Outsourcing Challenges and Solutions

Below is a Summary of Notes and Advice on Outsourcing Challenges and Solutions, provided by the facilitators and the audience in general at our event on October 20, 2006.

Comments from facilitator Dave Gardner, Founder and Principal of Gardner & Associates Consulting, DGardner@Gardnerandassoc.com:

At the edges, outsourcing relates to the ever present dilemma of "make or buy"—should a company do something itself or find another company to do it for them. For years and years, American companies have outsourced. Why? It simply didn’t make sense to "do everything yourself" or "vertically integrate" as it was once described. What’s changed during the past generation? Today, we not only outsource tangible goods but also intangible items such as information technology management, software development, product development, etc.

At one point in our economy, we talked about a company having "core competencies"—those things perceived as their value-add in the market place—those elements that you could never remove without ruining a company’s value proposition.

Today, we are finding that we can establish outsourcing "core competencies" heretofore considered unthinkable.

• Entrepreneurs no longer have to hire a staff of engineers to commercialize their innovations.
• Companies that design products do not have to manufacture them
• We have fabless semiconductor companies
• We no longer simply have to outsource the manufacturing of key components and sub-assemblies—we can go to turn-key outsource manufacturers who can drop ship complex capital goods directly to customers
• Need a software application but don’t want to spend a fortune? Outsource it!

The U.S. competes in the global economy for both market share and capital. Investors want to know what a company is going to do with their capital to create a return-on-investment.

If a start-up company commits to outsourcing from the outset:

• This strategy reduces the risk to investors and improves ROI
• Makes a company more agile
• Allows company to focus on those things it does best and avoid the things it doesn’t want to do
• The company doesn’t expend nearly as much capital on plant, equipment, inventory, people, employee benefits—the outsource company does that

Conversely, many companies are looking to migrate to an outsourcing as a way to reduce costs and improve their capital utilization. Outsourcing can be employed by start-ups as well as established companies. We’ve assembled a panel of experts who’ve "been there/done that" to give us insights about how to successfully outsource manufacturing, information technology, software development, product development and what you need to do to have legal agreements in place that protect you, your company and your intellectual property.

Manufacturing/Supply Chain, Comments from Dave Gardner with reflections from Lila Dormishian, Director of Global Supply Chain Management, Lam Research

This past month, a study produced by the National Institute of Manufacturers stated that U.S. manufacturers now suffer a 31.7% cost disadvantage—the equivalent of $6 per hour worked—over other countries including Canada, Mexico, Japan, China, Germany, U.K, South Korea, Taiwan and France.

The overall calculation takes into account corporate tax rates, employee benefits, tort costs, natural gas prices, and spending on pollution abatement.

Advice and Comments from Lila:

Be strategic about your outsourcing decisions:

• Consider your core competencies and bring those competencies in-house. Don't outsource them. Does outsourcing help you focus on your core competency?
• Consider materials sourcing for your short term and long-term needs. Where is the best place and who is and will be the best providers
• Leveraged model for volume purchase, sourcing, and manufacturing capability
• Efficiency of operations if DF is used
• Does it improve your ability to sell in the region (PRC local content mandate)?
• Does it bring you closer to customer base

Consider the Risks

• §Communication
• §IP infringement Risk
• Adequate top level management skills
• Engineering change management
• Systems/Tools
• Quality control
• Capacity management control
• Social and Political factors

Consider long-term and short-term costs for your outsourcing decisions.

• Cost reduction for high volume manufacturing
• Cost reduction if localized material is used
• Lead time and inventory increase (based on FOB terms)
• Transportation costs and delays
• Weigh in the infrastructure setup and maintenance for any outsourcing relationship and ensure that the value outweighs the costs in time and money and resources.

