Nine out of ten business cases that cross my desk contain material errors, which often lead to incorrect recommendations worth tens of millions of dollars. If you ever wondered why two thirds of change initiatives fail, here’s your answer: many of them are based on a fallacy, a case that does not exist. The issues run the gamut from poor understanding of objectives to complete disregard for the established methods of economic analysis, from strategic ignorance to financial ignorance.
Decisions on outsourcing and insourcing are also not immune from this flawed approach. In fact, many of them are deficient for one specific reason which I will outline here.
“We’ve spent the last three years transitioning our business from a focus on on-premise computer systems and infrastructure, to a Cloud Computing model that involves providing software and computing resources as a service rather than something you buy and house and manage” – Doug Girvin, President and CEO of Stantive
There is a discipline studied in all accounting and most finance programs which is known as managerial accounting. Managerial accounting provides managers with answers to questions like “How much does it cost us to manufacture one extra widget?” “How much of the factory overhead should be trimmed to decrease the cost of a widget by 10 cents?” “How many widgets should we produce to break even?” Given the known direct and overhead costs, production volumes and the established price for which a widget is sold, it is possible to calculate the cost of each widget and the margin realized. Naturally, one would want to maximize the margin by trimming the costs.
It works reasonably well for manufacturing of commoditized widgets with an established market but we are in trouble when the same method is applied to knowledge work. Take one of the largest overhead costs, IT. The typical reasoning, which is bound to get the attention of the Board goes like this: “We can hire a person there for one third of what we pay here. Therefore we can reduce our personnel costs by two thirds.”
There are a few issues here. First, it is assumed that a worker is a worker, knowledge or assembly line. Second, the new coordination costs don’t typically enter the picture. Third, risks are not typically discussed. Fourth, and most importantly, it is assumed that the amount of economic value generated by a group of knowledge workers will remain the same. Unlike on the factory floor where the economic value of a widget is its established price, the value created by one group of knowledge workers may be very different from the one created by another.
If you are working on an outsourcing decision for a function which has produced mediocre economic value, due to stunted innovation, support function mentality, poor leadership, it is incredibly limiting to decide its future based on the input cost of a worker. Instead, one needs to look for a way to significantly increase the value produced. Whether it is done best in-house or by outsourcing is not the most important problem at hand. Yet the mentality of bean counters often prevails and a mediocre is substituted by a cheaper mediocre. You cannot get to the top by pinching pennies.
What’s even worse is when we see the faith of highly innovative groups decided merely on direct (personnel) costs without any regard for the value they produce. Exceptional productivity is not easy to reproduce and should never be taken for granted.
If you are engaged in strategic planning today, eschew this limiting approach. Figure out the way to create exceptional value which would leave your competition in the dust and the rest will be history.
How One Company Does It
Kingston, Ontario is a small Canadian city of 120,000. It’s a home to Queen’s University, a few jails and some government offices. Not exactly a high technology hotbed, but it is here that I met Doug Girvin, President and CEO of Stantive Technologies Group Inc.
In the last year, while most of the world weathered the economic storm in a fetal position, Doug’s business grew 400 per cent. All of his staff is located in Kingston and not in a low-cost locale, and he is planning to hire aggressively in the next few months. How can they do so well working out of Canada, which is definitely not the cheapest place in the Americas to set up shop?
First, they are clear on the strategy. Mr Girvin explains: “We’ve spent the last three years transitioning our business from a focus on on-premise computer systems and infrastructure, to a Cloud Computing model that involves providing software and computing resources as a service rather than something you buy and house and manage. This market space is taking off while the older idea of computing is consolidating and being commoditized. We saw this coming five years ago and were determined to in this direction with as little disruption to our business and customers as possible. The result has been very gratifying.”
Secondly, they understand how to generate value for their clients. Mr Girvin continues: “There is always room at the top, and I fanatically believe that sustainable advantage only comes from the level of value that is provided. Value requires leadership because it is inherently differentiated from other products or services, so there is risk that the value will not be recognized. We are constantly seeking the highest value that resonates with customers and work hard to be responsive to those high value needs as they’re expressed in the marketplace. Customer engagement is very important as tool to hear the pattern of requests for different kinds of value.
We engage customers and prospective customers in conversations, understand their business and their organizational challenges and aspirations, and the opportunity to provide value becomes evident very quickly. Executing on the provision of that value has been a key component of our success to date.”
If you learn to create exceptional value, input costs will become a mute point. This is how the most successful companies think and act. What’s stopping you?
Ilya Bogorad is the Principal of Bizvortex Consulting Group Inc. a management consulting company with clients worldwide. Ilya specializes in building exceptional IT organizations, decision making and business cases. He can be reached at firstname.lastname@example.org or +1 (905) 278-4753 begin_of_the_skype_highlighting +1 (905) 278-4753 end_of_the_skype_highlighting.