From core to capability sourcing

In the previous Industry Insight in this series, I looked at the link between Ronald Coase and his economic insights and the understanding we have today of what is core and what is peripheral to one's business.

In this Industry Insight, I will look at how to begin selecting the non-core processes, functions and activities so as to have the right outsourcer deliver them.

What should be outsourced? The answer is: just about anything. A company such as Nike has outsourced everything except its logo, that is, its brand. As a consequence, it spends more on advertising its brand than it does on the manufacture of its products. It has stripped out cost to such an extent that it is able to spend just $20 on manufacture and $30 on promotion of the goods. It can then sell the goods for up to $200, resulting in huge profits.

Another good example, as I hinted at in the previous Industry Insight, is Wal-Mart. This retail giant outsources almost all of its activities, and along with McDonald's, is the only major American company to have grown in 2008.

So huge is its turnover that it dwarfs the gross national product of Austria, Argentina and Sweden. Wal-Mart now focuses on the management of its margin, and while it is unpopular in some circles in the US, its decision to outsource most activities has been a key factor in its unprecedented success.

Here lies the key to which activities should be outsourced to a qualified specialist, and which should be retained in-house: focus. While both Nike and Wal-Mart have been criticised for some of their corporate activities, their decision to hand over non-core business activities has been spectacularly successful for shareholders. To use a key measure, Nike delivers 20.67% return on equity to shareholders, while Wal-Mart delivers 22.4%.

There is no one-size-fits-all answer to the outsourcing question. What works for one company may not work for another.

Andrew Holden is MD of Bytes Outsource Services.

Both companies have approached their business with an unemotional, scientific eye and then jettisoned a broader and deeper range of activities that could in any way negatively impact their focus, and therefore their return to shareholders, as just one measure of their success.

There is no one-size-fits-all answer to the outsourcing question. What works for one company may not work for another. By way of example, American Express looked to outsource one of its core business activities, transaction processing, when it no longer provided competitive advantage. Standard Bank Card Division, on the other, outsourced the same function for some time before taking the function back in-house.

Jim Keyes, the former CEO of 7-Eleven, summarises the decision: "Everything outside direct store management and customer interaction is fair game for outsourcing. With the right outsourcing partners, a company can achieve virtual integration rather than vertically integrate internally."

His colleague, CIO Keith Morrow, now CIO of Blockbuster, has a profound insight: "The functions we outsource are very important, and they must be done well; however, they do not represent our core business. By outsourcing...we are able to stay focused on increasing customer service, merchandising and growing the business."

The way in which 7-Eleven went about transforming its business from 1991 when it was losing money and market share to today when it stands as a beacon for the retail sector hinged on the concept of capability sourcing.

Capability sourcing is the process whereby an organisation carefully considers each business process and seeks to become best-in-class at that process.

Once an honest review has been completed of each process, a decision is reached as to whether to improve the process and maintain it in-house, or to outsource it, either to a local outsourcer or an offshore entity.

In the case of 7-Eleven, the company formed a number of strategic partnerships across the length and breadth of its supply chain. Where its ownership and management of the supply chain had been seen as a source of competitive advantage, 7-Eleven moved away from vertical integration and, in the case that a partner could provide a capability more effectively than 7-Eleven could, that capability became a candidate for outsourcing to that partner.

In the next Industry Insight in this series, I will look in greater depth at the capability outsourcing model.

* Andrew Holden is MD of Bytes Outsource Services.