Strategic Sourcing: From Periphery to the Core

The Idea in Brief

Almost nothing a company does can't be outsourced anymore--even functions as critical as engineering, marketing, and manufacturing. Yet only 6% of the companies that outsource are satisfied with the practice. Why? Too many managers make outsourcing decisions piecemeal. They focus on incremental cost improvements rather than taking a strategic view of capability sourcing.

With strategic capability sourcing, you don't assume that your company's most vital capabilities must remain in-house. Credit-card giant American Express, for example, outsourced its crucial transaction processing function when it no longer provided proprietary advantage.

To source capabilities strategically, you must also decide which partners can best perform which capabilities. Rather than selecting suppliers based only on cost, for example, Chrysler consolidated component purchases with several suppliers it believed could sustain competitive costs, high quality, and efficient delivery.

And if your company's the best at a particular capability, consider making it an entirely new business--as UPS does by providing logistics management to other companies.

The right capability sourcing strategy can translate into industry dominance: Strategic outsourcer 7-Eleven consistently beats other retailers in same-store merchandise growth, revenue per employee, and inventory turn rate.

The Idea in Practice

To develop your capability sourcing strategy, apply these steps:

Identify your business's "core of the core". These are activities your company does better and cheaper than rivals. For 7-Eleven, they are product ordering and in-store merchandising--the pricing, positioning, and promotion of ready-to-eat food, gasoline, and sundries for car-driving consumers.

Decide what to outsource. Consider two factors:

Proprietary value: A capability has high proprietary value if your company executes it in a way that generates measurably more value than competitors could, and if your company would suffer major strategic damage if rivals imitated the capability.

Commonality: A capability has high commonality if outside suppliers can achieve scale or other advantages by providing it to many others in your industry.

Your strongest candidates for outsourcing? Capabilities that have low proprietary value and high commonality.

7-Eleven decided to outsource human resources, finance, IT management, logistics, distribution, product development, and packaging to outside partners with greater expertise and scale in these capabilities.

Decide what to insource. For capabilities your company excels at, consider "insourcing"--turning them into new businesses by performing this function for other companies. FedEx positioned itself at the leading edge of the $225 billion logistics-outsourcing industry by planning and managing inbound transportation for more than 1,500 product suppliers into 26 General Motors power train facilities.

Decide how to outsource. Compare each of your outsource-worthy capabilities' cost and quality to those of top-performing rivals or suppliers. Use these comparisons to define outsourcing relationships:

Outsource high-cost and unnecessarily high-quality capabilities to low-cost providers--even if that means some reduction in quality.
Outsource high-cost, low-quality capabilities to partners who can reduce costs and boost quality.

Also structure each outsourcing partnership differently, depending on each capability's importance to your company's competitive distinctiveness.

7-Eleven has outsourced all routine capabilities (such as benefits administration and accounts payable) to providers that can consistently fulfill cost and quality requirements. For more strategic capabilities, it makes more complex arrangements. For instance, the firm outsources gasoline distribution to Citgo but maintains proprietary control over gas pricing and promotion--activities that could differentiate its stores if done well.

Hong Kong-based trading company Li & Fung has based its entire business on smart sourcing. Rather than owning any assets, Li & Fung leverages the assets of other businesses operating at many levels of its value chain, capturing value for itself as a knowledge broker. For instance, the company owns none of the facilities involved in processing raw material into the finished goods it supplies to European garment retailers and designers. However, it has privileged access to some 7,500 firms around the world that possess specialized production and distribution capabilities. The hugely successful Li & Fung uses its knowledge of the apparel market to leverage those companies' assets, partnering with whichever companies are most suited to making whatever goods its customers demand.

Building Deep Supplier Relationships

Harvard Business Review

December 2004

by Jeffrey K. Liker and Thomas Y. Choi

This article sheds additional light on how to choose your outsourcing partners and forge the most mutually beneficial relationships with them. The smartest outsourcers--Toyota and Honda among them--have built great supplier relationships by consistently following six steps: They understand how their suppliers work, turn supplier rivalry into opportunity, and monitor vendors closely. They also develop those vendors' capabilities, share information intensively but selectively, and help their vendors continually improve their processes.

The outcome? Supplier harmony--networks of vendors that learn, improve, and prosper in sync with their parent companies. During the past 10 years, Toyota and Honda have struck successful partnerships with some of the same suppliers that are at odds with the U.S. Big Three and created effective keiretsu across Canada, the United States, and Mexico.

The Idea in Brief

The Idea in Practice

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