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Outsourcing .

Some definitions 1/2

• Outsourcing is subcontracting a process , such as product design or manufacturing , to a third
party company.
• Outsourcing involves the transfer of the management and/or day-to day execution of an entire
business function to an external service provider
• Offshoring is the transfer of an organizational function to another country, regardless of
whether the work is outsourced or stays within the same corporation.
• Multisourcing refers to ( predominantly IT) outsourcing agreements . Is a framework to enable
different parts of the client business to be sourced from different suppliers. Requires
governance model that communicates strategy , clearly defines responsibility and has end- to
end integration
• Business process outsourcing (BPO) is a form of outsourcing which involves the contracting of
the operations and responsibilities of a specific business function to a third-party service
• The make-or buy- decision is the act of making a strategic choice between producing an item internally
(in-house) or buying it externally (from an outside supplier or outsourcer )
• Make-or-buy decisions usually arise when a firm that has developed a product or part—or significantly
modified a product or part—is having trouble with current suppliers, or has diminishing capacity or a
changing demand.
• Make-or-buy analysis is conducted at strategic and operational level. The strategic level is the more
long-range of the two. Variables considered at the strategic level include analysis of the future, as well
as the current environment. Issues like government regulation, competing firms, and market trends all
have a strategic impact on the make-or-buy decision.
• Of course, firms should make items that reinforce or are in-line with their core competencies.( areas in
which the firm is strongest and which give the firm a competitive advantage )
• Make-or-buy decisions also occur at the operational level. Analysis suggest these considerations that
favor making a part in-house: Cost considerations (less expensive ), the desire to integrate plant
operations , productive use of excess plant capacity to help absorb fixed overhead , need to exert
direct control over production and/or quality , better quality control , if Design secrecy is required to
protect proprietary technology or unreliable suppliers , desire to keep a stable workforce (when sales
are declining), quantity to small to interest a supplier, control of time, transportation and warehousing
costs , political factors and emotions
• Among the factors that may influence firms to buy parts or services externally , we can include : Lack
of expertise , suppliers' research and specialized know-how exceeds that of the buyer , cost
considerations (less expensive to buy the item) , small-volume requirements , limited production
facilities or insufficient capacity, desire to maintain a multiple-source policy , indirect managerial
control considerations, procurement and inventory considerations , brand preference and Item not
essential to the firm's strategy
The two most important factors to consider in a make-or-buy decision are cost and availability of production
capacity. " Cost considerations should include all relevant costs and be long-term in nature. Obviously, the
buying firm will compare production and purchase costs. Elements of the "make" analysis include:
• Incremental inventory-carrying costs
• Direct labor costs
• Incremental factory overhead costs
• Delivered purchased material costs
• Incremental managerial costs
• Any follow-on costs stemming from quality and related problems
• Incremental purchasing costs and Incremental capital costs
Cost considerations for the "buy" analysis include:
• Purchase price of the part
• Transportation costs
• Receiving and inspection costs
• Incremental purchasing costs
• Any follow-on costs related to quality or service
One will note that six of the costs to consider are incremental. By definition, incremental costs would not be
incurred if the part were purchased from an outside source
Rule of thumb for outsourcing
Experts prescribe that a firm outsource all items that do not fit one of the following three categories:
(1) the item is critical to the success of the product, including customer perception of important product
(2) the item requires specialized design and manufacturing skills or equipment, and the number of
capable and reliable suppliers is extremely limited
(3) the item fits well within the firm's core competencies, or within those the firm must develop to fulfill
future plans. Items that fit under one of these 3 categories are considered strategic in nature and
should be produced internally if at all possible.
The process of outsourcing . Stages
Stage 1: Deciding to outsource
• The decision to outsource is taken at a strategic level and normally requires board approval. Outsourcing is
the divestiture of a business function involving the transfer of people and the sale of assets to the
• The process begins with the client identifying which process is to be outsourced and building a business
case to justify the decision.
• Only once a high level business case has been established for the scope of services will a search begin to
choose an outsourcing partner.
