OUTSOURCING: A STRATEGIC FRAMEWORK

Discover how best-practice organizations use outsourcing to aggressively reshape and fundamentally change the way they do business in order to reach unprecedented levels of excellence and profitability. In Outsourcing: A Strategic Framework, learn how to direct your own outsourcing processes more effectively, identify performance gaps to gain a better understanding of the issues and challenges involved in improving the outsourcing process.

Summary

Partner companies realize the value of maintaining process owners and functional

experts in house during the transition and into at least the first year of implementation.

This accelerates the knowledge transfer and provides experienced oversight. In addition,

training is considered a critical success factor to operational transition and full integration.

Internal outsourcing champions are credited with acting as key liaisons at most

points throughout the relationship. Although most study participants (including

half of the partner companies) do not employ full-time outsourcing personnel inhouse

to manage the integration, the participants do report using cross-fertilized management

teams and boards to effectively oversee the outsourcing partnership. Regardless

of whether the companies employ in-house outsourcing personnel, joint management

provides direction, monitors performance, and resolves performance issues.

This commitment of resources ensures the success of the partnership by assigning

specific duties and accountabilities that most often roll up into joint management

measures.

Measures of Success

Measures drive operations management, performance improvements, and incentive

programs. Companies ensure collective success by communicating strategies,

plans, and measures upfront to vendors and collaborating with vendors to establish mutually

beneficial incentives. Using key metrics frequently enables partner organizations

to improve their vendor relationships and increase user satisfaction. Although measures

vary by function outsourced, several common measures are used by companies

to track performance and take corrective action. All partner companies use both the

balanced business scorecard and customer satisfaction surveys. Since user satisfaction

is often the true indicator of performance, companies include this component in

the balanced business scorecard. In addition, innovative ideas and creative solutions

are often captured in the scorecard and rewarded. Measures are regularly tracked,

reviewed, and updated to meet the partnership goals and needs.

Within the above three macro topics, nine key findings emerged:

1. Corporate strategy, corporatewide re-engineering, and the annual budget process drive

outsourcing decisions.

2. Cross-functional teams, “due diligence,” senior management sponsorship, and input from

key functional areas are integral to the success of the outsourcing decision-making

process.

3. In making successful outsourcing decisions, partner companies examine noncore functions

for service quality, cost savings, and access to essential skill sets (weighing outsource

options against internal capabilities). Due diligence with supplier screening, usually

employing requests for information (RFIs) and requests for proposal (RFPs), is critical

to identifying companies that meet or match these key criteria.

4. Developing clear, measurable expectations with emphasis on incentives rather than

penalties establishes a win-win situation for all parties.

5. Using impartial experts in negotiating contracts (oftentimes with multiple providers simultaneously)

creates flexibility, options, and leverage.

6. Jointly developing plans, involving key company personnel, and thoroughly communicating

with users and the provider facilitate a smooth and successful outsourcing transition.

7. Assigning specific responsibilities for outsourcing providers and key company personnel

and training those who will manage the relationship are critical to integrating all parties

into a successful relationship.

8. Performance measures are key to providing incentives for, managing, and improving

supplier relationships.

9. Successful outsourcing organizations recognize that balanced business scorecards and customer-

driven measures are essential for managing, identifying opportunities for enhancing,

and improving their outsourcing partnerships.

Each of these key findings is explored in detail later in this report.

KEY FINDINGS

• Corporate strategy, corporate wide re-engineering, and the annual budget process drive outsourcing decisions.
• Cross-functional teams, "due diligence," senior management sponsorship, and input from key functional areas are integral to the success of the outsourcing decision-making process.
• In making successful outsourcing decisions, partner companies examine noncore functions for service quality, cost savings, and access to essential skill sets (weighing outsource options against internal capabilities). Due diligence with supplier screening, usually employing requests for information (RFIs) and requests for proposal (RFPs), is critical to identifying companies that meet or match these key criteria.
• Developing clear, measurable expectations with emphasis on incentives rather than penalties establishes a win-win situation for all parties.
• Using impartial experts in negotiating contracts (oftentimes with multiple providers simultaneously) creates flexibility, options, and leverage.
• Jointly developing plans, involving key company personnel, and thoroughly communicating with users and the provider facilitate a smooth and successful outsourcing transition.
• Assigning specific responsibilities for outsourcing providers and key company personnel and training those who will manage the relationship are critical to integrating all parties into a successful relationship.
• Performance measures are key to providing incentives for, managing, and improving supplier relationships.
• Successful outsourcing organizations recognize that balanced business scorecards and customer-driven measures are essential for managing, identifying opportunities for enhancing, and improving their outsourcing partnerships.

