Is operations outsourcing still a viable option today?
At the start of the industrial revolution, outsourcing was not in fashion. Operations were as much as possible vertically integrated: Henry Ford had 1913 iron ore come in on one side of the site while the Model T rolled out on the other. What happened in the Rouge production "town" in Detroit, Michigan, USA, was replicated by most companies worldwide. Each country had massive conglomerates established by larger-than-life entrepreneurs that combined manufacturing, hotels, hospitals, railroads, etc., under one umbrella. The reason for this was rather benign: communication was slow (remember letters?), and experience and knowledge were not as ubiquitous as today. Further reasons were economies of scale, cost control throughout the company, and access to capital.
Today access to knowledge, capital, as well as communication speed is less of an issue. Where it is, the same consolidation of businesses happens.
The phrase "Your back end is other people's front end", coined by Jack Welsh, both loved and hated General Electric CEO from 1981-2001, is an adequate guide for identifying improvement opportunities. Any part of the engineering and manufacturing organisation should constantly be assessed whether it is as good and competitive as external contract manufacturers, suppliers, or competitors.
Over the past 40 years, numerous companies have decided that they can not operate aspects of their company as effectively as externals: As a result, they typically adopted one of two strategies: Either they spun off portions of their operations, converting their back-end operations into a new external front-end to enhance their competitiveness. Companies like Delphi, Visteon, and Signify were created via this approach. Or OEMs outsourced their operations to External Manufacturing Services (EMS) providers, with Flextronics, Hon Hai/Foxconn, Venture, Plexus, Kaifa, and Celestica being the largest players. EMS providers have distinguished themselves by providing excellent operations and supply chain management, including the ability to quickly and efficiently respond to sudden demand surges.
In the first case, mergers and acquisitions, as well as spin-off knowledge, are available in abundance. Banks and external companies like Deloitte, Kearney, KPMG, McK and PWC have a deep-rooted knowledge base on thousands of business cases. Today, every CEO or CFO should possess the knowledge or at least have knowledgeable staff to understand what is required for an effective spin-off.
In the second case, the ability of operations and supply chain personnel to prepare and execute the task of outsourcing operations to an EMS is often limited. Moreover, allowing the outsourced organisations to define the statement of work is akin to "a turkey voting for Christmas," as succinctly expressed by British Liberal Party politician David Penhaligon in 1977 in opposition to a Lib-Lab Pact.
Nevertheless, the potential benefits of outsourcing operations are considerable. One of the most well-known examples is the collaboration between Apple and Hon Hai in China, which helped propel Apple to become the world's most valuable company in recent years. Many other companies utilised contract manufacturers or upskilled suppliers to produce quality products that often exceed the level of quality of their former internal operations.
Recently, we see now an opposite trend to pull back production either in-house or near-shore (or re-shore, friend-shore, etc.). See the two-part blog post “Implementing 21st-century supply chain - now” for more on this topic.
So, what now? As a leader in charge, it is helpful to assess the potential for reducing (or increasing) the vertical integration level of the company, before jumping to conclusions.
Here is a list of questions to assess the status quo:
1. What are the company's core competencies, and are these competencies critical to the company's success? Outsourcing or spinning off parts that are not core is a viable option. This review should be brutally honest; no area should be sacrosanct. In this context, benchmarking between own products and competitors through competitive tear-down analysis and cost estimating is essential. Today, a comparison of GHG footprint is as well relevant since setting up new operations without assessing the GHG emission impact is ignoring the writing on the proverbial wall - soon stricter legislation (in Europe, 2026 is the next significant change), as well as public (and therefore customer) opinion will make long tail supply chains very difficult to maintain.
2. Are there any operational inefficiencies or bottlenecks within the company that could be addressed by outsourcing or spinning off certain operations? How is the competition doing? Do they operate at a lower cost, higher margins, or higher quality than your company? If so, outsourcing or spinning off these operations could lead to increased efficiency and profitability. Alternatively, a manufacturing and quality ‘fitness program’, becoming more agile and digital, could be an alternative solution.
3. What risks are associated with outsourcing or spinning off operations, and can these risks be adequately managed? It is essential to carefully consider the potential risks, such as intellectual property theft, quality control issues, and supply chain disruptions, and have a plan to manage these risks. After more than a quarter of a century of globalisation reaching all corners of this world, enough information is available to assess the risk clearly - just google or bing it…
4. What is the potential impact on employees and other stakeholders? Outsourcing or spinning off operations can significantly impact knowledge management, employees, customers, and other stakeholders. So, this aspect needs to be considered carefully, followed by a mitigation plan.
5. What do customers and investors say: Do they see value in the company's vertical integration? While this should not be the deciding factor for outsourcing, it is good to know and consider in the change management communication. In the end, though, the firm's management needs to decide what is best for the company - everyone else just has an opinion…
6. Do you consider all options with the same open mind, including in-house and outsourced production, or just licensing intellectual property when exploring new markets? Continuing with a brick & mortar strategy in every new market or shipping semi- or finished products from the so-called single competence manufacturing centre worldwide (generally near the head-quarter) are tactics often based on strategic laziness or arrogance of the leadership team of a company.
