Continuing on an economic theme within our blog, topical due to the economic challenges and BPM’s relevancy to those challenges, here’s another offering along those lines.  A recent McKinsey Quarterly article discusses a new “managed services business model” that helps both customers and employees of offshore service providers.   The thesis of the article is that the recession has created competitive pressures for the offshoring business that are starting to separate winners from losers.  Allegedly, these new winners are focusing on the quality of services rather than on the cost-per-head, focusing on collaboration with clients, and are gaining more control over outsourcing strategies.

However, out in the field in the US, I haven’t seen this separation of wheat from chaff – I see the pressure, but the manifestation of that pressure still seems to be most clear with respect to cost discussions.  Although in some cases contract language has changed to focus on deliverables rather than cost-per-head – those deliverable-based contracts are merely reinventing the wheel of the old fixed-bid-contract -putting more risk on these IT offshoring companies to deliver, or else face punitive measures from their customers.  In the short term these fixed-bid strategies will likely pay off.  But without a superior delivery capability, fixed-bid offerings that win on price over time-and-material offerings, tend to produce lower margins or negative margins – risk has simply been transferred from one party to the other, with no additional compensation.

Worse news, this transfer of risk hasn’t historically proven to increase the probability of successful projects.  And there is no reason to think the results will be different this time.

The second thesis of the article is that the winners are developing deep talent pools that global clients demand, and developing progressive techniques to manage and retain these workers.  While I’ll concede that this may be true in some areas, I have not seen evidence of this in BPM.  This isn’t just my American perspective, when I’ve had informal conversations with BPM practitioners in other countries – in Europe, South America, and the Middle East – they all tell me that they can’t imagine doing BPM well without being close to the client on a regular basis.  When I ask them how successful they’ve been at leveraging offshore talent the answers have not been promising.  The chief complaint is the lack of understanding of business, of process, and of how to manage a project with requirements that are not set in concrete for the duration of the project.

Unfortunately media outlets and analysts routinely over-estimate the talent to be found in faraway places that can be plugged into Global or US companies’ projects, while under-estimating the talent to be found right in these companies’ backyards.  It makes for good print, and there are a lot of executives who will make these points to the media.  But it is a lot easier to say that you’re offshoring work because you “can’t find enough talent” than it is to say that you’re offshoring the work because “local talent is more expensive”.  I’m not making a moral argument against offshoring, but I think if the discussion was more honest, some of the hype could be reduced.  There is a global shortage of talent for BPM deployments and other important work in IT and process improvement.  And the nature of the work doesn’t lend itself to being separated by great differences in time and space.

The part that I think McKinsey got right is that the competitive advantage of “cheaper labor” has nearly run its course as cheap skilled labor becomes more scarce, and as customers become more discriminating.  Jaisundar writes a parable of this problem in The Corrosion of Competitive Advantage.  After reading the narrative, Jaisundar turns to a couple of very interesting facts:

1. IT has “sharpened” (increased) differences among companies rather than reducing them.  And yet conventional wisdom is that technology renders differentiated products and services into commodities.  The conventional wisdom is wrong because the pace of change favors those organizations that can adopt and leverage technology fastest and best.
2. The competitive shakeup in the US is intense, but may only be beginning in many other economies.

There are some fantastic lessons for Indian IT service firms in this article, but many of them apply in hotly contested markets in the US as well.  The key thing is that superficial changes (blue hat, anyone?) will not win the day in the long run.  The competitive advantages that will win in the long run are the values and culture and skills that run deep in your organization, and the way you surface those attributes to your customers via core business processes that make up the “customer experience.”

I was struck by a series of articles I’ve read recently regarding Outsourcing and how it is really hurting American businesses.  Robert Hayes raises the specter of the US possibly killing its Innovation Machine, and compares outsourcing of High Tech to the Subprime-Mortgage fiasco. He makes a few powerful points, for which it isn’t hard to look for data points to support.

The same forces can lead a number of manufacturing companies — each independently making apparently rational decisions to outsource certain segments of their operations — to ravage their industrial commons: the valuable infrastructure of suppliers and skills that underpins them. The supposed savings they expect to generate from such activities are based on costs that often do not properly reflect the damage they are causing.

