Seizing the strategic high ground in capability sourcing€¦ · Consider Procter & Gamble’s...

Seizing the strategic highground in capability sourcing

By Michael Heric and Bhanu Singh

How companies can realizethe full potential of outsourcingand offshoring to leapfrog the competition

Copyright © 2010 Bain & Company, Inc. All rights reserved.Content: Editorial teamLayout: Global Design

Michael Heric is a member of Bain & Company’s Global CapabilitySourcing practice and is based in New York. Bhanu Singh is theco-leader of the firm’s Global Capability Sourcing practice and isbased in Palo Alto and New Delhi, India.

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Seizing the strategic high ground in capability sourcing

How companies canrealize the full potentialof outsourcing andoffshoring to leapfrogthe competition

Wage inflation in traditional offshoring desti-nations, evolving government regulations andrecent high-profile instances of back sourcinghave led some companies to question the valueand sustainability of capability sourcing—getting the right capabilities from the rightpartners at the right price from the right location.Others, however, see it as even more criticalthan ever.

Many companies are not satisfied with theircurrent capability sourcing efforts, which includeoutsourcing and offshoring. Bain & Company’sglobal Management Tools and Trends 2009survey of 1,430 executives showed that 63 percentof respondents used outsourcing as a businesstool, but they ranked it in the lower third of25 business tools in terms of satisfaction.

Despite widespread dissatisfaction, many com-panies are expanding their use of capabilitysourcing. Why? Are these companies misguid-edly buying into the hype surrounding outsourc-ing and offshoring, or are they on to somethingthat others have yet to grasp?

What many companies are realizing is that capa-bility sourcing can be used for more thanjust cost cutting. When done right, capabilitysourcing can help companies achieve strate-gic objectives.

Companies that successfully create and sustainvalue over time are rare. A recent Bain studyof more than 2,000 companies across 10 yearsrevealed that, while many companies aspireto outgrow their market, only 1 in 10 companies

achieve sustained, profitable growth. Not sur-prising, these Sustained Value Creators oftenmake use of capability sourcing in more inno-vative ways. We found that 85 percent of thesehighest-performing companies use capabilitysourcing to fix either broad structural cost orquality disadvantages, or for strategic purposessuch as accelerating time to market or breakinginto new markets. Another 10 percent trans-formed their business models through capa-bility sourcing. Only 5 percent used outsourcingand offshoring less strategically, for purelyopportunistic reasons or tactical cost reduction(see Figure 1).

How winners win

Our experience with hundreds of clients hashelped us identify five key ways in which win-ners capture the strategic high ground by usingcapability sourcing. Let’s look at each of thefive opportunities.

1. Tap global talent pool

The war for top talent has become intense. Towin the war, companies must tap into sourcesof talent more broadly. Historically, companieshave pursued offshoring as a means to accesslow-cost resources to substitute for more expen-sive onshore talent. In doing so, companiesfocused on lower-skilled work that could besafely performed from remote locations. Inthe past, few companies used offshoring torecruit top talent or develop innovation out-side their home countries.

Companies that seize the strategic high grounddo exactly that: frame the war for talent inglobal terms and rely on offshoring and out-sourcing to access the best global talent. Forexample, Texas Instruments offshores notonly to tap new sources of talent, but also tobroaden the climate for innovation in newglobal locations.

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In 1985, Texas Instruments became one of thefirst global technology companies to establisha research and development center in India.The world’s largest maker of chips for mobilephones looked to India for more than cost sav-ings and has nurtured a rich Indian talentpool over the course of two decades. TexasInstruments India developed the first digitalsignal processor designed in India for controlapplications in 1996 and supported the devel-opment of LoCosto, the semiconductor industry’sfirst single-chip solution for low-cost handsets.Today, Texas Instruments India has the highestnumber of US patents granted to any organi-zation in India.

