The Credit Crunch and Outsourcing

October 14, 2008 9:17 am : Comments 000

The recent tumult in the markets - and its reverberations from Wall Street to Main Street - have made the business news channels compulsive viewing for executives across the globe.  One group of professionals that have been keeping a close eye on the day-to-day movements of the markets has been the Business Process Outsourcing (BPO) sector, especially in India.  These BPO firms - and their progeny, the Knowledge Process Outsourcing (KPO) firm - have seen tremendous growth in recent years as Wall Street embraced their blend of high talent and low cost to outsource everything from software design and application development to equity research and financial modeling.  The value delivered by this sector is undoubted but given the tectonic shifts occurring on wall street, it is inevitable that there would be some sort of impact on this growth story.

Indeed, a recent BusinessWeek article talked at length about the impact that the changing financial sector will have on info-tech spending and outsourcing in general - with some estimates suggesting a 15%-20% revenue impact by next year.  While one can argue about the precise magnitude of the impact, there is no doubt that many firms (outsourcing or not) will feel the pinch given the unprecedented changes we have seen over the past few weeks.At the same time, it is important to not get carried away by the paranoia that has engulfed many of those around us.  Experienced market watchers will point to one truism that has stood the test of time, and that is that everything goes in cycles.   In this instance, we have just gone through a massive up cycle and the current economic climate will see, not so much a down cycle but perhaps a reversion to a more moderate growth trend for the medium term.  (Long term, the potential is still huge.)

What is moderate growth?  How long is the medium term?  No two people will agree, but more important than arbitrary numbers are several core lessons that can be gleaned from the current environment:

Lesson 1: How many eggs and how many baskets?

In stocks as with customers, diversification is 75% of the path to success.  The growth of outsourcing was driven by its rapid adoption by financial services firms, and understandably so.  They had a defined need for these skills; they had the incentive to manage costs and; and they had a more progressive perspective towards outsourcing than many other business sectors (though this has also evolved over the years).  Not surprisingly, the growth potential, the economics coupled with the entrepreneurial spirit led to the creation of an entire sector developed to service these needs.  This is a good thing.

What isn’t good is the lemming-like rush that tends to follow supernormal growth - although economic purists would argue that this is needed, hence it is, in its own way, good.  In chasing the holy grail, many organizations tend to develop a singular focus on one customer set - with the view that a small number of anchor clients will ensure long term viability.  The more astute organizations, however, will have absorbed the lessons of our corporate forefathers and diversified their customer base beyond any given sector.  And the recent issues in financial services - where storied names have disappeared overnight - only go to emphasize this point.

This is not to suggest in any way, that the sector is dead or anywhere close to it.  Different, yes, but dead, no.  What this does suggest is that if one’s goal is to build a consistent, viable long term business, it is critical to ensure that one spreads one’s risk beyond a given customer set, in the event that market-level shifts ‘change the game’.

Lesson 2: Don’t believe the hype

Recent weeks have seen a raft of articles and stories on the need to rethink outsourcing and offshoring.  Inflation is rearing its head, wages have gone up, currencies have been fluctuating.   Listen closely and the underlying message is that offshoring could be going by the wayside.

While this may be the case with certain commodities, the economics do not entirely apply to the realm of services outsourcing.  The reality is that the labor arbitrage element - which is the fundamental underpinning of the industry - is still substantial and coupled with the talent available, is unlikely to change for the foreseeable future.

What’s more, the types and varieties of work being outsourced is progressing and changing as we speak.  In the KPO sector, for example, which is the space that The Smart Cube plays in, organizations are not just outsourcing data collection and company profiles, but rather complex analyses such as predictive modeling and consumer insight generation, emerging market strategy research support and deal due diligence research.

While it is foreseeable that there will be a short term impact due to the current economic turmoil, in the longer term, the situation for outsourcing firms will only improve due to the fundamental economic and quality proposition.

Lesson 3: Changing the Competitive Dynamic

One other interesting point that the BW article raised was that offshore firms (whether in India or elsewhere) will face a changing competitive dynamic as global players begin to entrench themselves in India and offer up a global economic proposition to their clients.

