Keep the Core? No More!

Keep the core: That has been the conventional wisdom about outsourcing, but it's being challenged by Mark Gottfredson and his co-authors in this month's Harvard Business Review. The Bain & Co partner told Kathleen Melymuka that in the new global economy, when it comes to outsourcing, virtually nothing is sacred.

You say that sourcing, which was always tactical, needs to become a core strategic function. Why now?

The reason it's so important now is that there is a confluence of events that makes it possible for you to literally be able to redefine your business in terms of whether you do things or have them done by someone else or more cheaply somewhere else. A population 10 times the size of the U.S. has come on stream in the last few years, and they have an average wage advantage of 85% to 95% versus us.

Also, a technological revolution has made it possible to do many things that used to be done manually over the Internet or a telecom pipe as quickly and cheaply around world as next door. Finally, there's a trend where things that used to be functions of companies are becoming industries, and whole companies are focusing on functions.

You also challenge the conventional wisdom that strategic capabilities should be kept in-house. Explain.

The traditional view has been to think about what's core and what's noncore and consider outsourcing the noncore. That's not a particularly useful framework anymore. Think of customer service and the call center: What could be more strategic than your interface with customers? Yet those customer-interface skills are not particularly proprietary across industries. The way you respond to customers is common for any number of companies. So even though it's strategic, many times other people can do the job better and more cheaply than you're doing it.

If "keep the core" is out, is there a new rule of thumb? A more robust framework is to keep functions that are highly proprietary and not common in the industry in-house. Anything not proprietary and common in the industry or across the industry is a candidate to see if anyone can do it better.

And that's what you call "capability sourcing."

Yes. We believe that companies should look at every single activity in the entire value chain and ask, "Are we the best in the world at this?" If not, there are three options: Invest to become the best, outsource to someone who is best, or move it to a shore where it can be done much more cheaply and at a high-quality level-and either outsource it or own it, but do it offshore. Look at every capability in the value chain, and for every one, you want to be sourcing from the right source on the right shore.

As you improve these critical capabilities through outsourcing, how do you stay in the manager's seat and not give up control?

It's common to say, "I want control over that." But there are two kinds of control: ownership control and contractual control. How you negotiate the contract when you're doing the outsourcing is important. If you write good contracts, contractual control can be greater than ownership control.

For example, your IT department is getting things to you late. What do you do? You own and control it, but what you usually do is provide feedback, bully them a bit to set new deadlines, and when they don't meet them, you get exasperated and fire people. Then you spend time hiring new people and you may get the same result. How much did you control the outcome? Not much. If you have a very carefully written contract for a service-level agreement, and if it's not met, there's an immediate financial penalty, so they'll do all they can to make sure you're satisfied. You actually have more control.

To move sourcing from tactical to strategic, you say you have to identify the "core of the core." What's that?

The core of the core is the set of activities for which you are the absolute best. If you ask, "How proprietary is it, and how common is it?" the core of core is both proprietary and uncommon, and you are very, very good at it. Low cost, high quality, proprietary and not common-that's core of core. In fact, you could actually think about selling that capability to others; it could be a business opportunity for you.

Once you know what you have to keep, do you outsource the rest?

You consider outsourcing the rest, but there may be reasons why you can't immediately or wouldn't want to. If you're as low-cost as the rest of world, it may not be a high priority to take all the steps and risks to outsource. Also, you may have labor issues or other contractual constraints that make it difficult in the short term. All the factors have to be critically evaluated. But the process of looking at it gives you a sense of how much you're leaving on the table, and that may affect your longer-term plans.

How does the issue of proximity affect these decisions?

There are many ways proximity matters. For example, if you were outsourcing manufacturing capabilities, sometimes it makes sense to go to a low-cost country and sometimes not. Logistics costs could outweigh lower labor costs. Some things have to be done at the location. For example, in retail you can't outsource cashiers. There's a series of things to think about whether it's feasible or possible to move offshore. But that doesn't mean you can't outsource.

What is "dynamic sourcing," and how does it relate to all of the above?

It's a capability. You need to develop the capability for managing the increased numbers and spectrum of vendors you have to deal with. You need a process to get benefits over time. If you contract at a certain price for seven years, you'll almost certainly not optimize because you didn't take into account costs coming down over time. You need to account for changes in the marketplace and to develop processes internally to manage that.

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