Executive briefing: Shareholder value and outsourcing

Trestle Group Research –

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:

  1. Work that is a source of competitive disadvantage and below average returns
  2. Work that is a source of competitive parity and average returns
  3. Work that is a source of temporary advantage and above average returns
  4. 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.

2. The second category of work is the work you outsource. If it's not done well, it can become a disadvantage, causing below average returns. This work should be done as efficiently as possible, at the lowest possible cost. Outsourcing this work reduces expenses while freeing up management to focus on the next two categories of work.

The following two categories are similar to each other in that both are sources of competitive advantage and above average returns. They differ in that one is a temporary advantage (category 3) while the other is sustainable (category 4).

3. Management should exploit the temporary competitive advantage with a great sense of urgency for as long as the advantage lasts, while trying to find ways to make the advantage last longer. Outsourcing should only be considered as the advantage approaches its end, changing this category of work into a source of parity and average returns.

4. The last category of work should never be outsourced. This work and the resources used to do it, are strategic assets, also know as core competencies. They are the sustainable competitive advantages that differentiate your firm from the competition, enabling you to deliver long-term value to your shareholders. This work should be kept close to the vest, if not under the covers. There is nothing to discuss about this work with outsourcing vendors because the work doesn't exist. Right? Right! Like the chess master who touches his pieces on the left side of the board to hide the fact that his attack will be from the right, smart managers know to mention other things when asked to explain their success.

Conclusion

Outsourcing can either strengthen or destroy shareholder value depending on how it is managed throughout the organizations. As executives consider various outsourcing initiatives, they should ask themselves how this project would affect shareholder value. Knowing "what" to do is necessary, but not sufficient. You must also know "why" and "how".

When evaluating opportunities, executives should remember the four types of work:

  1. Work that is a source of competitive disadvantage and below average returns
  2. Work that is a source of competitive parity and average returns
  3. Work that is a source of temporary advantage and above average returns
  4. Work that creates a sustainable advantage and also above average returns

Actively identify and eliminate 1. Always consider outsourcing 2. Guard and exploit types 3 and 4.

The twelve-step methodology will help organizations perfect the science of managing shareholder value into an art. Investment in human resources and ongoing continuation of the methodology will continue to increase shareholder value and produce above average returns.

Top executives should make outsourcing decisions based on concrete valuations including shareholder value, not on trends or pressure to jump on the bandwagon. Competitive advantage is maintained by those organizations that are hawkish about continually measuring their competitive advantage.

Outsourcing is not new - outsourcing is a paradigm in successful business. Combining outsourcing with the science of managing shareholder value will provide a competitive advantage that will extend far beyond a short-term focus on stock price.

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About the author

Mark W. Sickles is author of Shareholder Value Assurance - The Cure for Enronitis, plus numerous articles on achieving long-term shareholder value, including Tool Kit for the Post-Enron Board, published by the National Association of Corporate Directors (NACD). Mark has been a featured guest on television and radio talk shows as well as keynote and featured speaker for business and professional organizations. His role as strategic consultant to American Standard resulted in a cover story on driving increased shareholder value entitled, Setting the Standard. The founding principal of SVA Technologies, Mark is also President of the NJ Chapter of NACD. He serves on the Editorial Advisory Board of HR Innovator Magazine and Rutgers University's State Advisory Council, and is a past board member of Abington Health Care Corporation.

For over fifteen years, Mark has created sources of competitive advantage and long-term shareholder value for firms as both senior executive and advisor to boards, CEOs, and other "C" suit executives.

About Trestle Group Research

Trestle Group Research is committed to providing thought-provoking research and practical insights into such topics as corporate strategies, regulatory issues and global trends in outsourcing. This research enables organizations to maximize benefits from outsourcing initiatives.

Trestle Group Research is part of Trestle Group, an international management consultancy firm specialized in outsourcing. Trestle Group works with companies to help develop outsourcing strategies, locate the right location/service provider and support the implementation of the appropriate outsourcing model. Trestle Group is partnered with 70+ service providers around the world offering their clients a significant portfolio of capabilities and choice.

The ideas expressed in this article are solely those of the author and do not necessarily reflect the opinions of ITworld.com.

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