Getting outsourcing right

In the previous Industry Insight in this series, I examined the capability sourcing model. Now, I will look in detail at two examples of companies that have benefited from capability sourcing, and four of these deals that did not work.

In a previous Industry Insight, I looked briefly at 7-Eleven. The retail giant has built a model of tight collaboration with its suppliers, adopting the Japanese model of keiretsu.

When 7-Eleven began its review in 1991, it was vertically integrated, owning most of its own activities. It reviewed all capabilities and functions, and its measure was: "If someone else can provide a capability more effectively than we can, then that capability becomes a candidate for outsourcing."

In time, 7-Eleven contracted in for many aspects of its business, among them HR, finance, IT management, logistics, distribution, product development and packaging.

7-Eleven's model saw it strike up-close, highly strategic partnerships with many of its suppliers, among them Frito-Lay, Coca-Cola, American Express, Anheuser-Busch, HP and EDS. It went so far as to take a percentage stake in some of its suppliers.

The consequence: it leads all of its competitors in same-store merchandise sales growth, merchandise inventory turns and merchandise sales per employee.

Nike is the global leader in terms of constantly whittling away its core activities. Today, it is little more than a trademark and a distribution network, as it has contracted all of its capabilities to outsourcers.

Today, it [Nike] is little more than a trademark and a distribution network, as it has contracted all of its capabilities to outsourcers.

Andrew Holden is MD of Bytes Outsource Services.

One of the only aspects it retains is strategic thinking, which is clearly central to the success of the brand: it has 47% of the US footwear market, sales in the US of around $4 billion, and it has 500 000 people in Asia engaged in the production of its shoes. Most of its output is created in factories in China, Indonesia and Vietnam, but it also uses factories in Italy, the Philippines, Taiwan and South Korea; these factories are 100% owned by subcontractors.

In recent years, Reebok and Adidas, Nike's two largest competitors, have also shifted their manufacturing capabilities to Asia.

A vital lesson all three had to learn is that the outsource operations need to be managed: a hands-off approach can lead to significant problems, such as the conditions in which Asian labourers have to work. They are paid a pittance in sweatshops, and the manufacturers' brands have been negatively affected by the resultant publicity.

In 2003, the recently departed Lehman Bros financial services group cancelled a $70 million contract it had granted to Tata Consultancy Services. The contract had been for the provision of IT support services, notably its IT helpdesk, as it was not satisfied with the level of service. Instead, it repatriated the helpdesk back to the US.

This was on the back of a similar situation for Dell, which stopped routing support calls from corporate customers to India after complaints of voice and technical quality.

In 1997, Standard Bank contracted then independent EDS to fulfil the processing requirements of its credit card processing division. The decision at the time was made on the basis of EDS's global capabilities, and the insight that card transaction processing was not core to the bank's strategy.

This relationship lasted seven years, until it was terminated by Standard Bank in 2002, the bank deciding to take the function back in-house.

While the transition back in-house was taking place, the notorious Slammer worm infected EDS's systems, causing a major delay in the bank's credit card transactions, which led to something of a PR disaster for the bank as millions of customer transactions could not be processed.

After more than eight years, Old Mutual terminated its IT outsource agreement, widely viewed as the largest in South Africa, with Computer Sciences Corporation (CSC).

The subsequent R1.8 billion contract was won by competitor T-Systems - reports published on ITWeb at the time stipulated that CSC lost the contract due to issues around service quality rather than cost, which resulted in CSC not making the tender shortlist.

There are some vital lessons here for anyone looking to outsource an internal capability. The first is that service quality can never be compromised for cost savings. The second is that cultural differences can severely undermine a capability sourcing agreement. The third is that someone internally needs to manage the outsourcing relationship closely and with the outsourcer's interests foremost.

When it comes to outsourcing, as it can be seen, there can be many slips twixt cup and lip.

In the next Industry Insight in this series, I'll look at how to determine which functions to outsource.

* Andrew Holden is MD of Bytes Outsource Services.