In the last blog, we discussed the limits of cost based outsourcing: after initial savings three is little or nothing left for the next contract, “fractures” in processes develop between the client and the vendor that damage productivity and a focus on “managing to the contract” to keep costs down kills innovation and future savings. “The Paradox of Productivity,” which studied outsourcing programs and observations of these programs confirm that these three forces limit the value of cost based outsourcing… or dumbsourcing. Today, we’ll look  at dumbsourcing and see what we can do to invigorate these programs and convert them to into smartsourcing! But first, let’s take a look at another report by McKinsey & Co., the world’s largest consulting firm.

McKinsey’s study, “Understanding Your ‘Globalization Penalty,’” looks at data from 600,000 employees and 500 firms, and compares top performing locally focused firms with global focused firms. This study was not specific to outsourcing, but covered firms that buy, sell and work locally vs. globally. Consistently, firms focusing on local markets performed better. What was the penalty for the global firms: less coordination and control, weaker capabilities and significantly less innovation. We shouldn’t be too surprised that when you work in multiple cultures and countries, different team have different assumptions, skills in one location are missing in another, and in trying to establish control over this dispersed organization extra controls are put in place that limit initiative and innovation.

What’s truly amazing about McKinsey’s findings is that in the late 80s, McKinsey (along with General Electric) literally invented offshoring, and triggered the wave of knowledge outsourcing to India. Corporations today are still designing outsourcing programs based on this early model rather than current information, which may explain why so many of these program are failing. Over the years I’ve been invited by McKinsey to visit their operations in India and other locations. McKinsey is quite up-front about the limits of global outsourcing, as demonstrated in “Globalization Penalty.” Some firms can still benefit from outsourcing to India. Other firms might gain more by restructuring outsourcing with a larger local or nearshore component.  Still other firms might revitalize their outsourcing program by returning some staff to their headquarters, with improved management and more effective automation.  McKinsey’s new study reflects data that has been piling up for years: outsourcing “fractures” weaken these programs, over dependence on offshoring causes productivity problems in mature programs and a decade of dumbsourcing has drained innovation from many programs.

A cost-based outsourcing program, whatever its limits, provides you with a simple savings target. But how do you measure the value of innovation? Let’s look at commercial products, such as computer hard drives. This intensely competitive field requires intense innovative. Every year the cost of storage drops dramatically, because of innovation. Drives also become more durable, faster, smaller, and use less power. Innovations created these benefits, and the benefits translated into lower cost. In 1983 a 10 MB hard drive cost $10,000. In 1986 a 20 MB drive cost $500. Today a 3 TB (or 3,000,000 MB) drive costs less than $250. A GB of drive space in 1983 would cost $10,000,000 and costs $0.08 today. Innovation is very easy to measure!

The only remaining question is, “How can my firm develop an innovation based outsourcing program?” It’s not that difficult. Everyday technology firms launch products that redefine existing markets or create new markets.  They start with a high level definition of a product or with the identification of a gap in the market. They have design session to move from a set of specifications to the design of an actual product, that maybe constrained by cost or current technology.  When they have a product design and market information they determine the benefits of a product launch, the conditions of success and failure, and decide whether they will proceed. If we applied these same processes, it would look like this:

ACCURATE METRICS: Work volumes rise and fall, distorting the real cost and other metrics of a service. Before you can measure benefits you need to be sure that you are tracking the right metrics. For example, for document production the cost per hour for workers is not very meaningful; the cost per page of work is a better indicator. For an existing program, you should already receive reports on unit price, production volumes, quality levels and overall cost. If you don’t already have these reports, especially the unit cost, you need to collect these before you begin negotiating a new contract.

COORDINATED VIEW: Introducing one product can affect other products. Outsourcing programs attach to the corporation… somewhere. What’s on the other side of the program? Imagine a corporate library that introduces a product to  reduce work in the marketing department. Overall cost to the firm drops, but the cost of the library is unchanged (or even rises slightly). By limiting your view to just the library you miss the large benefit to the firm. The benefits of innovation rarely start and stop in just one group; a coordinated view of the firm allows you to identify benefits that cost focused programs miss.