Framework for outsourcing manufacturing: strategic and operational implications

ABSTRACT

Over the last decade, outsourcing has proved to be a relevant strategic option for companies narrowing their operations to focus on core competencies. This paper analyses the process of outsourcing manufacturing to cost-efficient and innovative suppliers in support of internal resources and capabilities. A scientific reference model founded on manufacturing strategy is proposed to help choose the right level of analysis and steer the research process. From this, a system model is developed to enable identification of the production system elements and internal support functions. Finally, a framework that links the phases of the entire outsourcing process to strategic planning is synthesised. The framework includes a logical sequence of key activities with built-in performance measures and expected output for each of the phases. The research methodology combines theory study with case study and action research in Aalborg Industries, which operates in the heavy industry. Thereby, the research pursues both academic and industrial application.

Keywords: action research, case study, competencies, manufacturing strategy, open systems theory, outsourcing framework

1. Introduction

Entering the third millennium, most industrial sectors face intensified conditions both in th marketplace

and within the corporate boundaries. The customers are putting higher demands and constraints on their upstream linkages. Formerly, the customers focused mainly on low total systems cost, high quality and good delivery performance. Presently, they also expect short product life cycles and time-to-market, innovativeness and customisation [1]. The companies and their suppliers are experiencing the emergence of a global economy and rapidly changing markets. At the same time, the complexity of products and technologies is increasing and their functionalities are expanding [2]. Globalisation and technological innovation appear to be common denominators of these marketing and corporate business challenges. From a corporate strategy point of view, they add new competitors and markets and put strong pressure on companies’ competitiveness and profitability. From a combined business and functional strategy viewpoint, they call for improved organisational adaptability and more flexible and advanced systems relative to manufacturing, logistics, engineering, information and process technology and the like [3,4].

Table 1 specifies the wide range of trends in the industry and their implications. Besides, the table

includes examples of initiatives that may be taken to proactively meeting the trends and implications.

It is noticed that the trends, implications and initiatives are not fully consistent in the sense that certain interdependencies and overlaps exist in practice. Nevertheless, they represent the problem context of the paper.

As indicated in the table, globalisation and technological innovation present a particular paradox.

Technology facilitates the integration of business operations between separate companies while the

rapid market changes on a global scale increase the investment risk in new technology, because it might become obsolete within the payback period [5]. In the table, I take a step further by arguing that the rapid development of information and process technology may reduce the need for middle management based on the rationale that some operating procedures may be automated. This contributes to obtaining flexibility and cost savings, and links to the trend of downsizing. Lewin and Johnston [6] support this point stating that while downsizing initiatives were initially aiming merely at increasing profitability by reducing costs, they now also reflect the search for more flexibility (cf. automation). The advances of information and process technology, thus, largely prompt the gradual change within the corporate boundaries.

In consequence of the internal and external conditions given above, companies must be able to change their organisation, operations, product portfolios, customer segments, etc. rapidly and efficiently as well as on a continual basis. This may involve a new approach to the strategic planning process in which production and operations management and industrial marketing are seen as integral parts. There is evidence to suggest that the success of outsourcing depends largely on such inside-out perspective which assigns production strategic considerations the same importance as market strategic considerations [7–9]. Hence, the frequently used term ‘‘paradigm shift’’ is highly legitimate at present, not only for the industry, but also for the scientific problem addressed in this paper.

Strategic Outsourcing Framework: Project Transition and Governance

Program Description:

The process of moving from in-house management of a project to an outsourced provider can be a daunting task. In this third program of a three-part series, Mark Power, President of ROS Inc., an outsourcing consultancy and education company, defines the transition plan requirements and identifies key processes and parameters to be implemented during the governance phase. Power begins by examining the transition process, including a number of well-defined activities, such as: gathering the appropriate contracts, manuals, and other documents; establishing the transition team; and assigning ownership of assets, roles, and responsibilities between the client and vendor. He also discusses what is involved in providing training for project management, contract management, and administration; and in developing and executing a transition plan. Turning to the governance phase of the outsourcing relationship, Power identifies the key elements of the governance plan, including activities, participants, and budgets. Next, he describes how to manage and control risk with an effective risk management plan. Power then discusses the importance of the governance communications plan to ensure a well-defined chain of command. He continues by explaining the elements of a quality plan to measure the results of the outsourced activities. Power concludes with a discussion of essential governance issues and concerns. In separate interviews, Manish Tomar and Carlo Bonifazi of ROS offer their comments on the project transition and governance phases of the outsourcing lifecycle. This revised version of one of WatchIT’s most requested programs has been updated with new multimedia resources, such as Web links and white papers.

After watching this program, you will be able to:

Ø  Define a transition plan requirement from in-house to outsourcing vendor;

Ø  Identify key processes and parameters to be implemented during the governance cycle;

Ø  Establish and manage quality and productivity metrics and measures for effective performance management;

Ø  Define and implement project and change management processes; and

Ø  Define and implement dispute resolution processes.

