A buddy sent me an email about an interesting discussion on outsourcing. It asked the question “Is outsourcing exploitation?”. It is not the first time to hear the question. I raised that question too as a young freelancer. As you know freelancing has a certain appeal to it. You are in complete control of your time, your finances – you are your own boss. you are responsible for your own success, and failure.
So how do we increase the odds so it tilts in YOUR favor?
As more companies embrace globalization (i.e. multi-country sourcing, multiple global markets), Filipino freelancers can generate substantial revenues and create more jobs for themselves and others. But, they have to understand the big picture. Otherwise, they will be blown out of the map and totally clueless on what hit them. The Filipinos have the option to philosophize about outsourcing, while its neighbors reap the benefits of the value chain – again. Globalization is here to stay – and global competition is no longer about brands – but between supply chains. The economy with the best managed supply chains will emerge on top of the pack. Compete or be blown out of the map. Understanding the value chain – and how it relates to outsourcing will help understand the bigger business model to which outsourcing belongs.
Filipinos are debating whether outsourcing is exploitation or not. I say this is the wrong kind of debate to have. Rather, I suggest the Philippines get its acto together and learn how to manage the value chain and compete. You don’t gain market share by whining – you gain market share by changing your paradigm.
Where it all began – The Value Chain
When it comes to these kind of stuff – I’d rather take you to “the source” instead of having me paraphrase it and have stuff get lost in translation.
So here goes.
These sites provide a very good explanation of the value chain and how it relates to outsourcing
- http://hbswk.hbs.edu/archive/3022.html – Outsourcing isn’t just a way to unload noncore costs. The real play with outsourcing is to use it as a tool to drive strategic value, transform businesses, and even fundamentally change industry dynamics. The key: Forget what you think you know about outsourcing.
The value chain, also known as value chain analysis, is a concept from business management that was first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance
ConceptA value chain is a chain of activities for a firm operating in a specific industry. The business unit is the appropriate level for construction of a value chain, not the divisional level or corporate level. Products pass through all activities of the chain in order, and at each activity the product gains some value. The chain of activities gives the products more added value than the sum of added values of all activities. It is important not to mix the concept of the value chain with the costs occurring throughout the activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond. Typically, the described value chain and the documentation of processes, assessment and auditing of adherence to the process routines are at the core of the quality certification of the business, e.g. ISO 9001.Activities
The value chain categorizes the generic value-adding activities of an organization. The “primary activities” include: inbound logistics, operations (production), outbound logistics, marketing and sales (demand), and services (maintenance). The “support activities” include: administrative infrastructure management, human resource management, technology (R&D), and procurement. The costs and value drivers are identified for each value activity.
Here’s another explanation on The Value Chain (from learnmarketing.net)
Value chain analysis
Michael Porter in 1985 introduced in his book ‘ The Competitive Advantage’ the concept of the Value Chain. He suggested that activities within the organisation add value to the service and products that the organisation produces, and all these activities should be run at optimum level if the organisation is to gain any real competitive advantage. If they are run efficiently the value obtained should exceed the costs of running them i.e. customers should return to the organisation and transact freely and willingly. Michael Porter suggested that the organisation is split into ‘primary activities’ and ‘support activities’.
Inbound logistics : Refers to goods being obtained from the organisations suppliers ready to be used for producing the end product.
Operations : The raw materials and goods obtained are manufactured into the final product. Value is added to the product at this stage as it moves through the production line.
Outbound logistics : Once the products have been manufactured they are ready to be distributed to distribution centres, wholesalers, retailers or customers.
Marketing and Sales: Marketing must make sure that the product is targeted towards the correct customer group. The marketing mix is used to establish an effective strategy, any competitive advantage is clearly communicated to the target group by the use of the promotional mix.
Services: After the product/service has been sold what support services does the organisation have to offer. This may come in the form of after sales training, guarantees and warranties.
With the above activities, any or a combination of them, maybe essential for the firm to develop the competitive advantage which Porter talks about in his book.
