The Flexible Corporation: How CEOs Can Do More for Less
It can make anyone nervous to let an outsider in. But nowadays, strategic outsourcing is practically a competitive requirement.
August 1 2003 by Jennifer Pellet
Roughly 10 years after the Internet first appeared on the radar screen as a possible commercial tool, its influence on the ways companies structure themselves is finally becoming clear. It is now possible to identify processes-from claims processing to call centers to bill collection-that can be pruned out of a company’s bureaucracy and transferred to third parties operating in destinations thousands of miles away.
The net result? CEOs are completely rethinking which functions they need to have inside their companies and which ones they can rely on partners to perform better, cheaper and faster.
Like many of the CEOs participating in a recent roundtable on business-process outsourcing cosponsored by Chief Executive and Accenture, Rick Roscitt of ADC Telecommunications has shifted several functions offshore, realizing substantial savings. “We do assembly offshore, and we’ve moved some of the business-process functions, such as billing and collection, to [companies in] India,” said Roscitt, CEO of the $1 billion Minnesota-based broadband company, which has sales in more than 100 countries. “They validate the billing process, correct anything that’s incorrect, then ask for and book payments. That function is done on about 15 percent of the U.S.-based rate in India, so the savings for us have been enormous.”
While business-process outsourcing originated with cost-cutting initiatives like Roscitt’s-limited to payroll functions and other back-office processes-more and more companies are now expanding the concept to encompass core pieces of their businesses. When the time came for Sysco, a $23 billion marketer and distributor of food-service products, to revamp its nationwide distribution system, CEO Richard Schnieders opted to contract with Infosys Technologies, based in India, to codevelop the software code that will play a crucial role in the company’s supply chain.
“We’ve always built our own enterprise resource planning systems and plugged other best-of-breed capabilities into that system, but on this initiative we’ve gone outside,” explained Schnieders, noting that the complexity of the project (see sidebar, page 54) demanded outside expertise. “Anybody can build a warehouse; the essential part of the success of the initiative is the software. The system involves aggregating demand around our 415,000 customers on a daily basis and passing that information all the way up the supply chain so that our suppliers can do a more efficient job of scheduling production. There’s no question that we didn’t have the skill sets or enough folks to do that.”
Quality rather than cost savings was the driving force behind both the decision to embark on a distribution revamp and the choice of Infosys, added Schnieders, whose company provides products and services to restaurants, health care and educational institutions and other food-service customers in the U.S. and Canada. “Efficiency is important, but in the food business it’s not the Holy Grail,” he asserted. “There are a lot of other things, such as quality and convenience, that are more important. The Holy Grail in food service is differentiating our product offering and helping our customers differentiate their products.”
Sysco’s quality-over-cost approach, suggested Jack Wilson, CEO of Accenture’s business-process outsourcing division, is evidence of a fundamental shift taking place in the outsourcing arena. “To me, outsourcing is misnamed,” he said. “Are you taking a function out or bringing talent in? It depends on how you look at it.
“Most people start with the whole notion of cost,” Wilson said. “But the more enlightened view is to really look at, €˜What are the things I really need to focus on most?’ Then you find somebody for whom that business process is their core competency and move in that direction.”
Uncover your corporate DNA
Done well, the outsourcing process itself can actually help a company pinpoint the real strengths that drive its business. “You get very, very specific about what makes your company valuable, what makes you competitive and what’s sustainable,” said Wilson. “It drives home the point that of all of the things that happen in your company, there are a few that are most important and make your company what it is.”
For Teleflex CEO John Sickler, who sought to outsource the packaging of his $2 billion manufacturing firm’s engineered products, the process drove home a different point entirely. Teleflex invited three outside firms to bid on providing product packaging. After examining its products, all three outsourcers passed on submitting a quote. “Every one of our [business] units has discrete specification, and because of those variations you couldn’t build a critical mass,” explained Sickler.
Yet, as other roundtable participants were quick to point out, even an outsourcing attempt that meets with mixed results can provide useful insights. “That input is fascinating in terms of shining the spotlight on your operations,” said Roscitt. “When you get such a stunning answer-all three had no bid-they’re telling you something about your business.”
ADC opens its doors to potential outsourcing partners for just such learning opportunities, he added. “We’ve routinely brought people into functions and said, €˜Have at it. Show us that you can do this better than we can,’” Roscitt said. “Half the time it resulted in something we pursued, [while] the other half they said, €˜We can’t save you any money-you’ve got too much of a mess of too many parts, processes or undefined outcomes.’ In either case, I think you can learn from the process of asking, €˜How would someone else tackle this problem?’”
