I found this interesting and wanted to share it with others. Jim Gunderson's company, Gamma Two, makes intelligent and useful robots. He's an Entrepreneur Community Online (ECO) member. I'm an ECO Advisor. From this posting, hopefully you can see how ECO Advisors help entrepreneurs struggling with the growth of their companies.

Jim wrote: Read an interesting article on Out-Sourcing and the 'virtual corp'  Used Black Rock Ventures as a shining example.  Lots of coverage of the business model, by Inc magazine, Forbes, etc. in 1997. http://tinyurl.com/6c4v4u8 Their spokesman said they simply manage the business process, everything from design to manufacturing, marketing to sales and order fufilment is out-sourced.

Company folded a few years later

Small start-ups can't do it all, so they must out-source, but they must also have some contibution to the business model.

Leads to the question "At what point does out-sourcing become counter productive?"

Marty Koenig responded:

Jim,

That's a great question. Some people take the E-Myth too far. They believe with just an idea and some money, they can hire or outsource all the hard work. In actuality, it doesn't work that way.

The entrepreneurs and business owners I know keep the most strategic areas in house. In fact, a company I worked with a couple years ago had outsourced their customer services (800 number and email) to their fulfillment center. That cost quite a bit every month, and we did not foresee the issues with that until we changed it. The CEO had documented all the procedures and responses to customer inquiries, and trained them in person a number of years before that.

During 2009, I was advising all small biz owners to figure out ways to increase their marketing budgets. My financial model showed that if we brought back in-house their customer service, we could use the savings to pay for in-house customer service agents, and have some left to increase marketing.

The fulfillment of the warehousing, product shipping and returns is not an area at which they wanted become experts. That's got high startup and operational costs, better left to those who do that every day and leverage multiple customers with their infrastructure.

We did not anticipate the level of positive results from bringing in customer service. In order for the CEO to train the new people, we agreed that he should spend a couple months doing the work himself so he could be fully prepared to train the new in-house customer service agents. The President and an operations guy was setup for overflow, and so was the original fulfillment center.

 

Net results:

1. Customer satisfaction increased (we did not measure that, but the next result speaks for itself.

2. Sales growth increased from 3% a month normally to 20% - 40% a month.

3. It seemed like such a simple strategy. It's so easy to just say, "In-source customer service." It was not easy to execute, took time, and took the CEO away from some important duties.

4. I sold the company a year later for 19X EBITDA, and the owners got a big check. Their check would have been smaller if they had continued outsourcing customer service.

Recommendations:

1. Prepare financial models that allow you to see different "flavors" of outsourcing what.

2. Don't exclusively use financial models for decision making. Use strategic planning.

3. Know that what you outsource today, may be better to bring back in-house later. Plan for that.

4. Don't outsource for the sake of outsourcing. Initially, it often looks like huge cost savings, but in actual practice it sometimes does not happen as planned. Why do you think there's less off-shore software development these days? The jury has come in, and the net savings over time aren't that great any more. That's because of increasing pay rates in India, for example, and the unforeseen, huge overhead costs associated with managing the requirements, people and processes remotely.

In summary, if a entrepreneur or business owner believe he/she can "just" have someone else do all the heavy lifting, that's a low probability of success. The most successful businesses I see are where the owner(s) spend every day doing actual work, not just coordinating. Selling, partnering, managing people, processes and information, leading, strategizing and paying close attention to the finances.

One of the first things businesses outsource is bookkeeping/accounting.

I think it's a pipe dream to have a successful company that outsources everything. A couple/few, very carefully chosen processes can be OK, as long as due diligence and risk planning can rule out not outsourcing them.

Would Zappos outsource their customer service? Would Amazon outsoure their fulfillment? Those tie closely with their differentiating factors, thus would be considered strategic assets not for outsourcing. Every company is different and what CAN be outsourced is often very different than what SHOULD be outsourced.

It's a bit art and a bit science to decide what point outsourcing becomes counter-productive. The answer for every business will be different.

I'm very interested in other's opinions and experience on this very relevant topic.

Marty Koenig

Jim responded:

 

Marty,  I think you have hit the nail on the head. The key to out-sourcing is balance.  The decision to out-source some business functions seems to be a no brainer, yes or no. Others seem to be a tricky call that could kill a business.

Take my company for example, we are designing and building service robots. An interesting aspect of our business is that the physical robot is not our key intellectual property. There are hundreds of companies producing robot bodies. What makes our robots unique are the brains that let them do useful things around the warehouse, the office, and (eventually) the home. But if our 'brains' are going to do useful work, they must be in a physical robot. So we build robots.

Some things, such as payroll and accounting, or sweeping and window washing we out-source without a worry.  Other functions, such as software development, are our key business functions, and stay deeply in-house. Things like this are the science part of out-sourcing, analyse the cost/benefits and the ROI and you are done.

But there are the grey areas. The most visible aspect of what we do is the physical robot, but we could put our brains in any chassis. Finding a cost-effective body has been difficult, so we need a new design. The question of out-sourcing the design of the robot body is a little trickier. Since we are not strongest on electromechanical design, it is a prime candidate for out-sourcing, but since the robot body is what our customers actually see, it is a prime product identifier, and should be kept close to the vest.

SIGH!  I love being an entrepreneur!