Evolving Excellence

What's Left to Outsource?

I know, I know, yet another post on the foibles of outsourcing.  But maybe a little reinforcement will help peel back the nonsense that justifies outsourcing in the minds of many executives.

Outsourcing is primarily driven by a desire to achieve cost reductions, particularly with labor.  Traditional financial methods create this situation as they don't adequately account for nuances such as longer supply chains, training costs, turnover costs, and cash sitting as WIP on the high seas.  Just yesterday we told you about a couple studies that poke holes in the myth of cost reductions created by outsourcing.  So leave it to a bunch of traditional financial executives to try to squeeze even more imaginary cost savings out of outsourcing.

An article in Financial Executive, the magazine of Financial Executives International, attempts to describe "outsourcing's next wave."  You have to know the secret handshake to read the article on their website, but it has been reposted openly at E-Commerce Times.

Most companies have outsourced some portion of their business to lower costs and, over time, have achieved cost savings in the outsourced portion of the business. Unless your efforts in outsourcing to lower costs are unusually good, you are not gaining a sustainable competitive advantage, since your competitors are outsourcing just like you are.

Very true... that's what leads to globe-trotting, constantly in search of cheaper labor.  As more companies move into a region, supply constriction will increase labor cost.  And as pointed out above, the net advantage becomes nil as competitors also take advantage of those same reductions. So what should be done?  Why, find even more areas to outsource!  Of course!  At least that's what "Financial Executives International" believes you should do.

The next wave of outsourcing is about assessing all aspects of an organization's business activities to determine if and where there are opportunities to leverage outsourcers' capabilities, intellectual property, best practices, global infrastructure or geographic presence to access resources and capabilities around the globe that may not be available to your business today.

The ultimate goal, of course, is to outsource everything.  Some company, somewhere, can obviously do it cheaper.  And that's exactly what the "leading edge of outsourcing" are doing.  Citing just one example from the article:

On Jan. 15, 2007, Banco Pichincha, Ecuador's largest private bank, announced the strategic outsourcing of its core banking solution, followed by its information technology (IT) and business operational processes to Indian outsourcer Tata Consultancy Services (TCS). The deal is valued at US$140 million over five years.

Let's see...  Core banking... check.  IT processes... check.  Business operational processes... check.  What's left?  I guess a few tellers in some lonely buildings across the beautiful country of Ecuador.  Presumably those tellers can be outsourced to a temp agency and the buildings leased.  Voila!  A virtual company! 

So what value does the original company create?  Beats me.

The article goes on to describe the supposed benefits of transferring R&D, engineering, and product development to GSP's (global service providers).  Those benefits apparently include faster time-to-market and lower costs.  But who owns the intellectual property... or at least who possesses it and can transfer it... officially or not? 

All driven by financial systems that measure labor costs down to the penny, but in no way account for the value of experience, creativity, innovation, and knowledge.  I wonder what would happen if all the effort that went into setting up complex outsourcing arrangements was instead applied to reducing internal waste.

Maybe Ecuador's Banco Pichincha would actually create real value.

A Lesson for Outsourcing Lemmings

Last week we discussed some data that was a rude wakeup call for the layoff lemmings, and now we have similar data for the outsourcing lemmings.  The European Management Issues blog describes this in a post titled Exploding the Outsourcing Myth.

Europe's €4bn outsourcing industry is facing a mid-life crisis as organisations find that far from saving them money, outsourcing deals end up costing them far more than they would have done had the work been kept in-house. To make matters worse, research by Compass Management Consulting has also found that as many as two thirds of outsourcing contracts worth more than £20m start to fall apart before the end of their contract terms.

In many cases this is a result of over-zealous pricing by the outsourcing provider, and perhaps a lack of due diligence by the originating company.

The research, based on an analysis of 240 deals worth more than £20m, found that outsourcing providers were winning business by pricing contracts in such a way that they produced savings of up 18 per cent in the first year compared to the cost of doing the work in house. But costs quickly began to climb in subsequent years, reaching 36 per cent above comparable top quartile internal operations by year three.

