<B>Outsourcing: the key to profitable business</B>

Ángel Díaz

15 January 2003

Strategies based on cooperation and alliances between companies are value-creating formulas that have existed since time immemorial.

Many centuries ago, country folk joined together in order to run olive-oil mills, vine growers in a given region agreed to share wine cellars, etc. They were all attempting to share expenses and reach sufficient critical mass in order to be able to compete. And along the same lines, at the present time, it is becoming increasingly evident that benefits can be reaped from the outsourcing of certain processes or services from a company. It is a formula on the increase, growing at the same rate as the globalisation process and responding adequately to 3 fundamental issues: focusing the business within a complex environment, the profitability equation and the reduction of fixed costs.

When I speak of “focusing” the business, I am referring to the fact that firms have to identify exactly what their core activity is, in order to concentrate all their efforts in that direction. And, while it might sound strange, those firms may decide to hand over part of what has been, to date, their conventional business to third parties, as they can thus gain in flexibility. For example, we can take the case of some car manufacturers, who, despite what might initially appear to be the case, are no longer dedicated so much to making cars as to providing a service. Smart has an assembly plant, but all the components come from external suppliers, who are actually physically located next to the principal factory. Smart feels that its business is rooted in design and after-sales service, not in manufacturing. We cannot forget that manufacturing margins are increasingly tight and sometimes very slim indeed. And if we turn to logistics, we can see examples such as Deutsche Post, which has bought up firms like DHL and Danzas, and is fast becoming a company on a par with FedEx or UPS, not only transporting goods but also carrying out integral logistics projects. In this sector, over 25% of all the European logistics activity is already handled by third parties.

As regards the “profitability equation”, it is evident that, if we reduce investment and sales costs, profitability will increase. Thus, if a logistics firm subcontracts vans instead of purchasing them, and reduces sales costs thanks to appropriate management of their relationship with subcontracted firms (which normally have lower costs for their volume of activity), it will improve its results account upon reducing its assets. On the other hand, we have the reduction of fixed costs, which we can convert, thanks to outsourcing strategies, into variable costs: e.g. if you reduce the number of employees, you do not have to pay their wages or social insurance each month, while you can pay a third party at 30, 60 or 90 days, thus gaining greater cash-flow flexibility.

These are all positive aspects of outsourcing. However, if we also analyse the risks, we see that companies sometimes go too far down the outsourcing road. This can happen because they have not identified with sufficient clarity what their key business activities are and they hand over their core activities to third parties. Extreme caution is to be recommended when it comes to outsourcing in a market that is not highly developed, given that, it is likely that the external suppliers do not have much experience. Moreover, the manufacturer is sometimes in an isolated area, where there is little choice and a truly suitable supplier cannot therefore be found.

This was precisely the case of Texaco-Chevron, one of the major international oil companies, in Latin America. At first, it decided to use third-party storage facilities, but later realised that it was not getting the service it required. For this reason, although its business is far from being that of storage, it has decided to use its own facilities in some countries, in order to exercise control over them and offer a quality service.

Co-Sourcing, In-Sourcing

On the other hand, and without wishing to flounder in a sea of concepts, I would like to differentiate between the various kinds of outsourcing possible. In-Sourcing takes place within a company, as is the case of Dupont, which places its own personnel inside General Motors to take charge of the painting line. Out-Sourcing is when the third party is outside the company and provides a service or manufactures a product for the principal company (we are talking here of a relationship that is normally long-term). And Co-Sourcing is where a shared service is received (e.g. two companies share a cafeteria and the expenses involved in running it, etc.).

Finally, we could highlight some singular cases here in Spain, such as Zara and Henkel. Zara employs over 400 housewives in La Coruña to produce garments, as this is the most difficult part of the process to automate. In this manner, thanks to these micro-businesswomen, Zara reduces its payroll, avoids trade union conflicts and eliminates fixed costs, without risking the quality of its manufactured clothing. And, along the same lines, this time through alliances, we have the case of Henkel and Eroski: Henkel receives prompt information from Eroski’s points of sale on computer movements, thus gaining knowledge of the pace of sales, restocking needs for certain products, the success of promotions, etc. And thanks to this alliance, they can generate, in real time, their production and restocking plans and readjust them at any moment in time.

To sum up, whatever our decision when it comes to forming business networks (through outsourcing – with vertical integrations such as the synchronization of core processes or JIT relations – or horizontal cooperation, through exportation consortia, purchasing groups, training and technological development centres), the important thing in every case will be to identify what the company’s true business is, in order to enhance its performance and delegate all those parallel processes that diminish flexibility and increase costs without adding value.

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