The support activities assist the primary activities in helping the organisation achieve its competitive advantage. They include:
Procurement: This department must source raw materials for the organisation and obtain the best price for doing so. For the price they must obtain the best possible quality
Technology development: The use of technology to obtain a competitive advantage within the organisation. This is very important in today’s technological driven environment. Technology can be used in production to reduce cost thus add value, or in research and development to develop new products, or via the use of the internet so customers have access to online facilities.
Human resource management: The organisation will have to recruit, train and develop the correct people for the organisation if they are to succeed in their objectives. Staff will have to be motivated and paid the ‘market rate’ if they are to stay with the organisation and add value to it over their duration of employment. Within the service sector eg airlines it is the ‘staff’ who may offer the competitive advantage that is needed within the field.
Firm infrastructure: Every organisations needs to ensure that their finances, legal structure and management structure works efficiently and helps drive the organisation forward.
As you can see the value chain encompasses the whole organisation and looks at how primary and support activities can work together effectively and efficiently to help gain the organisation a superior competitive advantage.
Companies are Outsourcing Processes which are not Core Competencies to Create Competitive Advantage
Where does outsourcing fit in? If any of these primary and support activities are not a core strength of the company – it should outsource the process. Would you spend money on internal HR people for the purpose of keeping track of ever changing labor legislation – or would you rather outsource it to a company which provides the same service at a lower cost than if you were to run the operation yourself. This means you can take money out of your HR operation – and shift it to your core competency – and create more value for your investment. This my friends is a phenomenon that is already taking place. And it all happened because you and I – yes, you and I, the customer wanted products that..cost less, have excellent quality, available when you need, at the price you are willing to pay for.
What this implies is that as globalization becomes the norm – companies that have a strong understanding of outsourcing will reap the benefits. For example, a Filipino company with strength in payroll processing can be an outsourced payroll department to a company based in Houston. Or a Filipino company specializing in HR can be an outsourced HR department of a company based in Delaware.
The earlier we Filipinos understand that – the better. More outsourcing means more revenues. But only if we Filipinos step up to the plate can we gain more market share. It boils down to outperforming the competition – and reap the rewards.
Exploitation? or a Flawed Pricing Strategy?
In competition – we Filipinos usually go for a price-based strategy – thus going into a pricing war and everybody loses – that’s because we are looking at the activity from a purely transactional point of view – a one shot deal.
In a pricing war – we Pinoys naturally go for the easiest differentiation strategy – via price. But so is everyone else. So we end up having a price war, when we do get the job, we have trimmed our margins to get the job – and as the project evolves – we wind up operating at a loss. Then, we feel “exploited”. We quoted a low price to undercut the competition, naturally the client will go for it.
We get the job but – we are losing money just to do the job because we adopted a volume pricing strategy when we should have priced based on value . Now, wasn’t that being a dumbass?
The Art of the Value Proposition
You dont’want a price war much less engage in a transactional relationship. Iif you are going to negotiate an outsourcing deal – you have to promote your value as a partner. For example, don’t just say you are better because you are cheaper. Say that – I might be more expensive but – I meet deadlines when you want them – 95% batting average.
Then load it up with all the “extras” that distinguish you from the rest. This creates a value for your customer. If the other side is offering lower prices – there’s probably a reason for that. He does crappy work and is offering a low price as an incentive. Don’t take that route don’t undersell yourself. I took that route before and got badly burned.
Go for a value proposition instead – you will not regret it. Do not compete based on price in this industry – compete based on value. Give a value proposition instead of a pricing quote – and you increase your chances. Don’t just be another vendor/service provider being played off with other vendors – present yourself as a partner.
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Resist the temptation to collude – Instead compete based on value
Oftentimes, the freelancer thinks that if he reaches out to other freelancers and they agree to fix the price – somehow they will get a better deal. No it will not. That’s doomed to fail – the nature of the market is that there will always be someone who will undercut the prevailing rate due to a competitive advantage which they will leverage to gain market share.