Ouch!  A 36% negative operational variance sort of blows away perceived labor cost savings, even versus so-called high cost countries.  But think about the fundamentals of the operation being outsourced...

"Outsourcing providers are not that different from an in-house operation," he added. "Indeed, they often use the same people as the in-house operation after the deal is signed and outsourcers cannot perform alchemy on a business process and turn an operation into gold."  [said Simon Scarrott, Head of Business Development and Marketing at Compass.]

We told you about this exact situation earlier this month in a post titled A Missed Opportunity, with Boeing selling one of their divisions to Onex, who proceeded to turn it around and make money selling the subassemblies back to Boeing.  With rare exceptions outsourcing intermediate components, especially when the outsourcing partner uses the original employees and processes, is just a coverup for pathetic leadership.  If some time had been invested to improve those processes and better train the people, that profit and intellectual property could have remined in-house. 

"With those figures, it is easy to see why the claim that all outsourcing will save money is a myth," said Scarrott. "There can be sound strategic reasons for outsourcing but saving money over the long term is not one of them."

And we haven't even touched on long supply chains, information delays, and large WIP inventories floating on the risky high seas.  Was it still a good idea?

French Organic Offshoring

Ironically enough, and with no stereotyping or political punditry intended, the French have shown more backbone than their offshoring lemming comrades from the rest of the developed world in resisting the urge to move core business processes overseas.  That wall of Gallic stubbornness is starting to crumble, but still leave it to the French to do things just a little bit different.

The rest of the West typically find a supposedly complementary partner in India or China or Malaysia, get mesmerized by the lure of cheaper labor, and voila!  Traditional costs are magically cut, core technology and processes are transferred, and an overseas company becomes richer.

As this article from The Economic Times of India outlines, the French prefer a more organic approach.  Instead of finding an independent partner, they create their own offshore subsidiary or acquire a smaller firm.

A slew of French companies, including Altran, Atos Origin, Bull, Capgemini, GFI Informatique, Silicomp, Sopra Group, SQLI, Unilog (Logica CMG) and Valtech have opted to create their own offshore subsidiaries — many of them located in India.  A Forrester Research report points out that apart from Capgemini’s deal with Kanbay, most companies chasing inorganic strategy have ended up acquiring smaller firms — 200 employees being the maximum. In addition, French services firms do not see long distance partnerships a ‘viable option’, Forrester added.

If a company believes it must offshore, then there are definite advantages to remaining the boss and having full control over the offshore entity.  Intellectual property is protected, full costs become better understood, and contractual arrangements, particularly escape clauses if the desire to globe trot arises, become simple. 

And unless the company is trying to be closer to new customers in those foreign markets, it may soon realize that offshoring isn't all that it was cracked up to be.

Show Me Some Respect

No, I personally don't need any respect, but lean manufacturing does.  Respect for people that is.  The other pillar of lean that it seems everyone has a habit of forgetting or even ignoring.  Once you really start to learn about and experience that pillar you realize how real lean simply can't function without it... and descriptions of lean that focus purely on the waste and value aspects seem empty.

For example, take this article on lean in the construction industry that appeared just today.  We like reading about applications of lean to non-manufacturing organizations and industries, so such articles are usually exciting.  But let's take a closer look.

“Lean thinking is no more or less than eliminating waste from business processes and focusing on generating value,” he [Philip Kirby] told a workshop at the Ontario General Contractors Association’s 4th annual construction symposium.

The article goes on to describe "multi-pronged approaches" to eliminating waste, adding value, synchronizing activities, reconfiguring processes, and the like.  There are even some odd comments like "Lean thinking combines the best elements of craft production with mass production." 

But nothing about people.  Nothing about respect for people.  As our friend Mark Graban at the Lean Blog likes to say, this isn't lean, it's LAME... Lean as Misguidedly Executed.