7. Are the above topics regularly discussed emotionless at the boardroom level?
By thoroughly evaluating these questions, a Managing Director can make an informed decision about whether outsourcing or spinning off operations is a viable strategy for reducing the vertical integration level of the company.
Size of the prize
Should you have identified a gap in your company's operations based on the above questions, congratulations! This presents an excellent opportunity to enhance your organisation's resilience and profitability.
Outsourcing operations can yield a cost of sales improvement ranging from 15% to 40% unless the production process is highly automated. You can find the reason why highly automated industries are still outsourced to Asia in the Epilogue of this post.
The alternative to outsourcing is the improvement of one's operations excellence through well-proven continuous improvements processes like Lean, Six Sigma, Theory of Constraints (ToC), and Total Cost Management (TCM). These can yield a similar cost of sales and speed improvements. Rather than spending millions on outsourcing the current state, hiring some excellent minds in operations management may be more effective and empowering them to achieve the desired results with a new, modern future state.
As always, inaction and expecting better results are not an option if you know you have a gap against your competition. In the famous, well-known words of Albert Einstein, "The definition of insanity is doing the same thing over and over again but expecting different results."
Next steps if you choose to outsource:
Time plan: 24 months
Board Sponsor: CEO
Lead: Head of affected business/operation & Head of Supply Chain plus MD of an outsourcing partner. Note: Both sides need to be appropriately incentivised - no one does this out of the goodness of their heart or because they feel it is just a good idea.
Project set-up: first six months is needed to establish the status quo and a future state blueprint with a daily task force with clear objectives (later weekly), monthly reporting on board level by lead with clear output KPIs (=project plan progress, opportunity identified...people, process, technology). Ensure that all relevant parties are part of the task force: no helicopter solution by corporate without proper engagement of outsourced unit.
Sustain success: Quarterly Business Review with outsourcing partner and own Head of operations - again based on clear dashboards - reviews to be physical at the outsourced operations with adequate time to deep-dive on the production and/or engineering floor.
Digitalisation/Automation: High - the Sales & Operations Planning (S&OP) process needs to be fully interlinked and validated (mainly on your side - are the signals that the S&OP process sends through the supply chain correct?). A typical data lake and clear API architecture must be defined for most other systems.
Risk: Very diligent planning and execution of every aspect of the outsourcing process is required. Pilot runs where possible, and there always needs to be an alternative design available - no point of no return. You always have to have a viable threat to cancel the relationship.
Contracts: Contracts must be designed to protect both sides rather than hoping for the best. So, no contract with a 'honeymoon', but with a clear 'pre-nupts' mindset. Get external talent to help if your team has never made an outsourcing contract - it is the ‘600-pound-gorilla’ of contracting.
Cost: Either set up an internal task force full-time and employ a small external team to support project management. If done well, the cost of outsourcing is not impacting the bottom line in the years of execution.
Watch out for…
Lowballing of own cost internally by comparing different cost levels on each side; high confidentiality is needed until a recommendation can be made. The team should be run for the first six months off-site. All people involved need a non-disclosure agreement and if possible, a success and/or retention bonus (and/or a job in a new set-up).
Summary
Outsourcing or spin-offs are no longer the panacea as in the last 30 years. Still, they continue to be well-used tools in the toolbox of every CEO, CFO, and Head of Operations of a certain age - and every major consulting company.
A decision on outsourcing or spin-off should be well-informed by looking at alternative tools in today’s world, such as re-shoring, re-vitalising operations and assessing the long-term viability of the solution considering triple bottom line considerations (profit, people, planet).
Today, experience is overvalued in a world where change velocity is ever-increasing. Today, the management traits needed are agility and digitalisation. In other words: having a lot of experience in and outside the company on spin-offs and outsourcing might be the wrong tool for today’s and tomorrow’s problems.
What if the solution to join two parts is no longer a nail but Velcro…what do you do with your ‘hammer’?
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Epilogue: Small excursion on macro-economic strategy and its long-term effects:
Question: Why are automated processes so often located in Asia? Most of our electronics, toys, automotive tier 3 parts, and white goods come from Asia - all being produced with high levels of automation - a labour cost differential is not a driving factor here.
Answer: European and US production moved to Asia since subsidies and cheap fossil fuel-based energy flows abundantly. While emerging market governments saw the strategic need to provide governmental support to modern industries and their production practices (manufacturing and high-tech subsidies range among the top three subsidies in many Asian countries - for example, China (#3), India (#3), and Singapore (#1)), the so-called ‘developed market’ governments provided their subsidies to the same sectors they supported hundred years ago (Europe: 1. Agriculture, 2. Energy - with focus on fossil fuels, and 3. Transportation; USA: 1. Healthcare, 2. Education, 3. Transportation).
End of excursion.
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Stay safe. Be bold.
Daniel
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