Alvarenga Scm-outsourcing 20102

7/27/2019 Alvarenga Scm-outsourcing 20102

1/24

Outsourcing

Core Competency 2.0:

The Case for Outsourcing In Supply

Chain ManagementCarlos A. Alvarenga and Pancho Malmierca


2/24

Table of Contents

1. Executive Summary

2. Test One: Is the FunctionReally a Core Competency?

3. Test Two: What Kind of Knowledge

Does the Function Require?

4. Test Three: Who Will Improve theFunction Most in the Future?

5. Test Four: What Is the Externalization Risk?

6. Supply Chain ManagementOutsourcing Examples

7. The Future of Outsourcing and

Outsourcing Decision Making

"I cant understand why peopleare frightened of new ideas. Im

frightened of the old ones."John Gage, Scientist

"Ideas are a commodity.Execution of them is not."Michael Dell, CEO

2


3/24

3


4/24

Executive

Summary

For decades, outsourcing has been anintegral part of most global supplychain management (SCM) operations.At many companies, in fact, the rise

of third party logistics entities suchas DHL and UPS has resulted in theelimination of in-house transportationfleets; likewise, the high-technologyand automotive industries frequentlyoutsource some or all of theirmanufacturing operations, thusmaking it possible for them tofocus on activities such as research,product design and marketing. Still,there are many non-logistical supplychain functionsforecasting, supplyplanning, and inventory management,

for examplethat generally remainin-house. While most supply chainexecutives may never have consideredoutsourcing these non-logisticsfunctions, the fact is that outsourcingsuch activities is now not just possiblebut in some cases preferable toperforming them in-house. This articlewill argue that outsourcing even thehighest-level supply chain functionis quickly becoming an economic andstrategic option. As this phenomenon

gains more exposure, it is importantto have a mechanism to structuredecisions about keeping an SCMfunction in-house or externalizing it to

a third party service provider. In thisarticle we present such a framework,built around four key questions:

1. Is the function really a corecompetency?

2. Is the knowledge managementstrategy associated with thefunction fully understood andaligned?

3. Who will improve the function most

in the future?

4. What is the externalization risk?

Understanding how to answerthese vital queries can help readersdetermine if a particular supply chaincapability is best outsourced or keptas an internal function. Based on ouranalysis of dozens of SCM outsourcingcontracts, we will argue that in somecases engaging an outside company

to handle activities such as inventoryoptimization or forecasting is actuallysuperior to hiring, training andproviding for those functions in-

house. Our main contention, in otherwords, is that what matters most isnot who executes a given functionbut who executes it best, and that theformer will usually be the organizationwith the most economic incentive toimprove that function.

After the analyses noted above(sections focused on each of the fourquestions), we present three casestudies, followed by an examinationof risk and liability in supply chain

outsourcing.

1.

4


5/24

Our contention is that whatmatters most is not whoexecutes a given function butwho executes it bestandthat who executes best willusually be the organization withthe most economic incentiveto improve that function.

5


6/24

1. Harvard Business Review, July-August, 1994.2. Gary Hamel, C. K. Prahalad. Competing for the Future. Boston, Mass: Harvard Business Press, 1996.

Test one: is the function really

a core competency?

Ever since Gary Hamel and C.K.Prahalad laid out the concept of thecore competency in their seminal1994 article, The Core Competence

of the Corporation,1

legions ofmanagers and executives havestruggled to define, build and maintaintheir own versions of this concept.Sixteen years later, however, manycompanies idea of a core competencybears little resemblance to whatHamel and Prahalad described. Someexecutives think of their companiescore competencies as the thingswe need to get right while othersdescribe them as the things we dobest. Still other executives define a

core competency as the basic skillsrequired to compete in our industry.Interestingly, some leaders simplyignore the concept altogether.

Returning to the original concept,however, it is interesting tonote that Hamel and Prahaladdefine core competencies as

the collective skills and learninginside an organization that createcompetitive advantage. Thisperspective is illustrated in Figure 1.

In other words, a core competency isnot a competitive advantage in andof itself. Instead it is the source of acompanys competitive advantage.In their follow-up book, Competingfor the Future,2 Hamel and Prahaladfurther argue that core competenciesmust provide a company with eithera real or perceived competitiveadvantage in the minds of customers.For example, customers may thinkthat a certain package delivery

company is more likely to deliver anovernight package on-time, eventhough statistical analyses show thatit is no better than its competitors.The reason customers hold this belief,however, is that the company hasgreat advertising. Thus marketing isthe real core competency that makesthe company stand out. Of course,

core competencies also can create realadvantages, not just perceived ones,and surely this is the main idea thatmost supply chain executives have in

mind when they seek to define theircompanys core competencies.

In the context of supply chainmanagement, like so many otherbusiness areas, the idea of corecompetency is as common as it isvaried. For the sake of this article,however, let us consider what webelieve to be the most commondefinition: A core competency is anyfunction a company must execute wellin order to be successful.