The no-bid packaging story also drives home the point that rather than fall hard for the outsourcing concept and try to force-fit initiatives into their organizations, CEOs need to weigh the advantages against other available options. Teleflex’s Sickler, for example, might consider creating a separate packaging unit, which would then service the company’s other business units, explained Wilson. “It’s a make-versus-buy decision,” he said. “One option would be what’s known as the €˜shared service arena,’ where you would consider creating your own internal service. The next step in that thinking process is, €˜Is there a better way to do it than ours?’”
For some companies-particularly those burned in the past-trust and relationship-management concerns present the biggest hurdle to committing to outsource a process. “I sat across from a financial services CEO who told me that his outsource IT vendor had once taken down the bank’s operating system for 96 hours and wouldn’t allow him into the data center,” recounted Roscitt. “They told him they were running the process and he wasn’t authorized to enter. I knew it was a dead-on-arrival conversation when I heard that. That CEO will never outsource anything again.”
Concern about losing control of a key function is another obstacle frequently cited by CEOs skittish about outsourcing business processes. For Leo Liebowitz, CEO of Getty Realty, a marketer and distributor of petroleum products, the potential cost savings of outsourcing distribution functions were far outweighed by the risks of lower quality service. “We’re dealing with a volatile product where you’re always worried about things like fire and explosions,” said Liebowitz. “So while we would periodically look at outsourcing to regional players that could theoretically be more efficient, we always found that the cost is pretty close, but we would lose a degree of control. You want to make that delivery when it needs to be done, not when they get around to it. So we’ve never done it.”
Due diligence can help guard against unpleasant surprises, said Derek Dewan, chairman of staffing specialty firm MPS Group. “When you look at an outsourcing provider, make sure that they are what they say they are and that they know their niche,” he warned. “Do they have customers in your sector that they are servicing and/or have serviced successfully that you can use as a reference tool?”
For other firms, the real difficulties arise after the deal is done. Often, for example, dissenters lower down in the organization can scuttle an outsourcing effort, said Michael Dowling, CEO of North Shore-Long Island Jewish Health System. “One of the greatest challenges CEOs face is to create a culture within our organizations that is continuously accepting of new ideas and new ways of doing things-and not just at the top layers of the organization,” he said. “Because at the end of the day it’s what goes on down at the lower levels of an organization that can kill you. It’s not the top executives who will be managing it or interacting with it on a daily basis, so you have to create that openness throughout the organization.”
Bringing competency in from the outside can also make employees within the company feel threatened, said Roscitt. “You’re always competing with the in-house team that wants to show they can do a better job.”
While concurring that issues about control and culture clashes are legitimate concerns, most roundtable participants argued that the potential pitfalls could largely be avoided or overcome through careful implementation and ongoing relationship management. “The control issue is an internal barrier and you need to find ways around that,” noted Sickler. “If you don’t work at this relationship, it isn’t going to happen. The contract alone will not make it a done deal to your satisfaction.”
“Control is a big issue in outsourcing, but when it’s done right you can improve control,” added Wilson. “Sometimes the very act of sitting down and going through service level agreements, metrics and problem resolutions makes your organization think more tightly about what €˜good’ and €˜acceptable’ means and you actually end up with more control.”
The cost reductions and quality improvements that can be realized by outsourcing also more than compensate for difficulties that crop up along the way, said Harvey Seegers, CEO of Global eXchange Services. “Although there probably are a few isolated horror stories with outsourcing, the big story is that it’s been hugely successful,” he noted. “The availability of real time information out over the Internet; the ability as a CEO to get information from your outsourcing partner better than you could when you had it inside; economies of scale; and the learning curve associated with task specialization-all of those things combined have brought outsourcing to the point where any substantially sized organization not doing it is probably competitively disadvantaged.”
In writing we trust
The complexity of today’s outsourcing relationships demands contracts that go beyond specifying service-levels, payment terms and deliverables to address the ways in which both sides will interact. Yet, in many cases, these details are overlooked during the deal-making race. “In multibillion-dollar outsourcing deals you’ll find there’s a huge effort in the chase, but not much thinking about what happens, about how you’ll run the marriage,” charged Roscitt. “That well-intentioned plan-those fellows over there will do this, we’ll do our piece, and life will go on happily ever after-just doesn’t work.”
