how do you bring global sourcing into the comfort zone of your

How do you bring global sourcing into the comfort zone of your company?

Bent Petersen Department of Strategic Management and Globalization,

Copenhagen Business School

Prins Bertil Seminaret 2012 1

Prins Bertil seminaret, 4 oktober 2012:

Global Sourcing – möjligheter och utmaninger för internationella inköp

Structure of my presentation

1. When does sourcing become transformational?

2. What are the risk-return tradeoffs of global sourcing?

3. What is my company’s comfort zone in relation to global sourcing?

4. How can your firm expand its comfort zone? (mini-case: SimCorp’s outsourcing)

5. An example of a risk reducing measure: outsourcing contracts with call options

2 Prins Bertil Seminaret 2012

1. When does global sourcing become

‘transformational’?


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4

EXPLORATION

SPECIALIZATION REVEALING Transformational global sourcing

EXPLOITATION

REPLICATION

Tactical global sourcing

CONCEALING

Transformational versus tactical global sourcing - A three continuum triangle

Prins Bertil Seminaret 2012

Continuum # 1: Replication Specialization

5

EXPLORATION

SPECIALIZATION REVEALINGStrategic global sourcing

EXPLOITATION

REPLICATION

Conventional global sourcing

CONCEALING

To what extent is the local operator assigned supply exclusivity?

REPLICATION Several providers (multi-sourcing) Multiple locations Dispersed value chain configuration Low degree of interdependence between activities Managerial control and transparency

SPECIALIZATION One provider One location Concentrated global value chain configuraion Benefits of critical mass Interdependence between activities in multiple locations Risk of global value chain disruption/break-down Prins Bertil Seminaret 2012

Continuum # 2: Concealing Revealing

6

EXPLORATION


EXPLOITATION

REPLICATION


CONCEALING

To what extent is strategically important knowledge transferred to the local operator?

CONCEALING Knowledge stickiness due to:

Co-specialized local knowledge Contextualized in home firm/country Tacitness

Confidentiality concerns Safeguarding of knowledge assets

REVEALING Transferable knowledge Augmenting local service provider capabilities High human asset specificity Risk of knowledge slippage


Continuum # 3: Exploitation Exploration

7

EXPLORATION


EXPLOITATION

REPLICATION


CONCEALING

To what extent is the local operator authorized to innovate?

EXPLOITATION

EXPLORATION

Implementation Efficiency High control by client firm

Discovery Innovation Independent judgment in execution


2. What are the risk-return tradeoffs of global sourcing?


9

Risk-Return tradeoffs of global sourcing

Transformational global sourcing

RETURN: AUGMENTED COMPARATIVE ADVANTAGE OF LOCAL VENDOR RISK: SLIPPAGE OF STRATEGIC KNOWLEDGE. HOLD-UP

RETURN: ECONOMIES OF SPECIALIZATION RISK: SUPPLY UNCERTAINTY. INTERFACE PROBLEMS

RETURN: IMPROVED INNOVATION THROUGH LOCAL VENDOR RISK: ”WHITE ELEPHANT” INNOVATION


Benefits (returns) of global specialization

’Location-specific advantages’ such as the exploitation of differences in comparative advantages

Factor prices

Specialized skills in the local workforce

’Hotspots’ for advanced knowledge

Advantages of specialization:

Economies of scale and scope

’Learning curve’ effects


Risks of global specialization

With geographic specialization, local risks may spread throughout the entire value chain:

Economic (inflation, exchange rates, strikes)

Operational (manufacturing, R&D)

Political (taxes, fees, repatriation, war)

Natural (earthquakes, floods, volcanoes)

Geographic specialization increases exposure towards these risks!


The two sourcing extremes

Multi-domestic (”Replication”) Transnational (”Specialization”)


Degrees of global specialization

”Replication” ”Specialization”


The replication-specialization tradeoff

Multidomestic

Moderate-Low Specialization

Moderate-High Specialization

Transnational

150

2.150

4.150

6.150

8.150

10.150

12.150

14.150

16.150

15.000 17.000 19.000 21.000 23.000 25.000 27.000 29.000

Return

Risk


3. What’s my company’s comfort zone in relation to

global sourcing?


