Outsourcing technology: here are guidelines for establishing sourcing partnerships that are...

OVERVIEW: Properly implemented, technology outsourcing can provide a number of strategic benefits, including improved quality, focus, flexibility, and leverage. But for companies to reap these benefits, their strategic sourcing decisions must take into consideration a number of factors. These

include the protection, development and exploitation of core activities, as well as the need to relate sourcing decisions to the organization's competitive business strategy. The complex issues and assumptions associated with a decision to outsource require that managers construct a framework for their examination. This framework allows assessment of eight key components: compatibility of the partners' cultures, technology, expertise, objectives, people, costs, capabilities, and the contract itself.

KEY CONCEPTS: alliances, partnership management, outsourcing strategy, biopharmaceutical industry.

Changing from a self-sufficient approach to technology development to one of strategic sourcing is a challenge because internal processes often acquire their own specific gravity and inertia over long periods of time. In deciding whether or not to outsource, managers must consider the implications of the decision for the company's design function, R&D, engineering, manufacturing and assembly, as well as the technology positions of current and potential competitors within the industry (1). The rationale for this is that an analysis of relative costs will provide only a partial answer to the question of whether or not to outsource a specific technology or function.

Thus, the practice of outsourcing select functions to external suppliers while retaining other applications in-house disregards the all-or-nothing approach to technology development in favor of a more flexible and modular method of outsourcing. At the same time, even though the decision to selectively outsource can provide managers with a greater array of options, the evaluation process is inevitably more confusing. This may lead managers to make incorrect decisions about which services to outsource and which to retain in-house, or to neglect the technical issues involved, or even to miscalculate the long-term economic consequences to the firm (2). In order to avoid potential pitfalls, it is therefore imperative that managers construct a framework for examining the complex issues and assumptions associated with the decision to outsource.

The Challenge of Outsourcing

In general terms, outsourcing has evolved from a once-concerted effort to reduce costs into one of the most preferred techniques for restructuring an organization. Nevertheless, research by Mullin suggests that many outsourcing contracts often end in failure, primarily because organizations have either renegotiated their supplier contracts, or have cancelled them altogether due to the outsourcing arrangements no longer relating to the needs of the organization (3).

For the most part, many of the problems associated with outsourcing are due to the nature of the process itself--it is a time consuming process, which requires dedicated expertise to achieve the desired outcomes. A consensus among many industry practitioners, outsourcing contractors as well as suppliers, is that the biggest mistake made by most businesses that enter into outsourcing arrangements is to virtually abdicate the responsibilities associated with managing the outsourcing agreement to the contracted firm. This helps create an environment in which the supplier manages the outsourcing relationship. In addition, the failure to clearly define performance expectations and measurement criteria within the contract has in many instances led companies to lose sight of the most basic purchasing and partnership principles involved.

A crucial factor often overlooked by management when calculating the potential benefits of an outsourcing strategy is that, by nature, outsourcing trades the problems associated with managing a specific service or function for those of managing alliances with external partners. Although a company may delegate the responsibility for managing various infrastructure services to an outside supplier, it still remains accountable for a number of important functions that help ensure the success of the relationship. Gantz (4) identified these as the need to:

* Establish the procedures and mechanics of dealing with strategic partners.

* Manage the individual alliances.

* Rationalize the relationship across alliances, given that some outsourcing suppliers may also be competitors.

* Recognize the changes required in the supplier's organization.

Criteria for Outsourcing Agreements

Given the complexities of implementing a successful outsourcing strategy, a framework for identifying the critical success factors for creating and engaging in strategic sourcing relationships is illustrated, below. The framework aims to provide a thought-provoking assessment of each of the factors that must be considered prior to entering into any sourcing agreement. Derived from a review of published literature, this appraisal distills the key principles identified, and consists of eight key components.

1. Compatibility.--Assessing the compatibility of the respective cultures of collaborating organizations has been frequently stressed as meriting serious consideration at the outset of any collaboration (5). For organizations to work together, it is imperative that there be some degree of cultural fit and compatibility between them. The importance of collaborating with an organization with a compatible culture and mode of operation, as well as complementary strengths and expertise, based on mutual understanding between partners, cannot be overemphasized. However, as any differences in culture and operating styles between partners are likely to emerge only as the collaboration evolves, much depends on being able to identify such differences quickly and to resolve them effectively.

