Sourcing Insights with a Dutch Twist

What has farming to do with outsourcing? That was also my initial reaction when I stumbled over this article in the economist. The article however points out that certain governments and companies buy the right to plant and harvest wheat, rice or other plants in countries like Cambodia, China and Ethiopia. The harvest will in this case not become available for the internal market, but is exported to the country/company ‘leasing’ the ground. The author calls it the ‘outsourcing’s third wave’ and the main question discussed in the article is whether this is beneficial for the country which provides the crops, or just another form of neo-colonialism. This is not the issue I want to write about, but more about the signs that ‘sourcing’ becomes more and more a (geo) strategic topic, with governments taking the role of ‘customer’ and ‘supplier’. Outsourcing was started of with in the seventies (see also this post ) by Western companies trying to cope with influx of low cost/high quality pro

The Middle East seems to be the next hot destiny for companies to near/offshore too. In a report from AT Kearny indicates that Bulgaria is still relatively ok (from ninth down to 13th place) as a destination to near/offshore too, but that other Eastern European countries lost quiet a bit of ground. The Czech Republic, for example, has fallen to 32nd place from 16th, Hungary to 37th place from 24th and Slovakia to 40th from 12th. According to the report are Asia, the Middle East and North Africa yielding ground, while China, India and Malaysia are the countries to beat. Within North Africa is Egypt one of the front runners when it comes to attracting companies to establish a centre/captive with TCS being one of the more recent companies investing in that North African country. The main reasons giving by TCS is that Egypt allows for 10-15 % lower costs than India and access to a large pool with skilled professionals. Also nearby Jordan is doing well and another of the upcoming countries

The value of outsourcing to an organization has a tangible and intangible component. The tangible dimension is largely monetary of nature and can be expressed in for example return on investment (ROI), Net Present Value (NPV) or Internal Rate of Return (IRR). Examples of potential intangible benefits from outsourcing are improved quality, access to a larger knowledge pool and flexibility of service mix. But even these intangible benefits should result in an improved financial bottom line even though their Euro value might be difficult to predict. The value of the outsourced service portfolio is determined on its discounted future cashflows (see this post ), and value is created only when the return on the capital invested in the portfolio exceeds the risk-adjusted cost of capital. Implemented properly value based management helps to align the overall outsourcing aspirations, analytical techniques and management processes to help the company maximize its value by focusing management dec

One of the key deliverables of the project aiming to get into a relationship with a 3rd party is the contract. A contract typically consists of a Master Agreement and exhibits/schedules. Together they are the legal ‘translation’ of all intentions, obligations and requirements of the relationship. Many of the requirements are related to price, quality, governance, intellectual property, exit and a dozen of other topics. The topics I would like to explore in this post is the difference between compliance and legal risk. The reason I think this is relevant is the different departments that typically deal with both types of risk. Not having a clear distinction might thus result in two departments managing and mitigating the same risk or not managing certain risks are all as both assume the other department takes care of it. In more general terms are the following risk categories the most relevant to an outsource relationship (I leave out financial risk, as that is to me the result of any o

Procurement did in the past not always receive the management attention it should. This situation has changed in many organisations, but I wonder whether the potential added value of the procurement department / function is fully used yet. What I try to explore in this post is finding out what the enablers are to unleash the full potential of procurement. I have for example seen situations where the business engaged in (out)sourcing without (hardly any) involvement from procurement. Some of my thoughts to change this are: Organise procurement as a process, not as a function If one would define procurement as: is ‘the total of activities and performed in order to effectively and efficiently provide the organisation with all products and services it needs to perform deliver its endproducts and –services to its customer’ than procurement is something that does not stop at the boundaries of a department. It would be a process consisting of a number of activities, clustered in processes, w

This posting is a follow up on this post and this post and describes at a very high level how the operational cost related to managing outsource risk can be reduced. Not just by decreasing all budgets by 10%, but by a targeted effort. I came up with this approach during my work for a large international bank (more elaborately described in some articles) and it aims to rationalise the way risk managers/officers should approach their work. The core of the approach requires (senior) risk officers (e.g. operational, compliance) to approach assurance and monitoring more from a financial perspective. The typical risk officer is not used to incorporate the (in)direct costs (operational cost) and potential lost in revenue (opportunity cost) into their considerations when proposing new controls. This results often in expensive assurance mechanisms, like using SAS 70 type II reports for area’s of low risk. By defining a more balanced control strategy which aligns the control requirements with

The ideas in this post are based on the work of Chris Verhoeff, a professor at the Dutch Free University in Amsterdam. More of his work you can find here . I made some minor adjustments, but most of this post is based on his work. The reason I wrote this post is that I use his ideas in approaching sourcing decisions from a more strategic risk-return perspective (I’m now working into the direction of combining this approach with option pricing principles to get a more advanced financial approach). Even though only a very few will find this post usable, those one or two out there might help it in your search for knowledge. The cost of capital of a portfolio with outsource contracts. Some outsourcing contracts in the portfolio will be successful and add value and some of them will not. This needs to be accounted for when setting overall thresholds on potential returns. The threshold for each outsource agreement needs to be at least the Weighted Average Cost of Capital (WACC), plus the av