Given this definition, it is commonlybelieved that activities such asforecasting and inventory optimizationare core competencies. But is thisreally the case? To answer thequestion, consider the case of logistics:a function that has been outsourcedso often that most supply chain

2.

6


7/24

End Products

1 2 3

Business

1

4 5 6

Business

2

7 8 9

Business

3

10 11 12

Business

4

Core Product 2

Core Product 1

Competence

1

Competence

2

Competence

3

Competence

4

Competencies: The Roots of Competitiveness

The corporation, like a tree, grows from its roots. Core products are nourished bycompetencies and engender business units, whose fruit are end products.

executives would never consider it acore competency. In the 1950s it wasrare for a company not to managethe physical distribution of its own

products. After all, it was importantto deliver products on time and tokeep a watchful eye on ones goods.However, as companies such as FedExand UPS arrived and focused theirtalent exclusively on the physicaldelivery of goods, their logisticalskills significantly eclipsed those ofmany manufacturing companies.Moreover, since a company such asFedEx can amortize its investmentsover many clients, no single clienthas to bear the full cost of leading-

edge logistics technology or a highlysophisticated logistics managementteam. Consequently, what probablywas a core competency in mostproduct companies in the 1950s nowis seen as almost completely (at leastin the developed world) as a functionbest performed by an external entity.What is interesting about this example

is that the change in perspective wasdriven by external agents (the logisticscompanies themselves) rather than bysuboptimal performance of in-house

logistics teams. This observationpoints out an important critiqueof core competency theorythat acompany can be great at somethinguntil an external force comes alongthat minimizes the relevancy of thatcapability and/or causes it to behandled better in some other fashion.

Another significant strategic change isthe rise of outsourced manufacturing.Many people are surprised to learnthat companies such as Apple and

Sonyas well as entities in industriesas diverse as fashion, pharmaceuticalsand cosmeticsdo not make theirown products. Most people do knowthat a lot of manufacturing happensin low-cost countries; however, theyprobably think those manufacturersfactories belong to the brandsthemselves. Discovering otherwise,

peoples reactions are logical: If amanufacturer does not manufacture,then what exactly does it do? Inother words, if manufacturing is not

a core competency at a manufacturingcompany, then what is?

The rise of outsourced manufacturingis a complex phenomenon brought onby many factors.4 As was the case withlogistics, even companies that wantedto keep manufacturing operationsin-house came to see that outsidespecialists were offering higher levelsof expertise and equal (if not lower)costs. In response, the manufacturersstarted letting subcontractors build

their products, while the manufacturersthemselves focused on engineering,design, brand management and (insome cases) supply chain management.Once again, what had been a corecompetency became less (or non) core,in large part because of the risingcapabilities of external parties ratherthan the deficiencies of in-house

Figure 1: Hamel and Prahalads original view of core competencies3

3. Ibid.4 For a thorough discussion of this topic in the high-tech industry, see From Silicon Valley toSingapore by David McKendrick, Richard Doner & Stephan Haggar

7


8/24

Time

A B C

Outsourced

Service Cost

First Contracts to

Outsource Function XOutsourcing Function X

Becomes Common Option

Outsourcing Function X

Becomes Default Option

Outsourced Service

Performance

Service Provider

Cost

manufacturing teams.

Nor are logistics and manufacturingthe only examples of how core

competency definitions evolve.Information technology, accountingand payroll also used to be consideredcore but seldom are now. However,the most interesting reference pointin the core competency discussionmay be the outsourcing of businessstrategy itself. One would think thatdefining a firms strategy wouldbe the most core activity of all.However, most large companies nowemploy consultants to help definetheir business strategy. In some

cases, consultants conduct the basicresearch, analytics and strategydefinition, so clients have only toselect a strategic direction fromamong a small set of options. Again,if someone outside a company cansuccessfully execute a critical functionsuch as strategy definition, then whywould most any supply chain function

be considered off limits?

Activities such as forecastingand inventory planning have

been less subject to outsourcingtrends. However, that is aboutto change for the very samereasons that drove the shiftsin the areas discussed abovenamely, that specialist outsidersare enhancing their abilitiesin these areas at a faster ratethan most in-house teams.Many of those outsiders also are

reducing the fees they chargeto clients, to the point wherethe service providers rates areequal to or even less expensivethan what it costs to maintainin-house teams. This evolutionis illustrated in Figure 2.

Activities such as forecasting andinventory planning have been lesssubject to the outsourcing trendsoutlined above. However, that is

about to change for the very samereasons that drove the shifts in theareas discussed abovenamely, thatspecialist outsiders are enhancing theirabilities in these areas at faster ratethan most in-house teams.

We believe that supply chainmanagement outsourcing has recentlypassed Line A in the evolution depictedin Figure 2. As a result, outsourcingwill soon become a more commonoperational option for supply chain

executives in many companieseventhose known for their supply chainexcellence. At this early stage, there isa spread in service performance versusservice cost levels among differentproviders, but some of these entitieshave already passed the breakevenpoint, thus making SCM outsourcingan attractive option for many

Figure 2: Outsourcing cost and performance evolution

8


9/24

companies. We expect that, in thecoming years, more service providerswill pass the breakeven point and thatSCM outsourcing will become more

widely discussed and put into practicearound the world.