Stuckey and White point out that the use of outside supply also requires careful consideration of the potential power of suppliers (6). In the event the supplier should prove disappointing, or attempt to impose price increases, the contracting company may incur substantial switching costs from negotiating a new agreement with new suppliers. Thus, the need to restore the required expertise may prove to be a difficult as well as an unattractive use of scarce resources. Furthermore, the contracting company must also consider the strategic intent of potential suppliers, as it cannot exclude the possibility of an outsourcing partner becoming a future competitor (7).

Key questions

* Is there cultural and organizational compatibility between the two organizations?

* Is the prospective partner a good strategic fit?

* Can the company identify the strengths and weaknesses of the potential supplier?

* Can the supplier fulfill all the necessary requirements of the contracting company?

* Has the company considered the potential power of suppliers?

* Could the supplier become a competitor in the future?

2. Technology.--For a business to develop and sustain a competitive advantage, it requires access to one or more technologies, combined with the ability to benefit from, or even lead, in the development of technology. Often, this development is costly and entails the risk of failing to provide any strategic benefit over the long term. For this reason, the decision as to which technologies should be developed in-house must be made on a selective basis, and must ensure support for sustaining the competitive advantage of the firm.

In terms of outsourcing technology, Welch and Nayak identified a number of issues that must be considered as part of the outsourcing planning process (8). For example, the importance of the technology must be considered. Management must focus its attention and direct investment toward those technologies that provide distinctive product and service characteristics. Second, the maturity of the process technology must also be considered. Through a study of other industries as well as its own, management can avoid recreating developments that have been achieved elsewhere, as these may be available through purchasing, licensing or outsourcing supply agreements. Third, the technological performance of the firm versus its competitors must be examined, lf there is a disparity, it may not be possible for the company to close the gap through internal development alone. This may then necessitate the sourcing of the technology through outside supply.

Key questions

* How important is the technology to the firm's business strategy?

* Will changes in the business strategy alter the relevance of the technology in the future?

* How mature is the technology in relation to other industries?

* Can the supplier support or provide future technical developments?

3. Expertise.--As part of the evaluation process, individuals who will take leadership responsibility, perform analyses, and make the decisions must be identified. This selection should be based on what is to be outsourced and the circumstances surrounding the outsourcing decision. Although a project leader or champion is desirable, in the case of larger outsourcing contracts, senior management must take an active role in the outsourcing process. It is important that in any event the team consist of a mix of managerial and technical talent. In terms of the size of the team, this inevitably depends on the size and scope of the project, although it is generally accepted that smaller teams are more effective than larger groups.

Klepper and Jones recommend that it is constructive to have individuals experienced with outsourcing on the team due to their prior experience and insight (9). However, if a company lacks sufficient technical expertise to appraise new technologies and/or processes, it is prudent to hire the supplier to work with the internal department so that the staff may acquire the "esoteric" knowledge needed to make better sourcing decisions in the future. Taken within this context, the contracting of outside consultants is also highly recommended.

Key questions

* Have individuals who will take leadership responsibility, perform analyses, and make the decisions been identified?

* Will senior management be required to play an active role in the outsourcing process?

* Are outside consultants required?

4. Objectives.--Outsourcing must be conducted carefully, systematically and with explicit goals. The primary motives for considering outsourcing should include strategic as well as tactical considerations at both the department and organizational level. It is important that management not use outsourcing to justify relinquishing control of inadequately managed, poorly understood or costly functions as this would result in an unsatisfactory outcome.

As with any strategic decision, the decision to outsource must also be made to comply with changes in the organization's environment (10). Management should, therefore, consider (or re-consider) the merits of having an outsourcing strategy, especially when changing market conditions, internal restructuring, industry-related or technological changes have taken place. It is essential that all sourcing decisions support the organization's overall business strategy and be revised accordingly as competitive conditions change.

Key questions

* Is there a clear understanding of the company's business strategy?