MARKET RESEARCH: You now know your unit price, and other key numbers. Ask your outsourcing vendor, perhaps several vendors, what they believe are best-in-class  metrics. Ask if they think they can exceed best-in-class  numbers… if they weren’t constrained by current procedures or product definitions. Let your vendors be as creative as possible, and understand the potential benefits. You can always remove unacceptable options later in the process, but first you need to understand the value of these features and the alternatives.

INNOVATION DELIVERABLES: Dumbsourcing focuses on cost, and has cost deliverables: fixed cost per hour, maximum staff positions, no overtime, etc. If you want innovation, start by defining innovation deliverables. Don’t focus on a specific product, since neither you nor the vendor yet knows what it will look like. Instead, focus on product features. For corporate services, consider: delivery time, unit cost, volume, and other metrics. Account for benefits anywhere in your firm. Use market research as a baseline for innovation, and look for the best possible metrics achievable.

INNOVATION PARAMETERS: The greater the level of innovation (and benefits), the greater the changes to the end product. Compare a 1960s style home phone… heavy, black, with a dial, wired to the wall and just one ring tone… to an iPhone. The marketplace tells us that the iPhone is the superior product, but you can imagine how difficult it would be for 60s product managers to even recognize the iPhone as a phone product.  Don’t be surprised that what appears to be a mandatory feature, isn’t very important. Follow the benefits of innovation, and then test if all current product features are needed, and if new features can provide new benefits. Be open to reductions or elimination of quality control, administration and management positions wherever they are in the firm, as well as elimination of little used (but problematic) product features. Review client complaints and management reports to develop questions for your brainstorming session.

PRODUCT MOCK-UP: Have a brainstorming sessions with vendors to design new products. You can play an active or passive role in new product development. This is where the vendor has an opportunity to pull together the best features from all of their programs and combine them into a coherent program. Ideally, this program should offer more than you want or would accept. Design of the final product should focus on removing the proposed new features that offer the least benefit, or have significant negatives or are least likely to be delivered.

PARTNERSHIP BENEFITS: The launch of a commercial product affects more than just the manufacturer. There are retailers, channel partners and other distributors who want to share in the benefits of a product launch. You have outsourcers and perhaps other vendors that you want to strongly incentivized to deliver this new product. If the outsourcer is your partner, are you willing to share benefits with your partner? Your vendor may enthusiastically deliver a product that aggressively reduces their revenues, but that’s not what usually happens. Aligning your interests with the vendors interests just makes sense.

• Product: When you developed your product mock-up, did you develop a clearly defined product with very specific benefits?
• Savings:  With this design, have you identified the dollar value of the new program?
• Scale: If the size of the program expands, you will  benefit from the economy of scale (read this to estimate benefits). Go back and examine where the program attaches to the firm; is there an opportunity to merge staff into one program?
• Incentives: And now the hard part. If a $10 million program was expanded to $20 million, and unit cost was reduced by 20%, you get a $2 million benefit. How much of this benefit are you willing to give to the vendor as an incentive? Start with a 50/50 split, and negotiate from there. If you fail to allow sufficient incentives for the vendor, you may not receive any benefits. If your current program delivers no additional benefits in the 2^nd or 3^rd contract, why wouldn’t you provide a high incentive for a higher probability of increasing productivity?

COMMIT: You know the changes you need to make, how you need to share benefits and how much freedom the vendor needs to be successful. If the program makes sense… and can deliver more benefits than another contract of cost-based outsourcing… it’s time to commit to a smartsourcing program.

If you want the benefits, you need to make changes and promote innovation. A true partnership with our vendors can turn functional fractures into bridges that expand the benefits of the program. If your firm is not ready to work in a real partnership and pursue innovation in outsourcing, what are your alternatives? If you stay with cost-based outsourcing, how will your unit price improve in a year, three years, five years? Smartsourcing can revitalize your outsourcing programs and provide a much needed injection of innovation. And that’s my Niccolls worth for today!