Guidelines for setting up outsourcing mimic M&A-style diligence
By Staff -- Manufacturing Business Technology, 11/1/2005 12:00:00 AM MST
Companies would be well advised to practice the rigors of merger & acquisition (M&A)-style due diligence to ensure that outsourcing achieves desired benefits, according to a recent study by New York-based McKinsey & Co.
As many as half of all outsourcing agreements reportedly fail to deliver expected value. Poorly planned deals often have many of the same flaws as failed mergers, joint ventures, and divestitures—to which they are closely akin.
The importance and size of outsourcing arrangements have morphed from the early ventures that involved off-loading nonstrategic functions such as payroll, facilities management, and IT maintenance.
"Many such deals are big enough to qualify as 'bet the company' arrangements," say McKinsey authors, with nearly 100 megadeals being worth more than $1 billion in the last 10 years. Yet deal-making has not shifted to reflect this. Instead, overreliance on third-party negotiators "often reduces the bidding process to a commodity comparison of vendors that limits transparency and uses price as the primary decision-making factor."
McKinsey has seven guidelines for conducting a strategic outsourcing arrangement:
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Clarify deal strategy from the beginning
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Assemble the right team
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Focus on value, not cost
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Create transparency
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Manage risks
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Negotiate internally, then externally
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Plan for transition and delivery
"Once the objective of the deal is clear, the best way to structure it becomes clearer, too," the report states. True divestiture may make sense if cost-cutting is the issue; if it is improved performance, then structuring it like a joint venture makes better sense. Whatever the structure, having a team with comprehensive skills is critical. "In any M&A deal, at least one team member should focus on the economics of the deal," says McKinsey.
Also like M&A deals, "A more complete examination of the sources of value … can help an executive team set a realistic and fair target price ….The key is to consider all the components of value, along with the risks."
Unnecessary risk often results from lack of transparency, particularly with regard to the asset and labor pools involved. Too often, "Vendors are not permitted to conduct their own due diligence before signing the deal," nor even "to verify the deal's assumptions-and thereby the price."
Negotiations [often are] more complex than M&A talks due to the number of internal stakeholders. "As a result," says the report, "negotiating teams must work internally with the business managers who control the process to be outsourced," including employees, union representatives, and executives.
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