Stage 2 : Supplier proposals
• A Request for Proposal (RFP) is an invitation for suppliers, often through a bidding process, to submit a proposal
on a specific good or service
• The Request process brings structure to the procurement decision and allows the risks and benefits to be
identified clearly upfront
• An RFP involves more than a request for a price. Other requested information may include basic corporate
information and history, financial information (can the company deliver without risk of bankruptcy), technical
capability , where the item has not previously been made or where the requirement could be met by varying
technical means), product information such as stock availability and estimated completion period, and previous
customer references that can be checked to determine a company's record
Stage 3: Supplier competition
• A competition is held where the client marks and scores the supplier proposals.
• This may involve a number of face-to-face meetings to clarify the client requirements and the supplier response.
• The suppliers will be qualified out until only a few remain. This is known as down select in the industry. It is
normal to go into the due dilligence stage with two suppliers to maintain the competition.
• Following due diligence the suppliers submit a "best and final offer" for the client to make the final down select
decision to one supplier. It is not unusual for two suppliers to go into competitive negotiations.
Stage 4 : Negotiations
• The negotiations take the original RFP, the supplier proposals, Best and final offer submissions and convert these
into the contractual agreement between the client and the supplier.
• This stage finalizes the documentation and the final pricing structure.
Stage 5: Signing the contract
• At every outsourcing deal is a contractual agreement that defines how the client and the supplier will work
• This is a legally binding document and will define the nature of the relationship.
• There are three significant dates that each party signs up to: the contract signature date, the effective date when
the contract terms become active and a service commencement date when the supplier will take over the
• The contract wil establish the rights and duties of each part as well the penalties in case of a non compliance
Stage 6: Transition
• The transition will begin from the effective date and normally run until 120 days after service commencement
• This is the process for the staff transfer and the take-on of services
Stage 7:Transformation and ongoing service delivery
• The transformation is the execution of a set of projects to implement the service level agreement , to reduce the
total cost of ownwership or to implement new services.
• Emphasis is on 'standardisation' and 'centralisation'.
• The ongoing service delivery is the execution of the agreement and lasts for the term of the contract.
Stage 8: Termination or renewal

• Near the end of the contract term, a decision will be made to terminate or renew the contract.
• Termination may involve taking back services (insourcing ) or the transfer of services to another supplier
Benefits from outsourcing ½
• Cost savings. The lowering of the overall cost of the service to the business. This will involve reducing
the scope, defining quality levels, re-pricing, re-negotiation, cost re-structuring.
• Cost restructuring. Operational leverage is a measure that compares fixed to variable costs.
Outsourcing changes the balance of this ratio by offering a move from fixed to variable cost and by
making variable costs more predictable.
• Improve quality. Achieve a change in quality through outsourcing the service due to higher
• Knowledge. Access to intellectual property and wider experience and knowledge.
• Contract. Services will be provided to a legally binding contract with financial penalties and legal
consecuences. This is not the case with internal services.
• Operational expertise. Access to operational best practice that would be too difficult or time
consuming to develop in the firm .
• Staffing issues. Access to a larger talent pool and a sustainable source of skills.
• Capacity management. An improved method of capacity management of services and technology
where the risk in providing the excess capacity is assumed by the supplier.
Risks associated with outsourcing 1/5
Strategic risks. Involve problems like:
• An outsourcing strategy that is out of line with the firm's general strategy or priorities and defining strategies which don't
take in account the long term outsourcing objectives
• Cost cutting as apriority
• Transferring processes without any changes
• Failure to identify elements of a process which should not be outsourced
• Lack of awareness of the local market when choosing the outsourcing partner, select of locations, regulatory compliances.