I believe this is more an open question at this time rather than a certainty.  The nature of large, multi-billion dollar organizations is that they have structure and protocols.  There are deals that they will chase and those that they cannot.  There are opportunities that fit in with their defined visions and financials targets (and public reporting requirements), and many that do not.  The gaps that are left behind are the gaps that smaller, more entrepreneurial organizations excel at filling.  They are nimble organizations that can flex to meet the client’s specific needs - both in terms of objectives and economics.  To date, the large corporation that can react and act like a smaller outfit is the exception rather than the rule.  As a result, mindset is as critical as global presence.

Posted in : Business Strategy, Knowledge Process Outsourcing

Tags : credit crunch, India outsourcing, Knowledge Process Outsourcing, KPO

The Asia vs. the West Business Debate: A Study in Strategy Contrasts

December 5, 2007 9:54 pm : Comments 000

“We don’t try to grab market share quickly by competing on price. That’s not a long term, sustainable growth strategy.”

Can you guess the technology CEO who recently said that? If you guessed anyone inhabiting the corner office of a Western company, you’d be off by a hemisphere.

The speaker was Jonney Shih of ASUSTeK Computer, a Taiwan-based company that’s one of the largest manufacturers of computers and related equipment, producing everything from motherboards and servers to PDAs and notebooks, among other products. Although you may not have heard of the company, with 97,000 employees and 2006 revenues of US$16.5 billion, they are unquestionably significant players in their niche.

Shih’s comment was lifted from a recent BusinessWeek story (Nov. 12th issue) about the growing trend of Taiwanese electronics companies evolving from their traditional role as behind-the-scenes anonymous suppliers to branded producers in their own right. The strategy shift is said to be due in large part to the suppliers’ weariness of the never-ending price competition game and the consistent margin erosion it inevitably brings.

Shih’s company is among those looking to play the margin game by launching a branded business not only in Asia but out here in the West. Although it’s a risky endeavor, hindsight will probably prove it to be a smart move for his company and other Chinese manufacturers currently following similar paths. Recent recall issues aside, the overall quality of their products is on par with goods produced in the U.S. or Europe. And, because these manufacturers are already familiar with Western product preferences and proclivities, they have the advantage of already knowing what “works” for Western consumers. These companies are building on this foundation by placing bets in the right places – investing in design, marketing, and strategic U.S. acquisitions to establish their gateway into the west – all of which are smart, practical investments that will smooth their transition from the price game to the margin game.

Now, contrast this approach to what many North American manufacturers are doing. The same BusinessWeek article featured a sidebar on how U.S. manufacturers – the ones who lost their business to the Asian companies in the first place – are trying to fight the decline of the North American contract manufacturing sector. Their strategy? Move into industry segments such as medical devices, aerospace parts, and auto components that haven’t farmed out their production to low-cost countries – yet. In other words, replace contract manufacturing business lost to Asia with contract manufacturing business in areas that the Asians aren’t particularly active.

They may want to rethink their Plan B. After all, unless there are legitimate national security or logistical or inherent product constraints, there are few areas where low-cost countries won’t be able to battle. Going after markets untapped by Asian manufacturers is more a stall tactic than a survival plan, much less a growth strategy. Ask any business person in any sector in any jurisdiction and they will tell you that cost containment is an issue. How could it not be? As such, it is no doubt a question of “when”, not “if”, the Asian producers will expand into these aforementioned underserved sectors themselves. And when they do, they’ll inflict just as much economic havoc and competitive angst on Western suppliers in those spaces as they have on companies in sectors already availing themselves of lower-cost outsourcing options.

Look at the story from a wider perspective, and you read a compelling tale between the lines about the contrasting competitive strategies of each “side”. It speaks not only to the battle for marketshare between Asian and Western manufacturers, but also more broadly about the business of business in the West versus the business of business in Asia.

