful so that it can start and manage a new one without turning to outsourcing.

16 Product Outsourcing 16 Hire stuff: A company can always hire more professionals if the economics allow it so that it would not need to turn to outsourcing to develop a new product or service. Relocation of resources: Frequently resources are badly managed. Due to this a company reaches the point that the resources required to start a new project are not enough and the company turns to outsourcing. Relocation and better management of resources could help avoid this. Use of Joint Ventures: A company can form an alliance with others (of same interests) so that the risks and turmoil of outsourcing can be shared. In this case the alliance must be very well managed since experience has shown that different strategies of the members of such an alliance can bring havoc to a joint outsourcing effort.

17 Product Outsourcing 17 ANNEX 1 OUTSOURCING STRATEGY CHECKLIST BACKGROUND INFORMATION Why outsourcing is needed? How can outsourcing by used as a strategic tool? What are the expectations from outsourcing? DECISION MAKING Who will decide what to outsource? Who will select the outsourcer? Who will approve variations to the outsourcing agreement? Who will approve budgets, timelines and deliverables? COMMUNICATION With whom should the company communicate? What will the outsourcer want to know and when? What is the best way to conduct communications? ENSURING A SUCCESSFUL OUTSOURCING PROCESS What are the critical success factors? What are the risks? How does one overcome risks or problems? What are the assumptions to be made before proceeding? RESPONSIBILITIES What are the company s responsibilities? What are the outsourcers? What knowledge - skills are required? ASSETS STAFF AND LICENSES What assets, staff or licenses need to be acquired? What assets, staff or licenses need to be transferred? What assets, staff or licenses need to be redeployed? What assets, staff or licenses need to be disposed of? OBLIGATIONS LEGAL MATTERS Are there copies of all arrangements and agreements? Are there any consents to be obtained from third parties? Are there any obligations after the outsourcing process begins? Source: Australian Queensland Government

18 Product Outsourcing 18 ANNEX 2 WHAT TO DO AND WHAT DON T FOR SUCCESSFUL OUTSOURCING Five do s of successful outsourcing One must outsource the bottlenecks, the things that are really keeping the company from growing profitably. One must pick great partners, check them out and speak to their customers. Once outsourcing is done, the outsourcer must be regarded as part of the company and treated as such. One must demand excellence, since outsourcing is what the outsourcer does for a living. Outsourcing might scare employees. One must communicate honestly with them. Six mistakes in outsourcing Not really defining the desired results and they could be measured. Not talking to the outsourcer current and past clients. Failing to consider long-term relationship dynamics. Not planning up-front on how the company-outsourcer relationship will end. Treating the outsourcer as an outsider. Four inhibitors to outsourcing Fear of loss of control. Work viewed as too strategic. Company s unique culture. Measuring the value. Source: Corbet M. F.

19 Product Outsourcing 19 ANNEX 3 POPULAR TYPES OF OUTSOURCED SERVICES 1. Technology Services Electronic Commerce Infrastructure Software Telecommunications Website Development - Hosting 2. Business Services Customer Contact (Customer Relationship Management) Equipment Accounting Finance Human Resources Logistics Security Supply chain management Source: Bierce & Kenerson

20 Product Outsourcing 20 DEFINITIONS GLOSSARY Benchmarking Joint Ventures Outsourcing (or sourcing) Quality of Service Scoreboard Service Level Agreement (SLA) Is a method of evaluating contract services. Alliances of companies with similar strategies and goals in order to share the outsourcing of a service or a product. Is the transfer to an external service provider the operation and day-to-day management of a business process. A good in terms of quality, outsourced service or product. Means of measurement outsourcer performance and end result. They are specifications for type, value and conditions of the outsourcing services to be provided. They also sometimes define the overall relationship between the company and the outsourcer and the quality of service.

21 Product Outsourcing 21 REFERENCES Australian Queensland Government Queensland Government Guide to Best Practices in IT Outsourcing, (Jun 1997). Avlonitis G. Strategic Industrial Marketing, Stamoulis, Bierce & Kenerson Insights on Effective Outsourcing, (2000), On-line < Bragg S. M. Outsourcing: A guide to Selecting the correct business unit Negotiating contract Maintaining control of the process, John Wiley & Sons, Jul Corbett M. F. A Small Business Guide to Successful Outsourcing, (2001), On-line < Corbett M. F. Managing the Outsourcing Relationship, (2001), On-line < Drummond G. Ensor J. Strategic Marketing: Planning and Control, Butterworth Heinemann, Goldafrb S. Heller R. Outsourcing Establishing a Winning Approach, Q/P Management Group Inc, On-line < Gonchar A. The When and Why of Benchmarking, Outsourcing Journal, (Dec. 1997), On-line < Greaver M. K. Strategic Outsourcing: A structural Approach to Outsourcing Decision and Initiative, AMACOM, Feb Griffiths D. The Theory & Practice of Outsourcing, KUDOS, On-line < Q/P Management Group Inc Outsourcing Management, On-line < Samuel P. B. Turning Lead into Gold: The Demystification of Outsourcing, Executive Excellence, Oct Terdiman R. Six Tips and Techniques for Managing Outsourcing Deals, Gartner Group Inc, On-line < Wiegler B. A. Managing Outsourcing Results, Sourcing Interests Group, On-line <