• Failure to evaluate the impact of outsourcing on the customer and errors in evaluate team adaptation, managerial styles
and cultural differences
Operational risks . They include:
• Failure to detect problems in providing services or make goods and the incapacity to react to unforeseen negative
• Poorly defined mechanism to measure performance
• Inability to put strategies in action
• Inadequate attention to recruiting, selection, learning curve evaluation and talent retention
• Difficulty in holding onto managerial talent
• Not regular review of service levels and scope
• Problems in transferring know-how
• Strong dependence on service providers
• Labor problems in countries where the cost of labor is low
• Infrastructure problems in places which receive the outsourced operations
Technological risks. These risks include:
• Inability of the service provider's IT environment to process and deliver products adequately
• Inadequate transition and migration strategies
• Disregard of technological advances
• Incorrect definition of the requirements needed to support the infrastructure or operations of the client
• Protection of intellectual property
• Failure to comply with international recycling requirements
• Difficulty in in defining, implementing , managing or maintaining security
Financial risks. They include:
• Incorrect evaluation of the financial risks and consequences of operational problems
• Bad definition of cost/benefits ratios
• Cuts in short term cost which not justify the long term costs
• Inability to reduce cost due to the failure in reducing labor costs
• Hiring of new firms without experience or a solid customer base
• Impact of fluctuations in exchange rates and interest rates on international contracts
• Incorrect analysis of tax benefits
Regulatory risks. These refer to the violation of laws rules , regulations, best practices and ethical standards ( for
example Basel II, USA Patriot Act, M & A rules or environmental laws…)
Reputation risks. These involves risks of negative publicity due to practices associated with outsourced operations.
They include the impact of the transition in consumer services, negative public opinion with respect to relocating
jobs, violation of prohibit child labor in certain countries….)
What is reengineering
• In today’s ever-changing world, the only thing that doesn’t change is ‘change’ itself. In a
world increasingly driven by the three Cs: Customer, Competition and Change, companies
are on the lookout for new solutions for their business problems
• Some of the recent headlines in the press read, “Wal-Mart reduces restocking time from 6
weeks to 36 hours.”” Hewlett Packard’s assembly time for server computers touches new
low- four minutes.”
• “Taco Bell’s sales soars from $500 million to $3 billion.” The reason behind these success
stories: Business Process Reengineering
• Reengineering is the fundamental rethinking and radical redesign of business processes to
achieve dramatic improvements in critical, contemporary measures of performance such as
cost, quality, service and speed
• BPR advocates that enterprises go back to the basics and reexamine their very roots. It
doesn’t believe in small improvements. Rather it aims at total reinvention. As for results:
BPR is clearly not for companies who want a 10% improvement. It is for the ones that need a
ten times increase.
• According to Hammer and Champy the last but the most important of the four key words is
the word-‘process.’ BPR focuses on processes and not on tasks, jobs or people. It endeavors
to redesign the strategic and value added processes that transcend organizational
What to reengineer
• According to many in the BPR field reengineering should focus on processes and not be limited to thinking about
the organizations. After all the organization is only as effective as its processes
• What is a process?
• “A business process is a series of steps designed to produce a product or a service. It includes all the activities that
deliver particular results for a given customer (external or internal)
• Processes are currently invisible and unnamed because people think about individual departments more often
than the process with which all of them are involved. So companies that are currently used to talking in terms of
departments such as
• marketing and manufacturing must switch to giving names to the processes that they do such that they express
the beginning and end states.
• Talking about the importance of processes just as companies have organization charts, they should also have
what are called process maps to give a picture of how work flows through the company. Process mapping
provides tools and a proven methodology for identifying your current As-Is business processes and can be used to
provide a roadmap for reengineering your product and service business enterprise functions
• Having identified and mapped the processes, deciding which ones need to be reengineered and in what order is
the key question. No company can take up the huge task of reengineering all the processes simultaneously
• Generally they make their choices based on three criteria:- dysfunction: which processes are functioning the
worst?; importance: which are the most critical and influential in terms of customer satisfaction; feasibility: which
are the processes that are most likely to be successfully reengineered
How To reengineer
Step #1: Prepare for Reengineering
• Planning and Preparation are vital factors for any activity or event to be successful, and reengineering is no
exception. Before attempting reengineering, the question ‘Is BPR necessary?’ should be asked? There should be a
significant need for the process to be reengineered.
