A variety of books and papers have been written on the growing trend of outsourcing products and services. Their basic premise is the need for companies to evolve from the vertically integrated, hierarchical organizations that were the norm for the last hundred years and to focus their energies on those activities that bring real business value.
The outsourcing trend naturally leads to the establishment of industry value webs or ecosystems, in which each participant specializes in its key areas of strength. The rise of the Internet, the adoption of technical and business standards, and plummeting transaction costs are key driving forces behind this trend, along with the need for businesses to become more flexible in order to compete in today's fast-changing, dynamic marketplace.
While the basic direction toward networked enterprises and industry value webs is a given, many important questions arise on how best to implement them. A particular concern is whether a company that outsources some of its key functions puts itself at risk of being hollowed out in those areas, and is thus trading long-term innovation for near-term efficiencies and flexibility. This is indeed a valid concern - one that lies at the nexus between outsourcing, and collaboration, talent and innovation. Let me offer some personal thoughts.
We should think of outsourcing as a spectrum of business relationships that extends from relatively straightforward procurement at one end to close alliances at the other, with various degrees of collaboration in between. Examples at the extremes are easiest to articulate, especially in more mature areas such as those involving technology and hardware.
In my many years at IBM, I have seen a number of instances when technologies have migrated from being at the very leading edge of research and market differentiation to becoming a standard, commodity component that we essentially outsource and procure from vendors in the marketplace.
Dynamic random access memory (DRAM) was invented by Robert Dennard at our Research Labs in the 1960s. For many years our ability to innovate in DRAMs was a big source of differentiation in our products, and it later became a business in itself, as we sold DRAMs to other companies. But in the 1990s, DRAMs became a commoditized component that could be acquired in the marketplace from a number of vendors at attractive prices and good quality. For a company like IBM, there was no longer a competitive advantage in designing and manufacturing our own DRAMs, so we exited the business.
A similar story can be told about hard disk drives (HDD). Once more it is a technology that we pioneered in our labs a long time ago and refined over the years. But eventually HDDs became a standard, commoditized technology, and we sold the business to Hitachi in 2002.
The lesson is clear - the more mature, standardized and commoditized a technology becomes, the better a candidate it is for being procured from specialized vendors in the marketplace.
At the other end of the spectrum from outsourcing-as-procurement are very close business collaborations and alliances between companies. For example, the Cell microprocessor that is at the core of the recently released Sony Play Station 3 was developed as an alliance between Sony, Toshiba and IBM (STI) with engineers from the three companies working closely together in the STI lab in Austin. Similarly, IBM's advanced semiconductor solutions, in particular, the 300mm foundry in Fishkill, NY, requires very advanced tools, which are built mostly by partners in very close collaboration with scientists and engineers from IBM.
Clearly, when it comes to alliances and collaborations, especially in new areas ripe with innovation potential, a company needs to retain a high degree of in-house talent, even as it might rely on other companies that can better achieve economies of scale in specific capabilities. Those other companies should be treated as collaboration and innovation partners, with talented people from each side working closely together, instead of as hands-off vendors to be dealt with primarily by procurement organizations who tend to focus primarily on price.
These are very different styles of outsourcing. In my experience, a mistake that companies sometimes make is to treat as a hands-off procurement an outsourcing deal that should be best handled in a more collaborative style. This is a particular problem in areas like software, IT infrastructure and business services where standards are less well defined than in the more mature technology and hardware areas. In such cases, it is harder to define the boundaries between what is being outsourced and what should remain a part of the business.
This is less of a problem if the companies view their relationship as one of collaboration and trust, with talented people on both sides working together, sharing management and decision making, and jointly solving problems as they come along. It is a big problem if one company is indeed hollowed out, lacks the proper talent and culture to collaborate, and the relationship turns into one of hands-off business procurement. Without the kind of close communications the situation calls for, the working relationship will likely begin to deteriorate at the first sign of trouble, and might lead to costly and wasteful litigation.
In the end, networked enterprises and industry webs or ecosystems are the wave of the future, because no individual enterprise, no matter how large and talented, can afford to go it alone in our highly competitive, global, integrated marketplace. This is a trend that will require that companies develop the skills and culture needed to successfully manage collaborative business relations. Without a doubt, it will be one of the most important and interesting aspects of business strategy in years to come.