The value chain in its traditional sense has been turned upside down, and we are all trying to figure out the new global playbook as it is being rewritten. That said, however, the value chain for any given product is not fixed and will fluctuate as industries grow and develop. Where once Japan was the hub of low-cost production, this hub has shifted and is now in China. Without question, it will move again in time – the difference between success and failure comes down to how a company reacts when it does.

Asian companies effectively introduced the concept of global price competition, and they are again taking the lead as the outsourcing arena evolves. These companies are adapting to changes in their business environments in innovative ways, carving out opportunities where there were previously challenges. While they have been busy redefining the rules of the proverbial game, their U.S. counterparts lag well behind, trying to figure out how best to play the old game. The notion of chasing industries not currently outsourcing to China on any grand scale is a prime example. Remind me – what is it they say about those that don’t learn the lessons of history?

The key to fighting a competitor with an inherent advantage (’superior’ products, vast resources, or, indeed, inherent cost superiority) isn’t to keep fighting the same battle over and over or, as is the case cited in the BusinessWeek sidebar, to delay the inevitable. You either join them (e.g. move your own manufacturing to Asia, perhaps splitting up higher end activities at the front end and shifting others to the back end) or you find a way to change the model.

Price competition doesn’t have to be the end game. Sure, you can buy and build, consolidate, play the numbers, and work the margins through scale economies, but that requires a certain level of intestinal fortitude, not to mention investment. Smart players try different tacks – for example, identify a niche that is focused on higher quality, emphasize an innovation that is sufficiently unique, positioning yourself differently by branding (and of course backing up with the right products). There are a myriad of ways to tackle this issue – none are easy or necessarily cheap. The key is to identify segments that allow you to play the margin (as opposed to margin erosion) game, and to look for ways to be truly innovative, the very bedrock of competitive strength in any geography.

As ASUSTeK’s Jonney Shih would agree, competing on price will only get you so far and for so long.

Innovation will carry you much further.

Posted in : Business Strategy

Tags : branding, china competition, china manufacturing, toy recall

Survey: Global Manufacturers Staying Put in China

November 26, 2007 6:31 pm : Comments 000

(click here to view the press release)

In the aftermath of the recent recalls of tainted and toxic China-made products, more than a few have speculated that manufacturers who have outsourced production operations there are no doubt rethinking their sourcing strategies and quality control processes, and, if some of the, shall we say, ‘more aggressive’ pundits are to be believed, even rethinking their continued presence there altogether. However, according to the results of a proprietary survey just completed by the smart cube, the pundits appear to be very much mistaken.

In fact, the majority of manufacturers surveyed are confident their supply chains are more than adequately secure to ensure the safety of their products. Indeed, nearly 80% of respondents (all of whom were manufacturers who currently manufactured their products in China) reported that they felt no need to review their supply chain activities in the wake of the well-publicized toy and toothpaste recalls. Further, these global manufacturers believe that the recent recall issues, while serious, are aberrations and not symptomatic of some more fundamental issue inherent within Chinese manufacturing. They appear to be on solid ground, as Mattel itself has apologized for initially putting the blame on its Chinese suppliers.

The fact that an overwhelming majority of manufacturers did not feel compelled to review their supply chains is reflective of remarkable confidence, especially in light of the media attention the issue has received. To be sure, though, this is not to imply any sort of complacency on the part of the these manufacturers. Indeed, in our one-on-one discussions with the surveyed companies, respondents indicated that they would “be more cautious” about their supply chain activities, which suggests that while they feel they are structurally sound, they are mindfully vigilant.

Among the 22% of respondents that did say they would review their supply chain activities, more than one-third said they would make changes to the supplier evaluation process during selection or they would assign a person to look over quality adherence at the supplier location. About 30% would send quality inspectors overseas to the production plants. This is noteworthy because these are not quick-fix solutions; these respondents are considering deploying significant resources to achieve greater product quality.

We were not surprised to see that none of the survey respondents indicated that they would stop outsourcing manufacturing altogether. Let’s face it – American consumers are bargain shoppers, and the big box retailers that clamor for their spending dollars are equally price sensitive. Consumer product companies are under constant competitive pressure to bring their wholesale costs down so that retailers can hit their target retail prices without cutting into their own margins.