* Does the decision to outsource support the overall business strategy?

* Do the motives for outsourcing include strategic as well as tactical considerations at both the department and organizational level?

* Have the implications of outsourcing for achieving the overall business strategy, including the effect upon cost quality and flexibility, been considered?

* Will the decision to outsource conform to future changes in the organization's environment?

5. Human resources.--People are a crucial component of the sourcing decision. It is important that managers execute changes without threatening the security of employees. The problem may have as much to do with how a sourcing decision is implemented as with the content of the contract itself. To this end, it is vital that staff be kept informed at all stages of the outsourcing process so as to instill a feeling of fairness among employees. Management should also assess whether or not the content and the method of implementation will motivate staff internally as well as within the supplier organization.

Key questions

* Will staff feel threatened by the outsourcing arrangement?

* What advantages will the firm gain from transferring people to the supplier?

* What are the identifiable risks in making the planned transfers?

* How can management ensure a feeling of fairness among its employees?

* Will the content and method of implementation motivate in-house as well as supplier staff?

6. Costs.--All businesses, including those that compete through differentiation, need to achieve the lowest cost consistent with the company's business strategy. In the case of outsourcing, the contracting organization is able to benefit from a superior set of cost drivers that include such factors as scale, learning and location, all of which are readily available in the supplier. As a result, outsourcing can make a significant contribution toward reducing the firm's overall cost base. However, any assessment of cost requires a thorough evaluation of the service provided, as well as the various components that make up that cost. This is because the costs of delivering a defined level of service are far-ranging and include both explicit and implicit costs (11).

Key questions

* Is attention focused on both internal transaction costs as well as those associated with the external sourcing process?

* Has the costing exercise included all costs, including the alternative net revenue available through releasing staff and facilities?

* How consistent is the price offered by the supplier, and will there be expensive additions?

* How does the overall cost quoted by the supplier compare with what else is on the market?

* Even if the contracting company is unlikely to save money, could it still over-pay for what it gets through outsourcing?

7. Capabilities.--According to Medcof, capability is one of the principal criteria on which to question the feasibility of a prospective partnership (12). This is because the capability lector examines whether prospective partners actually have the ability to meet the requirements of the prospective alliance. Thus, it is necessary for the organization to apply the capability criterion to its potential

partners as well as to itself. However, it is important to understand that because some of the capabilities sought in a potential partner are generic, they should be present regardless of the nature of the proposed alliance. For example, the prospective partner must have an efficient management team, and the supplier must also have a sound reputation for reliability and consistency.

In addition, it is important to assess whether the prospective partner fully understands the ramifications of entering into the partnership agreement, including the possible costs and benefits the partnering firm could incur. To this end, many of the strengths and weaknesses should be evaluated in relation to the specifics of the proposed alliance.

Key questions

* Does the contracting firm have the capacity to track, assess and interpret changing functional capabilities and relate them to the needs of the firm?

* Does the contracting firm have the capacity to define the desired functional requirements over time?

8. The contract.--A mistake that management often makes when entering into an outsourcing agreement is to sign the supplier's standard contract. Such contracts often contain legal details that are difficult to understand, and can include a number of hidden costs. Because every aspect of the outsourcing arrangement is governed by the contract, both sides must agree on all the terms and conditions of the partnership agreement. This requires that management consider every possible contingency that could arise during the course of the partnership, including the resolution of disputes after the contract has been signed. Thus, it is advisable that internal as well as external legal experts be consulted when drafting the contract.

If a company is to draw up a sound contract, it is essential that a number of clauses be included in the outsourcing agreement. These include:

* Minimum service levels.--Specify as accurately as possible the type of services that will be provided, the methodologies that will be utilized, the volume of work to be undertaken, and the time frame for achieving specified results.

* Performance measures.--Include the client's arrangements to monitor the services provided in order to ensure that service levels are being met, as well as the criteria for measuring success.

* Ownership and confidentiality of the data.--Make clear that the contracting firm will retain ownership of all data submitted to the supplier, and that such information will remain strictly confidential.

* Communication procedures.--Specify how the two parties should communicate to assess performance and take necessary remedial action. Include frequency of reporting, what the reports should contain, and the frequency of such meetings.