The logistics and manufacturingexamples noted above are evidencethat functions previously consideredcore eventually became non-coreand were outsourced after serviceproviders became more proficient thanin-house teams. If this is the case, thenwhat actually is a core competencyin supply chain management?

Our view is that the best definition isthe original one Prahalad and Hamelsuggestedwith the addition of twocriteria. Thus, for an activity to be acore competency within a given supplychain function, it must satisfy threeconditions:

1. It creates real or perceivedcompetitive advantage.

2. It cannot be done better at an

acceptable higher cost, or equally wellat a lower cost by an outside specialist.

3. Any increased risk in externalizingthe function is both understood andmanageable.

We call this definition CoreCompetency 2.0, and under thisexpanded definition, whether acompany should be executing afunction internally or externallydepends not only on whether that

function creates a real or perceivedcompetitive advantage, but also onwhether an outsourcing servicesprovider can perform that functionbetter than the company itself. Ourthird criterion is based on the factthat any externalization of a functioninvolves risk. So it would be unfairto compare performance and cost of

an internal operation and an externaloperation without considering thedifferent risks these alternatives pose.

Returning to the example offorecasting, if a company finds thatan outside specialist can executethis function better, even at a highercost (so long as there is a positivereturn on investment on the marginalcost difference), then the companyshould consider outsourcing itsforecasting operations. Likewise,if that same company finds that aspecialist can perform equally wellat a lower cost, then outsourcingalso should be considered. This is

especially true if the outside specialistplans to invest more to improvethat function than the companyis able to do itself. We will discussthis last point in more detail later.

9


10/24

Test two: what kind of knowledge

does the function require?

Most companies conduct periodicprocess improvement initiatives toincrease supply chain performanceand add capabilities. Some of these

initiatives will fail due to underfundingor lack of sufficient executivesupport. However the most commonreason is generally the absence ofknowledgethe skills and experienceneeded to execute the improvementproject or acquire/implement a newtechnology. In this section, we willdiscuss the different types of supplychain knowledge that companies mustacquire and retain, and how this supplychain knowledge dynamic impacts thedecision to outsource a given function.

For the purposes of our analysis,consider three specific types of supplychain knowledge:

FunctionalKnowledge,suchasstatistics, network dynamics andproduction optimization.

IndustryKnowledge,suchascustomer demand patterns, productlifecycles and material controls.

InternalCompanyKnowledge,such as legacy systems, inventorystrategies and company policies.

Functional Knowledge is specificto a discipline but independent ofany particular industry or company.Examples of this kind of knowledge areabstract (such as math and statistics),applied (such as engineering orbiotech) or procedural (such as projectmanagement and planning).

Functional Knowledge is acquiredfirst through formal education:college, graduate school, certificationprograms, training, etc. Indeed, formaleducation plays the most importantrole in the acquisition of abstractFunctional Knowledge, and thus itis very diff icult to develop this typeof knowledge internally within a

company. For this reason, companieshire people with the requirededucational credentials to performtasks that require abstract Functional

Knowledge.

Practical experience following formaleducation typically complements theacademic base, helping to consolidateand retain the concepts and skillsan individual acquired in his or heracademic setting. However, practicalexperience rarely provides thetheoretical fundamentals required toreally advance Functional Knowledge.For example, while someone with nostatistics background can be taught

how to input a forecast into a demandplanning system, that person willnot understand what mathematicalfunctions may be applied to thatforecast as it is merged with othersand integrated into larger demandpatterns.

3.

10


11/24

Industry Knowledge is common to agroup of companies operating withinan industry, such as chemicals orretail. Supply chain resources workingin these industries require knowledgethat is unique to the products movingthrough their supply chains. Forexample, to manage the productionof chemicals, employees need to

know the general concepts of themanufacturing function, but they alsomust be familiar with industry-specificaspects, such as chemical by-productsand co-products. Furthermore,the manufacturing of chemicalsoften requires handling hazardousmaterials whose use is governed byenvironmental regulations. In effect,the knowledge of how chemicals aremade is almost always acquired inan industrial, not academic, setting.Other industries, such as paper and

steel manufacturing, may share manysubstance-related issues seen inchemicals manufacturing, but theywill face other complexities andregulations that are specific to paperor steel production.

Internal Company Knowledge isspecific to each company. Examplesinclude: relationships with suppliersand customers; subject matter expertswith particular insights that arenot widely known or documented;

experience with home-grown tools,internal processes and approvals; andpolitical or organizational challengesand how to deal with them. Thesetypes of knowledge can be acquiredonly through experience within aparticular company. There is noexternal education or past experiencethat can replace internal companyknowledge. Despite these uniqueattributes, it is our experience thatinternal company knowledge is rarely

documented properly: companiesdepend heavily on the people whohave it in their heads. When theseresources leave, the knowledge oftengets lost, which generates unexpecteddisruptions in process performance. Ofcourse, some companies do make aneffort to formally document internalcompany knowledge. However, they

are aware that it is virtually impossibleto document each persons knowledgeand every nuance of daily operations.

