Supply Chain Outsourcing – Why, What, When, How?

Tom Peters, US Management guru once commented, ‘Do what you do best and outsource the rest.’  It is true that one should focus on core capabilities and outsource non-core functions.  But it is not as simple as 123.  In my opinion outsourcing is a strategic decision which could impact the company’s operations and performance.  Hence, care should be taken to answers questions such as why, what, when and how in the areas of outsourcing.  It is very important to understand that outsourcing is not a strategy, but is one of the solutions to achieve the targeted strategy.

“Outsourcing can be defined as turning over all or part of an organizational activity to an outside vendor.” This means trusting an outsider in handling your customers and handing over some of the business controls.  Unless a robust business continuity plan is in place, one cannot venture into such a risk.  Outsourcing may not be a risk.  However, the outsourcing process could be risky unless and until enough care is taken to make the process robust.

Why?

One should find answer to the question, why outsourcing?  “You’ve got to be careful if you don’t know where you’re going because you might not get there”.  It is true, before one embarks on outsourcing supply chain activities, should know clearly why outsourcing is a solution and what would be the expected outcome.  The first step would be to find answers to the question why.  Many would not think for a minute before answering the question.  The very popular answer would be cost savings.  We all know that global financial recession forced businesses to save costs to improve product margins.  Outsourcing is perceived as one of the biggest source of cost savings. If cost savings is the only reason, then outsourcing could be an impulsive decision.  Every organization embarking on outsourcing journey has some unique reasoning behind the decision.  Clifford F.  Lynch suggested that Managers planning outsourcing should seek satisfying answers to the below given four questions.

1. Is Logistics a core competency of our Firm?
2. If not, are we exceptionally good at it?
3. Will Outsourcing add true value to our Logistics Process?
4. Can we become comfortable with the risk of turning over control and customer relationships to an outside firm?

If the answers to the first two questions are “Yes”, organizations should make a serious attempt to restrain from outsourcing.  However, if the answers to the question three and four are “Yes”, outsourcing could be a viable option.  I am not concluding that one should outsource based on the answers to the above four questions.  In my opinion, it would be a valuable exercise to explore the outsourcing process further by finding answers to the questions such as what, when and how.

Along with these answers, organizations should also find answers to “what if question”, in other words risk mitigation.  There is no guarantee that outsourcing would deliver positive results. Management should have effective contingency plan in place to handle issues arising out of outsourcing failure.

Generally organizations outsource Supply Chain activities to save cost, to reduce capital deployment, to gain global capability, to focus on core functions and maximize customer satisfaction.

What?

What are the activities that could be outsourced is the second vital question to be answered in preparing the strategy for outsourcing.  It is a simple question and at the same time critical to find answers.  It is simple because, some of the Logistics activities are difficult to handle in spite of size and global presence of the organization.  The best example could be transportation (domestic and international).  The efforts involved in transporting goods from point A to point B are phenomenal and it makes a perfect sense to outsource the activity and manage the KPIs. At the same time it is critical to answer this question because Logistics activities include functions which could directly impact the customer and customer satisfaction.  Managers involved in outsourcing should feel comfortable with the thought of handing over customers to the third party and at the same retain the customer satisfaction levels.  The top three reasons given by organizations who do not favour outsourcing are loss of control, confidentiality and security reasons.  Hence, it is very critical to classify the activities into three categories and take appropriate decision based on merits.

In my opinion one can classify activates within supply chain into three categories.  The first level of outsourcing is transactional outsourcing.  This is typically transaction in nature and no long term contracts and no bonding between 3PL and outsourcing company.  This type of outsourcing is driven by cost factor and it is relatively easy decision.

The second classification is Tactical outsourcing.  This kind of outsourcing is on medium to long term basis with negotiated contacts in place and with integrated IT systems, to facilitate free flow of information and create supply chain visibility. The pricing will remain a factor but not prime factor in making outsourcing decision.  This is considered as a stepping stone for strategic alliances which is the third category.

Strategic outsourcing is also known as Strategic Alliance or Collaborative alliance. This type of outsourcing is based on long term relationships with successful outcomes and based on strategic issues.  In this category the 3PL companies become partners in supply chain management and complete transactional transparency will be established.   Very few 3PL companies are able to achieve this status with their customers by constantly innovating and constantly maintaining operational efficiency and integrity. In order to gain this status often 3PL companies offer open book costing method and gain share concepts to demonstrate the transparency and win confidence of the customers.  Below given graphic explains indicative supply chain activity classification.

When?

Timing is very critical in launching outsourcing strategy.  Launching a very critical strategy at a wrong time could lead to disastrous business results.  Every business will have peaks and lows in business operations cycle.  Outsourcing activity should be undertaken during the non-peak time in order to minimize the impact on business and customer satisfaction.  The best way to find answers to this question is to go through the next phase and find answers to the question how.

How?

“Setting a goal is not the main thing.  It is deciding, how you will go about achieving it and staying with that plan”.  I strongly believe that having a plan is great but executing a great plan in critical.  Goals are like milestones, the journey undertaken to achieve those goals is very important.  In implementing an outsourcing plan, project management plays a great role.  Three factors play a vital role in project management and they are, planning, execution and control.

Project Planning:

Planning phase is critical to time related positioning of resources.  The plan should clear describe the scope of the project, deliverables, time-line and cost implications and resources allocation.  A well-documented project plan will make project management lot easier. Many believe that outsourcing is all about handing over activities to the third party.  However, the process of handing over is very important.  If required resources were not allocated for the outsourcing, project, it is deemed to fail.

