Article

Sourcing Strategy: The Next Frontier

Outsourcing has tended to move toward the top of the CEO agenda when companies are under pressure to cut costs. As spending picks up and companies begin to refocus on growth, outsourcing usually falls off the agenda.

By Rudy Puryear

Published on March 11, 2004
min read


Outsourcing has tended to move toward the top of the CEO agenda when companies are under pressure to cut costs. As spending picks up and companies begin to refocus on growth, outsourcing usually falls off the agenda. But something very different is happening in the current economic cycle. As the economy has strengthened, the interest in outsourcing has not slackened. If anything, it's intensified. The most obvious manifestation of this trend is "offshoring"—shifting technical and professional jobs to low-cost countries like India and Russia. Because of its social and economic ramifications, offshoring has become a lightning rod for political debate. While CEOs certainly need to be a part of this debate, they also need to recognize that offshoring is just one piece of a larger puzzle. Although outsourcing used to be viewed as a way to cut costs on routine, low-value activities, companies are now moving entire processes, often very important ones, outside their walls. They're using outsourcing to strengthen their core strategic capabilities, from product design and manufacturing to distribution and customer service. There are many sourcing options. On one end of the spectrum are "insourcing" alternatives. A company can, for instance, house a particular capability in a traditional functional unit; or it can source it from a separate arm of its business. It can also establish a captive offshore operation. In all these cases, the company owns and operates the source. At the center of the spectrum are joint initiatives. A company can draw on managed-services programs for capabilities it needs, tapping an outside contractor to take over an in-house function, or it can partner with other companies to create a mutual capability. In each of these cases, ownership and operations are shared. At the other end of the spectrum lie outsourcing options. A company can use domestic contractors to provide a capability. It can call on a business process outsourcer to transform the way some part of its business works, or it can contract with an offshore outsourcer. Smart CEOs don't approach sourcing decisions on a piecemeal basis. Rather, they look at the entire spectrum of options from a strategic standpoint, literally assembling their companies by drawing together the right capabilities from the right sources at the right time. That results not only in greater effectiveness, but also in a flexible, modular structure that can be changed quickly to respond to shifting market demands. This is no pie-in-the-sky "virtual company" hype. Companies as diverse as General Electric, Dell, eBay and American Express are drawing on multiple types of sources in a coordinated way. GE, for instance, uses a 70-70 rule: 70 percent of all its information technology requirements are outsourced, of which 70 percent goes to global, preferred vendors. In India, GE has invested in several outsourcers it uses to get the best quality as well as higher rates of return from the $400 million it spends there annually. GE continually benchmarks vendors against its internal capabilities. The company has opened its own, competitive R&D software center in India and one of the nation's largest call centers. GE and like-minded companies are pioneers in staking out a whole new frontier of competition. For most of modern business history—from about 1940 to 1980—the basis of competition was determined largely by the assets a company owned, whether oil fields, factories, raw materials or bank branches. But during the last two decades of the 20th century, successful companies shifted their focus from owning assets to owning capabilities—think of Wal-Mart's supply-chain management skills. Now, we're entering a third phase of competition, in which companies will compete based on how skillfully they can exploit capabilities owned not just by themselves but by others as well. The way a company manages its sourcing network lies at the very core of this new mode of competition. In the years to come, sourcing strategy will be increasingly indistinguishable from competitive strategy. Rudy Puryear is a Chicago-based director of Bain & Company and co-leader of its Capability Sourcing practice.

But something very different is happening in the current economic cycle. As the economy has strengthened, the interest in outsourcing has not slackened. If anything, it's intensified.

The most obvious manifestation of this trend is "offshoring"—shifting technical and professional jobs to low-cost countries like India and Russia. Because of its social and economic ramifications, offshoring has become a lightning rod for political debate.

While CEOs certainly need to be a part of this debate, they also need to recognize that offshoring is just one piece of a larger puzzle. Although outsourcing used to be viewed as a way to cut costs on routine, low-value activities, companies are now moving entire processes, often very important ones, outside their walls. They're using outsourcing to strengthen their core strategic capabilities, from product design and manufacturing to distribution and customer service.

There are many sourcing options. On one end of the spectrum are "insourcing" alternatives. A company can, for instance, house a particular capability in a traditional functional unit; or it can source it from a separate arm of its business. It can also establish a captive offshore operation. In all these cases, the company owns and operates the source.

At the center of the spectrum are joint initiatives. A company can draw on managed-services programs for capabilities it needs, tapping an outside contractor to take over an in-house function, or it can partner with other companies to create a mutual capability. In each of these cases, ownership and operations are shared.

At the other end of the spectrum lie outsourcing options. A company can use domestic contractors to provide a capability. It can call on a business process outsourcer to transform the way some part of its business works, or it can contract with an offshore outsourcer.

Smart CEOs don't approach sourcing decisions on a piecemeal basis. Rather, they look at the entire spectrum of options from a strategic standpoint, literally assembling their companies by drawing together the right capabilities from the right sources at the right time. That results not only in greater effectiveness, but also in a flexible, modular structure that can be changed quickly to respond to shifting market demands.

This is no pie-in-the-sky "virtual company" hype. Companies as diverse as General Electric, Dell, eBay and American Express are drawing on multiple types of sources in a coordinated way.

GE, for instance, uses a 70-70 rule: 70 percent of all its information technology requirements are outsourced, of which 70 percent goes to global, preferred vendors. In India, GE has invested in several outsourcers it uses to get the best quality as well as higher rates of return from the $400 million it spends there annually. GE continually benchmarks vendors against its internal capabilities. The company has opened its own, competitive R&D software center in India and one of the nation's largest call centers.

GE and like-minded companies are pioneers in staking out a whole new frontier of competition. For most of modern business history—from about 1940 to 1980—the basis of competition was determined largely by the assets a company owned, whether oil fields, factories, raw materials or bank branches. But during the last two decades of the 20th century, successful companies shifted their focus from owning assets to owning capabilities—think of Wal-Mart's supply-chain management skills.

Now, we're entering a third phase of competition, in which companies will compete based on how skillfully they can exploit capabilities owned not just by themselves but by others as well. The way a company manages its sourcing network lies at the very core of this new mode of competition. In the years to come, sourcing strategy will be increasingly indistinguishable from competitive strategy.

Rudy Puryear is a Chicago-based director of Bain & Company and co-leader of its Capability Sourcing practice.