Program Topics:

 

     INTRODUCTION

     AGENDA

     EXPERTS FEATURED IN THIS PROGRAM

     PROJECT TRANSITION

     The Project Transition Lifecycle Process

     The Project Transition Lifecycle Process: Key Risk Management Responsibilities

     Carlo Bonifazi: Developing a Framework for Outsourcing

     The Project Transition Lifecycle Process: The Outsourcing Security Plan

     The Project Transition Lifecycle Process: Common Pitfalls

     GOVERNANCE

     Governance: An Organizational Model

     THE GOVERNANCE PLAN

     Reasons for the Governance Plan

     An Effective Strategy for Creating A Shared Vision Between Client and Vendor

     Strategic and Tactical Reporting

     Training and Development

     Knowledge Management

     The Business Continuity Plan

     The Risk Management Plan

     Contract and Statement of Work Administration

     Governance Policies

     Tools for Managing the Governance Process

     Program Management Activities

     GOVERNANCE: THE COMMUNICATION PLAN

     Tracking Equipment Used in the Outsourcing Relationship

     Governance: Quality and Metrics

     Performing a Lessons Learned Project Summary

     GOVERNANCE ISSUES AND CONCERNS

     Signs That Governance Activities Are Off Track

     Ensuring an Effective Governance Program

     Carlo Bonifazi: Concluding Thoughts

     Manish Tomar: The Trend Toward Outsourcing

The Outsourcing Decision: A Strategic Framework

Abstract

Outsourcing grew rapidly during the 1990s and has now become an accepted dimension of corporate strategy. While outsourcing continues to grow in importance, the nature and focus of outsourcing is evolving. Historically, most outsourcing took place in manufacturing industries, but it is now spreading rapidly within service industries. Whether in manufacturing or services, outsourcing is becoming increasingly cross- national and global. The growth of international outsourcing has accentuated controversy surrounding trade liberalization efforts in developed economies, especially in the United States.

THE BENEFITS FROM OUTSOURCING

There is emerging evidence that investors usually expect outsourcing to create value for shareholders (Hayes et al., 2000). The broad purpose of outsourcing is to: (1) lower the purchase price of some input by taking advantage of external suppliers’ lower costs, or (2) improve the quality of one or more inputs by purchasing some superior resource or capability from an external supplier. In either case, the supplier’s advantage will be one that is not easily imitable. If the firm could easily imitate the cost or capability advantage of potential outside suppliers, it could easily bring the production of the activity “in-house”. Both direct cost savings and the acquisition of superior capabilities can be thought of, and described, in cost-saving terms – superior capabilities could only be produced at the same quality within the firm at a higher unit cost. However, it is usual in the business strategy literature to analyze each specific activity on the value chain in terms of the firm’s ability to lower cost or to improve quality (or, more broadly, to in some way to differentiate their production process). We follow that distinction in the following discussion of the potential benefits of outsourcing.

Cost-Reducing Rationales for Outsourcing

The costs that must be compared are the costs of internal production of the activity to the cost if the activity is outsourced. Production costs are directly generated by the opportunity costs of the resources—land, labor and capital—actually used to produce the good. Of course, it is impossible to design firms to take advantage of economies of scale for all inputs – even the largest global pharmaceutical firms do not manufacture their own computers. Many inputs are inevitably outsourced. In practice, inputs that can be bought in highly competitive “spot” markets – “off-the-shelf” purchases -- raise few outsourcing issues. Therefore, outsourcing is really only a further step on the continuum from purchasing and procurement.

There are a number of cost-related reasons for considering outsourcing. The most basic reason for outsourcing is that in-house production of the activity entails production at too low levels to be efficient; that is, to achieve minimum efficient scale (McFetridge and Smith, 1988; Lyons, 1995). Many goods and services for which the organization has low unit demand exhibit significant cost “lumpiness”,

holding quality constant (Loh and Venkatraman, 1992; McFarlan and Nolan, 1995). An independent specialized producer selling to multiple (outsourcing) buyers can achieve minimum efficient scale. Economies of scale do not apply only to the core operations (production) of a firm: the most significant economies of scale may relate to secondary value chain activities such as administrative and information systems, knowledge and learning, access to capital markets and marketing (Muris et al., 1992; Veugelers and Cassiman, 1999). For example, a major rationale for the significant degree of outsourcing of information systems is the inability of firms to achieve minimum efficient scale in either installing, updating or managing these systems (McLellan, 1993).

