Leveling the playing field through adoption of IT and Non-Core Outsourcing Part 2

There is and has been a lot of talk about competitive of nations because of lower wages. In my mind, this is an over used reason for losing competitiveness. You see, cost is only one element of the total cost of doing business. In fact, it is, in many cases, not the largest contributor of cost – especially when we are talking about higher value added activities. Let’s take a look at some simple comparisons, say for a small factory producing labor intensive products:

Cost Element	Low cost	High cost
Materials	40	40
Labor	10	30
Overheads	30	40
Profit	20	-10

In a global environment, material cost differences are marginal as sourcing is done worldwide. Overhead, such as utility cost, management cost, equipment depreciation and administration cost is generally not very different around the world, with the exception of higher cost of people. If we look at the simulation table (not totally accurate, but sufficient to illustrate the point), high cost countries transfer their operations to lower cost countries and are able to generate profits out of products that actually lose money in their home countries. This coupled with incentives such as tax free status, makes it extremely attractive to make the move and not exit the business.

Let’s take a second scenario where higher value is added to the product. Here, labor content is much lower, maybe due to higher levels of automation or intellectual property. In place of this, overhead cost is higher due to more complex supply chains, technical services and administrative overheads. In this scenario, productivity is exchanged from physical labor to higher efficiency of moving information. Companies tend to be better positioned to overcome this via ICT infrastructure rather than continually moving to lower cost regions. The simple simulation below show how this works. Moving to a lower country to benefit from lower labor cost versus investing in lowering overhead costs through ICT show a much less compelling reason to move and manage remotely.

Cost Element	Low cost	High cost
Materials	40	40
Labor	5	15
Overheads	40	20
Profit	15	25

The message here is that overhead costs (compared to physical labor cost) can more easily be reduced via better people and using productivity improvement systems. This is the reason why companies from high cost countries have and are still investing heavily and rapidly to improve their overhead productivity via global systems optimization and only outsource their labor intensive operations to lower cost areas.

In general, companies in lower cost countries tend to be lulled into complacency by their temporary superior cost structures and consider investing in productivity enhancement systems as an extra expense. This is a potentially catastrophic paradigm. Global companies will gradually become integrated around the world and benefit from economies of scale to eventually become even more cost competitive than small companies operating in very low cost regions. These will be gradually reduced to play only in support roles and filling up gaps.

One reason for this is the relatively high cost of installing effective systems, which large companies can afford while smaller ones struggle. The key then is to offer cost effective solutions that may not function as well as the established systems but serve to kick start the smaller companies along the adoption curve and start the evolution process towards higher overhead productivity.

Leveling the playing field through adoption of IT and Non-Core Outsourcing

Why do some companies with seemingly superior technologies and competencies fail to grow, while others, whom, on the outside, seem fairly average, find great success? As a business consultant and management coach, this question has bugged and frustrated me in the course of my work. As a consultant, the greatest frustration is to see companies, whom we consider as having great potential, simply do not do well or fail, not because of the lack of opportunities, but their failure to take advantage of them in a way that their capabilities can.

Over the years, I have come to the conclusion that such companies suffer from one common affliction – THE LACK OF FOCUS! However, the solution is easier said than done. Managers will come back to say “How can I possibly focus when I am so overloaded already. My bosses want everything at the same time and each day, more work appears on my desk. You should be glad I am still at work!”

A visit to a government office kind of illustrates the point. These are great entities to study in terms of creating improvement opportunities. It is normal to feel that when you visit one, that you are not “serviced” rather than being “administered”. You finally get what you want done, after being shuffled from one counter to the next. They do help you (at least the helpful ones) fill forms, get things chopped, make payments, and watch television while you wait and queue. Many times, you leave with the feeling as to why their managers do not spend more of their time assessing the obvious flaws in their processes and come up with better and more efficient ones.

You know what’s the problem here? It is the lack of focus, or rather the inability to focus on value improvement because of the great de-focusing element of just keeping the existing processes running. So year after year, the organization fights with a lumbering process which takes up most of their human resources, leaving them no time to look for improvements and creating better value. The tragedy is that after a while, nobody thinks about creating better value anymore, but exist just to deliver existing ones. This is why, organizations, especially government ones, improve at such a slow rate, if at all.

This is the same for many companies. Leaders pilot their companies to continue to defend their income stream by delivering whatever value they sell. This consumes them and most times, lull them into a sense of comfort that things are going ok and there is no need for change. They would like to grow and do new things, but do not know how to proceed and complain that they really do not have the necessary resources to make that happen anyway.

For these companies, I think they have forgotten the basic mantra for building profitable businesses. This is:

1. Physical assets + Markets = Opportunities 2. People + Expertise = Solutions 3. Opportunities + Solutions = Profits

Value creation occurs when leaders continually focus their efforts on finding market opportunities that they can develop effective solutions for. When the initial focus causes the desired results, the normal scenario is that a company will then slip into an activity phase that is more administrative in nature (to keep the business going) while losing sight on markets, opportunities and solutions. This in turn causes growth stagnation.

You can easily imagine a phase in a company’s growth where key innovative leaders begin to be bogged down with keeping track of accounts, administering people, putting out fires and so on. The list is endless. Under these circumstances, can you imagine the productivity drop in the company’s innovation and leadership engine?

Nowadays, the solution is to improve productivity through the rapid adoption of information technology and the resulting enabling of effective outsourcing of non-core activities. Companies that do this well will gain the benefits of being relieved from the heavy burden of administrating their businesses so that they can focus on their core value-creation competences.

Most important of these non-core activities are those we call the shared service functions. These are functions that provide key administrative services to the business entities. Key candidates among these activities can be found in HR administration, payroll, finance and customer support.

If the answer is so simple, why then, does adoption of this strategy take so long? Why do so many companies (especially smaller ones in particularly in lower cost Asia) resist or are neutral to this solution? The answer is a simple one, and. In my mind, this will create catastrophic effects on productivity and consequent cost competitiveness, making even low cost regions non-competitive against higher cost but more productive regions.

We will discuss these reasons in my next submission on this blog. Wait for it. Meantime, please send in your comments and thoughts.