Without respect for people, there can be no real lean.

A Lesson for Layoff Lemmings

Ford, Whirlpool, NCR... and hundreds of other companies:  you've laid off thousands of people, tens of thousands of years of knowledge, experience, and creativity.  As Dr. Phil likes to say, "how's that working for you?"  (for readers wondering why I know what Dr. Phil likes to say, click here)

An article in this month's The New Yorker titled It's the Workforce, Stupid may give you a clue to what your future holds.  You might have thought that layoffs would help your stock price and inancial performance, but perhaps you should think again.

Instead of rising sharply, the stock of companies that trim their workforces is likely to fall. A recent meta-study that surveyed research from several countries, covering thousands of layoff announcements, concluded that, on average, markets had “a significantly negative” reaction to job cuts.

Downsizing may make companies temporarily more productive, but the gains quickly erode, in part because of the predictably negative effect on morale. And numerous studies suggest that, despite the lower payroll costs, layoffs do not make firms more profitable; Wayne Cascio, a management professor at the University of Colorado at Denver, looked at more than three hundred firms that downsized in the nineteen-eighties and found that three years after the layoffs the companies’ returns on assets, costs, and profit margins had not improved.

But many CEO's are just in the job for the short-term gain, not long-term growth. 

The increasingly short-term nature of C.E.O.s’ jobs, along with the pressure on them to deliver results quickly, doesn’t help matters. The average C.E.O.’s tenure today is just six years, long enough to see the benefits of downsizing (like a lower payroll) but not long enough to suffer costs that may appear in the long term. And the lack of job security means executives have to worry more about what analysts are saying.

And even in the face of contradicting financial data, analysts still believe that layoffs work.  And they can apply pressure.

While the market as a whole may be skeptical about downsizing, many powerful people on the Street aren’t. Before Citigroup announced its layoffs, for instance, it had to contend with a chorus of critics—including its biggest shareholder—insisting that the company was a bloated giant that needed to get its costs under control. Even if the job cuts didn’t move the stock price, they were at least a sign to those critics that the company was listening.

And that leads to a lemming effect... companies and executives believing that layoffs... err, downsizing... is an effective business strategy.

On top of all this, a C.E.O. is likely to look to layoffs as a solution because that’s what almost everyone else does, too.  Downsizing has become less a response to disaster than a default business strategy, part of an inexorable drive to cut costs. That’s why Circuit City can proclaim, “Our associates are our greatest assets,” and then lay off veteran salespeople because they earn fifty-one cents an hour too much.

But the fact that the market as a whole no longer rewards news of layoffs may be a good sign for the future.

This isn’t to say that Wall Street has gone soft—it still cares about profits, not people. But investors seem to understand that fewer people doesn’t always mean more profits. The problem is that too many companies today define workers solely in terms of how much they cost, rather than how much value they create. This is understandable: after downsizing, it’s easier to measure a lower wage bill than it is to see the business the company isn’t getting because it has too few salesmen, or the new products it isn’t inventing because its R. & D. staff is too small. These lost opportunities may be hard to measure, but over time they can have a huge impact on corporate performance. Judging from its reaction to layoff announcements, the stock market understands this. It’s time executives did, too.

Wow... can it be that The New Yorker actually understands the value of people?  The real value... not the traditional balance sheet and P&L value?  I would add "and analysts" to the very last line of the preceding quote, as they can be the kingmakers.  They hold the keys to capital market movement, and therefore control the pursestrings of many executives.  A few gutsy executives are starting to buck the trend by refusing to provide shorter term financial projects and insisting on focusing long term, but they are few and far between.

Look beyond your traditional financial statements and think about what your employees are really worth.   

Dreamlifter Sees [Small] Action

Regular readers know that I have a penchant for poking fun, albeit sad fun, at the concoctions some companies create in order to outsource.  Such as Boeing's Dreamlifter and the Airbus Beluga, both of which are monstrosities designed solely to ferry subassemblies around the globe.  Subassemblies that used to be built right next to the final assembly operation. 