Similarly, and closely related to economies of scale, economies of scope are becoming a rationale for outsourcing. With the advent of flexible manufacturing (Greenwood, 1988), the potential to achieve economies of scope has increased dramatically (Pine, 1993). Firms that produce a range of products that can utilize the same production equipment have a significant cost advantage that they can pass on to customers (Besanko et al., 2001; Morrison, 2003). Smaller firms, therefore, in a single line of business will often not be able to achieve the same marginal production costs. Also closely related to an economy of scale rationale is the potential to change large fixed capital costs into variable costs (Quelin and Duhamel, 2003). For example, semiconductor plants (“foundries”) that approach minimum efficient scale cost approximately a billion dollars. Capital-constrained smaller firms cannot access such capital. Even when they can, committing those funds might crowd out more critical investments.

Recent theories of the “boundary choices” of firms emphasize that the optimal scale and scope of a firm depend on the degree to which new undertakings are specific to the firm’s existing asset base (Poppo and Zenger, 1998). That is, the relatedness of the undertakings ultimately conditions the net benefits of locating the relevant undertakings within or outside the firm. Relatedness can extend beyond technological similarities to include shared management knowledge and even a common language. Nevertheless, a relatively large and indivisible scale of required investment combined with rationing of financial capital may limit the ability of firms to exploit relatedness across activities.

Other economic cost-based rationales for outsourcing include superior external supplier economies of learning or experience (Hayes and Wheelwright, 1984), superior ability to introduce new technologically superior product generations quickly, and at low cost, and superior capacity utilization (Morrison, 2003). When work force demands are unevenly distributed over time, it may be cheaper for firms to outsource the work involved rather than lay-off and rehire workers (Abraham and Taylor, 1996).

There are also organizational factors relating to cost that suggest a rationale for considering outsourcing. Most importantly, in many organizations, especially large multi-unit organizations, there is a tendency for internal production units to act as if they are monopolists (Alles et al., 1998). Monopoly-like behaviour blunts efficiency incentives by reducing comparative performance benchmarks for internal customers and by making it less likely that a good is efficiently priced in the internal firm market, thereby obscuring the efficiency of the internal supply unit. Inefficient internal prices can arise for two reasons. First, the internal production unit may be an efficient low-cost producer, but prices internally as a monopolist – production unit managers are usually responsible for this problem (Reichelstein, 1995; Vining, 2003). Second, the production unit may not have sufficient incentives to achieve the minimum production costs that are technically feasible. As a result, they allow production costs to “drift” upwards – either managers or employees or both may be responsible for this syndrome (Leibenstein, 1976; Button and Weyman-Jones, 1994). Competition, that is the absence of monopoly, is normally the crucial driver in forcing down production costs to their lowest level. Profit-maximizing firms in a competitive market will be forced to price at the lowest possible marginal cost, thus eliminating inefficient practices. Monopolistic internal production units may not be subject to this same level of competition. (Although firms can simulate such competition by forcing different internal units to bid against each other for production rights.) This rationale for outsourcing might be a more important reason for outsourcing than minimum efficient scale issues, especially for larger, bureaucratized firms.

An additional organizational-cost reason for outsourcing is that internal production of an input may generate significant organizational negative externalities (or more accurately “internalities”, as they are internal to the organization) that can be reduced or eliminated by outsourcing. (Conversely, as discussed below, outsourcing can also generate negative externalities for the outsourcing firm.) Internal production of an input, for example, may require a distinct corporate culture that is dysfunctional for the rest of the organization (Camerer and Vepsalainen, 1988). Similarly, firms can experience diseconomies of scope in management of multiple firm activities or diseconomies of scale in producing a single activity (Graves and Langowitz, 1993; Zenger, 1994).

Finally, cost savings can result from altering obligations that a firm faces under government laws and regulations or under agreements with labour unions. As an example, firms may be obliged to pay health care benefits to workers classified as “full-time”, whereas part-time workers are not entitled to the same level of benefits. Outsourcing specific activities may enable firms to “re-hire” the same or similar workers from external suppliers as part-time or temporary employees. To be sure, if labour markets are reasonably competitive and not segmented, such cost savings may prove to be only temporary. Market forces will force supplying contractors to pay higher wages to their employees to compensate them for the absence of health care benefits. These suppliers, in turn, will pass the higher wage costs on to those firms hiring the workers on a temporary basis.3

There is evidence from a variety of sources that outsourcing can lower production costs. Clearly, the anticipation of various kinds of cost saving is a major driver of outsourcing (Lacity and Hirshheim, 1993; McFarlan and Nolan, 1995; Kakabadse and Kakabadsee, 2002; Quelin and Duhamel, 2003) however, as noted by Leiblin et al., (2002) and other commentators, there is relatively little hard empirical evidence that comes from contexts where firms outsource to other firms. The limited evidence in part reflects the difficulty in measuring production and other cost savings (Bryce and Useem, 1998). Nevertheless, Ang (1998) found that a large sample of banks that outsource primarily considered production cost savings in their decisions, and there is some evidence to suggest that this finding is generalizable (Walker and Weber, 1987; Lyons, 1995; Benson and Ieronimo, 1996; Saunders et al., 1997). Much of the best empirical evidence comes from outsourcing by government to private suppliers.

