KUHN CAPITAL Wednesday, December 13, 2017
Dispatches from the front

Manufacturing Information
(7/15/2004)

In the Beginning
American manufacturers are our heroes. Those left standing after the great and first global outsourcing wave starting in the Fifties with cheap Sony Japanese radios and Honda motorscooters are now world-class competitors who have figured out how to use cheaper outsourced labor like their offshore competitors. Or they have cracked the code on exploiting their local presence for competitive advantage. Said another way, they have refined their business models to offer value-add specialty products and related services that protect them from the margin-crushing commodization that China and other emerging economies routinely apply to bulk merchandise.

But what’s happening now in business process outsourcing (BPO) presents a 21st Century challenge not only to information and services vendors -- our traditional client base -- but to US manufacturers as well. BPO is the second great outsourcing wave, and while today it may be most visibly remaking American service industries, we believe it will also redefine the ground rules of successful domestic manufacturing as radically as the first wave did.

What does BPO mean to manufacturers, and how can they use this powerful new competitive weapon to their advantage? To answer these questions, we start with a look at the evolution of BPO.

A Mercifully Brief History of BPO
In the Seventies, IT outsource pioneers EDS and IBM targeted mostly service industries for facilities management services (FM), an arrangement in which the outsourcer physically took over the computing facility of the client and ran it as a cost center. Then they cut the physical cord: EDS, IBM and others began using their own, more efficient computing facilities, and shared them with smaller clients who hadn’t ever needed to own elaborate physical computing plants anyway. Call this service “time-sharing”.

In time, processing services became increasingly specialized: ADP made available payroll administration. EDS and IBM offered claims processing services to regional Blue Cross carriers. (Interestingly, by so doing, they triggered consolidation among Blue Cross operators who concluded that since one of their most costly functions had been poured into a shared processing center, they could now also gain marketing and other economies of scale simply by merging.)

Fast forward to the mid-Eighties, when the first overseas Indian outsourcers emerged. They initially offered cheap data transcription and software coding services, gradually followed in the Nineties by processing “platforms”, or hardware/software systems maintained at overseas sites to deliver such services as credit card processing, and to support reps delivering customer service functions and HR benefit administration. Think of this rising sophistication as a drive toward more complete end-user solutions with their attendant higher margins.

All the preceding outsourced functions can be characterized as “ITO” or information technology outsourcing. We define ITO as the external supply of technical services and processing platforms that fulfill or support a portion of a user’s departmental functions. Department middle management remains with the user. But starting in 2000, ITO began evolving into a higher value-add proposition, BPO. Business process outsourcing is the external supply of all functions in a department. Often, only the department head remains at the user. And his job definition has changed to managing the outsource relationship and providing strategic leadership. Examples of where BPO is growing most rapidly today are in the HR and customer relations functions.

What are the cost and quality factors behind such changes? First it was greater outsourced technical and then business process expertise provided by domestic vendors. Second came cheap and increasingly capable overseas technical labor. Another accelerant is the fact that -- in contrast to the manufacture of goods -- few governmental obstacles (e.g., duties, regulations) impede the flow of information. But finally, unique to remotely offered services, has been the breathtaking decline in communications costs. The Internet goosed demand for cheap service delivery from overseas starting in about 2000, but its cost savings are far from over: VOIP threatens to replace already cheap overseas communications with a nearly costless alternative.

Making BPO Your Friend
All this means that BPO is here to stay and while its market penetration may have so far been greatest among service vendors, manufacturers are next up. BPO poses the question writ large: what are the “core” functions of a company that define how its adds value when many of its products and currently internal service functions are best put in the hands of outsourcing partners? See next month’s Part II for ideas on how to decide what to outsource, how to manage outsourcers, and how to redefine what is convincingly a company's “core” activity.

Ryan Kuhn


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