• The justification of this need marks the beginning of the Preparation activity
• This activity begins with the development of consensus on the importance of reengineering and the link between
business goals and reengineering projects
• A mandate for change is produced and a cross-functional team is established with a game plan for the process of
• An important factor to be considered while establishing the strategic goals for the reengineering effort, is to make
it your priority to understand the expectations of your customers and where your existing process falls short of
meeting those requirements. Having identified the customer driven objectives, the mission or vision statement is
Step # 2 : Map and Analyze As-Is Process:
• Before the reengineering team can proceed to redesign the process, they should understand the existing process.
• While some organizations attempt a new process design while totally ignoring the existing processes) most
organizations need to map the existing processes first, analyze and improve on it to design new processes.
• The important aspect of BPR is that the improvement should provide dramatic results.
• Many people do not understand the value of an As-Is analysis and rather prefer to spend a larger time on
designing the To-Be model
• The main objective of this phase is to identify disconnections (anything that prevents the process from achieving
desired results and in particular information transfer between organizations or people) and value adding
Step #3: Design To-Be process:
• The objective of this phase is to produce one or more alternatives to the current situation, which satisfy
the strategic goals of the enterprise.
• The first step in this phase is benchmarking. “Benchmarking is the comparing of both the performance of
the organization’s processes and the way those processes are conducted with those relevant peer
organizations to obtain ideas for improvement
• Having identified the potential improvements to the existing processes, the development of the To-Be
model is done using the various modeling methods available, keeping in mind the principles of process
• Then, we perform simulation and ABC to analyze factors like the time and cost involved
Step #4:Implement Reengineered Process
• The implementation stage is where reengineering efforts meet the most resistance and it is by far the
most difficult one
• The question that confronts us would be,’ If BPR promises such good results then why wasn’t it adopted
much earlier?’
• We could expect to face all kinds of opposition – from hostile antagonists to passive adversaries
• Would be prudent to run a culture change program at the same time with all the planning and
preparation. This would enable the organization to undergo a much more easy transition.
• The next step is to develop a transition plan from the As-Is to the redesigned process. This plan must align
the organizational structure, information systems, and the business policies and procedures with the
redesigned processes.
Step #5: Improve Process Continuously:
• The first step in this activity is monitoring. Two things have to be monitored – the progress of
action and the results.
• The progress of action is measured by seeing how much more informed the people feel, how
much more commitment the management shows and how well the change teams are accepted
in the broader perspective of the firm
• As for monitoring the results, the monitoring should include such measures as employee
attitudes, customer perceptions, supplier responsiveness etc
• Communication is strengthened throughout the organization, ongoing measurement is initiated,
team reviewing of performance against clearly defined targets is done and a feedback loop is set
up wherein the process is remapped, reanalyzed and redesigned. Thereby continuous
improvement of performance is ensured through a performance tracking system and application
of problem solving skills
• An intense customer focus, superior process design and a strong and motivated leadership are
vital ingredients to the recipe for the success of any firm
• Reengineering advocates strenuous hard work and instigates the people involved to not only to
change what they do but targets at altering their basic way of thinking itself
• 50 to 70 percent of reengineering efforts fail to deliver the intended dramatic results
• Moreover failure doesn’t mean that reengineering stops forever. “It usually stalls and then
restarts as the company gets itself refocused and remobilized”
What is Downsizing?
• A downsizing strategy reduces the scale (size) and scope of a business to improve its financial
performance .
• A reduction of the workforce is one of only several possible ways of improving profitability or
reducing costs.
Why do Firms Downsize?
• Reduce costs
• Reduce layers of management to increase decision making speed and get closer to the customer
• Sharpen focus on core competencies of the firm, and outsource peripheral activities
• Generate positive reactions from shareholders in order to improve valuation of stock price
• Increase productivity
Downsizing Effects: Overall
• Mixed effects on firm performance: some short-term costs savings, but long-term profitability &
valuation not strongly affected.
• Firm’s reputation as a good employer suffers. Example: Apple Computer’s reputation as good
employer declined after several layoffs in 1990s.