Empirical studies tend to find in this outsourcing context that production cost savings are approximately in the 20% range, especially if competitive bidding is used (Vining and Globerman, 1999; Hodge, 2000).

As we discuss below, a crucial point is that even those empirical studies that have examined the relative production costs of internal provision versus outsourcing have not included the costs of governing the outsourcing relationship, specifically, bargaining and opportunism costs, which a priori might be expected to be higher with outsourcing. Indeed, some governance mechanisms for outsourcing can be expected to raise production costs -- for example if cost-plus contracts are used (McAfee and McMillan, 1988; Ulset, 1996).

Differentiation (Quality) Rationales for Outsourcing

Firm-specific resources and capabilities are becoming increasingly recognized as the drivers of competitive success (Wernerfelt, 1984; Barney, 1986). Capabilities that are difficult to imitate, or, at the extreme, cannot be imitated, are therefore the key to sustainable competitive advantage (Barney, 1991). The capability may be inimitable for a wide range of reasons. Barney (1999) points out that the firm could attempt to acquire the capabilities through internal development or by acquiring a firm that already has the capability; however, it may be very costly or impossible to do either. Four reasons why it may be costly to develop a capability internally are: (1) unique historical conditions that no longer exist; (2) path dependency; (3) social complexity, and (4) “causal ambiguity” resulting from the difficulty of knowing what is the source of the capability (Barney, 1999: 140-1). Five reasons why it may be costly to acquire a firm that has the capability are: (1) legal constraints; (2) acquisition itself might negate the capability; (3) acquisition may be costly to reverse if the capability turns out not to be valuable; (4) there may be undesirable characteristics that offset the valuable capability, and (5) integrating the capability into the acquiring firm may be difficult both because of causal ambiguity and implementation problems (Barney, 1999: 142-3).

Whatever the reasons for inimitability, a firm producing a given product or service that requires a capability has to decide whether to compete with a firm that has a given capability or to attempt to purchase the higher quality input from them. If the capability is critical to the success of their product (that is, a “core competency”) the firm may have no choice but to attempt to acquire the capability internally, although some commentators disagree even with this assessment (Baden-Fuller et al., 2000) But, if it is not developed internally, the firm may be able to acquire the capability through outsourcing. Historically, for example, many firms have outsourced specialized legal services and advertising. The evidence suggests that this rationale for outsourcing is increasing (Quinn and Hilmer, 1994; Farrell et al., 1998; Kakabadse and Kakabadse, 2003). Specifically, Quelin and Duhamel (2003: 649) argue that “cost reductions, while important, are but one objective expected from outsourcing. Other objectives include improved flexibility, quality and control”.

Again, as with cost-reducing rationales for outsourcing, the systematic empirical evidence of the value of outsourcing for improving quality is still quite limited. Gilley and Rasheed (2000) and Gilley et al. (2004) have recently found evidence that outsourcing various aspects of human resources management can innovation although they did not find direct evidence of financial performance improvements. Leiblein et al., (2002) present evidence that there are benefits from outsourcing, but they are contingent on the specific attributes of the contractual relationship, both in terms of the nature of the activity to be outsourced and the governance response by the firm.

We turn to a consideration of governance costs that may potentially offset the cost-lowering or differentiating-enhancing benefits of outsourcing.

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CONCLUSIONS

There is increasing interest in outsourcing among firms in a wide range of industries. Moreover, there is evidence that outsourcing is becoming increasingly more international, so that the benefits and costs of outsourcing are becoming an increasingly important social issue, especially in the United States and Western European countries when it involves outsourcing activities to less developed countries. Although not dealt with here, as a result outsourcing governance is increasingly likely to include managing the political and stakeholder environment. In this paper, we suggest that many of the potential costs associated with outsourcing can be mitigated by contracting and related strategies on the part of the outsourcing firm. We propose a simple framework that relates some alternative strategies for standard problem situations surrounding outsourcing. This framework does not deal with all strategic outsourcing issues. The outsourcing firm also has to develop information strategies so that it can continue to learn – about changing costs and other relevant factors (Cross, 1995).

A strategic approach towards outsourcing must explicitly acknowledge the game-theoretic context in which the activity takes place and attempt to condition the environment in order to minimize the governance costs associated with outsourcing. It also must recognize that in specific circumstances the governance costs will be so high that a firm should not outsource. This approach is distinct from a strategy that emphasizes adaptation or renegotiation in response to conflict with an outsourcing partner (Melese, 2000). In this regard, management experts have argued that managers seriously underestimate the costs associated with transitioning to a new vendor (Barthelemy, 2001).