Dowling agreed. “I learned from experience that when somebody is trying to get you to outsource to them, they send a really smart person to build a good relationship,” he said. “These are the people you love to date-but they’re not the people who know anything about how to manage the relationship afterwards. And then when the contract is signed-and I’m a believer that if you have to keep looking at a contract once you’ve signed it you’ve got a real problem-they send new people in who are not tied into what it is you want to do at all.”
Despite these hiccups, said Dowling, North Shore’s outsourcing efforts have been positive overall. “They’ve been successful, but we would have been much further ahead if we had actually focused on that issue more,” he reported. “And I spend a lot of time on those issues now. The details of the contract are important, but the relationship aspects are just as important.”
To smooth the path for a solid relationship, Roscitt advised CEOs to set up a “governance model” with their outsourcing partners that will specify how often partners will meet, who will be present at meetings, what facts will be reviewed, and how problems will be handled. “There’s not enough attention paid to governance in the outsourcing world,” he said. “Everybody in it should think more about post-contract governing relationships.”
A focus on managing projects for the long-term will also help companies steer clear of destructive outsourcing arrangements, argued Dowling, who notes that a quarter-to-quarter mentality doesn’t foster ongoing relationships and long-range business outcomes. “If you can’t look out over the long haul, you can’t get there-and you can’t let yourself think of new ideas,” said Dowling, who pointed out that contracting a business process to an outsider-no matter how well thought out the contract-is just the beginning of a partnership.
“It’s important to recognize that the effort to enhance value and increase quality is a goal without a finish line,” he added. “It’s a continual process.”
Healthcare Puts on the Ritz
For Michael Dowling, CEO of North Shore-Long Island Jewish Health System, spending a few nights at a Ritz-Carlton was more than just another luxury hotel stay. It was an outsourcing epiphany.
“We do massive data collection about how people perceive their visits to hospitals and nursing homes, and what people complain about all the time is not the medical treatment, but the actual experience,” explains Dowling. “They talk about how we should improve the attitude of staff, the responsiveness of the service and address issues of respect and privacy.”
While struggling with the issue, Dowling happened to check into a Ritz-Carlton and found himself marveling at the seemingly effortless level of service that hotel staffers provided. “I was fascinated with how simple they made it look,” he recounts. “I thought, €˜There’s no rationale for why that can’t happen in a hospital system.’”
Back from his travels, Dowling asked his chief learning officer to contact the Ritz and look into how the premier hotel chain instills a culture of hospitality and service in its staffers. “We reached out to the head of the training center, and I invited him to present to my senior staff,” says Dowling.
Six months ago, North Shore contracted with the Ritz to work with its senior-level executives and do on-site training sessions with 700 of the healthcare company’s people. “They talk to us about how we should improve hiring processes, what kind of attributes we should be evaluating employees on, what personality traits you look for with people who will have direct relationships with customers and how you deal with certain kinds of problems,” explains Dowling, who says the initiative is part of an effort to create a learning environment within North Shore. “I consistently look outside the organization to find good ideas and adapt them,” he says. “It’s about bringing talent and ideas in and creating an environment in your organization where new ideas can seep through the culture.”
How does the Ritz program rate so far? “I’ve noticed a difference in attitude and we’ve seen some improvements in patient satisfaction scores,” says Dowling, “but it’s really too early to judge.”
SYSCO: Outsourcer Extraordinaire
The 38,000 products that bear the Sysco brand name make up a little less than half of its $23 billion food product and service business. But Sysco actually produces none of those products.
“They’re all made by other companies,” says Richard Schnieders, CEO of the Houston-based company, which is the world’s largest outsourcer of food manufacturing. “We do the product development, but all of the products are made by other companies to our specifications.”
Currently numbering more than 1,500, the members of Sysco’s network of food-manufacturing suppliers range from Carlos Pasta, a mother-and-son pasta-making operation in Connecticut, to H.J. Heinz, which supplies the company with both its own ketchup brand as well as a Sysco brand product geared toward the food service industry.
“We have everything from multinational food suppliers to companies making limited runs of specialized products,” says Schnieders, explaining that the company distributes both its own and other brands of food products to more than 415,000 customers nationwide. “We deliver raw materials to food service operations such as restaurants, airline carriers, and health care and educational institutions. Many of our products are designed specifically for food service use and perform in a way that off-the-shelf retail products would not.”
In theory, by outsourcing the manufacturing of products that bear its own name, Sysco violates the traditional view that companies should avoid outsourcing any business processes that touch the customer. But thanks to rigid quality-control measures, the company has been doing just that for 25 years without any reputation-marring mishaps.