2. Build ecosystems

The stakes in capability sourcing are gettinghigher. As the sourcing market has matured,companies have become more comfortableincreasing the scale and scope of what they out-source and offshore. Rather than focusing

on a single location, they have expanded theirsourcing network to include multiple coun-tries—and often multiple locations within acountry. While companies historically out-sourced and offshored low-risk activities, todaythey are increasingly outsourcing and offshoringmore mission-critical activities, such as finalassembly and product development, addingcomplexity to their supply chains.

The trouble is, while sourcing risks haveincreased over time, most companies continueto manage their sourcing relationships in muchthe same way they did when they first started—as arm’s-length vendor interactions overseenby the procurement department. Offshorecaptive centers are often managed as independ-ent delivery units of a particular function, suchas IT or finance.

The result of companies failing to keep pacewith the changing requirements of relation-ship management can be painful. This was

Periphery of business Core of business

Tactical cost reduction Enabling competitive advantage

China and India Global

Signing deals Maximizing value

Traditional vendor management Managing complex ecosystems

Early 2000s 2010

Figure 1: Fundamental shifts are taking place in capability sourcing

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nowhere more apparent than during the toyindustry’s lead paint crisis in 2007. Toy com-panies with more sophisticated systems andprocesses for managing their partners wererelatively unscathed by the lead paint contro-versy. To maintain control, companies like toymanufacturer Hasbro view their external rela-tionships as strategic partners, part of a broaderecosystem tightly integrated with their domesticoperations. That’s a major reason why Hasbrowas largely unaffected by the toy industry’slead paint recall. The toy manufacturer pre-qualifies and continually monitors its overseasfactories to ensure quality-management systemsare in place. The risks of a quality issue aris-ing can’t be totally eliminated, of course, withmore complex webs of suppliers spread acrossmultiple regions. The key is to limit the num-ber of potential problems and to act quicklywhen a problem does occur to prevent it fromhappening over and over.

3. Seize new market opportunities

Strategic companies outsource and offshore totap into local market opportunities and buildpresence in new markets.

AstraZeneca’s experience in China is an exam-ple of offshoring more strategically to penetratea fast-growing emerging market. It did notsimply build a local factory offshore to serve theChinese market. AstraZeneca made large-scale,multiyear investments in research and devel-opment, manufacturing and sales, and part-nered with local universities, government organ-izations and domestic companies. AstraZenecaincreased its market share by focusing on large-ly underserved rural hospitals and physicians.By 2008, the Anglo-Swedish pharmaceuticalgiant became the largest pharmaceutical multi-national in the Chinese prescription drugsmarket, with leading market share acrosseleven drug brands.

4. Accelerate and innovate

Leading companies use capability sourcing toaccelerate time to market and develop newsources of innovation. Traditionally, while thepromise of cost savings and improved servicequality from capability sourcing was appealing,many companies became disillusioned withthe time it took to start realizing those benefits,often many years. However, companies arenow reaping benefits faster by sourcing capa-bilities in more targeted ways.

Consider Procter & Gamble’s innovation net-works. The world’s largest consumer productsmaker turned the innovation paradigm on itshead a decade ago by developing strategicalliances and partnerships. Realizing its inter-nal capacity for innovation was flagging andits competitors were gaining ground, P&Gcreated the Connect + DevelopSM strategy thatwelcomed outside innovation through opennetworks. That was revolutionary for an indus-try in which R&D was considered a core com-petitive competency.

By outsourcing elements of R&D, especiallyfor accessing technology, Procter & Gambleboosted innovation productivity by 60 percentand generated more than $10 billion in revenuefrom over 400 new products. Today, about halfof P&G’s innovation is the result of externalcollaboration. Other companies are followingP&G’s example. Bain’s Management Tools andTrends 2009 survey showed that nearly six in10 managers believe their companies coulddramatically boost innovation by collaboratingoutside with other companies.

5. Disrupt the industry business model

In some instances, capability sourcing can helpcompanies to leapfrog the competition. It canfundamentally disrupt an industry’s economicsby changing the traditional basis of competition;

Companies arenow reapingbenefits fasterby sourcing cap-abilities in moretargeted ways.

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however, only a few companies have achievedthat objective.