John P. Kotter on comfort zones “Sometimes managers underestimate how hard it can be to drive people out

of their comfort zones” (Kotter, 1995:60)

“Instead of driving employees out of their comfort zones managers would do better in expanding these comfort zones” (Petersen, October 4, 2012)


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The 3 comfort zone components

In combination, three components define the “comfort zone” within which strategic global sourcing unfolds:

Organizational risk perception: the organization’s assessment of how risky a global sourcing situation is in terms of probabilistic estimates.

Organizational risk tolerance (propensity/profile/preference): The organization’s current tendency to take or avoid global sourcing risks.

The firm’s effectuation of risk reducing measures. The comfort zone pertains not only to the manager(s), but to

the various stakeholders of the firm: owners, employees, labor unions, NGOs, etc.


Narrow versus extended comfort zones

18

THE NARROW COMFORT ZONE: THE EXTENDED COMFORT ZONE:

Pessimistic risk perception Optimistic risk perception

The extended comfort zone

Risk aversion Risk willingness

The narrow comfort zone

No, or ineffective, risk-reducing measures

Effective risk-reducing measures


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4. How can your firm expand its comfort zone in relation to offshore global sourcing?


Expanding the global sourcing comfort zone

Changing the global sourcing risk perception:

Let someone from outside the firm make a reality check of the managers’ risk perception – it may be too optimistic or pessimistic.

High perceived uncertainty encourages imitation: The risk perception of managers may be overridden by “collective rationalism” where managers seek “organizational legitimacy” rather than hard facts.


Changing the global sourcing risk tolerance: Prevent or overcome organizational resistance

against global sourcing via creation of a “sense of urgency” or a “burning platform” in the organization (Kotter, 1995)

Education and communication (Kotter and Schlesinger, 1979)

Participation and involvement (Kotter, 1995) Develop internal change agents (Armenakis et al,

1993)


Expanding the global sourcing comfort zone (cont’d)

Expanding the global sourcing comfort zone (cont’d)

Reducing the actual sourcing risks – some examples of risk reducing measures:

Insertion of clear milestones in the outsourcing contract

Check the accreditation and certification of the vendor/supplier

Use of proactive remedies in the outsourcing contract Work out scenarios/emergency plans in anticipation of

operational/delivery disruptions. Insert call or put options in the global sourcing

contract 22 Prins Bertil Seminaret 2012

MEASURES TO REDUCE RISK OF ”WHITE ELEPHANT” INNOVATION: INTERNALIZATION, EXPOSURE TO CUSTOMERS,

AND SALES PERFORMANCE REMUNERATION OF LOCAL PARTNER

Discomfort zone MEASURES TO REDUCE INTERFACE PROBLEMS

AND SUPPLY UNCERTAINTY: INTERNALIZATION,

AND MODULARIZATION OF LOCAL ACTIVITY

MEASURES TO REDUCE RISKS OF KNOWLEDGE SLIPPAGE AND HOLD-UP: KEEPING COMPLEMENTARY ASSETS. INTERNALIZATION AND SOCIAL-IZATION OF LOCAL PARTNER

Strategic global sourcing

Comfort zone

Risk-Reducing Measures


Case: SimCorp’s Global Sourcing in Ukraine

• SimCorp is a Danish-based developer and marketer/licensor of asset management systems software. Most of the business is conducted outside Denmark. SimCorp is currently present in 16 countries and has around 1,100 employees worldwide, of which 140 are in Kiev. In 2010 the company generated revenue of EUR 180m and profit after tax of EUR 27m.

• The business model is based on three elements: sales of software licenses, maintenance income, and fees from professional services.

• The product: SimCorp Dimension, the sole company product since 2007, is a comprehensive software solution for professional investment managers. The programming language of SimCorp Dimension is APL/W is highly specialized and rarely used. As such, it is difficult to find APL programmers.

• Market and customers: Around 60 financial organisations, mainly European (but since 2010 also HSBC), have chosen to base their investment management activities on the SimCorp Dimension© software platform.


