Keys to Driving Supply Chain Outsourcing Success
Companies have outsourced supply chain operations for decades to glean more efficient labour-based processes and improved asset leverage/utilisation while simultaneously focussing their internal operations on core competencies. As the need for competitiveness is as urgent as ever in today’s economy, companies are continuing to explore this alternative. As they pursue this assessment and possible migration of operations from in-house to a third-party outsourcer, companies need to be aware of the full spectrum of benefits afforded through supply chain outsourcing and the uniqueness of supply chain outsourcing with respect to business functions and geographies served. They must also evaluate the unique cost drivers of their specific operation, the nature of the supply chain outsourcing marketplace, and the actions that will help drive a successful business partnership. Let’s walk through these issues, as well as discuss key steps for driving an appropriately scoped and well-structured supply chain outsourcing agreement.
Supply Chain Outsourcing: Why It Matters
Successful supply chain outsourcing deals allow customers to realise multiple beneficial business outcomes, including:
- Faster introduction of new products and accelerated innovation of existing products due to redirection of resources to focus on product innovation, research and development, sales and marketing, and customer service.
- Access to technologies that can eliminate manual processes (e.g. data analytics and reporting) and provide real-time information that enable optimised business capabilities, such as improved inventory management, demand planning and manufacturing efficiencies.
- Decreased direct cost of goods sold driven by the outsourced manufacturer’s capability and expertise to aggregate raw, packaging and incidental material requirements across its other customers that use similar materials.
- Improved asset utilisation derived from higher throughput rates and by leveraging the service provider’s assets across multiple clients for reduced overhead allocation on a per-unit basis.
- Improved productivity for up- and down-stream supply chain stakeholders based on having the right product(s), in the right place, at the right time.
Supply Chain Outsourcing Solutions Specific to Function and Geography
The end-to-end supply chain includes supply and demand planning, sourcing materials and services, transforming/manufacturing raw materials into finished goods, inventory storage/management (raw materials, work in process, finished goods), transportation and logistics, and reverse logistics (returns, service, repair, etc.).
However, not all providers of outsourced supply chain services are expert at or indeed offer this full portfolio of supply chain services, and not all buyers require or will benefit from receiving all of them.
Moreover, supply chain operations are often geographically dependent – especially as it pertains to the physical flow of goods. Companies must often place their supply chain operations in certain locations in order to best serve the business. Buyers of outsourced services may need a provider’s assets to be located in a geographically desirable location relative to the buyer’s operations and/or customers in order to create value. In other cases, buyers may benefit from technology capabilities but not want the providers to bring any assets to the solution. With the service provider community bifurcated into asset-based and non-asset-based providers, each with their own unique cost structures and risk profiles, buyers need to think critically about how success will be driven and which provider is best to deliver such solutions. This adds to the fragmentation of prospective service providers.
Since not all providers serve all functional elements of the supply chain lifecycle, and given the tendency towards geographic “stickiness” of services, the optimal end-to-end supply chain solution may involve a multi-provider approach utilising a portfolio of solutions based on the provider’s specific capabilities and asset bases.
How To Develop a Sustainable Outsourced Supply Chain: Evaluation and Procurement Stages
When assessing supply chain outsourcing opportunities and developing supply chain outsourcing strategies, it is important to develop a business case that identifies not only business outcome benefits (e.g. improved customer satisfaction, increased service technician utilisation), but also the specific benefits that can be realised as a direct result of the provider’s services: these can inform meaningful performance metrics for the service provider. For example, many supply chain outsourcing business cases rely on reduced inventory carrying costs. However, it is also the case that stocking level changes and inventory disposition decisions are typically retained by the buyer. In these situations, it is unlikely that a provider will agree to be held accountable for the reduced inventory carrying costs, and as such, their performance cannot be directly tied to the desired business benefit. Buyers must think creatively about how they will ensure that both they and the provider will work together to achieve the intended results. In this example, ensuring the provider is accountable for delivering inventory reduction recommendations and that the retained organisation is ready and able to act on these recommendations (in turn, allowing the provider to operate in the optimised environment) will ultimately drive the success of the transaction.
With this in mind, it is important that the buyer maintain a keen focus on how a provider can enable success and at the same time, how the retained organisation must be designed in order to collaboratively drive performance and results.
- Specify the definition of a retained organisation A retained organisation will be required to manage outsourcing relationships and to provide both tactical as well as strategic decision-making functions (e.g. planning and forecasting). Specifically as it pertains to managing the physical flow of goods through a supply chain, there are inherent capacity limitations, and as such, effective management of outsourced supply chains relies on a strong planning and forecasting process coupled with provider governance to ensure productive communications and information sharing. As described above, there is often a risk that supply chain service providers are not directly responsible for desired business outcomes because the buyer retains critical decision-making accountability. Buyers need to clearly delineate responsibilities where handoffs occur and contractually bind the outsource service provider to service levels that protect against the potential for a “that was not my job” mentality.
- Perform due diligence on how a provider leverages its assets In addition to vetting potential supply chain partners based on global reputation, buyers of geographically specific services with an expectation that the provider’s marketplace presence will drive efficiencies should perform the proper due diligence to understand how the service provider currently leverages its assets (e.g. transportation assets, warehouses, cross docks) and management personnel. This will typically manifest itself in terms of pricing flexibility, minimum commitments, and operational scalability. It is also important to consider an outsourcing partner’s full range of service offerings to understand their potential to meet additional current and future-state business needs as the relationship matures. When technology is involved in the outsourced functions, take care to understand the difference between what is promised by the providers and what is commercially available in the marketplace. It is often the case that packaged technologies offered by service providers are only marginally different from what customers could purchase on their own, outside of a fully outsourced solution (thus these technologies are not always strategic service differentiators).