“We spec every product we have,” explains Schnieders. “For our scallops, for example, we’ll write a three-page spec sheet that will state that they must be a certain size, frozen in a certain way, not pumped with any liquids and so on.”
A team of 200 quality-assurance technicians also roams supplier’s plants and warehouses daily, ensuring that specifications are met. “This morning when the sun comes up in California, we are out in the fields choosing which lettuce fields can be Sysco brand and which cannot,” says Schnieders. “We are on top of this process in a very big way.”
And that process is about to add a new layer of sophistication: Sysco is revamping its nationwide distribution system to build a network of redistribution centers and to develop the data-exchange system that will connect them to the company’s suppliers and customers. “It’s the biggest project in our history,” explains Schnieders, who says the first center, of what will become a network of five centers, is slated to open in July of 2004 in Virginia.
Products will flow into the redistribution centers in full truckloads, and then go out to the company’s 147 distribution locations in mixed truckloads-streamlining the entire supply-chain process. “It will enable our suppliers to do better planning and scheduling for production and [enable] us to significantly reduce inventory,” says Schnieders, who envisions a five-year timeline to complete the project. “It will also provide our customers with better service and a wider range of products.”
Tales from the Dark Side
The concept is straightforward enough. Save on labor costs by assembling your product overseas. Your company reaps the cost savings, an offshore partner profits as well, and together you help a developing country build its economy. Unfortunately, not all outsourcing stories end quite so happily.
For ADC Telecommunications, the grim demise of a plan to produce product in China came in the form of an egregious intellectual property violation, recalls Rick Roscitt, CEO of the $1 billion broadband firm. “No matter what we did, we couldn’t stop them from taking the product and replicating it in a factory three miles down the road,” says Roscitt. “They even had the audacity to put our badge and label on it and move it into the system.”
Confronting the company responsible did not help matters, he adds. “They basically denied it, and said, €˜Well, bring it to the legal process in China and see how far you get.’”
Disenchanted with the allure of manufacturing in China, ADC opted to continue distributing product there, but transferred the assembly to Mexico. “The cost per unit is 15 percent higher, but the actual cost to the company is far less,” says Roscitt.
While many companies are working successfully with offshore firms, stories like Roscitt’s are all too common, says Jack Devine, founding member and president of The Arkin Group, an international crisis management firm. “A lot of what we do is unravel problems, situations where companies spent a small amount of money to check something out, then find out $50 million disappeared,” says Devine, a 32-year veteran of the Central Intelligence Agency. “Or you check out a field representative and everything looks fine, but then you have your shirt taken.”
To guard against such scenarios, Devine urges performing heavy due diligence on the partnering company and any principals involved. “Most of the cases we have are really an example of wanting the deal so much that you don’t want to know the truth,” he says. “If you have the sense that there are gray clouds, there’s probably a reason.”
Saved By Outsourcing
When Capital Blue Cross’s partner of 40 years opted out of a joint venture arrangement-threatening it with acquisition or fierce competition-the company had to get up to speed quickly on a wide range of critical functions. In the following excerpt, president and CEO James Mead explains how the Harrisburg, Pa. healthcare company handled the challenge without losing its competitive edge.
“To a large extent, outsourcing saved us in the last 18 months. We are a Blue Cross-only plan, and we operated eight joint ventures for close to 40 years with our Blue Shield partner. Then our Blue Shield partner said to us, €˜Either we acquire you or we’re going to compete with you.’ Financially we were stronger than they were, but the total dollar bottom line-they were a much bigger organization.
“When somebody tells you, €˜I’m terminating your agreement and you have six months to get ready to go and compete with me,’ and you have not done certain services, outsourcing is a great way to get up to speed fast enough. We had to obtain what we didn’t have in terms of claims processing and networks of hospitals and doctors. Another example is the area of disease management. In our business, being able to manage specific disease states is very important. Developing the expertise would have taken us years. But we’ve found that it’s much better to outsource, for example, diabetes management. We use a company that does it for us nationwide. All we do is provide the names and the data that can be mined in order to find where the problems are, and they do an excellent job for us on a nationwide basis managing this.
“While I have to give our people most of the credit, over the last 18 months outsourcing was a very important part of keeping us competitive and bringing us to the point where we have the largest market share in the region where we do business. Will we in-source those functions over time? Some we probably will. But quite frankly, we are getting better service outsourcing some of them than we probably would have had we done it ourselves. We’re a company that went from practically doing everything in house a decade ago to taking a huge leap, just because we had to.”