• Downsizing forces re-thinking of Employment Strategy. Lifelong employment policies not credible
after a downsizing. Example: IBM abandoned lifelong policy after several layoffs in early 1990s.
Downsizing Effects: Employee Morale
• Employee motivation disrupted: increase in political behaviors, anger, fear - which is likely to
negatively impact quality of customer service
• “Survivors” experience more stress due to longer work hours with re-designed jobs, and increased
uncertainty regarding future downsizings
Downsizing Effects: Workforce Quality
• Many senior employees leave due to application of early retirement incentives: result is loss of firm’s
• The use of voluntary workforce reductions (buyouts) results in the most marketable employees
leaving -- difficult to control since all employees must be legally eligible to qualify.
• Early retirements & voluntary reductions often result in too many people quitting, and some are
hired back as consultants at higher cost to firm.
Downsizing Effects
Downsizing works best when:
• Changes in Strategy, Organization structure and Culture accompany job cuts of downsizing
• Weak business units and plant closures are used as basis of reductions, rather than across the board
cuts affecting all units (including healthy ones)

Source: Cascio ,1997

Value creation
• EVA = Oper profits – ( INV * COK)
One firm creates value if its ROE exceeds the cost of capital
• ROE = Earnings after taxes (EAT) / Equity
• ROE = ( EAT /Sales) *(Sales/TA) *( TA/Equity)
Margin Turnover Leverage
• To increase profitability, you should take measures that will attack each one of the 3 elements of
the formula , in order to :
Increase operational margins
Reduce liabilities
Get rid of non productive assets
Measures in order to increase margins
Consider measures in order to reduce financial expenses
1. Search of low cost financial instruments
2. Cash management and floating (Treasurer )
3. Give and take discounts for transactions in cash
4. Processes automatization
5. Incentives , credit analysis and new sales techniques
6. Reduction of some expenses in the financial area as % on sales.
Cash management during a crisis
1. Do not hold excessive cash. Payment of expensive credits , specially those on foreign currency
2. Take discounts for cash payments
3. If you don’t have enough cash and you have profits, take a leasing
4. Make a match between payments and credit periods. Try to get at least equivalent interest rates
5. Do not finance assets with short term loans
6. Get options, forwards against changes on exchange rates and interest rate fluctuations
Measures in order to reduce turnover
• Try to reduce the quantity of assets and to improve your turnover ratio
• Remember that your objective is to reduce the risk coming from receivables, inventories
and fixed assets getting more credit from your suppliers at the same time
1. Use of factoring, reducing the risk of non payment and the collection costs
2. Use of leasing on fixed assets .
3. Titularization , getting debt from the stock exchange backed by a secure payment mean
Customer’s credit allocation
1. Maximize profits (expected profits). Build up a model considering the probability of
default by each one of your customers.
2. Look for the dangerous accounts . Analyze the biggest or the most doubtful. Give credit
limits at each customer .
3. Consider business relationships in the long run with any customer
4. Use of factoring with selected customers
5. Consider recovery costs against the amount of credit assigned to each customer
Inventories’ management
1. Know the exact amount of inputs, processed products and final goods.
2. Establish an adequate relationship between expected sales and the amount of inventories
3. Analyze the inventories’ cost , their buying cost and all the holding cost of all of them
4. Estimate the optimal level of stocks
5. Estimate the stocks turnover and compare them with the # of targeted days. Look for
Measures in order to improve the level of leverage
• The firm should try to get its “ Optimal financing mix”
• Maximize the firm’ value minimizing the weighted average cost of capiital
• Normally financial functions such as payments, receivables, accounting are realized in house, but
today exists the possibility of outsourcing . Should we consider such instrument?
Other measures
1. Liabilities’ restructuring , + Time ,- Costs, currency change
2. Cash centralization policy
3. Sell any investments that are not related with the business itself.
4. Huge cost controls . Reduce some personel’ benefits l
5. Suspension on dividend payments
6. Sell unmovilized stocks
7. Review some strategic decisions such the extent on the value chain or making a M&A …