To achieve high performance in supplychain management, companies need allthree types of knowledge. They needto understand what each capabilitymeans and involves, what constitutes

the optimal mix of skills, and howthey can best acquire or develop thecomplete set of required skills. Forexample, if a retail company wantsto implement a statistical forecastingfunction, it will have to acquiretalent with statistical and forecastingskills. Implementing a sophisticatedforecasting tool and setting up theright forecasting process will notbe enough without the right teamto leverage the technology andmanage the process. In this case, the

company could be tempted to putits current planners in charge of thenew forecasting process and tool.However, given that new abstractFunctional Knowledge is required,and that abstract knowledge is bestacquired through formal education,it is quite likely that the knowledgerequired by the new process/tooland the knowledge available withinthe team will not align. When thishappens, the tool, the implementationor the process are often blamed, since

it is difficult for a company to realizethat not having the right people withthe required skills could have been thecause of the failure. This is why systemimplementations without the rightteams often fail or (at a minimum)dont deliver the expected results.

Companies also should know how eachtype of knowledge is obtained so theycan invest in the right methodologyto acquire it. Continuing with thesame example, an organization may betempted to send its current plannersto statistics training to fill the gap inskill sets required to manage a newforecasting process. However, it isunlikely that a short statistics coursewill provide planners with the depthof statistical knowledge needed tomaximize performance. Similarly, a

company whose demand dependshighly on a few government customerscould easily err by hiring a veryadvanced statistician or forecastingexpert to run the forecasting process.The reason is that the variabilityof the forecast will depend mainlyon decisions made by those fewcustomers. In effect, company-specific

knowledge (e.g., the companyscustomer buying behavior) is key potentially more relevant than thefunctional forecasting knowledge.Thus the company might be betteroff teaching forecasting techniquesto internal employees who alreadyunderstand the entitys customers.

In summary, recognizing the typesof knowledge required to performeach process allows companies tounderstand the mix of knowledge they

need to optimize key supply chainprocesses, and to make the rightinvestments to acquire or developknowledge in the most effective way.

Unfortunately, even when companiesknow the types of knowledge theyneed and how to acquire them,acquisition and retention of suchknowledge remains challenging.This is yet another reason why morecompanies are considering outsourcingvarious supply chain functions.

In addition, talent attraction andretention are especially difficultwhen a particular set of FunctionalKnowledge is not critical foradvancement in a company. Considera retail company with complexdemand-management challenges thatis struggling to attract and/or retaintalent with these critical skills. Sinceit is rare for a statistician to have aclear career path to a senior executiveposition in retail, a highly-trainedindividual is less likely to find the retailposition attractive. Instead, the personmay be more drawn to a companyin which statisticians are valued asrevenue generators, such as a marketanalysis firm, forecasting softwarevendor or supply chain servicesprovider.

11


12/24

On the other hand, internal companyknowledge is very hard to transferfrom company to company. Forexample, the knowledge of a particular

home grown software tool cannot beapplied in a company that does not usethat tool. Thus knowledge of that tooldoes not qualify an employee to do asimilar job in a different company. Onthe positive side, deep knowledge ofa companys products and processesare strong assets for internaladvancement.

From a skills-acquisition perspective,Industry Knowledge is a mixed case.Important areas of Industry Knowledge

are developed inside each companyand companies have a special interestin conserving these (and in ensuringthat competitors do not acquire them).Also, there is Industry Knowledge thatis enhanced by working with multiplecompanies in the same industry.In this case, companies benefit byhiring experts who have worked at

competitors or in related industries,and who would bring knowledge ofleading practices. This is one reasonwhy consultants can be so valuable:

they represent a way to leverageIndustry Knowledge without having tohire experts from other companies.

In conclusion, when consideringwhether to outsource a supplychain function, one critical test isunderstanding the fundamentalknowledge basis of that activity:functional, industry or company-based.This relationship between knowledgetype and the outsourcing decision issummarized in Figure 3.

If a particular supply chain activitydepends on knowledge that isfunction-based, then a top-notchservice company probably will bemore likely to attract and retain thebest people in that field. As a result,outsourcing this function may be alogical decision since there is a strong

chance that the services provideremploys the best of the best. If theactivity depends mostly on IndustryKnowledge, then an external services

provider with deep industry experiencemay again be a logical option.Only in the case where an activitydepends mostly on company-specificknowledge might the choice favorkeeping the function in-house.

Only in the case where anactivity depends mostly oncompany-specific knowledgemight the choice favor keepingthe function in-house.