As I read this, I think of Dell, once the pinnacle of the PC industry’s drive toward efficiency… But under the hood of Dell’s efficiency engine we discovered that a lot of their benefits had to do with financial engineering – taking ownership of inventory as late in the process as possible, owning the warehouses (and charging rent) that their vendors used to store their equipment prior to final assembly, and paying creditors as late as possible.  Reading on in Mr. Hayes report:

A company’s competitive advantage is rooted in things it can do (e.g. design, make, distribute, or market) that its competitors cannot do as well, if at all. As the number of these core capabilities decreases, the company’s competitive vulnerability to those that are able to master the same capabilities goes up.

This sounds like what Dell did – outsourcing the manufacture of increasing parts of the value chain, until you reach the logical conclusion, where Dell no longer does even final assembly of much of its inventory, it is simply the design, marketing, and distribution vehicle for other companies’ computers.  They reduced the number of areas in which they could differentiate from the competition.  And the competition (HP, Lenovo, Acer) have adopted very similar business models, and now enjoy similar (and in some cases, better) margins.  As Mr. Hayes writes: “[...] teaching an armada of hungry potential competitors first how to master, then how to surpass their capabilities.” Meanwhile, it is difficult to unwind this change in the food chain because the necessary infrastructure and skills to support manufacturing and assembly in the US has now been outsourced overseas (largely to Taiwan and China). Restarting that infrastructure in the US is a daunting task in dollars, time, and leadership.

Mr. Hayes makes a persuasive argument that these companies have not, in fact, been improving profitability – that they have instead been cashing out their intellectual property and assets in exchange for a temporary improvement in margins… Which is now evaporating.

Now that the field has been reduced to competing largely on: Design, Marketing, Distribution… Branding becomes more important.  And this probably explains in large part why Apple has been so successful of late -they can outsource the production efficiencies that Dell (and others) have produced in overseas outsourcing shops, and they can exceed these other manufacturers with differentiated software and hardware design and branding (The aluminum unibody Macbooks with Mac OS X are the envy of the industry), better marketing (Apple ads), and distribution innovation (Apple Stores).

What Mr. Hayes is arguing isn’t entirely new, but our titans of industry have been unwilling to listen.  In an issue of CIO magazine in 2005, the then-CIO of Aflac, Jim Lester, said that he wouldn’t consider outsourcing his IT because he couldn’t replace the organizational learning, the knowledge of the business, and the alignment with the business that he had in his current IT organization (some people call this caring about your company).  But he was a minority voice at the time.  The fact that his organization out-performed the insurance industry as a whole for the next few years might be unrelated, but I wouldn’t bet on it.  Of course if particular IT services trail the industry averages then it may make sense to switch to commodotized service offerings as a way to play “catch-up” with the industry – a firm will sacrifice its ability to excel in that area, but will eliminate the possibility of self-inflicted wounds in that area, while it can then focus on the areas it knows best.  One could argue that this is what Apple did with its back-end fulfillment – which trailed the industry in efficiencies – so that it could focus on its strengths in design without the drag of inefficient manufacturing operations.

I worry that over the last 10 years, the US been on a similar course with regard to software development. Increasingly attempting to jam down the costs of software developers, and going anywhere in the world in order to achieve it, without regard to the specific qualities of the firms they are outsourcing to.  If this goes too far, we’ll lose the critical ecosystem here in the US that supports software developers (and many software-related professions and the businesses that are based on them).  I see signs of this in startups who don’t do any software development in the United States and assume that this financial engineering will give an edge to their “ideas”.  But what software has often proven is that ideas are cheap.  Execution is differentiating.   These startups are betting the farm on unproven execution resources, which then puts them in competition with hordes of competitors with fewer ways to differentiate.  Counter to this trend, I also see a number of firms now with hybrid software development models that include doing development on- and off-shore to gain some cost advantage but without losing the ability to try to differentiate on execution.

In a very cogent piece on the subject of Indian outsourcing in particular,  Jaisundar argues that IT can sharpen competitive advantages, rather than diminish them.  That India based service providers need to migrate from being order takers to a deeper relationship that can address business process problems proactively and cooperatively.  This is likely true, but it runs counter to much of the order-taking culture at these firms – it will take time to push the mindset in the right direction and to find and train the right people to lead them in that direction.