- Understand the balance of results accountability and expected outcomes Given the mix of physical assets, technology, and labour-based activities that must come together to form a supply chain solution, it is important to understand the level of integration that the service provider is delivering within their offering, as this will drive their ability to provide incremental value beyond what can be achieved internally. Simply aggregating a team of partners/subcontractors to perform discrete activities within the outsourced supply chain solution may not be good enough. What is critical is that the offering provides an integrated solution. For example, an outsourced solution that is expected to manage orders of multiple items (e.g. a complete bill of materials) from order placement through to delivery must measure on-time delivery based on the successful delivery of a completed order, not the individual components. If the provider cannot offer such end-to-end accountability, then it may be better to seek individual solutions for the discrete activities (e.g. order management, transportation) in order to more acutely focus providers on areas where they can control performance and remain accountable for the intended results.
- Define meaningful performance expectations A mature contract will include explicitly defined performance expectations in the form of service level agreements (SLAs). As an extension of the delegation of responsibilities to a service provider, expected performance levels with associated credits to the customer for failure to meet certain threshold levels will help drive predictable business outcomes. Buyers should avoid succumbing to the “pain/gain” argument often employed by service providers whereby they set provisions for additional compensation in return for exceeding performance metrics. Service level credits are typically not intended to be punitive – they are a mechanism to help the provider focus on the buyer’s priorities and maintain the expected level of service. A service provider should not feel entitled to additional compensation for doing what is defined in the scope of services. Any gain share should be tied to meaningful business outcomes as opposed to proper service delivery performance.
- Develop a comprehensive, predictable cost model It is important to include realistic estimates regarding internal labour (e.g. change management, productivity loss), equipment, and services costs related to transition activities in the financial model. Steady state services costs are often dependent on volume bands, which represent incremental changes in cost resulting from variations from a baseline set of expectations. Pre-determined volume bands are important for service providers as they are used to size their solutions and allocate resources accordingly. Establishing accurate volume bands that represent reasonable cost changes that result from volume movement is important as it will provide a framework for cost predictability as the relationship scales up or down.
- Establish fair disengagement parameters that protect the business in case of termination While it can be unpleasant to contemplate a failed relationship with a service provider, it is exceedingly important for customers to protect their businesses by establishing provisions to terminate the agreement without incurring unreasonable costs or disruption to operations. Disengagement and transition will be difficult or even impossible to negotiate while parties are entangled in conflict resolution or, even worse, litigated disputes. To avoid these types of situations, it is necessary to pre-establish defined wind-down costs, disengagement services, and transition activities during the structuring of the deal.
Establishing and Maintaining a Sustainable Outsourced Supply Chain: Transition and Steady State Management
Once the transition to an outsourced solution has begun, customers must have the ability to maintain and enhance the key benefits considered in the original business case for outsourcing. Without the ability to avail themselves of clearly defined governance processes and relevant performance information, customers may experience diminishing returns on their investment over the term of the contract.
- Invest in vendor and contract management The value realised from an outsourcing transaction – which includes cost savings, enhanced performance, and potentially service delivery innovation – is obtained throughout the life of the contract, not simply at contract execution when customer leverage is at its peak. Invest in vendor and contract management team resources, policies, processes and tools to increase the likelihood that the outsourcing produces the value identified in the original business case and to identify incremental opportunities over the life of the relationship as each side matures within the scope of the transaction.
- Include a formal governance structure and codify it in the steady-state services playbook Clearly defined governance roles, responsibilities and procedures will protect customers from unknowns relative to future processes and changing business needs. Customers will inevitably find the need to modify the deal over time in response to changing demands on the business, and a formal governance document will provide them with defined procedures for executing changes to the services and escalating issues to the appropriate decision-makers.
- Establish data control and process consistency to ensure a successful outsourcing partnership As a supply chain involves more entities, it becomes critical that all parties have access to the same data and consistently execute well-defined processes across a distributed network. This is important in controlling the enterprise at all stages, from ensuring sufficient raw and finished goods inventories to providing high-quality customer service. Most importantly, working from a common set of data drives a common view of performance metrics and results, regardless of the party that is accountable for specific or dependent activities.
- Enable long-term adjustments and growth As suppliers prove themselves to be competent service providers and learn more about the business they are serving, customers may identify other areas of opportunity within the supply chain to enhance value and expand the scope of the relationship. This type of growth can amplify the outsourcing benefits and allow buyers to invest further in core differentiating processes within the business. Good suppliers will find ways to work their way up the value chain within a business, allowing customers to specialise even further in the areas that set them apart from competitors. It is important to remember, however, that building this type of relationship can take time, and customers should be reluctant to delegate too much authority without a service provider’s demonstrated alignment with business needs and ability to collaborate with upper management.
Supply chain outsourcing has proven to be an effective approach for gaining competitive advantage through access to best practice processes and assets that might not otherwise be available (e.g. technology, physical assets), but this does not mean that buyers should pursue these transactions with a “one size fits all” approach. Buyer-specific requirements and service-provider-specific capabilities and assets often make each deal somewhat customised. Proper analysis, deal scope and structure, and a focus on the retained processes and organisation, are essential to ultimately driving sustainable supply chain outsourcing success.
About the Author
Marc Tanowitz is a principal at Pace Harmon, an outsourcing advisory services firm providing guidance on complex outsourcing and strategic sourcing transactions, process optimisation, and supplier program management.