A risk category that is not unique to outsourcing, but nonetheless relevant, is project risk. The selection of a suitable vendor, contracting and transition of the service from the own organization to the vendor is typically managed as a project. Some of the standard project risk categories are: Business risk: Is the business reasoning behind the decision to buy sound, independent from emotions and ‘me too’ rational? Organizational risk: Are the relevant stakeholders (e.g. business, senior decision makers, workers counsel) willing to support decision to outsource and able to make the transition from making to buying the service? Execution risk: Can the outsourcing and disentanglement be done on budget and on time? Can the project handle the complexity of outsourcing both business process and IT (hybrid contract) or should it be done in separate projects? Result risk: Will the outsourcing project deliver the business the anticipated results (e.g. services, quality, products)? Which gen

The most common reason for labelling the decision to outsource a failure is the inability to show a positive financial return, like Sears outsourcing its IT services for 10 years to an external vendor for 344 million pounds, only to cancel the contract after seventeen months at a loss of 55 million pounds. The risk financial failure is, beside too positive expectations by the buyer, related to the fact that the economic principles guiding an external supplier differs fundamentally from those steering an internal supplier. This financial risk has three basic appearances: The market of external vendors is a competitive one with the bidder offering the lowest price likely to get the contract. For the vendors the winners’ curse may now materialize: winning a contract at a price level below the cost it has to make to deliver the services. The logical result is a supplier trying to improve its yield by selling new services with a higher margin or supplying agreed services at lower quality or

This post builds further on the comments given on the strengths and weaknesses of the widely used SAS 70 statements to gain assurance over the control maturity of an external service IT provider, see this post . The message in short of the other post was that a SAS 70 report has its uses, but its value depends highly on the expertise available within your organisations´ retained organisation and audit department as these can ensure that relevant services, processes and controls are included in the audit scope. Some of the weaknesses addressed within the first post can be mitigated by: alternative to the SAS 70 report, discussed in this posting, a different way of looking at assurance over your third party vendor, discussed in future posting. Next generation SAS 70, meet ISA 402 and ISAE 3402 SAS 70 reports are issued on every continent and country leading to various audit and accounting standards being used. To address the inevitable overlap that arises from multiple similar standards,

The biggest winners will be the vendors active in Legal Process Outsourcing (LPO). These parties have a lot of work lately due to the increased number of bankruptcies and desinvestments, especially from the U.S. Looking at typical mainstream IT service providers than it becomes clear that the traditional European service providers are struggling with Capgemini's -0.6% revenue in Q1, Ordina -4% in Q1, Atos Origin -8.5% in Q1, Logica -11% in Q1 and with only Getronics showing decent figures (6% growth). These figures are in sharp contrast to the figures presented by some of the Indian vendors: WNS Global Services revenues (less repair payments) for Q1 2009 up 27.1% compared to 2008; Cognizant up 16%, and Tech Mahindra up 3%. Of course are there also Indian vendors which saw its revenue decline, but I did not see any reports regarding large scale layoffs by Indian vendors. This in contrast to European vendors which are currently retrenching thousands of employees. I do not directly wa

A recent article from the economist indicates that it is more than just a hype and that even though the term may become passé, the cloud itself is here to stay and to grow. Cloud computing accordingly to Wikipedia is ‘a style of computing in which dynamically scalable and often virtualized resources are provided as a service over the Internet. Users need not have knowledge of, expertise in, or control over the technology infrastructure "in the cloud" that supports them’. This makes cloud computing to me not so different compared to other hypes like Software as a Service (SaaS), ASP or any other service delivery models where application functionalities are made accessible over the network/internet from a third parties location. I thus wonder whether the buzz word ‘cloud computing’ will be replaced by another flashy term in the near term if it does not show the return predicted by the marketeers….(I for example hardly hear anybody talk anymore about ‘utility based computing’.

In response to the need to understand the service providers’ control environment, companies turn increasingly to requesting a Statement on Auditing Standards number 70 (SAS 70) report. SAS 70 is based on SAS 55 (Consideration of Internal Control in a Financial Statement Audit) and on the Committee of Sponsoring Organisations of the Treadway Commission (COSO) framework. SAS 70 reports come in two formats: Type I and Type II. Type I is a description of control activities while Type II includes the testing of controls over a period of time (typically six months). The SAS 70 is actually a hybrid audit that includes many of the audit objectives performed during operational audits with a close secondary focus on the information technology that supports the business process and may even include elements of financial audits . A SAS 70 can be useful, but only when it is applied with care. Some of the issues are: If the service provider defines the scope itself, it is likely to include those con

