Going beyond commodity outsourcing.

• Author: Millman, Gregory J.
• Position: Special section

Talk to enough people in the outsourcing business, and you will hear the same message over and over: Don't outsource to cut costs. That certainly sounds counter-intuitive--isn't outsourcing mainly about cost-cutting, after all?

Not necessarily. That was true in the early days of outsourcing, especially for IT. But the word most heard in contemporary outsourcing circles is not cost-cutting but transformation. As outsourcing has moved beyond IT to include a broader range of business processes, it has evolved from a short-term tactic into a long-term strategic play. "It's a classic make-or buy decision," says Bob Pryor, a vice president at Cap Gemini Ernst & Young. "Is it a core competency? Can you do it better than anyone else in the world? If not, outsource."

Outsourcing used to be a simple concept. Now, it can mean a multitude of things. At its most basic level, derisively referred to as "body shopping" or "your mess for less," an outsourcing firm merely takes on responsibility for an existing function, offering to do it cheaper. This is commodity outsourcing. All of the major outsourcing service providers do it, but since commodities are by definition undifferentiated, few want to be trapped at this end of the scale.

The industry leaders are pushing not only low costs but also the opportunity to differentiate by redefining and improving business processes. They offer innovative financial and risk-sharing arrangements. They put skin in the game, tying their compensation to their ability to deliver both top- and bottom-line results. Outsourcing at this level offers much more than cost reduction.

Strategy Play

The history of outsourcing has been to a large extent a history of redrawing the line between core and noncore business processes. A study published in 2000 by Stern Stewart & Co., the economic value added (EVA) consulting firm, found that outsourcing can boost effectiveness by eliminating distractions, allowing management to focus on critical strategic issues. Stern Stewart's research examined 27 major outsourcing announcements and compared the stock performance of the outsourcing companies with the market at large to determine whether the decision to outsource affected investors' views.

The conclusion: on average, outsourcing companies outperformed the market by 5.7 percent. The median equity capitalization of the outsourcing firms was $7 billion, so the decision to outsource put an additional $400 million in share holders' pockets.

BP plc (the former British Petroleum) was one of the first global firms to commit aggressively to outsourcing non-core business processes. The oil giant made Andersen Consulting (now Accenture) responsible for finance and accounting for its North Sea operations in 1991...