EXECUTIVE SUMMARY
| OUTSOURCING IS REVOLUTIONIZING
the way business is being conducted around the
world, and that means CPAs will have to rethink how they
establish the value of a business and the metrics they
traditionally monitor. If they fail to do this, they
will be left in a place equivalent to the days of green
eyeshades and columnar pads.
A GROWING NUMBER OF
manufacturers no longer operate factories.
Instead, their products are produced and distributed
by specialized contractors.
AS A RESULT many
financial managers are expected to answer questions
they never had to address before: Which business
capabilities should our company own? Which should it
contract for?
IN THE PAST the goal of
financial managers was to optimize internal
business-process costs, focusing on price rather than
on total cost. But the emphasis now is on cost
—not price.
ACCOUNTANTS MUST NOW
determine the true cost to a company of its
various business activities by establishing the value
of a specific business capability.
COMPARING THE CURRENT
dollar cost of performing an activity
internally vs. externally is only the start. The CPA
must take the next step: to determine and quantify how
important that activity is to the company’s strategic
objectives. | STEVEN
L. GOLDMAN, PhD, is the Andrew W. Mellon Distinguished
Professor in the Humanities at Lehigh University,
Bethlehem, Pennsylvania. His e-mail address is slg2@lehigh.edu .
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utsourcing—the management strategy for
contracting out a company’s manufacturing and services
operations to specialized contractors—is not only
revolutionizing the way business is being conducted around the
world, it’s requiring CPAs to rethink how they value a
business and the metrics they traditionally monitor. If they
fail to change with it, they will be left in a place that is
equivalent to the days of green eyeshades and columnar pads.
Until recently, outsourcing was a strategy applied by
just a handful of forward-thinking companies. Today, it’s the
way to go for many businesses. Look down the list of the
Fortune 500 and you’ll see that a growing number of
major manufacturers no longer operate factories or even
assembly plants. Instead, all their products are produced, and
even distributed, by specialized contractors. What
does that mean to the accounting profession? It means many
financial managers are being expected to answer questions they
never had to address before. For example: Which business
capabilities should our company own? Which should it contract
for? And what information do we need to make those decisions?
For the past 100 years the goal of financial managers
was to optimize internal business-process costs. Contact with
the external world was limited to purchasing and sales, both
of which traditionally focused on price rather than on total
cost to the organization. But for the company that outsources
not only production but its distribution, as well, accountants
must now compare internal business-process cost with the cost
of outsourcing those processes; the emphasis now is on
cost —not price. Accountants must
now determine the true cost of a company’s various business
activities by establishing the value of a specific business
capability —and that includes such things as
quantifying the value of contracting out supply chain
logistics or human resources management.
Comparing the current
dollar cost of performing an activity internally vs.
externally is only the start. The CPA must take the
next step: to determine, and even quantify, how
important that activity is to the company’s strategic
objectives. For example, how much could current costs
be reduced if an outside company’s price for
performing that activity was lower? If a reengineering
plan could reduce costs to the best outside price, or
even beat that price, would it still be worth the
company’s while to use internal resources to perform
that function? And since outsourcing gives a company
the opportunity to change its product line swiftly,
how valuable is that flexibility to change the
company’s market position or to exploit new customer
opportunities? What business strategies would become
available if time-to-market could be reduced
drastically through outsourcing? How could the real
cost of product development—including the higher
profit from getting products into the marketplace
faster—be reduced by partnering, even if that incurred
higher development costs? And, as if the
aforementioned questions weren’t hard enough,
consider this one: How do you quantify the value of
internal cooperation? For example, how do you assess
the value of quality as an integral part of
operations, product development and strategic
planning rather than as an outside function? Or how
valuable would it be if engineers could be
transferred freely within a company as their skills
were needed across lines of managerial authority at
a lower cost than hiring that expertise from a
contract engineering firm? Clearly, these
questions present a unique challenge and opportunity
to the accounting profession. However, what makes
the challenge more thorny is that there are no
textbook processes for examining these questions or
even existing metrics for quantifying them. The
processes and the metrics must be developed. “Where
to Find the Answers,” at right, suggests books that
begin to explore ways to address these questions.
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Where to Find the Answers
Identifying metrics for valuing
business capabilities draws on a wide
assortment of management fundamentals
including knowledge of Economic Value
Added, activity-based costing, time-based
costing and the balanced scorecard. In
addition, the following books will provide
guidance:
Real Options, by
Martha Amram and Navil Kulatikala (Harvard
Business School Press, Boston, 1998).
The Real Options
Solution, by F. Peter Boer (John
Wiley, Hoboken, New Jersey, 2002).