Information Technology Comments from Dave Gardner with reflections from Usha Sekar, CEO of CriaTech, usha@sekars.com

Is outsourcing IT overseas past its prime? According to a new survey, some think it is. Consider this:

• Two years ago, 84 percent of the respondents to a Global IT Outsourcing Study sponsored by a Chicago-based consulting firm said they planned to increase their level of offshore outsourcing.
• In October 2006, that figure fell to 64 percent.
• Meanwhile, 47 percent of respondents said they "abnormally" ended at least one outsourcing deal in the past 12 months—up from 21 percent in 2004.

There are several reasons why the bloom is coming off the outsourcing rose-- the largest factor is cost. The claim is, "New tools are making it easier to manage and measure projects in-house, so many firms are realizing that it's actually less expensive to bring certain IT functions back."
Meanwhile, companies have learned that getting outsourcers to deliver to specifications requires far more oversight and management than they bargained for. And then, of course, there's the security issue. All these factors, the study claims, make outsourcing IT overseas "grossly inefficient."

Usha's Thoughts and Advice:

• Companies in general are more comfortable with outsourcing in general and outsourcing to countries like India for example.
• There has been a history of success working with outsourcing companies.
• In addition, there is a trend for Indian entrepreneurs and executives to return to their native India and providing development and support services there. These outsourced services are attractive to corporate executives in Silicon Valley for example because the former-Silicon Valley entrepreneurs and executives in those companies better understand the corporate and cultural expectations for Silicon Valley technology companies.
• Be strategic about your outsourcing investment
• Similar remarks to Lila's comments about long-term and short-term needs for the company.
• Identify the best of breed for your outsourcing needs.
• Accept that there might be a drop-off in service in the second and third year of an outsourcing relationship and plan around that/anticipate it.
• Understand what needs to be outsourced, why it needs to be outsourced. What needs to be done in-house - e.g. a company's core competencies and why it needs to remain in house. Then plan accordingly.

Legal Advice around Outsourcing: Stephen Gillespie, Partner, Intellectual Property Group at Fenwick & West, Sgillespie@fenwick.com

Stephen's Thoughts and Advice:

• Provide detailed and specific descriptions, deliverables, milestones and consequences prior to an engagement.
• Manage the relationship based on those agreements
• Consider consequences for cost overruns. Be specific about budgets and caps.
• Be clear on IP ownership agreements prior to project engagement
• Everyone involved should have an NDA signed and a release form
• Be clear about who should have access to your data, and involvement on your project.

Product Development/Software Development Comments from Dave Gardner with reflections from Yogen Upadhye, Omnivant, yogen@omnivant.com

Yogen's Comments and Advice:

• For IT services or Business Processes in general, the industry has learned about many hidden costs in terms of continuous oversight of the process and the controls needed to enforce agreed SLAs. Therefore, after factoring the company's own compliance and oversight costs and costs of onsite vendor resources needed for success, savings are significantly less than what was/is touted by vendors. Again, the savings depend on the type of engagement model actually being used and the skills and location mixes involved.
• Consider the business and technical risks when making outsourcing decisions, such as Loss of IP. Unless proper controls are put in place and thoroughly tested first, losing customers due to perceived lack of quality of service or product is a very real possibility. Litigation and consequences of a less than ideal break in relationship with an outsourcing partner if such a break is desired. Other risks include information security, unclear communications due to cultural and other differences, etc., Even if business continuity plans are in place, managers should check whether the plans are sustainable, scalable and easy to implement.
• When managing technology risks, consider the architecture, design, quality and maintainability of final product. Understand the software development process and its limitations and opportunities and gauge the expertise level and process maturity of the vendor's team.
  Formal communication and formal documentation are critical factors to success. Over-communicate to begin with and then pull back as both parties learn what's the optimal level. Be prepared for initial setbacks. It will get better over time.
• Have well defined and agreed SLAs and Acceptance Criteria at different points throughout the delivery process - not just the final point. Have controls to monitor them and remediation process defined.
• Don't put all eggs in one basket and have a good plan to pull back gracefully with minimal impact on your operations.

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