Taiwan-based personal computer maker Aceris one rare success story. Starting with the spinoff of its contract manufacturing operationsin 2000, Acer sought to focus exclusively onbranding and marketing. Its virtual model allowsAcer to maintain a strikingly lean and flexibleoperation. Its nearly 6,800 employees repre-sent a workforce less than one-tenth the sizeof its largest competitor. Capability sourcingplayed a critical role in helping Acer to neu-tralize the historical cost advantage of the PCdirect model and become the world’s second-largest PC manufacturer (see Figure 2).

Using experience as a guide

As more companies seek to replicate the successof leaders in capability sourcing, they first needto consider their capability sourcing experiencewhen drawing up a game plan. Their strategy

will depend on whether they are first-time users,testing the waters or experienced practitioners.Let’s look at each category.

First-time users: Learn from others’ mistakes—and successes

1. Establish a clear mission with strong executive support

Strong corporate sponsorship and on-site lead-ership are critical to successful offshoring pro-grams. Many companies fall into the trap ofusing offshore locations as body shops: Mostinnovation occurs onshore and then work ishanded off to the offshore center for lower-value activities. This makes it difficult to attractand retain the best talent offshore as well as toscale a company’s offshore capability over time.Developing a local team offshore with an inde-pendent charter and autonomy improves thelong-term odds of success.

Source: IDC; Gartner; Frost & Sullivan; Datamonitor; analyst reports; literature search; expert interviews; Bain analysis

0

2

4

6

$8T

2008

4.7

2012

G&A

Distribution and logistics

Manufacturing/services operations

6.2

CAGR08–12

Global outsourcing spend growth ($T)

Customer careSales and marketingProduct development

9%

7%

8%

6%7%

7%

7%Overall

Figure 2: Continued healthy growth expected for outsourcing market

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General Electric has successfully done this overits long history of offshoring. One example ishow GE has used offshoring to develop a multi-disciplinary R&D hub in India that supportsthe company globally and, in the process, hasbuilt up a large and deep Indian talent pooland strong onsite leadership. The John F. WelchTechnology Center in Bangalore is the largest,integrated multi-disciplinary R&D center forGE, and is the first located outside the US.

2. Develop a comprehensive capability sourcing blueprint

Companies can achieve full potential value fromtheir capability sourcing efforts by developingand then implementing a sourcing blueprint.The starting point is a comprehensive assess-ment of a company’s activities across the valuechain to determine what should be kept inhouse, what should be outsourced and whatshould be offshored. No area should be offlimits in this assessment phase. Then, everycompany should develop a multiyear roadmapof both short- and long-term actions, linkedto financial and service quality improvementmetrics, to track progress over time. This blue-print should be drafted in collaboration withthe corporate center, with the CEO’s involve-ment if possible.

3. Consider emerging capability sourcing models

Not surprising, most first-time users pick upthe playbooks used by companies already out-sourcing and offshoring. They assume that,given their experience, those companies mustbe model examples. However, that’s rarely thecase. As we saw in our tools and trends survey,satisfaction with outsourcing was less than theoverall average of the 25 tools studied. Mostcompanies are not achieving their expectedreturn on investment: That’s why first-time

users should be very careful about assessingthe lessons they learn from other companies.

New capability sourcing models such as equityinvestments and managed captives are emerg-ing to help companies avoid the mistakesmade by other companies or to address thespecific strategic, operational or change man-agement challenges that have historicallyprevented companies from outsourcing oroffshoring (see Figure 3).

The pharmaceutical industry, for example, hashistorically been slow to adopt outsourcing andoffshoring. However, with escalating costs andlonger cycle times in drug discovery, develop-ment and launch, pharmaceutical companiesare increasingly turning to outsourcing andoffshoring. While traditional forms of outsourc-ing and offshoring like active pharmaceuticalingredients (API) and dosage-form manufac-turing still dominate, some large pharmas areexperimenting with new models. Alternativedrug development models such as Chorus, anautonomous early phase drug developmentdivision within Eli Lilly that operates a fullyoutsourced model, is one example.

