The Idea in Brief
Almost nothing a company does can’t be outsourced anymore—even functions as critical as engineering, marketing, and manufacturing. Yet only 6% of the companies that outsource are satisfied with the practice. Why? Too many managers make outsourcing decisions piecemeal. They focus on incremental cost improvements rather than taking a strategic view of capability sourcing.
With strategic capability sourcing, you don’t assume that your company’s most vital capabilities must remain in-house. Credit-card giant American Express, for example, outsourced its crucial transaction processing function when it no longer provided proprietary advantage.
To source capabilities strategically, you must also decide which partners can best perform which capabilities. Rather than selecting suppliers based only on cost, for example, Chrysler consolidated component purchases with several suppliers it believed could sustain competitive costs, high quality, and efficient delivery.
And if your company’s the best at a particular capability, consider making it an entirely new business—as UPS does by providing logistics management to other companies.
The right capability sourcing strategy can translate into industry dominance: Strategic outsourcer 7-Eleven consistently beats other retailers in same-store merchandise growth, revenue per employee, and inventory turn rate.
The Idea in Practice
To develop your capability sourcing strategy, apply these steps:
Identify your business’s “core of the core”. These are activities your company does better and cheaper than rivals. For 7-Eleven, they are product ordering and in-store merchandising—the pricing, positioning, and promotion of ready-to-eat food, gasoline, and sundries for car-driving consumers.
Decide what to outsource. Consider two factors:
- Proprietary value: A capability has high proprietary value if your company executes it in a way that generates measurably more value than competitors could, and if your company would suffer major strategic damage if rivals imitated the capability.
- Commonality: A capability has high commonality if outside suppliers can achieve scale or other advantages by providing it to many others in your industry.
Your strongest candidates for outsourcing? Capabilities that have low proprietary value and high commonality. Example:
7-Eleven decided to outsource human resources, finance, IT management, logistics, distribution, product development, and packaging to outside partners with greater expertise and scale in these capabilities.
Decide what to insource. For capabilities your company excels at, consider “insourcing”—turning them into new businesses by performing this function for other companies. FedEx positioned itself at the leading edge of the $225 billion logistics-outsourcing industry by planning and managing inbound transportation for more than 1,500 product suppliers into 26 General Motors power train facilities.
Decide how to outsource. Compare each of your outsource-worthy capabilities’ cost and quality to those of top-performing rivals or suppliers. Use these comparisons to define outsourcing relationships:
- Outsource high-cost and unnecessarily high-quality capabilities to low-cost providers—even if that means some reduction in quality.
- Outsource high-cost, low-quality capabilities to partners who can reduce costs and boost quality.
Also structure each outsourcing partnership differently, depending on each capability’s importance to your company’s competitive distinctiveness. Example:
7-Eleven has outsourced all routine capabilities (such as benefits administration and accounts payable) to providers that can consistently fulfill cost and quality requirements. For more strategic capabilities, it makes more complex arrangements. For instance, the firm outsources gasoline distribution to Citgo but maintains proprietary control over gas pricing and promotion—activities that could differentiate its stores if done well.
For years, “sourcing” has been just another word for procurement—a financially material, but strategically peripheral, corporate function. Now, globalization, aided by rapid technology innovation, is changing the basis of competition. It’s no longer a company’s ownership of capabilities that matters but rather its ability to control and make the most of critical capabilities, whether or not they reside on the company’s balance sheet. Outsourcing is becoming so sophisticated that even core functions like engineering, R&D, manufacturing, and marketing can—and often should—be moved outside. And that, in turn, is changing the way firms think about their organizations, their value chains, and their competitive positions.