Meanwhile, there’s quite a bit of abuse of foreign workers going on in the US.  An expose in Business Week on this practice goes into excruciating detail of some of the worst cases.  However, BusinessWeek makes the claim that most employers are unaware that these abuses are being perpetrated by the staffing firms that they employ.  I don’t buy that argument.  I think companies bear a responsibility to know that the people they staff are legitimately employed, and brought to the US under appropriate Visas (for all the attention on H1-B visas, no one is talking about the vast abuses of L1 visas going on right now). Companies bear a responsibility to work with reputable firms – if they don’t, then it is with the intent of getting workers at below-market conditions, which normally can only happen when you have a captive or disadvantaged workforce.  This is a bit like buying a Cartier watch for $10 and pretending that you don’t know it either (a) isn’t a Cartier, or (b) wasn’t acquired in a legitimate fashion. The buyer has a responsibility to buy legitimate goods and services.

In another article, Charles Green blames the money-first-above-all-else culture of Wall Street (and, increasingly, the executive suites of large firms) on Harvard Business School.  Charles Green, himself an alumna of Harvard Business School, argues that HBS has failed to imbue our “Best and Brightest” with a well rounded perspective of business:

Harvard Business School led the charge away from an approach to business centered in relationships and commerce, and toward one rooted in markets and competition. They promised us competitive advantage and efficiency. They delivered.

Unfortunately, the cost of this change is that American business is not prepared for a world that is increasingly interconnected, and increasingly relationship-driven.  Its a great, thought-provoking read.  As a long-time professional services guy, hearing someone say that business is relationship-driven is a bit like hearing that the sky is blue.  Of course it is relationship-driven, trust driven, commitment-driven.  And when organizations ignore this or trample on these aspects of their business, the chickens will come home to roost.  But apparently this was hasn’t been part of the culture of Wall Street for some time.

These articles only scratch the surface of what I’ve seen lately in the press and in blogs, but I think each one captures a specific issue perfectly.  If you can’t differentiate part of your business, it may make sense to outsource it, but be careful.  There are serious landmines in outsourcing, and it isn’t clear that American businesses have correctly assessed those trade-offs for the long run.

Phil Gilbert writes provocatively, as usual, in When Process is Your Product.  Fresh from a trip to India to meet with some of the world’s top outsourcers/offshorers, Phil asserts that these are the new strategic partners to the Fortune 500 and:

To put it bluntly, a great outsourcer may be better at quickly improving your business than you are. Why is this? Because, these companies are quickly achieving the cultural maturity required for BPM that eludes even the most progressive companies in the world.  [...]

If change is so hard, then why is it moving faster at outsourcers than at beleaguered companies? I think it is because process is their product.

I’m not going to debate his assertions, but that last sentence got my attention: … because process is their product.

Well, at some level, isn’t process everyone’s product?  Maybe not process generically – but the specific processes that make your business work?…  This concept gained a lot of traction when Dell was taking the PC market by storm with a better process than the competition, rather than a differentiated product (notebook, desktop).  But in some sense, the process of acquiring the hardware is part of the what Dell was selling – the lower cost structure, taking ownership of inventory at the last possible second, the customization, the quick turnaround.

So, aren’t the processes that your customers interact with part of what you sell?  And isn’t what you sell your product?  So, if it isn’t quite accurate to say that process is your product, is it fair to say that it is inextricably entangled with your product and with your customers’ perceptions of your product?  And with your company or brand? And then haven’t we come full circle?

I think the answer is essentially yes.  Therefore, whenever you consider outsourcing your product, you have to be careful. You don’t want to forgo outside expertise at the expense of speed or quality.  But you want to make sure that you absorb expertise and culture internally that will nurture and sustain your Product (your Process!).

Does this mean you don’t leverage outsourcing?  If I rephrase this to take away the locality aspect- does this mean you don’t leverage vendors?  of course not.  But I think it will be increasingly natural to demand a better process (product) from your vendors – you are, after all, their customer.  Phil writes:

But what if you could simply augment your business people in order to graft the culture of change? Is this a new value prop for the Indian companies?

I’m not sold that the IT outsourcing firms will lend you a BPM culture.  Too much time and distance and competing interests between staff for that.  But again, it doesn’t mean that you can’t demand good process of any vendor you work with, and long term contracts that imply more efficient delivery over time.

So if your “product” includes the processes that affect your customers, are you investing adequately in the process?  Are you investing as much in the processes that delight your customers as you are in the nuts and bolts of your product?  Are you investing in the processes that create repeat business?  In the processes that help customers extract more value from your product over its lifespan, or extend its useful lifespan?

If you’re not, it may be time to re-evaluate that.