Our blog buddy Mark Graban at the Lean Blog has a post today telling us more about Boeing's nonsense.  Not only did the company modify several 747's to transport parts, they had to create supporting machinery to load and unload the Dreamlifters... what they affectionately call the DBL, or "Darn Big Loader." 

But it gets even better.  The particular load that the Seattle Times was reporting on was rather small.

The DBL's laser-guidance system lined up precisely with the holding fixtures that secure the 787 sections inside the Dreamlifter. It took 55 minutes, from the tail cracking open until the tail parts were completely out.  With floodlights illuminating the scene, the hold of the Dreamlifter seemed almost empty at first -- so small was the load compared to its capacity.

Mark's reaction is the same as mine, although he puts it more eloquently:

Holy Overprocessing, Batman!

Jump over to the Lean Blog to read the entire story.

The Bottom Line of Commitment

It's that time of the year again and those of us that own stocks are beginning to receive the annual reports.  In most cases I just skim through the reports to ensure key investment criteria are still in line.  But I also have a few favorite companies that warrant a closer read, because the text and discussion are as inspiring as the financial results are spectacular. 

Take Danaher for example.  On the top of the very first page of text, directly across from a series of graphs showing phenomenal growth in sales and operating income, is the following in large bold print:

The Danaher Business System drives exceptional levels of performance in each of our businesses by focusing on improving quality, delivery, cost, and innovation. DBS is a customer-centric approach enabling continuous improvement and is further enhanced by an increasing number of growth breakthrough initiatives.

That demonstrates how important DBS is to the company, and the pervasive effect it has on the culture and decision-making.  And it gets reinforced and repeated, over and over, in the annual report.

For more than 20 years, DBS has defined Danaher’s culture and operating model. This distinctive approach to continuous improvement has been instrumental to building high performance businesses over time – and it is what makes Danaher unique. The central focus of DBS is the customer, and we aim to anticipate and address their needs for quality, delivery, cost, and innovation.

And when discussing acquisitions,

DBS is how we build market leadership positions in the businesses we acquire. DBS also provides the means to strengthen existing businesses and help them to satisfy customers, and to compete and grow.

And when discussing goals and objectives,

To accomplish these goals the Company uses a set of tools and processes, known as the Danaher Business System (DBS), which are designed to continuously improve business performance in critical areas of quality, delivery, cost, and innovation.

And when discussing people,

Danaher continues to invest in our people to build good businesses. Through DBS training, tools and processes, our associates are key to the achievement of our business objectives.

Those are just a few examples.  It is repeated time and time again.  DBS. Quality, delivery, cost, innovation.  Simple, repeated, embedded, pervasive.  The CEO talks about it, the business managers talk about it, their associates talk about it.  And it works, which can also be seen via some of the other commentary in their annual report.  One example:

Backlog is generally not considered a significant factor in our businesses as relatively short delivery periods and rapid inventory turnover are characteristic of most of our products.

That can be pretty gutsy in a traditional Wall Street world where backlog and inventory can be viewed as positives.  But those of us in the lean world understand.

At the risk of turning this into a long post, I'll give you one more example just because their annual report also came today.  Wabtec, the old Westinghouse Air Brake, and another star of lean enterprise.  In the Message from the CEO at the very front, once again right across from some spectacular performance graphs:

As with everything we do, it all starts with our Wabtec Performance System, a model of lean manufacturing and continuous improvement principles.  Using these principles, we improve product quality and bring new products to market faster.  We gain manufacturing efficiencies while reducing operating and capital costs.  We improve safety and work processes.  We strive for incremental and lasting benefits, and we work this cycle over and over again.

Each year our general managers participate in a week-long Kaizen event in one of our factories.  We suspend organizational boundaries, roll up our sleeves and pick up a wrench.  [examples of kaizens here] From these efforts, we generate cash to invest in our four growth strategies, and we have made significant progress on each initiative.

