Why well-managed outsourcing can energize a company

Energy companies are facing a changing, challenging environment that requires them to manage their operations in the most cost-efficient and flexible manner. Outsourcing is one of the management strategies that can help, but only if it is designed, implemented and managed effectively, as Richard K. Ostrander and Jagdish Dalal explain.

There are a number of strategic concerns that demand the focused attention of power company managers and the capital resources of their companies. Deregulation in particular has brought about many changes, but in doing so it has removed the assurance that shareholders would make money. One has to look no further than the proposed KKR led buy-out of TXU to see the impact that social considerations now have on businesses. These changes, coupled with the significant rise in expected demand for energy over the next two decades, have created new challenges for management.

The question is whether companies are organized to respond to what the market is demanding; are they capable of making ‘strategy on the run’ decisions and committing the huge amounts of capital that are inherent in this industry? For many the answer is no; burdened by their silo-like organizational structures, patched infrastructure systems and monopolistic-centric support services, these companies find it difficult to focus their energies and resources on the business. So what can be done to enable the dramatic changes that are necessary and get results quickly?

Outsourcing provides a new business model for power and energy companies; an inclusive model in which the company uses its relationships with outside resources to enhance its ability to change and react quickly in a highly dynamic marketplace. In essence, you gain knowledge and competencies that support your own core strengths – thus improving performance, profitability and shareholder value.

Outsourcing enhances shareholder value
By outsourcing, we do not mean just the parceling out of discrete activities such as payroll and building services. Instead, what we call business process outsourcing (BPO) is the long-term contracting of some or all of a company’s business processes to an outside service provider to help build shareholder value. Generally, BPO refers to the outsourcing of business processes such as payroll, HR or facilities management, and information technology outsourcing (ITO) refers to the outsourcing of information technology functions such as infrastructure or applications management.

Outsourcing isn’t just reactive; it creates a new business model – a boundary-less corporation in which the company pursues its core strengths (its network, its brand, its intellectual capital) to serve its customers while looking to outside partners to provide the competencies and services that allow it to do what it does best. Through outsourcing, a company becomes a more inclusive entity that benefits from the collective knowledge of the business of outside service providers.

Outsourcing benefits are both tactical and strategic
An outsourcing strategy creates expanded flexibility and increased strength. Competing becomes easier for the corporation because non-core investments are shared among multiple businesses, and a more professional management approach to non-core activities adds to the returns. In addition, the company has access to the intellectual capital of the outsourcing partner thereby expanding the total pool of intellectual capital the company can leverage. The corporation can also improve its market position by leveraging the outsourcer’s global capacities. Every one of these advantages is a competitive advantage.

There a number of benefits companies can obtain from outsourcing. Business process outsourcing is both a catalyst and agent for positive change in today’s competitive environment. Like the wheels of a bicycle working in tandem, BPO creates two spheres – core functions under immediate management control, and non-core functions provided by the outsourcer who is responsible and charged with meeting ‘stretch’ performance measures. An outsourcing contract itself creates change. It can serve as a catalyst to the whole organization (not just the non-core elements), providing needed changes in people, culture, values, beliefs and more. This was the objective of one of the largest utilities that outsourced all of its back office functions. The company also benefited from a renewed strategic focus.

A critical element in a company’s success is its sustained ability to concentrate energy, investment, intellectual capital and management attention on creating and executing strategies for the future. Management must have the time and flexibility to address a constantly changing business environment. An integrated outsourcing alliance frees resources within the company to do just this.

The expectation of cost savings remains a significant driver for outsourcing. This is achieved over a period of time when the outsourcer applies its expertise in streamlining the business function and processes. Reduction in costs is generally comparable when you consider a baseline of volume and service delivery metric. Importantly, these savings can then be used to drive strategic investment.

Corporations have looked to outsourcers to provide core competencies in areas the corporations lacked expertise (or where it would have been too expensive to develop the expertise). In some cases, a corporation may find that it has a strategic strength in a process that can be used to drive new revenue; one utility company, for example, leveraged its expertise and processes in construction and maintenance to create an outsourcing business that provides turnkey engineering, construction, procurement and maintenance services to commercial and industrial customers, electric cooperatives and municipal utilities.

Another benefit is conversion of fixed costs into variable costs. Fixed baseline costs are high in the power industry. Outsourcing enables management to turn meaningful components of fixed cost into variable cost by creating a contractual relationship in which volume and pricing sensitivities work in favor of the corporation. Within limits, this creates a ‘pay-as-you-go’ basis that is important for companies experiencing high growth or decline in their business volume. By paying for the resources as they are used, the companies do not have to make any of the ‘step function’ investments that are generally required.

Selecting the right process for outsourcing is critical
Long-term corporate success, as measured by the market, depends on two factors: the company’s ability to generate cash flow from current operations, and the company’s perceived potential to generate future growth in shareholder value. A particularly important element in creating shareholder value is intellectual capital. Companies succeed or fail depending on the amount and quality of their intellectual capital and their ability to leverage it. If a company diffuses part of its intellectual capital into managing non-core functions, that much less will be available to devote to improving the performance of its core businesses. Though in theory most shared services processes can be considered for outsourcing, some processes are better suited than others. Experience has shown that processes that are stable and robust in their definition, and have less business dependence, are often the best candidates for outsourcing. They are less tightly integrated with other business processes and require less management interaction. Regardless of the processes being considered, what is crucial is that there be a thorough understanding and agreement on the objectives for the outsourcing engagement and that a total process map be designed and interactions defined before going forward. Figure 1 is one of the tools utilized by JDalal Associates’ methodology for creating appropriate outsourcing strategy for a business.

There are varying degrees of examples of process outsourcing in the power and energy industry, including revenue management (billing/receivables), finance and accounting, IT, supply chain, human resources, asset management, customer care, marketing, line maintenance, facilities management, engineering and construction. Outsourcing for some of these processes is still evolving while other processes are commonplace. We believe that when you look at the value-to-risk ratio (indicated by the size of the circle in Figure 2), there is good benefit potential for outsourcing many of these processes ¬– even when considering that the level of maturity may not be commonplace.

Well-planned risk management is a key success factor in outsourcing
Proving a realistic business case and having the necessary experience are two primary hurdles in getting outsourcing off the ground; most companies believe they are more adept now than in the past at handling employee opposition in a manner consistent with a corporation’s culture. Detractors of outsourcing generally point to the fact that since the responsibility and control have shifted to an outsourcer, businesses can effectively lose control over the work process and output. Studies have shown that processes that were not stable to begin with, coupled with a poorly executed outsourcing arrangement, can lead to this lack of control. In a large majority of the outsourced agreements, however, outsourcing has actually led to improved controls and performance. A good outsourcing contract will ensure a set of metrics and periodic inspection of processes. These generally do not exist in most businesses when the process is being internally managed (i.e. ‘monopolistically’).

The best of times
As Dickens said of another period, “it was the best of times, it was the worst of times”. These are the best of times for those companies that have created a flexible and inclusive business that consists of partners whose knowledge capital contributes to achieving the highest results for shareholders. They are the worst of times for companies that insist on managing all processes and functions themselves, thereby diluting management focus, investment options and operational performance-all of which results in less, not greater shareholder value.

Corporations that understand the strategic need to create a boundary-free model of business and the critical role outsourcing plays in reshaping the organization, as well as the importance of focusing on what the company does best, will make the most of its opportunities. Such an organization will succeed in building a collaborative partnership with its outsourcing suppliers resulting in a long-term continuum of rising productivity, competitive advantage, growth and shareholder value creation.