SimCorp’s “Stepping Stones” from Outsourced to Captive Global Sourcing

2005: SIMCORP ENTERS OFFSHORE OUTSOURCING CONTRACT

TACTICAL GLOBAL SOURCING

TRANSFORMATIONAL GLOBAL SOURCING 2008: SIMCORP

COMPLETES TRANSITION TO CAPTIVE OFFSHORING

2005: STARTING SOCIALIZATION PROCESS

2006: INTRODUCING REWARDS OF

INDIVIDUALS (QUASI-INTEGRATION)

2007: NEGOTIATING JOINT VENTURE

OPTION (NOT EXERCISED)

2007-2008: GREENFIELD SUBSIDIARY.

OPTIONS FOR PERSONNEL TRANSFER

2008: EXERCISING CALL OPTIONS FOR

TRANSFER OF PERSONNEL


RISKS: SUPPLY UNCERTAINTY, INTERFACE PROBLEMS

RISK: ’WHITE ELEPHANT’ INNOVATION

RISK: HOLD-UP, KNOWLEDGE SLIPPAGE

SimCorp’s initial comfort zone (2005)


COMFORT ZONE RISKS:

SUPPLY UNCERTAINTY, INTERFACE PROBLEMS

RISK-REDUCING MEASURES:

B-O-T INTERNALIZATION

RISK: HOLD-UP, KNOWLEDGE SLIPPAGE RISK-REDUCING MEASURES: SOCIALIZATION, QUASI-INTEGRATION, JV OPTION B-O-T INTERNALIZATION

RISK: ’WHITE ELEPHANT’ INNOVATION RISK-REDUCING MEASURES: B-O-T INTERNALIZATION

COMFORT ZONE

SimCorp’s extended comfort zone of today


5. Example of a new risk reducing measure: B-O-T outsourcing contracts


What is B-O-T outsourcing? It is an outsourcing contract in which the client firm has a call

option, i.e. the right, but not the obligation to transfer pre-specified, non-financial assets – typically project staff – from the vendor to the client organization (e.g. a local subsidiary) at a prefixed price (= transfer fee).

BOT = Build-Operate-Transfer: The delivery model originates from the engineering/construction industry where a consortium provides a physical infrastructure, e.g. a bridge, operates it for a specified period of time, and eventually hands it over (transfer) to the local client/partner.

In recent years, the BOT delivery model has been adopted by service providers in emerging economies, primarily India; though, in a version where the transfer is decided by (i.e. optional to) the client firm.


Basic global sourcing delivery models


FFS (Fee-for-service)

Incr

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, ris

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Incr

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ontr

ol

ODC (Offshore Dedicated Center)

B-O-T (Build-Operate-Transfer)

JV (Joint Venture)

CU (Captive Unit)

Examples of B-O-T outsourcing contracts


YEAR CLIENT FIRM VENDOR FIRM SECTOR

2002 Prudential ICICI Insurance

2002 Exult Hexaware Support

2003 Lloyds TSB Firstsource Finance

2003 British Telecom HCL Support

2005 Oracle Covansys IT

2005 Oracle Hexaware IT

2006 SAP Ness Tech. IT

2006 Tensilica eInfochips Engineering

2006 Cadmus Datamatics IT

2006 Business Objects Ness Tech. IT

2007 Portal Software Ness Tech. IT

2007 Dendrite Aztech Software IT

2008 NetApp Symphony IT

2008 Aviva EXL Insurance

2011 KMD MahindraSatyam IT

2011 Cisco MahindraSatyam IT

The 3 Build-Operate-Transfer phases


Client leases facilities with vendor in a

traditional outsourcing fashion. Contract is

negotiated to include a transfer option.

Phase I: Build

Vendor is responsible for running the operations in an interim period of time.

Client may exercise transfer option to acquire assets and set up a wholly

owned (captive) entity.

Phase II: Operate Phase III: Transfer

Exercising the call option


Client Firm

Vendor Firm

Project unit

Knowledge

exchange ?

Knowledge exchange

Take-aways

A risk-return tradeoff framework for analyzing your company’s engagement in offshore global sourcing

Attention to your company’s comfort zone

Suggestions as to how you may expand the comfort zone...

… including risk reducing measures…

… such as B-O-T internalization

Thanks for your attention! Prins Bertil Seminaret 2012 34

how do you bring global sourcing into the comfort zone of your

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