Can you hear the typical investor going "what the heck?!"  But we understand.  These companies understand real lean, they demonstrate it year after year, and they aren't afraid to promote their sometimes counterintuitive programs.

Quality, delivery, cost, innovation.  Simple.  Pervasive.  Embedded. 

Toyota Squeezes By GM

This morning brought us the news we've been expecting for several years:

Toyota Overtakes GM As Top World Auto-Maker

Whoopee.  Who cares?  Toyota is actually a little afraid of being number one.  But the reason this is so meaningless is because sales and volume don't really matter.  Unfortunately GM doesn't get that and remains focused on pure volume.  The reason sales and volume are meaningless, especially to a lean company like Toyota, is given in the original article:

Toyota dwarfs its rivals in almost every other measure including profits, market capitalization and cash reserves.

As those of us who have started and run a new company know, you can very easily sell yourself out of business.  Profit and especially cash flow is what matters.  I would much rather be in a tiny company that makes money than a huge company that's losing money.  Of course I'd rather be in a tiny company than a huge company anyway, but that's a different story.

To GM's credit, they are trying to improve.  They have several lean initiatives, but the depth is questionable.  And they continue to do battle with customers, suppliers, and employees.  It's dicey, but I'm not willing to write them off quite yet.  And the situation could become very interesting, especially with today's news that the UAW may even attempt a buy-out of GM.  Of course presumably they would then go back to the old strict work rules and convoluted job structures that cripple the flexibility required by lean manufacturing.  But an interesting angle none the less.

An Inspiring Lean Tear-Jerker

Last week I received a review copy of the second edition of Bob Emiliani's Shingo Prize winning Better  Thinking, Better Results. I've always considered that book to be one of the top two or three lean books, as it tells the story of a very successful lean enterprise transformation at Wiremold. The executives at Wiremold, led by Art Byrne, understood that lean was not just about continuous improvement, but also required respect for people. That understanding let them create incredible lean excellence, with rather amazing and inspiring financial results. As Bob writes in the preface to the second edition,

Both "continuous improvement" and "respect for people" must be practiced, not just "continuous improvement" as is normally the case. Art Byrne and his management team understood this... and they thought deeply about what they were doing and its implications on employees, customers, suppliers, investors, and the communities in which they operated. Most executives don't do that.

Unfortunately the "respect for people" principle is difficult to understand and apply, and the interplay between "continuous improvement" and "respect for people" is even more difficult to understand. For example, can you describe how andon lights, takt time, or standardized work relate to and support the "respect for people" principle for each of the following stakeholders: employees, suppliers, customers, investors, and the community? If not, then you have a lot more to learn about Lean management. We all do.

There have been several updates to the text to clarify the compelling story of Wiremold's lean transformation. However I found the most riveting part to be the "Update to the Second Edition" at the end of the book, where Bob describes what happens after 2001. Unfortunately this is not a good story, but still one that holds some lessons. Basically the Legrand company acquired Wiremold and forced old-style batch and queue manufacturing back into the company.

Legrand managers did not bother to learn about Lean and did not heed Art or Orry Fiume's advice to apply Lean management across the corporation. Instead they found reasons not to do Lean - basically, "we're different" - and Wiremold quickly backslid. In fact, Legrand management seemed to actively dismantle almost everything that Art and his management team and people of Wiremold accomplished.

Bob Emiliani then goes into considerable detail describing how this happened. The final chapter was written only last year.

In January of 2006, a standard-cost software system was installed at Wiremold, adding headcount to the finance function and thus completing the return to batch-and-queue thinking and management. Lean management at Wiremold was extinguished just three years after Art and Orry's retirements.

Call me a softy, but the thought of a leading example of lean excellence being destroyed in just three years hit me hard. Think about what many of you are going through with your transformations. It is very difficult. It impacts everyone, takes effort to change thinking, and eventually creates immense personal and financial satisfaction. All gone. I emailed Bob to share some of my thoughts, and he was kind enough to respond with some observations.

