Ailment #1 – Penny Wise and Pound Foolish

As we noted in the introductory blog to this series, our research and experience exposed the 10 most common problems in business relationships. These are “ailments” that can plague and potentially destroy an outsourcing relationship.

Let’s start with the first and the easiest ailment to identify. The one that materializes when, for example, a company outsources based purely on costs. We’ve all heard the warning against being “Penny Wise and Pound Foolish.” Unfortunately, many procurement professionals are still in the dark ages. Too many companies profess to have a “partnership” while behind the scenes they focus solely on beating up their service providers on price.

You need to think beyond the short-term bottom line in your business and outsourcing relationships. The danger in focusing on the cheapest offer is like anything else –tradeoffs are made in quality, service or both. Unfortunately, many executives view outsourcing as a “quick fix” solution to resolving balance sheet problems. Often companies suffering from a case of “Penny Wise and Pound Foolish” tactics fall into a loop of frequent bidding of their work to the lowest price provider and making the transition to reliance on that supplier. This tendency can lead to a vicious cycle of bid and transition, bid and transition, bid and transition. Companies that become caught in this cycle typically end up with unintended disadvantageous consequences, such as these:

– Service providers that work with the company eventually will refuse to work with the company again. They become tired of getting beat up on price, only to have their efforts rewarded by losing the work the next time around. Ultimately, they choose to pursue revenue from more productive outsourcing relationships. In one extreme example we witnessed a company re-bid their transportation services every three months. In this case the company had recklessly churned through nearly all of the top 20 suppliers during a five-year period, and consequently was forced to work with suppliers of lesser quality.

– Outsource providers bid such low prices in order to work with a company that they go out of business; the outsourcing company consequently struggles to find a new outsource provider. One company, as an example, was described by its suppliers as an “800-pound gorilla.” This company dabbled with outsourcing in manufacturing and had some successes. As a result, company executives decided to outsource all manufacturing to allow the business to focus on core competencies – a strategy that usually is a smart move. The book of business was worth roughly $100 million in revenue for the winner. In this case, three contract manufacturers had the experience and scale to manage the outsourcing company’s work volume. The “800-pound gorilla” strained its relationships with its vendors, however, by putting them through several rounds of extreme negotiations to save the last possible dime on the multimillion dollar outsourcing deal. Following the grueling negotiations, the company awarded the work to a $1 billion outsource provider, which achieved an estimated 10 percent increase in revenue as a result of the transaction. The problem? The outsource provider “bought” the business, and eventually could not sustain the losses of profit. The overwhelmed vendor gave the “800-pound gorilla” a 30-day notice that it would no longer manufacture the outsourcing company’s products and went into bankruptcy – eventually tanking what was once a successful and profitable $1 billion firm.

Organizations that engage in this spendthrift ailment give outsourcing a bad name – and should not be outsourcing in the first place. Their myopic focus might pay off in the short term, but this approach has proved time and time again that being Penny Wise and Pound Foolish does not pencil out for vendors – or for outsourcing companies.

Read More! Move on to Ailment #2 The Outsourcing Paradox

Comments

  1. Very well written. I have been looking for balanced and insightful commentaries on exaclty this subject. I am a sales exec for a 3PL company (3rd party logistics) and outsourcing is how I make a living. Price alone decision making creates problems for all industries. So many professionals today are educated enough on LEAN principles to know that LEAN DONT MEAN CHEAP! Lean concepts are about efficiency and long term cost savings. Evaluate your outsourcing alternatives by proven success metrics, reliability and competitive analysis and win the right to keep your job perople!

  2. Thanks Kate! Your brief descriptions reflect the conventional Outsourcing very well. I will use some of your ideas for my Slideshare presentation on Outsourcing/ Offshoring (of course with reference to this good blog).

  3. Sorry I lost the plot.

    #The outsource provider “bought” the business, and eventually could not sustain the losses of profit.#

    I didn’t quite get that. Are you saying the outsource provider bought the outsourcing company – 800 pound gorilla in question

    Would appreciate a clarification

    • Kate Vitasek says:

      Thank you for asking for clarification. By the term “bought” what I meant was the service provider priced the work so low they in essence won the work because of the price advantage over the competitors/market prices. The service provider lost money on the work – and those losses could not be sustained.

  4. Well spoken.
    One of your early paragraphs reminded me of a cartoon I did on the subject of parthership here: http://www.sourcingsage.com/cartoons/2012/4/5/cartoon-of-the-week-1212-partnership.html

  5. I’ve been outsourced and replaced by outsourcing companies. It’s disconcerting to think just how much of a pawn the individuals that are outsourced really are.

    I wonder if the 800 lb Gorilla knew that the 1 Billion dollar outsource company was losing so much during the deal? I would think the 800 lb gorilla company should have had enough understanding of the realities of manufacturing to develop a realistic understanding of the risk the outsource company was taking? I would think that the 800 lb Gorilla company might want to consider that risk before awarding the bid.

    How would the 800 lb Gorilla and the 1 Billion dollar outsourcing company protect themselves?

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