Testing the waters: Achieve full potentialfrom existing efforts and take a stand

1. Maximize return on investment from existing sourcing programs

Rather than achieving full value from existingcapability sourcing programs, companies oftenmove on to the next outsourcing or offshoringproject. Our client experience suggests thatcompanies should be getting at least 25 per-cent return on investment on their sourcingprograms. If companies are not on a path toachieve that level of return, they should care-fully review, and if needed, fix their currentprograms before moving on to new projects.

New capabilitysourcing modelsare emerging tohelp companiesavoid the mis-takes made byother companies.

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Companies often underestimate the value thatcan still be unlocked from their current sourc-ing programs.

2. Build a repeatable formula

As companies outsource and offshore morecomplex activities, it is critical for them to applywhat they have learned. One way of doing thatis to build an internal organization with capa-bility sourcing experience to manage partnerrelationships and transfer experience from oneproject to the next. Another way is to institutea systematic approach to partner evaluationand selection.

One company that continuously applies whatit learns from its capability sourcing programsis Cisco Systems. The global leader in IP-basednetworking equipment aggressively turned tooutsourcing production in the early 1990s tomanage its rapid growth. Despite supply chainchallenges in the early 2000s recession,

Cisco recovered. Today, Cisco may face morecomplexity and change than ever before. Thepace of technology change remains relentless,but Cisco continues to expand globally anddiversify its product and services portfolio.Due in part to its ability to carry out supplychain innovation, Cisco continues to applysuccessfully its outsourcing model to newproducts and services with remarkable effi-ciency and effectiveness.

3. Take a stand on the role of capability sourcing

Companies rarely understand the implicationsof starting down the path of capability sourcing.Though outsourcing can fundamentally changea company’s operations and economics, manycompanies testing the waters approach it as aseries of one-time, contractual events whereresponsibilities are often delegated to functionalleaders or to the procurement department. Theinevitable result is often a disparate collection

Greatest control Least control

Captive center

• Greatest opportunity to realize value• IP management and regulatory compliance easier (perceived)

• Significant management talent required• Risky if local knowledge is lacking• High investment• Scaling up and down an issue

Equity investments

• Can use partner’s local knowledge• Opportunity to share rewards

• Complex to set up • Moderate investment

Managed captive

BUT...

Build�Operate�Transfer (BOT)

• Useful if customer lacks local knowledge and/or supplier cannot understand client’s environment• Customer retains control

• Most start as business process outsourcing operations with IT as an add�on• Must ensure incentives are aligned• Moderate investment

Outsource(External service

provider)

• Opportunity to leverage partner’s capabilities• Supplier has contractual obligation • Lower investment

• Requires strong supplier� management skills

Figure 3: New capability sourcing models are emerging

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of outsourcing contracts. Since these variouscontracts are not part of an integrated effort,they often fail to achieve the promised benefits.

Companies testing the waters need to decidequickly on the strategic role of capability sourc-ing in their operations and take a stand onwhich programs to keep and which to unwind;which to expand or which to shrink; whichnew areas to outsource or keep in house; andwhich to keep onshore and which to offshore(see Figure 4).

Experienced practitioners: Avoid com-placency and look to change the game

1. Challenge the status quo

Just as first-time users should not on faith pickup the playbook of experienced practitioners toexecute their plans, experienced practitionersshould avoid becoming complacent about eventheir most successful sourcing programs. Similar

to companies testing the waters, many expe-rienced practitioners fail to achieve full valuefrom their sourcing programs.

Experienced practitioners should regularlyundertake a comprehensive review of theircapability sourcing programs. For example,while an offshore captive may have been thebest approach years ago, conditions may havechanged and outsourcing may now be the moreattractive solution. Experienced practitionersshould continuously evaluate their capabilitysourcing strategy and operational approach.They may want to consider changes includingmodifying scope, converting captive operationsinto independent profit centers, diversifying orchanging their low-cost country footprint orrationalizing and changing outsourcing partners.