The success of outsourcing largely depends upon the dedication and commitment shown by the organisation in making the outsourcing a success.  In many cases, organisations disengage from the process, thinking that the project implementation is the responsibility of the 3PL. This is biggest possible reason for the failed relationships. Outsourcing is like a marriage, the success of partnerships with 3PLs requires a combination of trust and collaboration.

Outsourcing is a change management process.  The resistance for the change may come from three sources. The first resistance could be from content (what is changing, i.e., structure, systems, technology); the second possible resistance could be from Process (how the change will be planned, designed and implemented) and the last but not least is the people (those impacted by or participating in the change).  A good project manager should develop a comprehensive plan to counter the resistance.

Inefficient Costing methodology will directly contribute to the downfall of outsourcing.  An efficient costing system will not only help in understanding the costs involved in outsourcing but also will help the organisation in measuring the cost efficiency. Often we hear the question, “Are we making any money doing this?”, or the answer, “I don’t know. We don’t have the costing data.” Collecting cost data relative to a specific functional area is a challenging task. Gathering detail of true Supply Chain Costs is fundamental in assessing outsourcing success.

Clearly, Activity Based Costing (ABC) offers great potential for improved performance and competitive differentiation.  Activity-based Costing enables organisations to enhance profits through cost control and tracking practices. The North American and Western Europe users prefer deal structures which eliminates risk of outsourcing.  However, Asia Pacific users are still following the conventional costing methodology.  An efficient costing system and periodical cost analysis which is translated to performance indicators will help both the parties to keep the project on track.  It has been established time and again that a transparent costing system helps in bonding relationship between the user and the 3PL company.

Project Execution:

Executing the plan plays a critical role in outsourcing.  Some of the factors to be considered during this phase would include, selecting the appropriate service provider, Develop water tight legal documentation, developing a joint project team.  Outsourcing an activity to a third party is based on cost and service compatibility. Some of the critical factors considered in selecting the right partner for outsourcing include, reputation, financial stability, industry experience, asset ownership, IT capability, customer service, feedback from the existing customers, flexibility, commitment to continuous improvement, top management involvement and general reputation as a third party service provider.  A scientific selection process will help in find the fight match.  According to one report published by “EYEFORTRANSPORT” in 2005, the following are the key drivers in choosing a 3PL.

Inept Legal Documentation will also add confusion to the relationship and contribute to the failure.  Even though contracts are administered and managed by humans through structured processes, it is very much necessary to document what is agreed and what is disagreed clearly in order to avoid ambiguity in the relationship.  The legal document (contract) should address all possible friction points and address them with remedies.  In the absence of clarity, confusion prevails and confusion leads to inefficiency and inefficiency leads to downfall. Exit strategies such as mediation and arbitration should also be part of any 3PL contract.

A well-defined project team with roles and responsibilities clearly defined will help the outsourcing process a success.  The project team should be supported by the top management from both the sides.  The initial phase of the execution is very critical and people get bogged down by issues during this phase, it is the leadership team that should save the project from the initial hiccups and take it to the next level.

Project Control:

“Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.” – H. James Harrington

Competence is critical to profitability, it is of little value unless it accompanies by quality effectiveness. While competence defines the economical use of resources, Effectiveness reflects how well a process achieves its business objectives. Hence, it is very much necessary to identify “Qualitative Measures” which focuses on effectiveness and “Quantitative Measures” which focuses resource efficient utilisation. This is a very critical exercise and while defining the measures, it is very much necessary to follow a practical approach and based on current performance standards and taking into account the targeted objectives.  Ambiguous and ambitious performance targets will ruin the whole objective of outsourcing.

One of the most critical tasks during the planning phase is developing performance measurements and reporting methods. The outsourcing organisation must take initiative to design measures that support the company’s business goals for the outsourcing strategy. Absence of efficient Performance Measurement system will also directly contribute to the downfall of outsourcing initiatives. The five studies published by the Council of Logistics Management on the subject of performance measurement in logistics had three significant findings in common. 1. Most firms do not comprehensively measure logistics performance, 2. Even the best performing firms fail to realize their productivity and service potential available from logistics performance measurement, and 3. Logistics competency will increasingly be viewed as a competitive differentiator and a key strategic resource for the firm.

Hence, it is essential to measure the project performance periodically as documented in planning process and share the outcomes with the team.  This helps in understanding limitations if any and also helps in improving the performance through further innovation in the business processes.  The ultimate goal of outsourcing is to continuously improve the performance in order assure smile on the face of the ultimate customer.

Sincere advice may offend the ear but is beneficial to one’s conduct. – Chinese Proverb.  The success of outsourcing largely depends upon collaborative approach adopted by outsourcing company and the service provider.  Collaboration is possible only when there is a trust in partnership.  Where trust is the foundation for the relation, where is the question of betrayal and failure?  In order to summarize, I would strongly recommend the following steps to make supply chain outsourcing a success.

1. Develop a Strategy and obtain approval from all stake holders;
2. Define deliverables of Outsourcing Project;
3. Select the best suitable service provider;
4. Develop a good legal contract with well-defined exit clauses;
5. Develop Business Operating procedures;
6. Engage actively in managing the process;
7. Measure the performance;
8. Reward the extra-ordinary performance.

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