Tuesday, July 22, 2008
Executive
Every executive knows what a high-stakes game M&A talks can become. But even before the formal negotiations start, a one-on-one conversation that plants the seed of a deal or a back-of-the-envelope sketch of the business case for it may present deal makers with conflicts of interest and strategic vulnerabilities. Who would get what value from a deal? Who would govern the new entity? What legal boundaries must prospective partners be careful not to cross? Moreover, deal makers also know that failing to close a transaction can turn today's potential partner into tomorrow's better-informed competitor.
Knowledge Management Ideas
Outsourcing deals have come a long way from the simple sourcing contracts that were once negotiated by the IT services department. Today's outsourcing agreements are huge, complex, and far more strategic in their goals—and in many ways, have come to resemble mergers, joint ventures, and divestitures in the way they shape what businesses are part of a company's portfolio. Many outsourcing deals are tantamount to strategic divestitures and joint ventures.
When companies first started thinking about farming out nonstrategic functions—such as payroll, IT maintenance, facilities management, and logistics—their goal was to reduce costs. Today, however, these corporations regularly contemplate outsourcing core operations to third-party specialists in order to improve operational performance. Many such deals are big and strategic enough to qualify as "bet the company" arrangements involving a complex mix of people, processes, and assets.
When outsourcing deals were smaller and limited to noncore processes, executives could treat the transactions as fairly standardized, the strategic implications as limited, and the risks as well understood. Today, the executive team no longer has the luxury of easy decision making, and not merely because the average size of deals has grown. How a company develops its outsourcing relationships directly affects its core strategic planning: the shape and boundaries of its corporate portfolio and the focus of its executives. Certain guidelines can increase the odds of outsourcing success. Firstly, we need to clarify deal strategy from the beginning. The strategic objective of an outsourcing deal must be explicit from the outset. The goal of some deals is simply to have a low-value job done more cheaply, to make the cost base more variable, or to leverage a provider's skills, expertise, technology, or processes. Many of today's arrangements go further, aspiring to improve operational performance and service levels or to free managers to focus on higher-value-added activities.
Once the objective of the deal is clear, the best way to structure it becomes clearer too. If the outsourced function or process is noncore, for example, and if cost cutting is the primary goal, then often an outright divestiture makes sense. On the other hand, if the goal is to improve the performance of a strategically important function or process, then managers should consider structuring the deal like a joint venture.
Secondly, we need to assemble the right team. Companies typically rely on teams with a heavy concentration of IT managers to execute and oversee outsourcing relationships. Historically, IT functions were early targets for outsourcing, so these managers developed expertise in this area. Today's complex arrangements, however, require a deal-making team with a wide range of skills that go well beyond those of most IT experts.
Thirdly, negotiations are to be done internally and then externally. A successful outsourcing deal involves both internal and external negotiations, which are often more complex than M&A talks, in part because many more internal stakeholders are involved.
Fourthly, transparency needs to be ensured. Increasingly, the initial proposal is used as the baseline for the asset and labor pool that the outsourcer will handle, and vendors are not permitted to conduct their own due diligence before signing the deal.
Fifthly, No matter how well structured a deal is, conditions can change to upset the value equation. These factors include management turnover, poor service delivery, major increases or decreases in business volume, and corporate activity such as mergers or acquisitions. M&A practitioners have devised a number of safeguards that companies can apply to outsourcing deals to protect their interests.
Finally, a plan for transition and delivery is needed. As M&A practitioners know, effective post-deal management can mean the difference between success and failure. Yet this aspect of outsourcing is often given short shrift as the deal team becomes focused on the near-term objectives of evaluating and negotiating the deal. Before signing a contract, a company and its outsourcing vendor must clearly structure the new management organization, define the roles and responsibilities of each party, design and install reporting and control mechanisms, and plan hiring for new roles.
Uncertainty during an outsourcing transition also increases the risk of staff turnover, so companies should design a retention program that targets and retains key personnel.
When companies first started thinking about farming out nonstrategic functions—such as payroll, IT maintenance, facilities management, and logistics—their goal was to reduce costs. Today, however, these corporations regularly contemplate outsourcing core operations to third-party specialists in order to improve operational performance. Many such deals are big and strategic enough to qualify as "bet the company" arrangements involving a complex mix of people, processes, and assets.
When outsourcing deals were smaller and limited to noncore processes, executives could treat the transactions as fairly standardized, the strategic implications as limited, and the risks as well understood. Today, the executive team no longer has the luxury of easy decision making, and not merely because the average size of deals has grown. How a company develops its outsourcing relationships directly affects its core strategic planning: the shape and boundaries of its corporate portfolio and the focus of its executives. Certain guidelines can increase the odds of outsourcing success. Firstly, we need to clarify deal strategy from the beginning. The strategic objective of an outsourcing deal must be explicit from the outset. The goal of some deals is simply to have a low-value job done more cheaply, to make the cost base more variable, or to leverage a provider's skills, expertise, technology, or processes. Many of today's arrangements go further, aspiring to improve operational performance and service levels or to free managers to focus on higher-value-added activities.
Once the objective of the deal is clear, the best way to structure it becomes clearer too. If the outsourced function or process is noncore, for example, and if cost cutting is the primary goal, then often an outright divestiture makes sense. On the other hand, if the goal is to improve the performance of a strategically important function or process, then managers should consider structuring the deal like a joint venture.
Secondly, we need to assemble the right team. Companies typically rely on teams with a heavy concentration of IT managers to execute and oversee outsourcing relationships. Historically, IT functions were early targets for outsourcing, so these managers developed expertise in this area. Today's complex arrangements, however, require a deal-making team with a wide range of skills that go well beyond those of most IT experts.
Thirdly, negotiations are to be done internally and then externally. A successful outsourcing deal involves both internal and external negotiations, which are often more complex than M&A talks, in part because many more internal stakeholders are involved.
Fourthly, transparency needs to be ensured. Increasingly, the initial proposal is used as the baseline for the asset and labor pool that the outsourcer will handle, and vendors are not permitted to conduct their own due diligence before signing the deal.
Fifthly, No matter how well structured a deal is, conditions can change to upset the value equation. These factors include management turnover, poor service delivery, major increases or decreases in business volume, and corporate activity such as mergers or acquisitions. M&A practitioners have devised a number of safeguards that companies can apply to outsourcing deals to protect their interests.
Finally, a plan for transition and delivery is needed. As M&A practitioners know, effective post-deal management can mean the difference between success and failure. Yet this aspect of outsourcing is often given short shrift as the deal team becomes focused on the near-term objectives of evaluating and negotiating the deal. Before signing a contract, a company and its outsourcing vendor must clearly structure the new management organization, define the roles and responsibilities of each party, design and install reporting and control mechanisms, and plan hiring for new roles.
Uncertainty during an outsourcing transition also increases the risk of staff turnover, so companies should design a retention program that targets and retains key personnel.
Q1) According to the caselet, a successful outsourcing deal involves both internal and external negotiations, which are often more complex than M&A talks, in part because many more internal stakeholders are involved. Explain.
Q2) According to the caselet, if the goal is to improve the performance of a strategically important function or process, managers should consider structuring the deal like a joint venture. Briefly explain how joint venture arrangement is advisable in this case
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