I recently talked to a senior IT executive from a large insurance firm and they are considering (offshore) outsourcing certain additional activities, while they are at the same time contemplating whether some of the IT activities they outsourced more than ten years ago should be insourced again. See also this post . While discussing their rationale behind their sourcing strategy and why they are happy with some vendors and unhappy with others, we also got into the effects of the economic situation on retaining employees in general. Within the American branches of the insurance firm employees had seen already seen several rounds of retrenching, while a hiring frees was as far as it went within European entities (so far). Another example demonstrating the difference in handling the economic crisis. A Dutch friend of mine just came back after having worked in NY for 3 years for a consulting company. She survived three rounds in layoffs in NY and after coming back two months ago she starte

The stock exchange in Mumbai, India is in the middle of an impressive rebound (last week an average of 38% increase over the lowest point). As several large Indian outsource suppliers are stock listed in India does it imply that traders expect that the worst is behind us and that future earnings and revenue will grow. Similar trends can be seen in the U.S. and Europe which means that more stock traders believe the future looks bright than vise versa. This bright future for the outsource market might however still be some quarters away as vendors still struggle to fill sales pipelines and close deals. That the, sometimes double digit, growth figures are something for the past and future show recent figures from Capgemini, Logica and Atos Origin. These companies have their gravity point within the U.K. Netherlands, Belgium and France and their revenue remained more or less flat during Q1 2009. Those companies which built a strong presence in government and healthcare can congratulate the

This post continues with the business trends and its effect on the adaptation of sourcing models like shared services/captives and outsourcing. Deregulation or regulation? Deregulation is the removal or simplification of government rules and regulations that constrain the operation of market forces [Sullivan, Arthur; Sheffrin, Steven M. (January 2002), Economics: Principles in Action] and aims to limit the amount of regulations businesses have to comply too or to create more competition. Deregulation of previously government owned companies has different effect and one of them is lower prices for the end-consumer (and thus typically lower margins for the company fulfilling the demand) An example of the effects on the cost price is depicted in the figure below (Source: 3rd CEO Conference of Italy, Mc Kinsey & Mondo Economico). Effects of deregulation are: Lower margins and more competition (if deregulation means introducing competition into a market segment) Less spending on compli

Most of the stories about outsourcing are these days about cost cost cost. This provides in my opinion a too one sides view on the benefits that shared services and outsourcing can provide to a companies’ value chain. For this reason I made the following overview of generic business trends and how various sourcing options can help to address them. Competition . Especially during the current economic crisis is competition among companies fiercer than ever. But even in two years time when the current situation is likely to be all but forgotten, competition will be something that remains an integral part of our economic system. Some of the symptoms of competition are: Demanding customers and multiple bidders to fulfil a demand Decreasing pricing power and profit margin Continuing pressure to increase productivity Shared services can help primary in the area of increasing productivity and thus keeping the profit margin at a healthy level. Shared services are typically about producing more

To those companies that want to benefit from the opportunities in the market the following recommendations regarding the structure of new contracts: Limit the scope of the services/ products and the duration of the contract. Start for example with one service and/or country and progress from there. Start with a structure base don hiring people / knowledge/skills and evolve into a more complex delivery model based later on. The future model can consist of a service/product catalogue describing the service/product in terms of deliverables, activities, quality parameters et cetera. Split (analogue to the first point) the transition phase into multiple smaller phases (e.g. transition per country) and avoid a ‘big-bang’ project. Incorporate a performance based payment structure linking the successful delivery of a phase by the supplier to an invoice. This approach requires among others a definition of every phase in SMART deliverables. Avoid complex transformation projects where existing pr

I have written the following piece of text as a kind of introduction for an article, but the piece would become too large with it so I had to skip it. For those who are new to the world of outsourcing it can however provide a bit of theoretical background info on the subject. Outsourcing started in the 1970s-1980s when companies used to produce goods and services in the same country as they were consumed were confronted with imported goods of higher quality and lower costs. These market pressures forced companies to rethink their own backward and forward integration-based business model and worked as a catalyst to differentiate between strategic and non-strategic activities. The concept of looking at a company as a collection of value added activities was described by Quinn et al in 1990 (Quinn J. B., Doorley T. L., Paquette P.C., Beyond Products: Service Based Strategy. Harvard Business Review, March/April 1990). Executives world-wide capitalised on their ideas and analysed their valu

Risk aversion and focus on operational issues may result in a lot of organizations not paying a lot of attention to their existing outsourcing contracts (besides bargaining for a lower price here and there). This is of course an understandable reaction, but you might miss some opportunities and risks that come with the current situation. Risks may come in a slightly higher probability of suppliers going bankrupt (strategic risk) while more operational risks may be induced by the reaction of the suppliers management on the economic circumstances. To reduce costs, the supplier may for example reduce its innovation budgets which could lead to (even) more pressure on expressed and contractually agreed intentions regarding ´strategic partnership´ and ´adding value´. Be thus mindful that the supplier lives up to these parts in the contract even though the supplier may assume that the economic situation allows for non-compliance to some parts of the contract. To reduce the potential impact of