Strategic Outsourcing
by James Brian Quinn, Frederick G. Hillmer
By assessing the relative and risks of making or buying, companies can leverage their skills and resources for increased profitability.
Two new strategic approaches, when properly combined, allow managers to leverage their companies' skills and resources well beyond levels available with other strategies:
- Concentrate the firm's own resources on a set of "core competencies" where it can achieve definable preeminence and provide unique value for customers.
- Strategically outsource other activities including many traditionally considered integral to any company for which the firm has neither a critical strategic need nor special capabilities.
The benefits of successfully combining the two approaches are significant. Managers leverage their company's resources in four ways.
First, they maximize returns on internal resources by concentrating investments and energies on what the enterprise does best. Second, well-developed core competencies provide formidable barriers against present and future competitors that seek to expand into the company's areas of interest, thus facilitating and protecting the strategic advantages of market share. Third, perhaps the greatest leverage of all is the full utilization of external suppliers, investment, innovations, and specialized professional capabilities that would be prohibitively expensive or even impossible to duplicate internally. Fourth, in rapidly changing marketplaces and technological situations, this joint strategy decreases risks, shortens cycle times, lowers investments and creates better responsiveness to customer needs.
Two examples from our studies of Australian and US companies illustrate our point:
- Nike, Inc. is the largest supplier of athletic shoes in the world. Yet it outsources 100 percent of its shoe production and manufactures only key technical components of its Nike Air System. Athletic footwear is technology and fashion intensive, requiring high flexibility at both the production and marketing levels. Nike creates maximum value by concentrating on preproduction (research and development) and post-production activities (marketing, distribution and sales), linked together by perhaps the best marketing information system in the industry.
Using a carefully developed, on-site "expatriate" program to coordinate its foreign based suppliers, Nike even outsourced the advertising component of its marketing program to Wieden and Kennedy, whose creative efforts drove Nike to the top of the product recognition scale. Nike grew at a compounded 20 percent growth rate and earned a 31 percent ROE for its shareholders through most of the past decade.
- Knowing it could not be the best at making chips, boxes, monitors, cables, keybroads and the like for its explosively successful Apple II, Apple Computer outsourced 70 percent of its manufacturing costs and components. Instead of building internal bureaucracies where it had no unique skills, Apple outsourced critical items like design (to Frogdesign), printers (to Tokyo Electric), and even key elements of marketing (to Regis McKenna, which achieved a "$100 million image" for Apple when it had only a few employees and about $1 million to spend).
Apple focused its internal resources on its own Apples DOS (disk operating system) and the supporting macro software to give Apple products their unique look and feel. Its open architecture policy stimulated independent developers to write the much-needed software that gave the Apple II's customers uniquely high functionality. Apple thus avoided unnecessary investments, benefited from its vendors' R&D and technical expertise kept itself flexible to adopt new technologies as they became available and leveraged its limited capital resources to a huge extent. Operating with an extremely flat organization, Apple enjoyed three times the capital turnover and the highest market value versus fixed investment ratio among major computer producers throughout the 1980s.
How can managers combine core competency concepts and strategic outsourcing for maximum effectiveness? To achieve benefits like Nike's or Apple's requires careful attention to several difficult issues, each of which we discuss in turn:
1. What exactly is a "core competency"? Unfortunately, most of the literature on this subject is tautological - "core" equals "key" or "critical" or "fundamental". How can managers analytically select and develop the core competencies that will provide the firm's uniqueness, competitive edge and basis of value creation for the future?
2. Granting that the competencies defining the firm and its essential reasons for existence should be kept in - house should all else be outsourced? In most cases, common sense and theory suggest a clear "no". How then can managers determine strategically rather than in a short-term or ad hoc fashion, which activities to maintain internally and which to outsources?
Two examples from our studies of Australian and US companies illustrate our point:
- Nike, Inc. is the largest supplier of athletic shoes in the world. Yet it outsources 100 percent of its shoe production and manufactures only key technical components of its Nike Air System. Athletic footwear is technology and fashion intensive, requiring high flexibility at both the production and marketing levels. Nike creates maximum value by concentrating on preproduction (research and development) and post-production activities (marketing, distribution and sales), linked together by perhaps the best marketing information system in the industry.
Using a carefully developed, on-site "expatriate" program to coordinate its foreign based suppliers, Nike even outsourced the advertising component of its marketing program to Wieden and Kennedy, whose creative efforts drove Nike to the top of the product recognition scale. Nike grew at a compounded 20 percent growth rate and earned a 31 percent ROE for its shareholders through most of the past decade.
- Knowing it could not be the best at making chips, boxes, monitors, cables, keybroads and the like for its explosively successful Apple II, Apple Computer outsourced 70 percent of its manufacturing costs and components. Instead of building internal bureaucracies where it had no unique skills, Apple outsourced critical items like design (to Frogdesign), printers (to Tokyo Electric), and even key elements of marketing (to Regis McKenna, which achieved a "$100 million image" for Apple when it had only a few employees and about $1 million to spend).
Apple focused its internal resources on its own Apples DOS (disk operating system) and the supporting macro software to give Apple products their unique look and feel. Its open architecture policy stimulated independent developers to write the much-needed software that gave the Apple II's customers uniquely high functionality. Apple thus avoided unnecessary investments, benefited from its vendors' R&D and technical expertise kept itself flexible to adopt new technologies as they became available and leveraged its limited capital resources to a huge extent. Operating with an extremely flat organization, Apple enjoyed three times the capital turnover and the highest market value versus fixed investment ratio among major computer producers throughout the 1980s.
How can managers combine core competency concepts and strategic outsourcing for maximum effectiveness? To achieve benefits like Nike's or Apple's requires careful attention to several difficult issues, each of which we discuss in turn:
1. What exactly is a "core competency"? Unfortunately, most of the literature on this subject is tautological - "core" equals "key" or "critical" or "fundamental". How can managers analytically select and develop the core competencies that will provide the firm's uniqueness, competitive edge and basis of value creation for the future?
2. Granting that the competencies defining the firm and its essential reasons for existence should be kept in - house should all else be outsourced? In most cases, common sense and theory suggest a clear "no". How then can managers determine strategically rather than in a short-term or ad hoc fashion, which activities to maintain internally and which to outsources?