It was personally very painful for Wirmeold people to go backwards. So, yes, it is sad what happened to Wiremold... but not from the perspective of Legrand management. They did what they were trained to do. I tried to write about what happened in a dispassionate clinical fashion, and just focus on the facts. I think doing it this way helps make it more educational (useful) for practitioners and provides accurate documentation of Lean history. Wiremold's story should help us be more vigilant and install countermeasures to prevent this from happening in the future.

And perhaps that hints at the lesson. We like to think of lean manufacturing and lean enterprise as being strong and robust, especially when they are fully-developed. But here we have an example of just how fragile and tenuous lean can be. The results of Wiremold's efforts were very visible, especially on the bottom line of financial reports. The people were among the most passionate and knowledgeable of lean in the world. Yet that wasn't enough. Confronted with a traditional batch thinking, traditional accounting methods, and traditional people and leadership, tradition won. How do we change that? How can we make lean more robust and durable? Education? I don't know.

I encourage you to pick up the second edition of Better Thinking, Better Results. The original story is an inspiring roadmap to lean, and the Update at the end may leave you tearful. At a minimum it will make you think. Better.

China Bites Wal-Mart

Depending on your perspective Wal-Mart is either a god-send or the bane of society.  On one hand their volume and lower costs are in effect a larger social welfare program than even the government's, making it easier for lower income families to afford many necessities while employing hundreds of thousands of people who may not have been able to find any employment.  On the other hand they have helped put many small stores out of business and have procured much of their products from overseas, in particular China.  This has hurt prices and profits from many domestic suppliers, thereby hurting the people that work for (or used to work for) those companies.

Wal-Mart is unfortunately one of those companies that looks almost purely at cost without much regard to value.  A product's cost is predominantly labor-driven, and of course it's easy to find cheap labor in China.  But according to this week's issue of Business Week, Wal-Mart just learned a lesson on value.

[Wal-Mart Chief Merchandising Officer, John E.] Fleming may be America's most powerful merchant, but a timely solution is beyond him even so. Wal-Mart failed to order enough of these China-made T-shirts last year, and so they and other George-brand basics will remain in short supply in most of its 3,443 U.S. stores until 2007's second half, depriving the retailer of tens of millions of dollars a week it sorely needs. "The issue with apparel is long lead times," says the quietly intense Fleming.

As the kid down the street likes to say, "sucks to be you!"  But seriously, if Wal-Mart understood value, and also knew that they could get more value for almost the same cost, they wouldn't be in this pickle.  I wonder if they know that out on the west coast American Apparel is making low-cost t-shirts, with very short lead times and workers with full benefits, at prices that are comparable to Chinese or other Asian sweatshops.

Long distance supply chains have another effect... they create the desire for "safety inventory" to buffer problems like what was described above.  And those of us in the lean world know what inventory can do...

A dubious milestone was reached in 2005 as inventories rose even faster than sales. "You'd see these big storage containers behind stores, but what was more amazing was that [local] managers were going outside Wal-Mart's distribution network to subcontract their own warehouse space," says Bill Dreher, a U.S. retailing analyst for Deutsche Bank.

I wonder how much it's costing to hold that inventory.  How much non-performing cash is tied up.  How many containers of clothing that could go out of style.  How many containers of plastic parts getting brittle in the cold winter just to soften during the summer heat. 

For all the good... or bad depending on your perspective... Wal-Mart does, it could stand to learn a thing or two about value and cost.  But I guess I better watch what I say about them...

What began as an attempt by Wal-Mart's Threat Research and Assessment Group to detect theft and pro-union sympathies among store workers grew into surveillance of certain outside critics, consultants, stockholders, and even Wal-Mart's board.

Uh... ok... "Wal-Mart is a great company!"  Wink wink.