In the section that follows, we arguethat it is in the area of FunctionalKnowledge that outsourcing servicesproviders have the greatest economicincentive to improve performance of asupply chain activity.

Figure 3: Relationships among knowledge types and the outsourcing decision

1. Do not outsource Company Knowledge impossible to replicate

Sophisticated Functional or Industry Knowledge not required

Regulatory constraints prohibit outsourcing

If function must be outsourced, re-engineer to reducedependency on internal knowledge (e.g., by adopting externalstandard) and plan for 3rd party learning curve

Examples: Regulated materials documentation

4. Outsource for performance Partner with service provider and set up a collaborative

process that leverages partners functional skills and thecompanys internal knowledge

Minimize learning curve on both sides

Partner on-site presence typically required

Examples: Replenishment management for retailoperations, product forecasting in short lifecycle markets

2. Outsource for cost Capabilities and knowledge are not complex and learning

curve should be short

Offshore to reduce cost of operation

Examples: Tactical procurement support, product datamaintenance, basic analytics

3. Outsource for performance Outsource to service provider with demonstrated skills in

function and/or industry

It will typically be more expensive and less successful todevelop sophisticated Functional Knowledge internally

Examples: Advanced statistical analytics, advancedinventory optimization, global transportationmanagementIn

ternally-DependentKnowledge:Systems,

Cu

stomers,etc.

Externally-Dependent Knowledge: Functional, Industry, etc.

NotRelevant

Not Relevant Highly Required

Highly

Required

12


13/24

13


14/24

4.Test three: who will improve the

function most in the future?

Consider the dilemma faced by asupply chain executive who takes overa poorly-performing organization.He completes the analysis described

above and decides that the mostcritical activities depend primarilyon functional knowledge. Morespecifically, what the executive needsmost are people who understandcomplex multi-echelon inventoryoptimization mathematics andstatistical forecasting. In our view,what should happen next is a classicmake versus buy analysis.

Makeimpliesthatthecompanyowns the resources with the

required knowledge (hired fromoutside or internally developed) andassumes the responsibility and riskof managing those resources tomaximize the value and benefits thetalent is expected to contribute.

Buyimpliesthatthecompanyrealizes the results and benefitsgenerated by such talent byengaging a service, such as

consulting, outsourced analytics oroutsourced business processes.

The case for make has been mademany times in many ways. However,the case for buy is largely new toareas such as forecasting and supplyplanning, and we believe there areseveral reasons why this alternativeis not just a valid option for manycompanies but actually a preferredapproach. Below are several reasonsfor this conclusion:

1. Third party services providersare better prepared to deliver highperformance in operations thatrequire deep functional knowledge.

Third party services providers focusedon a function (e.g., forecasting,inventory management, supply chainmanagement) can create the rightenvironment to attract and retainexperts. Because they help to generaterevenue, subject matter experts have aclear career path with the third partyservice provider.

2. For the implementation of newsupply chain capabilities, companiesfrequently face implementation risks,

cost overruns, extended timelines andrequests for functionality that is notneeded at present but may be neededsometime in the future. By contrast,third party services providers havethe advantage of lessons learnedfrom multiple implementations, andthus may be able to shorten time-to-value and eliminate much of theimplementation risk.

14


15/24

3. Third party services providers cantake advantage of economies of scale.An advanced statistician may berequired only a fraction of the time

at a retail company, so it is hard tojustify a full-time position. However,the third party services providercan assign the functional expert tomultiple projects and clients and thusdivide the cost among them.

4. Third party services providers oftenhave valuable industry knowledgebecause of their lengthy exposureto multiple companies withinan industry. Third party servicesproviders usually specialize in specific

functions and organize their teamsalong industries to create industrysubject matter experts. These entitiestherefore have a mix of industryknowledge that internal companytalent can rarely match, since thelatter are exposed mainly to therealities and practices of their oneemployer.

5. Third party services providers canbe a particularly preferable choiceif their client has positioned supplychain expertise as a source of profit

to be maximized rather than a cost tobe minimized. Most in-house supplychain teams struggle to acquire fundsto invest in new skills and technology.However, a world-class service firmwill make these investments morereadily, since it sees those costs asinvestments for which there is a directand measurable revenue stream.

It should be acknowledged that in-house operations may be a superiorchoice when internal company

knowledge is a key leverage point.After all, internal knowledge is notrepeatable across multiple clientsand thus economies of scale and pastlearning curves do not present anadvantage for a third party servicesprovider. However, this scenario iscomparatively infrequent; instead,most companies seeking to improve

supply chain performance are likelyto determine that outsourcingsstrengths far outpace its weaknesses.

15


16/24

Test four: what is the

externalization risk?

