Businesses increasingly outsource activities and services to flex up and down throughout business cycles. It’s a key lever for managing the downturn and uncertainty we’re facing now. Additionally, there is a once in a decade softness in most labour markets that buoyant businesses can capitalise on.
Some businesses seriously overshot on cutting contractor costs in the Global Financial Crisis. To remain competitive and nimble for the long-term, businesses need to think strategically about where to use contractors in the mid-term and run immediate cost reduction programs accordingly.
In this first part of our five-part series, we explore the first component – Strategy. Setting up for success is half the battle if we get it right... and all the battle if we get it wrong.
Strategy
The long-term strategic contracting decisions develop through answering progressively tighter questions:
- For a given area, should we insource or outsource?
- For that area, which contractor (or contractors) should we use?
- For that contractor, how should we contract with them?
Insource or outsource?
The insource/outsource decision is the first and most important decision. Getting it wrong can lock us into the wrong position for years, even decades. Because it’s so important, it’s easy to overinvest in overanalysis. That’s why, paradoxically, a focussed approach balancing a small number of key factors succeeds by building a directionally right and, more importantly, understandable and explainable assessment.
These factors balance internal and external, and near and long term, considerations across four fundamental types:
- The intrinsic nature of the area itself and the activities in it
- The risk to our business and our people if it’s done poorly
- The structure of the market for the required services
- The relative cost implications of our decision
For example, the more specialised the intrinsic skills needed to perform the required activities, the more likely it is that outsourcing is the better choice. Incidentally, we say “likely” because we see the insource/outsource decision as a spectrum. All the factors lining up one way is a very hard assessment to ignore, but 75% one way is still a solid directional indication.
On the other hand, core functions we would normally want to keep in-house to control our risk. If we don’t actually do our core functions then what are we?
Shifting to the external view, is the market for the services competitive? And what would our total cost position be in the medium-term? Ideally, the market would be highly competitive, and full of contractors with a history of ongoing technical and cost improvement.
In principle we recommend forcing a binary choice (high/low, yes/no) on these factors – otherwise it’s too easy to sit on the fence and avoid a decision.
Contractor selection and preparing for consequences
Now that we’ve decided on outsourcing, we need to work through some potential long-term consequences.
- Are there aspects of the activity that are more specialised than others?
Then it makes sense to carve out the specialised niche and contract that separately.
- Would we be exposed if our contractor suddenly went out of business?
Sometimes we can just step in and take over the activity even if only temporarily, or it’s easy to find a replacement at short notice. In this case single-sourcing is likely to be best. If not, we’ll need a panel of contractors as self-protection, even if that’s not the most efficient solution day-to-day.
- Will we be able to manage the activity effectively in the long term?
For example, if we’re at risk of losing the knowledge required to manage the activity closely then working with a panel makes sense to ensure there’s competitive tension.
If we need to have multiple contractors, we may even need to create a contractor. That might mean subsidising a non-local one. For example, we have seen clients pay travel and accommodation costs for several years to support a contractor while they establish a local office.
The right panel size is a delicate balancing act. Every extra contractor means more management and an extra mouth to feed. Too many and we incur extra costs and lose volume discounts; too few and we incur higher risk and create dependency.
Contracting and the language of mutual success
We need to be clear both with ourselves and with our contractors on what we each need and want before we commit. If we can’t both succeed the relationship is sure to fail.
There are key commercial terms we can’t just leave to the legal eagles. One common gap is performance management. Outsourcing doesn’t mean performance management stops! For example, if I make myself a bad coffee I throw it out and try again. If my local café gives me a bad coffee, I give them a chance to fix it... and if they can’t I change cafés.
Managing contractor performance can be harder than managing internal performance. We need to be crystal clear on how we measure performance, how we review performance, and how we reward (or penalise) performance.
The contract needs to support effective performance management, and a continuous improvement mindset. If the contract doesn’t support these critical commercial processes, we’re going to have a very hard time implementing them after the fact.
Review and revise for ongoing success
It’s important to review strategy on a regular basis because the world is in constant motion. For example, one of our clients outsourced processing plant maintenance at an integrated mine due to market conditions and ongoing performance issues, saving several million dollars in annual spend as well as improving quality. 10 years later, market circumstances had changed, the incumbent contractor had not improved with the times, and our client was able to save over $5m per annum by distributing some maintenance to other contractors and insourcing the rest.
In the next part of our blog series, we'll explore how medium-term tactical decisions will help set us up for contractor management success.
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