NEW DELHI: Manufacturing outsourcing began in the 1970s, when companies contracted non-core processes to third-party vendors to alleviate labor arbitrage and avoid settlement payments. The concept of outsourcing was officially recognized as a business strategy, with increased adoption in the 1990s. Outsourcing opened up opportunities for economies of scale, lower production costs and access to quality production.
Today, recognizing the gains from outsourcing, several Fortune 100 companies have rapidly expanded their sourcing capabilities. The trade shock triggered by the pandemic, leading to supply chain disruptions and sharply rising input costs, has reinforced the tangible benefits of outsourcing. Effective outsourcing strategies can help build resilience through increased capacity; achieve sustained cost savings through specialized knowledge, skill sets and digital technology deployment by outsourced vendors; and securing a long-term competitive advantage.
Unlocking Value Through Outsourcing
Bain’s analysis indicates that the adoption of outsourcing has immense strategic potential with multiple benefits. While improved scalability and flexibility can help optimize fixed costs to around 20% of original levels, reduced capital intensity can help increase asset turnover by 30%. More importantly, outsourcing can deliver a 200% increase in bandwidth allocation for senior management focused on extracting value from core businesses. For example, outsourcing construction, preventive maintenance, and business operations have proven to be beneficial for utility companies.
Development strategy: As a first step, companies must identify the potential functions that will benefit from outsourcing. Functions should be considered at two levels: strategic relevance to the entire company and potential cost and quality improvements by engaging an external business partner. This will allow the creation of an “outsourcing roadmap”. While non-core functions with low strategic relevance and cost / quality advantage can be outsourced to business partners from the start, core functions can be gradually moved or deconstructed into sub-functions for later evaluation.
Supplier evaluation and negotiation: This is a critical phase with full due diligence of potential suppliers based on strong competitive selection criteria including quality, price, compliance, capability and service delivery. Additionally, examining this phase from the perspective of business continuity and cost / gain estimation would guide final partner approvals based on risk / return tradeoffs.
Management of suppliers: Outsourcing should be seen as a value-managed partnership requiring three key elements: a unique team attitude, incentives based on service level agreements (SLAs) and key performance indicators (KPIs), and well-defined compliance and governance structures for operational reviews. Incentives and strong governance can help instill a mindset of ownership and create common goals towards a value-driven relationship.
Organizational capacities: Supplier capabilities are built on five key principles: a single point of contact (SPOC), cross-functional teams to drive the implementation, clearly defined roles and responsibilities, a strong governance structure and escalation matrix and support. These elements are crucial to streamline and improve the efficiency of workflows.
Risk mitigation strategies
Outsourcing is a powerful business tool but it is not without risks and challenges.
Four key risks can derail the entire program: misalignment of business goals with partner goals, inept cultural and change management practices, and inability to factor in total cost of ownership and a insufficient investment in skills development.
Clearly defined KPIs for payments linked to business objectives and a strong win-win proposition incorporating risks and incentives as a counterweight for partners can ensure alignment and risk reduction. Cultural alignment and change management are essential for business continuity. Companies and partners need to find the right balance in the way they work: Visible sponsorship by senior leaders through rigorous up-front engagement and clear communication would pave the way for buy-in from across the organization. Partnership agreements must also take into account volume variability and other exceptions, which leads to a full cost view rather than a single focus on base price negotiations. Additionally, companies need to devote resources to technology upgrades of the supplier pool and upgrading employee skills.
A non-zero sum game that fosters a strong ecosystem of trading partners
Bain & Company has engaged with a leading global manufacturing player to help define and deploy its outsourcing strategy with around 40% coverage of total costs and a potential 3-5% improvement in EBITDA. While core activities with high strategic relevance and critical technology requirements will be outsourced with a view to progressive involvement of specialized external partners in the future, non-core activities such as procurement, specific operations and maintenance were outsourced to specialist business partners after extensive diligence and alignment with specific KPIs to achieve the best results. This can prove to be a tremendous stimulus for the development of an ecosystem of symbiotic business partners.
In summary, manufacturing companies that opt for outsourcing stand to gain from improved efficiency, cost reductions, increased scale and value extraction from core businesses. The time has come for manufacturing companies to view outsourcing as the holy grail of accumulating the elusive trinity of benefits: increased capacity, sustained improvement in costs, and a focus on quality.
(Arunava Saha Dalal and Deepak Jain are partners and Rohit Singh is a senior manager in Bain & Company’s New Delhi office. They are members of the company’s Advanced Manufacturing and Services practice, with Jain leading the practice in the Asia Pacific region. )
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