Strategic Sourcing: From Periphery to the Core

For years, sourcing has been just another word for procurement a financially material, but strategically peripheral, corporate function. Now, globalization, aided by rapid technology innovation, is changing the basis of competition. It's no longer a company's ownership of capabilities that matters but rather its ability to control and make the most of critical capabilities, whether or not they reside on the company's balance sheet. Outsourcing is becoming so sophisticated that even core functions like engineering, R&D, manufacturing, and marketing can and often should be moved outside. And that, in turn, is changing the way firms think about their organizations, their value chains, and their competitive positions.

Its no longer ownership of capabilities that matters but rather a company's ability to control and make the most of critical capabilities.

Forward-thinking companies are making their value chains more elastic and their organizations more flexible. And with the decline of the vertically integrated business model, sourcing is evolving into a strategic process for organizing and fine-tuning the value chain. The question is no longer whether to outsource a capability or activity but rather how to source every single activity in the value chain. This is the new discipline of capability sourcing.

Perhaps the best window on the new sourcing landscape is a handful of vanguard companies that are transforming what used to be purely internal corporate functions into entirely new industries. Firms like United Parcel Service in logistics management, Solectron in contract manufacturing, and Hewitt Associates in human resource management have created new business models by concentrating scale and skill within a single function. As these and other function-based companies grow, so does the potential value of outsourcing to all companies.

Its not always obvious which functions have the most potential for developing scale and skill. Virgin, for instance, has successfully extended its brand management capabilities from planes and trains to music, mobile phones, personal finance, and even bridal wear. And you might still think of Nike as a sneaker and sportswear company. But as it lends its brand and merchandising expertise to an increasing array of products from golf instruction centers to MP3 players to eyewear its evolving into a focused provider of marketing services to other companies.

Migrating from a vertically integrated company to a specialized provider of a single function is not a winning strategy for everyone. But all companies need to rigorously assess each of their functions to determine in which they have sufficient scale and differentiated skills and in which they don't. Greater focus on capability sourcing can improve a company's strategic position by reducing costs, streamlining the organization, and improving quality. Finding more-qualified partners to provide critical functions usually allows companies to enhance the core capabilities that drive competitive advantage in their industries.

Yet despite the enormous opportunities available through capability sourcing, our research indicates that many executives remain unprepared for this transformation. A recent Bain survey of large and medium-sized companies reports that 82% of large firms in Europe, Asia, and North America have outsourcing arrangements of some kind, and 51% use offshore outsourcers. But almost half say their outsourcing programs fall short of expectations, only 10% are highly satisfied with the costs they are saving, and a mere 6% are highly satisfied with their offshore outsourcing overall.

The reason these efforts often fail to measure up to expectations, even purely in terms of cost savings, is that most companies continue to make sourcing decisions on a piecemeal basis. They have not put hard numbers against the potential value of capability sourcing, and they have been slow to develop a comprehensive sourcing strategy that will keep them competitive in a global economy. To realize the full potential of sourcing, companies must forget the old peripheral and tactical view and make it a core strategic function.