NEW DELHI: Outsourcing in manufacturing began in the 1970s, when companies contracted nonessential processes to third-party vendors to mitigate labour arbitrage and avoid settlement payouts. The concept of outsourcing was formally recognised as a business strategy, with increased adoption in the 1990s. Outsourcing opened possibilities to realise economies of scale, lower production costs, and access quality output.
Today, recognising the gains from outsourcing, several Fortune 100 companies have rapidly expanded their capability sourcing. The business shock triggered by the pandemic, leading to supply chain disruptions and steep input cost escalations, has reinforced the tangible benefits of outsourcing. Effective outsourcing strategies can help build resilience through capacity augmentation; realise sustained cost efficiencies from specialised knowledge, skill sets, and digital technology deployment by outsourced vendors; and secure long-term competitive advantage.
Unlocking value from outsourcing
Bain analysis indicates that embracing outsourcing has immense strategic potential with multiple advantages. While enhanced scalability and flexibility can help optimize fixed costs to approximately 20% of original levels, reduced capital intensity can help deliver a 30% uplift in asset turnover. Most crucially, outsourcing can enable a 200% uplift in senior management bandwidth allocation focused on value extraction from core business activities. For instance, outsourcing of construction, preventive maintenance, and commercial operations has proved beneficial for utility companies.
Strategy development: As a first step, businesses need to identify prospective functions that will benefit from outsourcing. Functions need to be viewed at two levels: strategic relevance to the overall business and potential cost and quality improvements by engaging an external business partner. This will enable creation of an ‘outsourcing roadmap’. While noncore functions with low strategic relevance and cost/quality advantage can be entrusted to business partners up front, core functions can be progressively moved out or further deconstructed into sub functions for subsequent assessment.
Vendor assessment and negotiation: This is a crucial phase with comprehensive due diligence of potential vendors based on robust competitive selection criteria comprising quality, price, compliance, capability, and service delivery. Additionally, viewing this phase through a lens of business continuity and cost/gain estimation would guide final approvals of partners based on risk/return trade-offs.
Vendor management: Outsourcing needs to be viewed as value-managed partnerships requiring three key elements: a one-team attitude, incentives driven by service level agreements (SLAs) and key performance indicators (KPIs), and well-defined compliance and governance structures for strategic and operational reviews. Incentives and robust governance can help inculcate a mind-set of ownership and create common goals towards a value-centric relationship.
Organisational capabilities: Vendor capabilities rest on five key principles: single point of contact (SPOC), cross-functional teams for driving implementation, clearly defined roles and responsibilities, a robust governance structure, and an escalation and support matrix. These elements are crucial for streamlining and improving efficiency across workflows.
Risk mitigation strategies
Outsourcing is a powerful business tool but is not without risks and challenges.
Four key risks can derail the entire agenda: nonalignment of business objectives with partner objectives, inept cultural and change management practises, and failure to take a view of the total cost of ownership, and insufficient investment in skill-building.
Clearly defined KPIs for payouts linked to business objectives and a robust win-win proposition incorporating risk and incentives as counterweights for partners can ensure alignment and de-risk delivery. Cultural alignment and change management are crucial for business continuity. Businesses and partners need to find the right balance in their ways of working: Visible sponsorship by senior leaders through rigorous up-front engagement and clear communication would pave the path to organization-wide buy-in. Partner agreements also need to account for variability in volume and other exceptions, leading to a total cost view rather than a singular focus on base price negotiations. Additionally, firms need to dedicate resources for technology-based upgrades of the vendor pool and employee upskilling.
A non-zero-sum game that fosters a robust business partner ecosystem
Bain & Company engaged with a leading global manufacturing player to help define and roll out their outsourcing strategy with approximately 40% of total cost coverage and a prospective 3% to 5% EBITDA improvement. While core activities with high strategic relevance and crucial technology requirements will be insourced with a view of progressive involvement of specialist external partners in the future, noncore activities like sourcing, specific operations, and maintenance were entrusted to specialist business partners after thorough diligence and alignment on specific KPIs to achieve the best outcomes. This can prove to be a tremendous stimulus for the development of a symbiotic business partner ecosystem.
In summary, manufacturing companies opting for outsourcing stand to gain from improved efficiency, cost reductions, enhanced scale, and value extraction from core activities. Time is ripe for manufacturing firms to view outsourcing as the Holy Grail to accrue the elusive trinity of benefits: capability augmentation, sustained cost improvements, and focus on quality.
(Arunava Saha Dalal and Deepak Jain are Partners and Rohit Singh is a Senior Manager at Bain & Company’s New Delhi office. They are members of the firm’s Advanced Manufacturing and Services practice, with Jain leading the practice in the Asia-Pacific region.)
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