The difficulties and costs associated with implementing a comprehensive strategic approach to outsourcing should not be underestimated. However, it is important to emphasize that there are likely to be economies of scale and scope in the outsourcing activity itself. Hence, substantial efficiencies may be realized by establishing a group or department specifically devoted to integrating company-wide experiences with outsourcing and using the resources in that unit to establish project teams with expertise in specific outsourcing activities (Barthelmy, 2001).

Why Malaysia?

Choose Malaysia as your offshore location - the regional gateway to the Asian markets - and a world of business advantages awaits you. Considered the world's largest exporter of semiconductors and consumer electronics, Malaysia has earned the reputation of being an attractive location for both trade and investments since the colonial era. The dynamic economy and 25 years of uninterrupted growth has positioned Malaysia as an economic leader and premier market in Southeast Asia . Now, more than ever, two decades of incessant effort resulted in development of infrastructure and technological expertise, complemented by a very knowledgable workforce and diverse economic activities. Over the years this effort has resulted in establishment of a powerful foundation for Malaysia , making it a location of choice, as organizations globally scout for satisfying their high quality outsourcing needs. In short, there are three reasons why Malaysia is a location of choice in the globalized world today!

Seamless Business Environment Pro-business government : Business focused governmental leaderships have aggressively streamlined regulatory processes to expedite business needs. Tangible procedures for offshore outsourcing has been established, refined and implemented to ensure companies hit the ground running from day one. Some of the established procedures are minimum customs formalities, relaxed monetary exchange controls, attractive tax incentives and deductions for R&D training. IP protection, Data Security & Information Privacy: The Malaysian Government is serious in combating piracy and protecting the intellectual rights of corporations and individuals. The setting up of Special Copyright Task Force as the enforcement arm to provide adequate copyright protection and enactment of related legislation are testimonies to this commitment. Malaysia is a member of the World Intellectual Property Organization (WIPO), Paris Convention, Berne Convention and signatory to the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS). Quick Facts Malaysia is U.S' 10th largest trade partner (est. $44 billion in bilateral trade for 2005) and our largest trade partner in SE Asia . Malaysia is America 's 10th largest export market for manufactured goods (source: The National Association of Manufacturers). U.S. per capita exports to Malaysia exceed exports to Japan , France or Germany . The U.S. is the largest foreign investor in Malaysia - U.S. private investment exceeds $30 billion. Malaysia ranked 3rd most attractive investment destination (source: AT Kearney Global Rankings 2005 & McKinsey Global Institute's Emerging Global Labor Market Survey Study 2005) Five Malaysian outsourcing companies made it to the Global Services 100 list, a capabilities-driven assessment of IT/ IT enabled service providers globally (source: neoIT-CMP Media) Malaysia ranked very high in terms of an ?enabling business environment?, only a few notches behind countries like USA, Canada, UK, Australia, Germany, New Zealand, France, Ireland and Singapore, and better than the largest services markets of India and China (source: AT Kearney Global Rankings 2005) 53.7% of Malaysia 's economy driven by Services, ahead of markets like India (23%), China (38.2%), Poland (53%) and Philippines (47%).(source: McKinsey Global Institute's Emerging Global Labor Market Survey Study 2005) Cost of Living as a percentage to total net income for individuals approximately 27% lower than cost of living indices for India and Philippines (comparative costs between Kuala Lumpur , Manila , Bangalore , Mumbai and Noida) Malaysia reflects attractive supply of labor in areas of Engineering (CAGR 10%), Finance & Accounting (CAGR 6%), Analysts (CAGR 6%), Generalists & Support Staff (CAGR 3%) year on year (source: McKinsey Global Institute's Emerging Global Labor Market Survey Study 2005).   Superior Infrastucture Malaysia 's deep-water ports, modern airports and a sought-after expertise with developing sustainable and affordable public transportation systems, telecommunications, and reliable power and water facilities enable complex infrastructure necessities. An investment-friendly environment coupled with attractive tax breaks backs these catalysts.  The Federal Government of Malaysia has made development of the global ICT industry a main focus. By establishing a unique quasi-government body, the Multimedia Development Corporation (MDC), a multimedia super corridor spanning various regions in the country has been established, so as to provide investors and opportunity seekers with not just superior enablers spanning infrastructure and policy flexibilities, but also a direct leverage factor into responsible government ministries. Companies like Shell, BMW, DHL, and HSBC are (just to name a few), large multinationals that have chosen Malaysia as the base for their regional headquarters. Also, large multinationals like NEC, Sacramento Coke and Sanyo have commenced strategic service partnerships with global service providers across a range of verticals spanning IT and business processes. Talent development and enhancement is supported by 11 universities that focus continually, with industry input, on developing talent, providing high-quality education, strong work-ethics and language skills. This continued effort has resulted in the country attracting skilled workforce from other countries as well. With a unique regional ability to provide a very high standard of living within a very reasonable cost structure, investments continue to pour in to the country.

