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A business model that doesn't always work

If someone can do a better and cheaper job than you, it makes sense for you to hire them. You do what you do best and let them do their bit for you. This is, of course, a theory of economics and it promotes outsourcing. Outsourcing is a business model that has been around forever and it gained great popularity from the 1970s onwards. It has been helped by globalisation. Clothing companies, manufacturers of consumer goods, and manufacturers of electronics have been able to take advantage of lower labour costs around the world. The design of products and marketing can be retained in-house while the boring, boring assembly jobs are given to anyone who can do it cheaper.

The ability to off load unattractive jobs has gained pace and in some companies it has gone wild. They outsource customer service, payroll, advertising, manufacturing, logistics – everything and anything except directors emoluments. It often is a bridge too far.

These thoughts occurred to me the other day when I read about the debacle of outsourcing at Dialight. Dialight isn't a company many people have heard of. It was new to me. It claims to have a strong position in an industrial niche. It says it has the largest installed base of industrial LED fixtures in the world. It makes industrial LEDs such as floodlights for factories, street lights, lights for signals and so on. It is a public company and seven years ago its shares hit a high of £11 each. That was before they discovered outsourcing.

The problems began when they signed a contract with Sanmina, a large US electronic manufacturing company. This may be another name you are not familiar with but it is huge. It is the world's largest maker of printed circuit boards and has revenues of over $7 billion a year.

It was here that Dialight's problems arose. Dialight’s revenues at £200 million are small by comparison with Sanmina’s. When there were problems with Dialight’s outsourcing contract it didn’t keep Sanmina awake at night. Supplies of components were mishandled, lead times were extended and product quality deteriorated. The effect on Dialight was catastrophic. The company was at risk of collapse and its shares fell to just £3. After ending its contract with Sanmina and taking control of manufacturing in its own facilities, it has taken nearly two years for Dialight to see a brighter light at the end of its financial tunnel.

A similar thing happened to Hornby, a manufacturer of model trains. In the 1990s it subcontracted their manufacture to Chinese companies. In doing so Hornby lost control of quality and delivery and struggled to exit the terms of its contract. It led to a series of profit warnings.

I understand the theory of efficient markets. If someone can do something better and cheaper, they should get the business. But what control are you losing? It is a huge risk if your business reputation is on the line. The quality of your products and the ability to deliver them at the right time is surely a fundamental requirement of your brand. Dealing with customers through a service desk is also something that you would only entrust to people who really know what they are doing. Again your reputation could be at risk.

Outsourcing is a risk and it isn't going to go away so here is a check list of do’s and don’ts if you are considering it:

  • Don’t outsource a key part of your business to someone who may not care about it as much as you do.

  • Don’t assume that cheap is cost effective. The real cheap contracts are the ones that could cost you in the long run.

  • Don’t outsource to a company that you need to micro manage. If you need to do this it suggests your outsourcing partner is not capable of carrying out the work.

  • Don’t outsource to someone who is millions of miles from you. There are sure to be occasional snags and it can be helpful to face your outsourcing partner over the table.

  • Don’t outsource so much of your business there is nothing left.

  • Do keep an eye on things. Monitor how the outsourcing company is performing and let them know you know how things are going.

  • Do due diligence on the outsourcer. Get references and reviews to make sure you are going with someone who is trustworthy. You wouldn’t give your baby to just any child minder.

  • Do have a back stop. Make sure that if the contract goes wrong you can get out quickly and easily.

  • Do find an outsourcing company that really wants to work with you. Your business must matter to them because, my goodness, it matters to you.

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