Sunday, February 18, 2007

Outsource Everything But Company's Core Competencies.

There's a new calculation taking hold in corporate suites: Identify a company's core competencies. Outsource everything else.

Businesses once agonized over the risk of compromising quality and customer service by moving internal functions like software programming and call centers to outside contractors. Today such moves are commonplace, and the vendors more competent. Cost-cutting executives are combing their operations for new categories of work to farm out.

The trend is likely to accelerate in coming years, even as critics complain the practice is taking a toll on the American workforce.

"Companies are extending the logic of outsourcing," said Joseph B. Fuller , co founder and chief executive of Monitor Group, a global consulting firm in Cambridge. "Over time, if you assume they're going to be under permanent, unrelenting pressure to improve their financial performance, more and more of their time, effort, and discretionary investment will go into activities that are core to their strategy. They'll look for third-party vendors for other activities."

Vendors have sprung up from Boston to Bangalore to Belarus to take the handoff of business processes, and the industry is attracting private equity. Last week, Charlestown's Keane Inc., a pioneer in an earlier era of domestic outsourcing, agreed to be acquired for $854 million by a smaller California company with the bulk of its employees in India. The transaction was financed by Citigroup Venture Capital International, which sees the pace of outsourcing picking up.

In its first incarnation, outsourcing revolved around services like building maintenance and food preparation. Then companies began casting off business processes such as payroll and claims management. These were data-intensive operations that, in the age of the Internet, could be sent not only down the street but outside the country. In the latest wave of outsourcing, businesses are parceling out a raft of activities that was traditionally performed in-house.

Pharmaceutical giant Wyeth has contracted with Accenture for offshore clinical research. Consumer product companies like Procter & Gamble Co., Unilever NV , and Kimberly-Clark Corp. have sent parts of their product development to outside parties. Dozens of companies have shut down their human resources departments and turned over health benefits administration to vendors like Towers Perrin, EDS Corp., and Hewitt Associates Inc., while others, including automaker General Motors Corp., have even outsourced some internal financial auditing functions.

Not everything is going out the door, though. CEOs will hold on to activities they see as defining their businesses. "Liz Claiborne's not going to give up developing the next generation of women's apparel," Fuller said, "and GE's going to develop the next MRI or jet engine."

Still, the advance of outsourcing, and its spread to new arenas, will have vast implications for the economy. In the most benign projections, Fuller and others believe the trend will spawn a flowering of business creation and entrepreneurship to handle all the operations companies are contracting out. But there are plenty of people, in technology and politics, who see a grimmer scenario unfolding.

"Over the years, Americans have been told, rightfully, they would have to move up the ladder on education," said Norman Matloff , computer science professor at the University of California at Davis. "The problem is there's nowhere to move up the ladder anymore. Once you have the ability to offshore intellectual activities such as software development and financial auditing, education isn't going to help."

Among the factors driving the trend are the globalization of business and a wealth of cheap technology talent in emerging countries like India and China, which have younger populations and graduate far more engineers than the United States, said Peter A. Allen , partner and managing director at TPI, a Houston consulting firm that advises companies on outsourcing. For efficiency-minded executives, Allen said, the value proposition of outsourcing is "moving from just decreasing costs to increasing capacity, speed to market, and quality."

But the parceling out is accompanied by pain that does not always show up in economic statistics. Despite government-funded retraining programs that have sprouted across the country, workers displaced by outsourcing frequently end up in lower-paying jobs where their core skills aren't utilized, said Matloff, citing laid-off software engineers in Silicon Valley who have become real estate appraisers.

"You're going to see more and more of that," he said.
"This may have a positive impact on the gross domestic product. The question is to whom is this positive impact going to go. It will be a boon to top executives and stockholders, but not to the US middle class."
Fuller, however, sees outsourcing as part of the same evolution that expanded the economy in earlier generations, even as it idled agricultural and manufacturing workers.

"This type of activity has some episodic negative effects for some people," he conceded. "And it creates lots of opportunity for new business creation. People have been scared of automation and economic dynamism for hundreds of years. But the shift to higher-value activity has always advantaged the US."

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