Identifying the right outsourcing strategy

For far too long, the issue of outsourcing versus insourcing has had the proportions of a religious debate between often fanatical supporters and opponents of both.

 

But this highly partisan passion is not helpful. There are no absolute rights and wrongs when it comes to how to source IT.

 

"Sourcing is not a strategy in itself -- it has to be the business strategy that drives the sourcing decision," says Bob Carlson, former group head of IT and telecommunications at HSBC, with 25 years experience at the bank -- a major user of outsourced IT.

 

"Business strategies can vary hugely -- and therefore so will IT sourcing strategies. For example, a key part of HSBC's business strategy is to acquire other companies, and integrate their customer base, which in turn requires integrated IT systems, whether those systems are sourced in-house or out, onshore or offshore," says Carlson. "Contrast this with GE, whose business strategy is buying and selling businesses which they therefore do not want to integrate."

 

Any sourcing strategy has therefore to take into account two such divergent views on integration. Business strategy can also change totally, and sometimes very swiftly indeed, as radically new competitors arrive in a market to transform it.

 

"Kodak used to be in the photographic film business," says Carlson. "They got overtaken by Nokia -- a telephone company they assumed had nothing to do with them but which were now selling mobile phones that could take digital photos."

 

IT sourcing strategy must, therefore, map to business strategy and be flexible enough to allow the business to make radical changes to adapt to changing market contours. One key advantage of outsourcing, for example, points out Carlson, is to support a business strategy of rapid expansion without time-consuming scaling up of internal IT and the up front costs that requires.

 

"Outsourcing can give you the opportunity to play on a global scale," he says.

 

However, even when the business strategy does make outsourcing a compelling sourcing strategy, such as when accelerating globalisation, it is essential, says Carlson, to appreciate the risks as well as the opportunities.

 

"Outsourcing is not a panacea. The worst option is to do with great efficiency what should not be done at all," he says.

 

Some things should not be outsourced. "Do not outsource your own core competences," warns Carlson. Moreover, "Never outsource a problem -- often, the quickest way to get a big problem is to outsource a small one."

 

Sort problems out first, internally. "Since IT automates processes, always look at the processes first," says Carlson. "Look at the end-to-end flows of information and follow the transactions all the way along, find where value is added -- often half of all the stages in a process can be totally unnecessary.

 

Process re-engineering can cut stages, time and cost, says Carlson, "Ford, for example, used to have a huge building in Michigan that just did accounts payable and receivable and purchase orders all day. Then someone realised that since Ford built cars, and cars were easy to count, if a thousand cars were shipped then the company simply needed to pay for four thousand tyres, without tracking every purchase order. It saved them a fortune, counting cars instead of tyres."

 

Any process re-engineering required should be done in house, says Carlson.

 

"Compared with programming, which is a piece of cake, process change is hard to outsource," he says.

 

Where processes and systems impact corporate governance, says Carlson, even greater caution must be exercised.

 

"Sarbanes Oxley makes it illegal to outsource risk," he says. That means that for any such outsourced systems and processes, he says, "Sufficient in-house competence is needed to recognise that the outsourcer is competent to meet your corporate risk requirements."

 

Assessing outsourcer competence is essential when it comes to issues of corporate risk, but it is also essential from a commercial consideration as well.

 

"Outsourcing fails where there is poor governance and the wrong expectations of it," says Carlson.

 

One very popular expectation is that outsourcing will cut IT costs.

 

"The outsourcer has to make a profit, and to pay tax -- and what if the law changes and outsourcing becomes liable to value added tax, which can of course be applied retroactively? So the outsourcer has to be highly efficient at running your IT if they are to pay their costs and cut yours as well," he says.

 

Moreover, even if the outsourcer does reduce their clients' IT and process costs it may not be the user that benefits. Carlson says, "IT costs savings always devolve to the customers."

 

This is because if any company in a market sector can cut its costs, then so can all the others. Those savings are then passed on to all the company's customers in order to win their custom. The commercial advantage of any savings in IT costs that an outsourcer can bring, therefore, are only ever temporary.

 

Users all too often have expectations that they will remain the valued customer they were at the contract bidding stage. The outsourcer has to grow his business, and get new customers -- so will he lose interest in your work?

 

Another potential dangerous expectation is that outsourcers will see the world the same way as their users. That may not be so, especially if there is a difference in nationality and culture..