– Freelancer A – topnotch design skills (photoshop + flash + dreamweaver) – minimal marketing and pricing skills
– Freelancer B – medium design skills (photoshop + flash + dreamweaver) – topnotch pricing and marketing skills + operations management skills
Freelancer A can get by with four or five projects in a year; Freelancer B will probably have 10 or 15 or projects. Freelancer B will have possibly smaller margins than freelancer A on a per project basis. But overall Freelancer B has greater revenue at the end of the year – and has spread his risk by having more customers.
Give it 2-3 years, Freelancer A will be complaining about “exploitation” and Freelancer b will be worshiping outsourcing.
Know thy Customer and Know Thyself and Thou shalt Generate Revenue
AP colleague BenK pointed that one should consider the market side of the equation as well; the price-based strategy of the supply side is perpetuated because the customer side is strongly price-based as well. In doing so, one can undertake Customer Profitability analysis.
In a sense, everyone is trying to drive down cost. The question to ask is whether the customer is looking at this as transaction-based – which becomes a one-shot deal. Or whether the customer is looking for an outsourcing partner – which means the outsourcing activity isn’t just a one-time transaction but a long-term partnership.
In the context of web freelancing – this implies that the customer recognizes content generation is not their core competency – and therefore have outsourced it so they can focus on their core strength – most likely, marketing and distribution. Chances are, they have outsourced manufacturing. -This allow the company to shift capital from assets that were previously “sleeping” or underutilized – and turn this into working capital – thereby increasing revenue.
A customer knows what he wants. The job of the freelancer is to identify and probe what the customer needs, reconcile this what the customer “wants” – and seek to nurture the sale so the customer transitions from being a one-shot deal into a strategic partner. But first – he must size up the customer. Is it worth doing business with a specific customer – or not? Customer Profitability analysis will allow you to size up the client before going further down the road.
Amitkumarthaku’s Blog provides a very concise description of the qualifying process:
The relationship matrix method is based on the relationship life cycle theory that can be used to determine what priorities should be given in managing customer relationships. To ensure long-term profitability and value creation, a company should focus on building a strong and lasting relationship for continuous growth in terms of value and profit.
It has 2 dimensions: Potential profitability of customer and opportunities for adding value. The basic idea behind the matrix is that the customer having highest potential profitability and which gives the highest opportunities for adding value the better it is for the company.
Placing profitability/opportunities in the matrix results in 4 approaches in the qualifying prospects for relationship building of a company:
1. Build a Strong and lasting relationship (=high profitability, high opportunity for adding value).
– use large amounts of cash and are leaders in the business so they should also generate large amounts of cash.
-Opportunity for adding values is very high. If needed any attempt should be made to acquire or retain the customer, because the rewards will be a very high if a relationship is maintained.
2. Focus on loyalty-building program (=high profitability, low opportunity for adding value).
– Profits and cash generation should be high, and because of the low potential for adding values and growth, investments would be.
3. Use a non customized approach (= low profitability, High opportunity for adding value).
– have the worst relationship characteristics of all, because low potential profitability and high opportunity for adding values.
-avoid and minimize the number of such relationships with a company.
4. Seek better opportunities elsewhere. (=low growth, low market share).
– beware of any new plans for value building.
– Efforts should be made to get out of the relationship as these companies will simply absorb great amounts of time and effort
If the customer ends up in the low end of the customer profitablity matrix – we don’t participate because doing so will lead to a loss, we are better off looking somewhere else.
Another thing, when the market is so fierce – I’d really start to adopt a niche/segment strategy and look at other market segments where I get more buck for my time.
The Value Chain
Transportation Department Outsourcing
3rd Party Logistics – Building the Global Supply Chain
Playlist on th Value Chain
Morale of the Story
Before crying exploitation – ask yourself first –
what are others doing which I am not doing that allows them to quote low prices while maintaining value.
Fail to ask the question – and your business fails. Don’t blame outsourcing – blame yourself.
Better yet, get over the blame, move on and reinvent your company – adopt a new business model, new strategies, new ways of thinking, compete smartly – and watch your revenue grow.