Perhaps the most critical issuethat arises in any discussionabout outsourcing a supply chainmanagement function is the issue of

risk. Using forecasting as an example,this issue typically is summarized bytwo logical questions:

1. Why should I risk letting an outsiderdo something as complicated as (say)forecasting demand for my products?

2. Who is liable if a forecast createdfor me by an outside entity is wrong,and my company loses sales as aresult?

Point 1 might accurately be deemedexecution risk: the fear that apartner will not be able to execute thefunction for which it was contracted.This concern is legitimate. However,in Accentures view, the real issueis not the failure of the servicesprovider but whether that firm has a

higher probability of failure than theorganization that hired it. After all,internal teams can (and do) fall shortas well.

Direct Risk in Supply ChainOutsourcing

To answer the first question morefully, consider the five potential causesof functional failure in supply chainmanagement noted in Figure 4. Ofthese five, only one is potentially moreprevalent in an outsourcing context:incomplete or wrong informationused to perform a function. Becausemany supply chain processes depend

on company knowledge, failure toapply or communicate that knowledgemay increase the chance of failurewhen performed by an externalpartner. An example from retail mightbe promotional forecasting: in theseoperations, knowing which categorymanagers really understand the

impact of sales or rebates on finalconsumer demand is critical. However,this determination is seldom easyto make without several months of

experience. Another example couldbe spare parts planning in consumerelectronicswhere calculationsare heavily tied to new productintroductions and products end-of-lifecycles. Both these scenarios presentpotentially higher risk with a servicepartner. But the key to amelioratingsuch problems is not complicated:thorough documentation and constantcommunication between client andservice provider can diminish this riskto a level similar to that encountered

by an in-house team.

5.

16


17/24

Indirect Risk in Supply ChainOutsourcing

Along with direct risks, there also areindirect risks involved in any decisionto outsource. Examples include:

Bankruptcyoftheserviceprovider.

Sensitiveinformationnothandledcorrectly.

Highturnoverinserviceproviderstaff.

Commitmentoftheserviceproviderto supply chain managementoutsourcing as a long-term strategy.

Poorchemistry/workingrelationshipbetween client and service provider.

Challengesposedbyextendedtime differences and geographicaldispersion of teams.

It may not be possible to fullyeliminate these risks; however, theycan be managed at an acceptablelevel if the relationship is anchored

by committed, communicating andhighly competent third parties andframed by an appropriate operatingmodel. Moreover, it is Accenturesexperience that, in areas such as datasecurity, outsourcing can actuallyincrease the level of rigor within clientorganizations.

Liability in Supply ChainOutsourcing

In the outsourcing arena, who is

liable when something goes wrong?is a viable concern. Imagine thata third party forecasts X amountof sales for a fashion retailer and,based on that forecast, the retaileronly stocks Y levels of merchandise.When the merchandise reaches thestore, demand far exceeds supply.

Who bears responsibility for the lost(missed) sales? Or perhaps a thirdparty is inaccurate in its planning andpurchasing of MRO materials for a

manufacturer?

These examples might seem to suggestthat outsourcing a function suchas sales forecasting or spare partsmanagement is inadvisable. However,evidence and experience suggest thatthis is not the case. Moreover, theactual process of determining liabilitycan be very useful to both sides.Consider the methodology outlinedin Figure 5: a formalized approach todetermining degrees of separation

between output and outcome.

Figure 4: Supply chain outsourcing risk drivers

Risk Driver Higher Direct Risk in External Service Partner?

External Disruption, e.g.,

Weatherdisruption

Supplierqualityfailure

Productlaunchfailure

No (Risk level is identical for both external and internal teams)

System Failure, e.g.,

Crashinplanningsystem

Baddataresultsinun-usableproductionplan

No (Risk level is probably lower for external teams)

Process Failure, e.g.,

Incorrectcalculations

Failuretoexecuteaprocesscorrectly

No (Risk level is identical for both external and internal teams)

Failuretoadequatelyupdaterequiredskillsets No (Risk level is higher in most internal teams)

LackofsufficientCompanyKnowledge,e.g.,

promotion/discount impact on customer behavior

Yes (Risk level is probably higher in most external teams)

17


18/24

Figure 5: A high-level liability definition model

To understand the degrees ofseparation concept better, considerthe case of an electronics companythat outsources spare parts planning

to a third party services provider.The services provider collects returnand warranty data from its clientsrepair centers, combines the datawith product launch and terminationplans, and creates a parts plan thatit provides to the client and its mainsuppliers. So what happens if thethird party orders too many or toofew parts on behalf of the repaircenters? Referring to Figure 5, theservice output in this scenario is theforecast, while the service outcome

is the clients inventory level, whichideally is neither too low (which wouldcause service disruptions) nor too high(which would elevate inventory costs).The key is determining the degrees ofseparation between the output and theoutcome. Two potential analysis resultsare presented in Figure 6.

Referring to Figure 6, it is not hard tosee that the relationship between theservice providers output (forecast)and the clients service outcome

(inventory levels) is more closelylinked in Scenario A than in ScenarioB. Consequently, one would expectthat there is greater likelihood of risk/liability transfer from client to serviceprovider by applying Scenario A.However, this is not always the case.In outsourced supply chain contracts,clients sometimes opt to not transferrisk, even when they are able to doso. This reluctance has several causes,not the least of which is that serviceproviders will usually seek a premium

for agreeing to a risk transfer. Moreoften than not, it is simpler to developa performance mechanism based onservice level targets and incentives/disincentives.