 

"Offshore outsourcing is very different from onshore," says Carlson. "The issue of cultural fit is critical -- you must have shared business values, not just between the outsourcer and the user, but with the user's own customers. Moreover, never underestimate the amount of coordination that will be required -- everything always takes longer with distance. The more distant the offshorer, the more management effort it will take."

 

Whether the outsourcer is on or offshore, emphasises Carlson, managing the relationship with him is not only vital, but inevitably it is another cost to consider.

 

"Relationship management is critical and must be well defined," he says. "Flexibility and goodwill are far, far more important than service level agreements and price, which are not important issues in comparison because everything about the contract will inevitably change over time, often rapidly, making renegotiation necessary."

 

But, critical though relationship management is to ensure outsourcing is successful, it is not the first thing that should be addressed when outsourcing.

 

Carlson is blunt about the first priority any outsourcing contract must engage with. "The first clause of the contract you write is the exit clause," he says. "It's imperative to agree how the contract will terminate while the supplier is still selling and negotiating with you. If you can't get the exit conditions at that point, you're doomed."

 

A key aspect of any exit clause, irrespective of the financial implications, is what happens to your IT.

 

"It's critical you have a way to recover your intellectual property, your data and your systems. Remember too, that if your supplier is in trouble, you are in trouble. Law courts simply pick over the bones of both. The judge won't have a clue about IT, neither will the jury. You might as well roll the dice in Las Vegas as go to court for a resolution," says Carlson.

 

Nor is it an option to avoid thinking about the end of the contract. "All contracts terminate at some point," says Carlson.

 

This reminder should be borne in mind especially if those who sign the contract at the user end do not intend to be there when it concludes, leaving a messy termination for others to sort out.

 

The second clause to set out, says Carlson, is the one dealing with the governance, principles and relationship management.

 

"The relationship should be equal," he says. "It will be a case of 'we have a problem'. There has to be a clear escalation process to take the heat out of any problem, early on, and to find solutions."

 

Nor is there any point assuming that won't be necessary. "You have to go into outsourcing with the idea that there will be problems, or you will get meltdown," says Carlson.

 

The other assumption you must accept as a de facto part of outsourcing is that the contract cannot be static. "You must include change management clauses because everything will change during the outsourcing term," he says.

 

Not only will IT requirements inevitably change to track business changes, but also there will be personnel turnover on both sides.

 

"The people will change," he says. "In a year, the guys who set up the contract won't have anything to do with it any more. You'll hit problems that are not covered by the contract and those who devised it will have moved on."

 

It is imperative, therefore, to have mechanisms and management structures in place that will last for the duration, and that these processes are adequately staffed and resourced.

 

Only, says Carlson, when the issues of termination and relationship and contract management have been dealt with, should issues about what the outsourcer will actually do, and to what standard, be discussed.

 

"The last thing to talk about is the work, the price and the service levels," he says. "Those are the easy parts."

 

Essentially, because outsourcing is such a key decision, running part of the organisation that is critical to daily operations and future survivability of the business by enabling business change, the key to successful outsourcing, says Carlson, is the relationship.

 

"If you're building a relationship, keep the purchasing people away," he says. "They add value by checking that the contract covers everything, and that is very good in a purchasing relationship, but not in a partnership relationship.

 

"Far better to bring in your own company's marketing people because not only will they get on with the outsourcer's marketing people that you are dealing with during contract set up, but also, most importantly, they will have the skills to recognise the outsourcer's own marketing ploys that you may not."

 

"Be in no doubt," says Carlson, "that the decision to outsource is a major one, carrying significant risks as well as potential benefits, and should never be undertaken without due cognisance."

 

"When you outsource IT it's still your business. It's not a transaction, it's a commitment," he says.

 

But it's a commitment that must be reciprocated. "Outsourcing is a joint venture whether you like it or not -- you both have skin in the game."

 

Outsourcing checklist

 

• Business strategy is the key driver in the outsourcing decision
• Don't outsource a problem -- re-engineer your processes before outsourcing them and the IT that runs them
• Don't seek to outsource risk -- corporate governance regulations disallow it
• Don't allow outsourcing to dangerously deskill your company in vital competencies
• Outsourcing risk increases with the distance of the outsourcer
• Costs must factor in the outsourcer's marketing costs and profit margins
• Any cost savings will eventually be passed on to customers thanks to competition
• Business and requirements will change, so build in flexibility and renegotiability
• Detailing work, service levels and price are less important than setting out partnership, relationship and problem resolution terms
• The contract and the relationship must be designed to be independent of those that initiate them, because people will move on
• Engage your own marketing people in contract negotiation -- they will be able to spot the supplier's ploys
• All contracts will terminate -- write your exit clause before you agree any other clause, when you still have power to negotiate strongly
• All outsourcing is a joint venture -- insist on both sides having skin in the game.

http://www.offshoringtimes.com/Pages/2006/offshore_news1369.html