Hagel: Yes, companies were managing offshoring as near-term a operating decision without recognizing that it had much more fundamental implications for the business. Ultimately, it really needed to be viewed as a strategic issue, not just as a short-term operating issue.
The way I would characterize it is that many companies are moving now from a view of offshoring as a simple wage arbitrage play to a realization that there's an opportunity to connect with some very distinctive skills and capabilities in these offshore locations and to enhance their own business focus in the process.
But I'd say that this still is thinking too narrowly about the opportunity. From our perspective, the real opportunity is to connect into environments and relationships that will accelerate capability-building in ways that you just couldn't do in onshore locations. And here, I'm referring in particular to the opportunity to connect into some very specialized ecosystems — business ecosystems emerging in particular cities either in India or China specializing around particular kinds of technologies or industry expertise that are quite deep and quite rich in their capabilities — as well as to connect into global process networks through relationships that the offshore companies have already established.
So when you build a relationship with an offshore provider, you're not just building a relationship with that company. You're actually connecting into a network of relationships that that offshore provider typically has developed. One of the best examples — actually, one of the most sophisticated examples — is in the apparel industry, where you have apparel designers like Calvin Klein and Ann Taylor, who are using a very specialized company called Li & Fung to connect into a global process network of over 7,500 business partners. These business partners are highly specialized in various aspects of apparel manufacture or the sourcing of some very specialized kinds of synthetic fibers.
And what Li & Fung does is essentially organize the right set of participants to support a particular apparel designer's apparel needs. It could be a wool sweater, which would require a very different set of participants than a pair of cotton slacks, for example. And so, in essence, the apparel designer connects with Li & Fung, has the most direct relationship with Li & Fung, but, in the process, is leveraging a much richer and broader global process network.
CM: You might suspect that these networks first grew there in response to a company's own regulatory environment. Perhaps they became a necessity because this was the only way they could accomplish certain things …
Hagel: No. In fact, many of these networks emerged from a sense of urgency on the part of these Asian companies, particularly, again, in China and India, around a need to rapidly build skills, to add more value around their low wage rates. So there was real urgency about that, and then a real philosophy of bootstrapping. How do I get better faster by connecting with other people who are just as specialized in complementary areas?
This led to this very different way of organizing business activities, largely out of, again, necessity and urgency. And now there is a risk that, over time, as these networks become more, as you said, integrated with Western companies or as the Chinese companies begin to get larger, I see that many of them have, if you will, Western envy. They want to look more and more like Western companies, whereas, in fact, they don't realize that they've actually developed some very different and innovative ways of organizing that should be preserved.
CM: Is it likely that these types of networks could take root in a meaningful way domestically?
Hagel: It's certainly possible, and there are some early examples. In our book, we talk about what Cisco is doing. Many observers have commented on Cisco's supply chain operations, but we actually think that the more interesting insight or innovation at Cisco is around their customer relationship processes, where they basically have organized a process network of thousands of business partners to add more value in customized ways to their customers.
So when a customer comes to them for a particular network product need, Cisco invests time to really qualify what their needs are and then, based on that understanding, will reach out and, again, organize in a very customized way the right sequence of business partners to help support that customer — whether it's initial consulting and needs definition or preparation of facilities or the actual installation of the equipment and training of the people to use the equipment and get more value out of it at the other end.
CM: The other theme we are beginning to hear more about is how the offshoring phenomenon relates to medium-size business. Does much of your thinking apply to the medium-size business as well?
Hagel: Yes. Medium-size as well as very-small-size. One of the phenomena we're seeing in Silicon Valley is this notion of micro-multinationals. From day one, startups actually are expected to have operations — a portion of their operations — based in either China or India as well as in Silicon Valley. And they're doing that, again, in part because of the cost savings but in even greater part because of the ability to focus their own operations on the areas where they can be distinctive and to gain the benefit of connecting with more specialized capability that's already in place in China and India.
In the midsize range, there's a similar opportunity, and I'd also say a potential threat, because I think that, from my experience, midsize enterprises are still relatively slow in taking advantage of using these offshore capabilities. Many of them are under some pretty substantial margin pressure because of increasing competition from companies that are using these offshore locations.
I know that a number of private equity firms are now beginning to put together funds to basically go after midsize companies that have not been aggressive in exploiting these opportunities, basically taking them private and then stripping out the activities that should be offshore, moving them offshore, and refocusing the company on the areas where they really can be distinctive.
CM: Are medium-size businesses behind the curve as far as having a cost-driven strategy goes? And are the larger enterprises a little further ahead of the curve in seeing strategic components come into play?
Hagel: Right. They more focused on cost. They also, quite naturally, are nervous about it, because they don't have a lot of experience. I think that one of the things you find is that the first step, in terms of moving offshore, is a quite challenging one. There's a different way of managing those relationships, and it can be a fairly high-risk transition. So once you've gained that experience, there is a kind of reinforcing cycle. You become more and more likely to offshore the next wave of activities, because you have more comfort and experience in what it requires. I think that both of those factors are operating at the midsize level to make companies slower than the larger enterprise companies in exploiting these opportunities.
CM: When business leaders seek to identify the portions of their businesses that can effectively be offshored, where do they begin?
Hagel: Well, there are a number of dimensions to it. One of the key points that we make in The Only Sustainable Edge is that offshoring is forcing an unbundling of companies in a fairly predictable way. We have a point of view that most companies today are an unnatural bundle of three very different businesses.
You have customer relationship businesses, which are about getting to know a set of customers and becoming more helpful to them, and, based on that knowledge, bringing the right products and services together for them.
You have infrastructure management businesses, which are very high-volume routine processing kinds of activities. It could be a manufacturing assembly line, it could be a logistics network, it could be a customer call center.
And then you have product innovation and commercialization businesses, which are all about coming up with creative new products, getting them into market quickly, and gaining adoption of the product.
Those are three very different businesses, different skill sets, different economics, even different cultures, and yet most companies have all three, tightly bundled together in one company. If you look at what's happening in offshoring, the first wave of offshoring has been to carve out a lot of the infrastructure management businesses, the high-volume routine processing kinds of activities, like manufacturing and logistics.
Ultimately, it's creating the choice, the opportunity for companies to decide which of these three businesses they really want to specialize in and focus in, and which other two they are going to look for partners to support them in. And in the end it's not just a choice or an opportunity. We would assert that it's a necessity, that you're going to become increasingly vulnerable to more focused competitors who have made these choices and are world-class in the one area they've specialized in.
So when we talk about specialization, it's a fairly broad specialization. It's not saying that you need to focus on just one kind of product or one type of business activity, but rather it's "choose among these three business types" and then really use the opportunity to concentrate your own resources to ensure that you're world-class in that business type.
John Hagel III is an author and business strategist who has advised business executives around the world for more than 25 years. His latest book titled The Only Sustainable Edge (Harvard Business School Press 2005) he co-authored with John Seely Brow. From 1993-2000 Hagel served as leader of McKinsey's Strategy Practice and Global Leader of its Electronic Commerce Practice, a practice he also founded.
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