The recent meltdown in financial services, anindustry with some of the longest and deepestexperience in capability sourcing, has causedmany companies in the industry to reevaluate

• Establish a clear mission with strong executive support

• Develop a comprehensive capability sourcing blueprint

• Consider emerging capability sourcing models

First�time users

Testing the waters

• Maximize return on investment from existing sourcing programs

• Build a repeatable formula

• Take a stand on the role of capability sourcing

Experienced users

• Challenge the status quo

• Create innovative partner collaboration models

• Use capability sourcing to change the game in your industry

The approach to

capability sourcing

depends on a

company’s experience

Figure 4: Using experience as a guide

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their outsourcing and offshoring programs. Inthe new economic climate, the relative benefitsof owning and operating captive offshore centershas declined, even for pioneering financialservices firms such as Citibank and AmericanExpress. That has led to a wave of activity aimedat extracting more value from existing captiveoperations, which, in some cases, includesselling them. Citibank sold its offshore captiveto Tata Consultancy Services at the end of 2008,and American Express divested its offshoretravel center to Nasdaq-listed Indian companyExlService in November 2009.

2. Create innovative collaboration modelswith partners

Companies that seize the strategic high groundby building partner ecosystems rather thanmanaging their outsourced vendors at arm’s-length invest in developing innovative approachesto collaboration. Experienced practitioners areoften best positioned to make such investments.Collaboration can take several forms and extendacross the entire value chain.

Cisco is pioneering innovative collaborationmodels with its Electronic ManufacturingServices (EMS) partners. After the recession ofthe early 2000s, the company focused on fewerpartners to enable more collaborative rela-tionships, and aggressively invested in newapproaches. The company and its partnersjointly develop technology roadmaps in Comm-odity Councils and rely on a collaborative net-work that captures real-time data from partnerfacilities. This network provides Cisco a unifiedview of its entire production network. Thecompany also developed and expanded stan-dards-based partner interfaces in ordering,logistics and transportation that require sharedgoals and processes.

3. Use capability sourcing to change thegame in your industry

Outsourcing and offshoring can change thegame, freeing up scarce resources that allowcompanies to invest successfully in new andmore sustainable areas of differentiation.

The semiconductor industry was disrupted bythe change that outsourcing brings. With theindustry’s birth in the 1960s, semiconductormanufacturers felt the need to be highly inte-grated, given the complexity of the manufac-turing process. In the 1980s, however, out-sourced foundry manufacturing changed thegame. Companies that outsourced productionto low-cost Asian foundries took off, as theywere free to focus on research and developmentrather than investing in fabrication and itsassociated operating costs. Fabless companieslike Qualcomm and graphics-chip makerNVIDIA quickly gained market share. Today,outsourced semiconductor foundries makeup close to 25 percent of total semiconductormanufacturing capacity.

Capability sourcing creates real value, but com-panies will need to adapt to the shifts takingplace. High-performing companies are movingfrom using capability sourcing narrowly andtactically to using it more broadly and strate-gically. The results will depend on whether acompany is just getting started, testing thewaters or is an experienced practitioner. Intoday’s uncertain business climate, a strategicview of capability sourcing isn’t an option, it’san imperative.

Outsourcing andoffshoring canfree up scarceresources thatallow companiesto invest inmore sustain-able areas ofdifferentiation.


Undergo a capability sourcing health check

A company looking to understand whether it is achieving full potential from its currentoutsourcing and offshoring programs should undergo a health check.

Answering the following questions will help a company understand the opportunitiesto improve the efficiency and effectiveness of its capability sourcing programs.

• Is your sourcing strategy aligned with shifts taking place in your industry?

– Is outsourcing and offshoring on the CEO’s agenda?

– Has capability sourcing improved competitive differentiation—in cost, servicequality, time to market and flexibility?

– How is the competition approaching outsourcing and offshoring, and couldyour competitors’ actions potentially affect your position?

• Are you implementing sourcing programs effectively?

– Have past transitions to outsourcing or offshoring been on time, on budgetand without disruption to your organization?

– Do you have a repeatable formula for implementing outsourcing and offshoring programs?

• Are you achieving the benefits you were expecting?

– Are you achieving at least 25 percent return on investment?

– Are you achieving the non-financial benefits you were expecting?

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