Whose Risk Is it Anyway?

The question of risk and liability isextremely valid. However, Accenturesview is that not only can the issue

be resolved, but that the resolutionprocess often produces additionalbenefits. For example, the kind ofanalysis illustrated above can helpcompanies identify the real drivers ofsupply chain performance and betterunderstand the relationship betweena supply chain function and specificbusiness outcomes such as productsales, working capital requirementsand new product introductions. In theend, the supply chain executive mustunderstand the drivers of both internaland external risk. But he or she shouldnot assume that externalizing anyfunction automatically entails higherdegrees of risk.

1: Define processand processinputs/outputs

2: Define desiredbusiness outcome

3: Define degreesof separationbetween output andoutcome

4: Build serviceliability model onbasis of output-outcome analysis

18


19/24

Figure 6: Output-outcome analysis results

Output: Spare parts forecast created by service partner

Degree 1: Forecast accepted by client with (at most) onlyminor deviations within 72 hours

Degree 2: Forecast accepted by repair centers andsuppliers with no changes within 24 hours

Degree 3: Suppliers send forecasted materials with (atmost) only minor deviations from forecast within 7 days

Degree 4: Materials received in repair centers in goodcondition and put into stock in accordance with forecastwithin 24 hours

Outcome: Inventory of materials calculated per a givenperiod becomes reality in repair centers within 7 days ofOutput

Output: Spare parts forecast created by service partner

Degree 1: Forecast accepted by client two weeks later butwith major changes

Degree 2: Forecast accepted by repair centers one weeklater

Degree 3: Forecast accepted by suppliers two weeks later

Degree 4: Suppliers send forecasted materials with oftensignificant deviations from forecast

Degree 5: Suppliers send forecasted materials inshipments that often arrive weeks late

Degree 6: Materials received in repair centers in variousconditions

Degree 7: Materials put into stock in as late as twomonths after original forecast

Outcome: Inventory of materials calculated per a givenperiod becomes reality in repair centers only months afterOutput is created and then with changes

Scenario A Scenario B

19


20/24

Supply Chain Management

Outsourcing Examples

Fashion Retailing

A North American retailer specializingin womens fashion and householdproducts has more than 1,000 retail

outlets. With the help of a thirdparty services provider, the companyimplemented a state-of-the-artstatistical forecasting softwarepackage. However, the company wasunable to train or recruit enoughpeople to master (and thus leverage)the new software. For this reason,it opted to outsource forecastingto the same services provider. Theexternalization decision logic wasclear:

Isforecastingacorecompetencyin our company? No; others canperform it better than we currentlycan.

Doesthefunctiondependoncompany knowledge? No; it dependsprimarily on functional knowledge ofmathematics and statistics.

Arewelikelytoinvestheavilyinforecasting in the future? No; themajor investment was already madeand there are no plans for further

investments.

Doesexternalizingmeanhigherriskof failure? No; since the forecastingservices provider implemented thesystem, it clearly knows best how tomake it work.

The services provider that implementedthe forecasting system subsequentlydeployed an expert forecasting teamstaffed partly at the clients location inNorth America and partly in India. The

team successfully managed statisticalforecasting for three years and thecontract was recently renewed andexpanded to cover demand analytics.

High-Tech Manufacturing

A global consumer electronicscompany based in Japan set out toimplement a spare parts planning

system for its European serviceoperations. However, the project wasover budget and behind schedule, andthe company was having difficultyfinding staff in central Europe toexecute the function once it wasimplemented. Like the fashionretailer, the electronics companysexternalization decision logic wasstraightforward:

Issparepartsplanningacorecompetency at our company? No;others can perform it better than wecurrently can.

Doesthefunctiondependoncompany knowledge? No; it dependsprimarily on functional knowledgeof mathematics and transportoptimization.

6.

20


21/24

Arewelikelytoinvestheavilyinspare parts planning in the future?No; the major investment was thesoftware implementation.

Doesexternalizingmeanhigherrisk of failure? No; the companywas already facing a high risk ofimplementation failure.

An outsourcing services provider withdeep skills in spare parts planningwas contracted and the companysinternal software implementationwas halted. The services providerlicensed a different spare partsplanning application, implemented it,

and then staffed a team in Europe toforecast and plan spare parts for itsclients repair facilities. The contractsfinancials were based on parts volumeand driven by the performance of theoutsourced planning team. Three yearslater, the relationship has been a greatsuccess and the contract was recentlyrenewed and expanded to includeadditional products across Europe.

Chemicals

A large European chemicalsmanufacturer had no advancedforecasting systems or team, nor was

it equipped to handle global demand-supply synchronization. Sourcing andtransport of raw materials (mostlyfrom China) was neither optimizednor synchronized with productiondemand in Europe and North America.To reach an outsourcing decision, thecompany addressed key externalizationdecisions, such as:

Areadvancedforecastinganddemand-supply synchronizationcore competencies? No; this activitydoes not provide a perceived or realcompetitive advantage.