In addition, almost all of the companies that outsourced to China indicated they would continue to do so, which if you really think about it, shouldn’t surprise anyone. After all, the underlying cause of many of these recalls has to do with inadequate product design specifications at the front end and improper oversight at the back end. Those shortcomings are not China-specific; they could happen anywhere. But if China is to continue to be the preferred source for production, how can we protect the supply chain from the breakdowns that have made consumers so fearful (at least temporarily) of the “Made in China” label?

A huge challenge is China’s rampant growth. One could argue that the demand for Chinese manufacturing has likely exceeded the supply of superior quality, reliable and competent sources. A consistently robust supply chain has been weakened by a multitude of opportunistic suppliers eager to meet even unreasonable cost expectations by any means necessary. For their part, many of the ‘outsourcerers’ i.e. those companies that subcontract to Chinese manufacturers, have done little to discourage this – if not by intent, certainly by implicit action. The pricing pressures they face are very real. Yet, competition among Chinese manufacturers for production contracts is intensely fierce – and western companies dealing with China know that, for the most part, if they lose one contract, there will always be another manufacturer waiting in the wings to take over. And so the cycle continues until we have the situation we went through this summer.

We would be remiss to suggest that western companies are without a sense of responsibility, though. Interestingly, survey respondents were very explicit that the onus was on them to ensure effective supply chain management and quality control. They feel that the U.S. government is doing everything reasonable within its power to improve the quality of outsourced products. The Chinese government, in their view, could do more, and by some possibly extreme measures, is at the moment trying. However, at the end of the day, it is the individual company’s responsibility to ensure safety and quality of the end product. (To illustrate the limitations of the regulatory approach, although the Consumer Product Safety Commission (CPSC) and General Administration of Quality Supervision (GAQS) of the U.S. and China, respectively, recently reached an agreement to boost the safeguards on Chinese-made toys, this is a mere sliver of the manufacturing universe.)

So how will they manage control? The majority (61%) of survey participants said that quality checks at multiple levels are their preferred strategy for managing quality control. It is worth noting that in Mattel’s situation, it was subcontracted suppliers who used paint from unauthorized suppliers that ultimately led to the recalls. Interestingly, while one would expect that better communication with vendors and more rigorous vendor selection and certification processes (throughout the value chain) would be foremost on manufacturers’ minds, these aspects of the supply chain management process were actually prioritized very low on the list of companies’ ‘quality strategies’.

So what does this all mean?

At the end of the day, there are probably a handful of truisms here that we can walk away with:

• It is counterintuitive to suggest that global manufacturers are producing substandard goods in overseas locations simply to squeeze a tad more profitability out of the process. Recalls are simply too costly in terms of the bottom line, reputation management, and consumer trust for such a misguided strategy to work in the long run.
• Most companies (well, the good ones, anyway) accept that the buck has to stop with them. They understand that, at the end of the day, their a** is on the line and the only folks who will make sure that there are no quality issues in their supply chain is themselves.
• Outsourcing isn’t going away. Its critics can rail against the perils of outsourcing and the problems it creates, but the reality is that most of the goods we encounter in our everyday lives are made anywhere but the US. And most of it (gasp) works.
• China isn’t going away. If that sounds like an obvious statement, it is, and it should be thoughtfully considered in light of the outcry over the last few months. The reality is that China has a pool of talent and a cost structure that allow us to pay a heck of a lot less for products than we would have to otherwise. And the reality on main street is that we implicitly value this economy. And there is no reason we wont continue to do so.
• (As for the manufacturers who operate in China, what are their alternatives? Sure there are other cost competitive locations – but who’s to say they wont encounter the same issue (perhaps even worse) in those locations?)

As our survey respondents would agree, there are meaningful ways to safeguard against the likelihood of production-related safety risks, but manufacturers must be vigilant and proactive. Superior quality products come from superior supply chain management, which is most definitely a “do it yourself” job.

Posted in : Business Strategy

Tags : china competition, china manufacturing, toy recall