When "Just Doing It" is "Just Wrong"

2003-08-14
Reprinted from The Triangle Technical Journal

When it comes to deciding whether or not to outsource, keep one simple mantra in mind — “Do what you do best and outsource the rest.” Sounds simple, but in today's competitive landscape, it is a decision that is not and should not be taken lightly.

Let's face it — businesses are born because someone finds a better way to meet customers' needs. But of the many functions that must be performed in a company, not all are equally critical to the needs of your customer. The most critical ones are “core” to the business, while others are just necessary. The core functions provide strategic advantage to the company, and evolve slowly through collective learning and information sharing. They cannot be quickly enhanced through additional large investments, nor can they be easily imitated or transferred to others.

Understanding the core competencies that make a business special is a critical step in any make-or-buy decision, because these are the activities that a company should focus its internal operations on while outsourcing nonessential services. The decision-making process related to outsourcing starts with a determination of what you will “make” versus what and when you will “buy.” To get to that decision, managers must analyze all the parts of the process and decide which functions staff will perform and which functions can be better and more cost-effectively accomplished by creating a partnership with one or several suppliers. Simply put, it is essential to consider the total costs (even those that are difficult to quantify) when assessing the make-or-buy decision for any function. In addition to these concrete assessments of functional areas and their costs, qualitative factors, such as integration of internal operations and communication with those of chosen suppliers should be considered.

On the quantitative side, to fairly assess the costs and benefits of outsourcing a particular function, all of the related costs that arise (immediately and over some time horizon) from the production or delivery of the goods or service in-house must be taken into account. As an outsourcing decision relates to future expenditures, analysis must be in terms of comparing the expected future costs associated with supplying the goods or service from within the organization, with those of procuring the goods or service externally. Cash flow considerations, together with the recognition of the time value of money, may substantially alter the nature of the costing calculation. Specifically, managers must address: “What is the initial outlay?,” “What is the nature of the ongoing operational costs?,” “What effect would outsourcing have on variable costs?,” “What fixed costs can be avoided by outsourcing?,” and “How do additional 'hidden' outlays, if they exist, alter the financial impact of each option?”

As we know, the outsourcing decision requires not only a computational cost analysis, but also consideration of a wide range of qualitative factors. In fact, these qualitative factors may prove significant and may take precedence over the quantitative analysis — especially in the evaluation of cost centers where traditional ROI analysis may not provide adequate decision support. Some qualitative issues that should be considered include: “Is there a cultural match and trust between the company and the outsourcing partners?,” “Are you willing to share information openly?,” “How reliable is the outsourcing partner — in terms of operations and long-term survivability?,” “Can true partnerships be forged, or must it be an arm's length arrangement?,” “What is the turnaround for decisions required to respond to market/customer needs or meet competitive threats?,” “Who has the best skills and practices — you or a provider?,” “Is the technology broadly known or is it proprietary?,” “Is the functional area dynamic in terms of how frequently requirements change?,” and “How difficult is it to staff for the function?”

Though not core to your business, outsourced functions should be core to your vendor's business — in fact, outsourcing should return such benefits as cost reduction, benchmark quality, flexibility, access to state-of-the-art technology, targeted expertise, and efficiency gains through economies of scale. If your outsourcing efforts are not achieving such positive results, then you are not outsourcing to the right partner. It is important to remember that cost centers pose an analytical challenge because their lack of revenues make traditional ROI analysis difficult. Such functions must be expertly handled to prevent real financial loss, but excellence in these areas may not result in a quantifiable corresponding increase in revenues.

Two functional areas that fit into this category are web development and regulatory services. In today's business environment, a Web presence is critical for a company's communication, collaboration, and commerce. But there is a huge difference between having a web site and effectively using the web in your business— and this is often where bad make-or-buy decisions occur. Because web sites represent a cost to a business, they are often not thoroughly evaluated for strategic outsourcing, and as a result, they are tasked to inexperienced, in-house dabblers or outsourced to sub-par quality freelancers. Is this the first impression a company wants to make to its potential customers, suppliers, employees, or shareholders? No, but it happens.a lot. Benchmark web development outsourcing involves strategic design — a design philosophy that incorporates business objectives, user's goals, usability, and great visuals to maximize a web investment. In a strategic web initiative, an experienced firm helps companies assess their business goals, clarify their target audience, determine their competitive position and strategy, communicate their brand, and develop measurable goals that can help target online activities that generate business as well as reveal those that do not. Though subtle in many instances, such a strategic approach can improve the usability and effectiveness of a web site by 69%. This could mean direct costs savings due to reduced bandwidth and maintenance or less measurable ROIs due to increased collaboration and communication, broader audience reach, more accessibility due to Section 508 compliance, more diversity in terms of browsers, and better search engine ranking — all accomplished by making a strategic outsourcing decision to select an appropriate web partner who is able to offer access to state-of-the-art technologies, methodologies, and practices at a level of efficiency that would be difficult, if not impossible, for a company that does not recognize this function as core to accomplish.

While powerful examples of strategic outsourcing exist in all industries, perhaps few have as long a history of visibly embracing outsourcing as the pharmaceutical industry. Today, even more opportunities exist to outsource functions to specialty companies providing best-of-breed solutions — and not only during times of peak demand, but permanently as a part of an overall corporate strategy. One such example of a specialty function is drug safety and surveillance, which can be summarized as an FDA requirement of drug companies with marketed products to manage and monitor adverse events on an on-going basis as these events occur in the marketplace. This function lends itself well to outsourcing for several reasons including the fact that adverse event volume is inherently unpredictable, regulations change over time, and technology advances rapidly in order to respond to regulatory changes or otherwise better manage the process.

Keeping up with technology and regulatory changes requires substantial effort and investment, and provides a strong basis for strategic outsourcing. A current example, European regulators already require electronic submission of adverse event data (no more paper), and it is widely expected that the FDA will follow suit in the near future. Companies that have already made large capital investments in software and IT infrastructure now find themselves having to invest again to meet this imminent requirement. Not only could the initial capital outlay be avoided by partnering with a drug safety management organization, but the drug company would be insulated from downstream technology upgrades and advances like electronic submission software.

Two pitfalls of ROI analysis for outsourcing are evident: First, when evaluating whether to outsource, companies tend to underestimate the true effort and absolute cost over time of performing all or part of the function in house. The technology example above is case in point; after the initial investment is made to get up and running, more expenditures are likely to follow and need to be included in a three or five year analysis.

Second, companies tend to glaze over the strategic advantages, as well as other hidden costs, that may be difficult to measure. Basically, in a world where we barely have time to eat three-square meals a day, it may simply require too much effort. Some of these less obvious advantages of outsourcing include the ability to leverage a vendor's Standard Operating Procedures and Working Practices (the regulatory playbook) which takes time and expertise to develop, acquiring the benefit of experience over a wide client-base, and utilizing your partner's validated IT infrastructure, as well as avoiding the process of recruiting, hiring, training and retaining qualified and experienced employees. Perhaps most important, there is much to be said for handing off a function to a company whose very existence depends on proficient and cost-effective management of that function.

Regardless of the function in question, one of the best ways to decide when and where to outsource is to benchmark which company is best at value-added functions and various non-core functions. Then decide whether to improve or to outsource. But make sure to fully understand what, why, when, where, who — and how much. And like any powerful medicine, use it with care. A poor outsourcing decision can create problems, but with solid analysis and proper due diligence, strategic outsourcing can yield tremendous long-term benefits.