* Warranty.--The supplier must certify that all services will be provided as defined under the terms of the agreement, and that accommodation will be made for any specified increase in requirements.

* Incentives.--Management must provide the supplier with an incentive to perform. For example, this could include the prospect of guaranteed savings, and/or the sharing of benefits and risks by both parties.

* Disclaimers.--Although a disclaimer should be included, take care that it does not invalidate the warranty of the agreement.

* Bankruptcy.--Both parties to the outsourcing contract should consider the possibility that the other could go bankrupt or encounter serious financial difficulty.

* Anticipate change.--Contracts should provide for all eventualities and should include a termination agreement.

* Terms of the agreement.--Management must make sure that the contract will be renewed only if a renewal clause is inserted and a prior notice issued.

Additional steps may also be taken to safeguard the interests of the contracting firm. For example, the company could withhold a piece of the business from the supplier and use that potential contract as an enticement for future business. Alternatively, the company could split a specific function between two suppliers, thereby maintaining a degree of competition between them. The company could also strive to enter into short-term contracts, which may be renewed periodically.

Key questions

* Does the contract clearly define the: terms of the agreement, minimum service levels required and performance measurement criteria?

* Does the contract provide for: ownership and confidentiality of the data, warranty for services provided, supplier incentives, disclaimers in the event of contract failure, bankruptcy of either party, and unanticipated change?

When To Outsource

Advances in technology over the past few decades have enabled managers to effectively segment their value chains, thereby presenting companies with a number of options. This has allowed for the maintenance of key strategic elements internally and, at the same time, the flexibility to outsource some or all remaining components to suppliers anywhere in the world with the minimum of cost. Given the complex issues associated with the external sourcing process however, it is imperative that all matters be considered in a coherent and structured manner, since organizations inexperienced with outsourcing frequently underestimate the degree to which new capabilities may be required for managing the outsourcing agreement.

As with most partnership arrangements, outsourcing entails a unique set of problems, which for the most part stem from the need to change long-established management practices within the contracting organization. This often necessitates the reinforcement or even replacement of certain key personnel involved in the administration of in-house departments, since they may not have the necessary skills to fulfill particular responsibilities. In light of this, it is essential to view the decision to outsource as a process of continual strategic analysis. Due to the inherent difficulties involved, it is therefore prudent to buy from external sources when the:

1. activity is of low significance to the company's competitive advantage,

2. supplier has proprietary knowledge that the company needs,

3. services provided by the supplier are better and/or cheaper than those provided internally,

4. activity requires specialist expertise,

5. development process requires external accountability.

When considered from a managerial point of view, however, the focus should not merely be on whether or not to outsource a function per se. Rather, emphasis should be placed on how a company will be able to use the market and associated services for organizational advantage, should it choose to follow the outsourcing route. Management should therefore ensure that it has the necessary skills and capabilities to: 1) Select a suitable supplier; 2) negotiate and draft the contract; 3) manage the supplier relationship; and 4) identify and manage both the existing and future needs of the organization. Only then can the decision to outsource be considered truly strategic.

References

(1.) Nayak, P. Ranganath. "Should You Outsource Product Development?" Journal of Business Strategy, Vol. 14, No. 3, May-June 1993, pp. 44-45.

(2.) Lacity, C. Mary, Willcocks, P. Leslie and Feeny, F. David. "The Value of Selective IT Sourcing." Sloan Management Review, Vol. 37, No. 3, Spring 1996, pp. 13-25.

(3.) Mullin, R. "Managing the Outsourced Enterprise." Journal of Business Strategy, Vol. 17, No. 4, July-August 1996, pp. 28-36.

(4.) Gantz, J. "Outsourcing: Threat or Salvation?" Networking Management Journal, Vol. 8, No. 10, October 1990, pp. 25-40.

(5.) Mason, C. Julie. "Strategic Alliances: Partnering for Success." Management Review, Vol. 82, No. 5, May 1993, pp. 10-15.

(6.) Stuckey, J. and White, D. "When and When Not to Vertically Integrate." Sloan Management Review, Vol. 34, No. 3, Spring 1993, pp. 71-83.

