January 28, 2005, 12:39 PM —
 Contents |
| Understanding outsourcing |
| Connecting shareholder value and outsourcing |
| About the author |
| About Trestle Group Research |
| Download the complete briefing (PDF) |
This Executive Briefing from Trestle Group Research focuses on illustrating the link between shareholder value and outsourcing. Many companies are outsourcing today to achieve various goals -- examples include reduction of costs, increased efficiencies and increased flexibility. As companies outsource, executives should continuously evaluate the link between shareholder value and the outsourcing initiative using measurable indicators -- will today's outsourcing initiative increase or erode shareholder value?
Understanding outsourcing
Outsourcing is often defined as the transfer of activities or processes to a third party for some type of benefit including cost reductions, increased efficiencies, access to flexible labor pools and ability to focus on core competencies.
Offshore outsourcing is the transfer of activities or processes to a lower cost country - further increasing cost savings as well as flexibility.
If outsourcing engagements are conducted properly, shareholder value will increase. If done improperly, adverse effects to shareholder value are likely to incur. As executives evaluate outsourcing initiatives, the following questions should be addressed:
- Throughout my organization, have I properly identified core versus non-activities?
- Can I realize the cost savings projected in the business plan and are these savings sustainable?
- How does this outsourcing initiative affect my core employees?
- Will my customers be affected by this initiative thus affecting sales?
- Will the quality of my product or service be compromised?
- How do I measure the impact on shareholder value created through an outsourcing initiative?
Outsourcing has existed for thousands of years in one form or another. For example, people have outsourced their money management to banks for centuries, companies have relied on governments to manage city infrastructures for thousands of years and very few people today supply their own energy.
The question is not whether or not I should outsource, the question is - How can I outsource to increase shareholder value?
Connecting shareholder value and outsourcing
There are 9 basic ingredients in the recipe for shareholder value that fall into three categories:
Income: Revenues, Margins, and Expenses
Cash Flow: Inventory Turns, Age of Receivables, Age of Payables
Return on Assets (ROA): Inventory Levels, Levels of Receivables - Payables, PP&E (Plant Property & Equipment)
To create shareholder value, all these measures need to go in the right direction. For some, that's up, for others, down. In other words, outsourcers seeking to reduce expenses must do so in a way that, at worst, does not adversely impact the other 8 measures and, at best, has a positive impact on the other measures. When done right, outsourcing is an excellent means for reducing expenses in ways that increase income, cash flow and ROA.
So the question with outsourcing is not "Should we do it?" but instead, "When, where, and how?" To answer this question correctly, we need to break work down into four basic categories.
These four categories are:
- Work that is a source of competitive disadvantage and below average returns
- Work that is a source of competitive parity and average returns
- Work that is a source of temporary advantage and above average returns
- Work that creates a sustainable advantage and also above average returns
1. The first category of work is the wrong thing to do, whether you do it well or not. This work should be continuously identified and eliminated. If you do not regularly "weed the garden", then by doing this work you are destroying shareholder value in the process.