Innovation Explosion,
by J. Brian Quinn (Simon &
Schuster, New York City, 1997).
Knowledge Assets, by
Mark Clare and Arthur Detore (Harcourt
Brace, Orlando, Florida, 2000).
The Strategy-Focused
Organization, by Robert S. Kaplan
and David Norton (Harvard Business School
Press, Boston, 2000).
Digital Capital, by
Don Tapscott (Harvard Business School
Press, Boston, 2000).
Value Migration, by
Adrian Slywotzky (Harvard Business School
Press, Boston, 1995).
Cooperate to Compete,
by Kenneth Preiss, Steven L. Goldman
and Roger N. Nagel (John Wiley, Hoboken,
New Jersey, 1997). | |
GO BACK IN TIME If we examine how
business got to this stage, where outsourcing has become so
prevalent, we may be able to begin to see how such processes
can be formulated. To do that we must go back nearly two
centuries—to 1814. At that time Francis Cabot Lowell, who
owned a textile mill in Waltham, Massachusetts, took a
revolutionary step. Up until then textile manufacturing was
done by outside contractors—work was put out to independent
crafts people, so the system was called “putting out.” Each
step in the manufacturing process was moved from one home or
small workshop to another—a slow and expensive operation.
Lowell decided to junk the putting-out process and,
instead, brought all the operations under one roof, with the
work performed by his own employees—a management concept later
called integration. Lowell was 100 years ahead of even Henry
Ford, who applied the same principle at his River Rouge car
assembly plant in Michigan. It took many years for
Lowell’s idea to catch on—not just because it was
revolutionary, but because switching to integration from the
putting-out system required both hefty capital costs and the
hiring of a large number of full-time employees at a time when
U.S. labor costs were relatively high compared with those of
Great Britain, the major competitor in the textile trade. But
Lowell saw integration overcoming those obstacles because it
was able to process converted raw material into final products
more quickly. It wasn’t until later, in the 19th
century, that economic changes began to support integration:
Improvements in mass production, communication and
transportation technologies made the value of time more
precious; in addition, managers acquired new skills that
improved the running of complex integrated enterprises. And
then, when U.S. labor costs declined as immigrants flooded the
country, the advantages of integration became so overwhelming
that the vertically integrated, hierarchically organized,
centrally managed industrial corporation became the model for
20th century manufacturing. But in the 1990s two of
the integrated enterprises’ most prized advantages began to
slip. Internet-based business collaboration software was
introduced and that almost immediately weakened integration by
making real-time coordination of business capabilities among a
group of collaborating companies a cost-effective option. At
the same time, technological innovations were changing the
marketplace. The market lifetimes of even highly successful
products and services started to decrease— narrowing profit
windows. To remain competitive, companies were forced to offer
a wider range of continually changing models or services. They
even found they had to abandon still-profitable products
because fast-moving new competitors threatened to chip away at
their market share. This inevitably led to the growth
of manufacturing outlets that could produce special-purpose
products and services aimed at niche markets—perfect
candidates for outsourcing—quickly, cheaply and in high
volume. Finally, the market change that, for many
companies, sounded the death knell for integration was the
switch from selling individual products and services to
producing solutions: customer-specific combinations
of physical products, information and services. General
Electric and IBM are outstanding examples of traditional
manufacturing companies that in the 1990s successfully made
the transition from sellers of products to marketers of
solutions.
AND THEN DISINTEGRATION If the
gathering of production under one roof was called integration,
its demise is nothing short of disintegration. Once suppliers
have been integrated into production operations, why not have
a key supplier manage the entire supply chain? Can a
specialized logistics company take over that function at a
lower cost than an internal operation? Given the value
of flexibility in the face of rapidly changing demand and
constantly changing products, why not form an alliance with a
company whose sole competence is highly flexible
manufacturing? Given the extremely short market lifetimes of
information and knowledge, why attempt to “own” information
and knowledge personnel, as opposed to acquiring information
and knowledge opportunistically, as new solution opportunities
arise? How far can disintegration be pushed? General
Motors and Volkswagen are building auto assembly plants whose
workers are employed and supervised by a few key suppliers.
Suddenly, an auto company doesn’t even assemble cars let alone
manufacture them. GM is moving toward becoming a vehicle
design and marketing company—in effect, the customer
interface. Boeing is moving in this same direction: Partners
and contractors do all the manufacturing and assembly.
The message is clear: A high-tech version of the old
putting-out system is back, and that means the role of the
accountant must change apace. That opens an extraordinary
opportunity for the profession to exercise creativity—but CPAs
will have to be proactive. In short, financial professionals
can either count dollars or they can measure value.
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