Doesthefunctiondependoncompany knowledge? No; it dependsprimarily on functional knowledgeof mathematics and transportoptimization.

Willwereallyinvestinthefunctionin the future? No; the company didnot want to spend money on newsystems or staff.

Doesexternalizingmeanhigherrisk of failure? Possibly; which iswhy the outsourcing arrangementbegan with a full-scope, six-monthtransition period, during which theinternal/external model was defined,implemented and refined.

Two years later, the external teamis performing at a high level andthe company has asked the serviceprovider to assume long-term

responsibility for this function.Moreover, the company and serviceprovider have begun to refine theservice in other ways, such asaccounting for carbon impact to helpconfirm that the operation meetsthe companys environmental supplychain standards. This green investmentwas driven primarily by the serviceprovider.

21


22/24

The future of outsourcing and

outsourcing decision making

Supply chain executives often ask us ifthere is a decision tree that can helpa company determine if a functionis worth externalizing. Figure 7

illustrates this sort of externalizationdecision logic.

Obviously, a great many factorsinfluence an outsourcing decision.However, the decision tree is a goodplace to begin because it can guidehigh-level options for improving aflawed function, determining whetherto build or buy needed capabilities,and deciding if significant supplychain investments are justified, givena companys long-term strategic

direction.

We also recognize that corporateculture and external (e.g., industryand market) factors influence theoutsourcing decision process asmuch (or more) than cost and currentperformance; and that these driverscannot easily be mapped. However, itstill is possible to chart the state of

supply chain management outsourcing(as distinct from areas such asstrategic sourcing or logistics). Thisstate is presented in Figure 8.

Based on the trends implied by thegraphiccombined with evidencepresented in this paperit should notbe surprising that more and moreworld-class companies are outsourcingsupply chain management functionssuch as product forecasting, retailreplenishment, inventory managementand spare parts planning. At firstglance, some supply chain practitionersmay perceive this evolution as a threat.But a closer look could reveal to them

the strong potential for turning one orseveral supply chain functions into acompetitive weapon or even a revenuegenerator. This is a profound changethat can open new career paths, createbroader recognition of supply chainmanagements power and even createstronger companies that subsequentlybecome leaders in internal as well asmarket growth.

The foundation is being set fora world where virtually anyoperational functionfromlogistics to manufacturing toengineeringcan, with the righteffort, be performed equally wellinside or outside an organization.

7.

22


23/24

Outsourcings evolution also willbe significant because it couldgenerate new options for executivesand operational strategists who,

until now, have had to dependexclusively on internal organizationsto achieve excellence in supplychain management functions.Already, the foundation is beingset for a world where virtually anyoperational functionfrom logisticsto manufacturing to engineeringcan, with the right effort, beperformed equally well inside oroutside an organization. As thishappens, supply chain strategists willdiscover more (and more impactful)

operating models. This freedom willallow entirely new companies to bebuiltcompanies that operate infundamentally new ways. For all thesereason, supply chain outsourcing willultimately be a positive force thatwill continue to move supply chainmanagement toward the forefront ofbusiness strategy.

Figure 7: Externalization decision logic

Figure 8: Current state of SCM outsourcing.

1: Is it a Core

Competency

2.0?

2: Does it

depend most

on purely

Company

Knowledge?

3: Will we

really invest

and improve

this function

in the future?

4: Does

externalizing

really mean

higher risk of

failure?

Outsource

Keep In-House

N N N N

Keep In-HouseKeep In-HouseKeep In-House

Y Y Y Y

Time

A C

Outsourced

Service Cost

First Contracts to

Outsource Function X


Becomes Common Option


Becomes Default Option

Outsourced Service

Performance

Service Provider

Cost

SCM

Outsourcing

MFG

Outsourcing

Logistics

Outsourcing

B

23


24/24

Copyright 2010 AccentureAll rights reserved.

Accenture, its logo, and

High Performance Delivered

are trademarks of Accenture.

About Accenture

Accenture is a global managementconsulting, technology servicesand outsourcing company, withmore than 190,000 people servingclients in more than 120 countries.Combining unparalleled experience,comprehensive capabilities across allindustries and business functions,and extensive research on the worldsmost successful companies, Accenturecollaborates with clients to help thembecome high-performance businessesand governments. The companygenerated net revenues of US$21.58billion for the fiscal year ended

Aug. 31, 2009. Its home page iswww.accenture.com.

About The AuthorsCarlos A. Alvarenga is the global leadof Accenture Supply Chain Services.He is also a senior research fellowat the Robert H. Smith School ofBusiness at the University of Maryland.Pancho Malmierca is a senior solutionarchitect with Accenture Supply ChainServices.

Documents

Alvarenga Scm-outsourcing 20102