Reputation risk outsourcing is underestimated
March 22, 2010
The outsourcing of activities is a trend which started in the seventies with car manufacturers and has since then progressed into almost every aspect of our economy. The main drivers behind this trend were technological advances and the breaking down of national trade barriers.
The same technology which enabled outsourcing also allows for an increasingly intimate relation between company and customer. Books, pizza’s, insurances, movies; almost everything can be ordered these days by TV, laptop or PDA. The technology behind these advances are however so complex that most companies have to rely on external technology partners/service providers to design and manage the technology. The pressure to work with external partners is increased further by the relentless pressure to lower cost, increase quality and innovate.
If this goes all well, the advantages for the company interacting with the consumer are overwhelming. It allows the company to gather valuable information of the consumer behavior, allowing for more tailor made offerings. More precise consumer data allows furthermore for optimized production volumes and better prioritization of future innovations.
The increasing complexity of the value chain due to the ever growing number of external parties a company is relying on also poses a serious risk. So are the troubles with the Toyota Prius ‘insourced’ from an external partner as Toyota does not make the affected components itself. Other examples are consumers investing in the Madoff scheme without them nor the bank knowing this because the bank did not exercise adequate control over its asset management value chain. In Germany financial and personal data of some 21 million went on sale on the internet after some dodgy service desk providers got hold of it. In this case the prime service provider had subcontracted the service desk activities to smaller service providers to further reduce cost.
This creates situations where the consumer thinks it does business with one company, but actually has to deal with a dozen. This should not be an issue, but it turns out that the consumer often has to absorb more than a fair share of the risk when the company overstretches its ‘span of sourcing control’. The consumer is the one driving the faulty car against the tree, is the one seeing its pension evaporate due to mismanagement by the bank or sees its credit card information for sale on the internet.
With outsourcing becoming increasingly a mainstream business decision, managing reputation risk induced by it becomes increasingly important. The potential damage to the own brand due to external partners messing up is a factor of increasing importance. External partners which are often selected for one reason alone: lowest cost. And lowest cost is directly related to what you get at the end of the day. An example is the report by Apply released on February 23rd stating the treatment of workers at several of its contractors in various countries broke both local laws and Apple’s own standards. Both Nokia’s and Apple’s names were also connected to the dead of 62 workers which had been poisoned in a poorly ventilated factory in Suzhou. The factory was run by Wintek, a Taiwanese manufacturer that makes products for both firms.
The resulting effect is consumers and media making noise, damaging the reputation and brand of the company (typically the external partner creating the issue in the first place stays out of the lime light). That reputation risk is becoming more of a general topic can be derived from a recent statement by Goldman Sachs, addressing it as one of their key strategic risks. On the other hand is outsourcing also a topic which gets more attention from for example regulators. The Dutch financial regulator DNB has appointed outsourcing as one of its key attention points for 2010.
I’m not saying that outsourcing is a bad thing, on the contrary. It drives innovation and productivity gains and a more even distribution of wealth across the world. What I am saying is that companies introduce a strategic risk when cutting up their value chain in many pieces without being able to execute adequate control over it. Governing and integrating end-to-end value chains (from consumer all the way down to the subcontractors) is thus a topic I expect to grow further in importance. And that starts with transparency. Transparency and trust. Transparency, trust, and not just going for the lowest bid.