(7.) Bettis, A. Richard, Bradley, P. and Hamel, G. "Outsourcing and Industrial Decline." Academy of Management Executive, Vol. 6, No. 1, February 1992, pp. 7-23.

(8.) Welch, A. James, and Nayak, P. Ranganath. "Strategic Sourcing: A Progressive Approach to the Make-or-Buy Decision." The Academy of Management Executive, Vol. 6, No. 1, February 1992, pp. 23-32.

(9.) Klepper, R. and Jones, W. Outsourcing Information Technology, Systems and Services: A Practitioner's Perspective. London, Prentice Hall, 1998.

(10.) Willcocks, P. Leslie and Fitzgerald, G. A Business Guide to Outsourcing IT: A Study of European Best Practice in the Selection, Management and Use of External IT Services. London: Business Intelligence. 1994.

(11.) Jennings, D. "Strategic Guidelines for Outsourcing Decisions." Strategic Change, Vol. 6, No. 2, March-April 1997, pp. 85-95.

(12.) Medcof, W. John. "Why Too Many Alliances End in Divorce." International Journal of Strategic Management: Long Range Planning, Vol. 30, No. 5, October 1997, pp. 718-732.

(13.) Buggle, I. "Low NAS Numbers Highlight the Need for New R&D Tactics." IMS Health Report, IMS Health, 2003.

(14.) Kermani, F. and Bonacossa, P. Outsourcing jot Successful Drug Development. Chiltern International, August 2002.

(15.) Mathieu, M. Parexel's Pharmaceutical R&D Statistical Sourcebook. Parexel Inc. 2002.

Outsourcing for the Biopharmaceutical Industry

The pressure on pharmaceutical companies to increase their output of new drugs is constantly escalating. Despite expenditures on R&D increasing by 121 percent over the 1990-2000 period, the output of new drugs has steadily been dropping. The number of New Active Substances (NSAs) launched in the global biopharmaceutical industry in 2003 was only 30 compared with 36 launched in 2002 (13). This marked the lowest output in 25 years since the introduction of 32 drugs in 1979.

Not surprisingly therefore, many pharmaceutical as well as biotechnology companies have been turning to outsourcing as a way to control costs, as well as a means of rising their internal resources in order to achieve maximum value. As they have begun to re-evaluate their own core competencies and decide how to direct their R&D in the most time-and cost-effective manner possible, companies have started to use outsourcing proactively rather than on a tactical basis. To this end, the development of formalized plans to use contractors for particular areas of work is becoming increasingly a part of the companies' overall R&D strategy (14). This is reflected by the nature of the partnerships being forged between Clinical Research Organizations (CROs) and sponsor companies. Thus, it is predicted that the increasing proportion of pharmaceutical R&D being outsourced will drive future growth of the CRO sector by 10-12 percent (15).

However, as trials become more complex for new drugs, the task of selecting a suitable CRO for a particular project still remains a difficult choice for many pharmaceutical companies. Although there is a view that by building longer-term relationships pharmaceutical companies will get the best out of their CRO partners, a successful relationship inevitably implies that efforts be made by both parties if a successful outcome is to be ensured. However, achieving such a relationship is often difficult through short, one-of projects. What is needed, therefore, is for both parties to build an effective working relationship that is dedicated to getting products through clinical trials successfully and thereby meeting patient demand for new medicines. The challenge for many of these companies, of course, is to be able to implement and execute a successful outsourcing strategy.--B.P.

Bianca Piachaud is an independent writer and analyst specializing in strategic management in the pharmaceutical and biotechnology industries. She received her M.A. (Hons.) degree in economics and management from the University of Aberdeen, Scotland, and her Ph.D. in strategic management from the Aberdeen Business School at The Robert Gordon University, where she later held the position of post-doctoral research fellow. She has published in a number of international journals, and is the author of Outsourcing R&D in the Pharmaceutical Industry (Palgrave MacMillan Publishers, UK, 2004). Her areas of research include outsourcing strategy, technology management, alliance and partnership strategies, bpiachaud@yahoo.com