Capability Analysis
The type of advantage
The advantage can be based on attributes such as lower costs, superior quality, service levels, etc.
Superior performance in an activity can also include a combination of these attributes. There are a number of elements of this analysis.
? Cost analysis – part of this analysis involves comparing the costs of sourcing the activity internally and from an external supplier. An assessment of the relative cost position of the sourcing organisation in relation to both suppliers and competitors in the activities under scrutiny should also be undertaken. An assessment of costs can form a significant part of capability analysis. The major drivers of cost associated with each activity should be identified. For example, for capital-intensive activities the major cost drivers are likely to be the cost of equipment and production volume. Alternatively, in highly labour-intensive manufacturing processes, the major driver of costs is labour rates.
? Benchmarking – can assist in determining performance levels in the activities under scrutiny. Organisations considering outsourcing must rigorously evaluate their capabilities in relation to suppliers and competitors. This analysis involves a structured benchmarking approach to assessing the organisation’s capabilities relative to potential suppliers and competitors. Benchmarking also involves consideration of the cost position relative to competitors and suppliers.
Cost analysis
Identifying cost drivers
At a general level, there are a number of drivers of costs that impact upon the relative cost position of the sourcing organisation in relation to suppliers and competitors.
? Factor costs – one of the most prominent influences in relation to cost analysis in outsourcing evaluation is that of factor costs. Factor costs refer to the inputs that are used to perform organisational activities and include labour, capital, land and raw materials. For example, external suppliers may have a significant cost advantage in a number of areas as a result of having lower factor costs. Perhaps, the most common influence in relation to factor costs is that of labour rates. Many organisations can realise significant cost reductions by outsourcing to suppliers that have much lower labour costs. As well as considering the labour cost per employee, Bruck (1995) argues that the total annual labour costs should be considered. Total annual labour costs – including ancillary costs such as unemployment insurance – divided by the number of hours worked will yield net labour cost per hour. In many cases, suppliers work longer hours than their counterparts in original equipment manufacturers (OEMs). If this is added to the lower annual labour cost per employee then the personnel cost advantage per hour reaches 30 to 40%. Organisations have realised significant cost savings in areas ranging from manufacturing to telephone call handling by outsourcing to either local suppliers or foreign supply sources.
? Economies of scale – can be obtained through internal development or outsourcing to suppliers. Economies of scale in certain processes can be realised internally through the achievement of high relative market share in the sourcing organisation’s respective product markets. Alternatively, suppliers are often in a position to realise scale economies because they are supplying the same products to a number of customers. But what is often not realised is that economies of scale may also exist in material costs, especially if a manufacturer is paying more for all the various components together than it would for a complete outsourced system.
? Experience – costs can be reduced through experience built up over time that competitors can find extremely difficult to replicate.
? Complexity – the range of products and services offered by an organisation influences costs. Enhancing value for customers through adding unique product or service features is also likely to increase costs. Complexity can dilute the impact of reduced costs associated with other cost drivers such as scale economies. For example, introducing a constant stream of new and innovative products and services can make it extremely difficult to realise scale economies.
Procurement Cost drivers:
Location of suppliers
Relative bargaining power
Volume of purchases per supplier
Manufacturing Cost drivers:
Scale of facilities
Plant location
Level of automation
Labour rates
Capacity utilisation
Design Cost drivers:
Number and frequency of new product introductions per planning period
Average sales per new product introduction
Labour rates
Labour skills availability
Customer service Cost drivers:
Number of customers
Sales per customer
Service level offered
Benchmarking
The American Productivity and Quality Centre (1993) provides a comprehensive definition of benchmarking as the process of:
? comparing practices and results with the best organisations in the world, and adapting the key features of those practices to one’s own organisation;
? accelerating organisational learning, customer-driven quality and continuous improvement;
? helping organisations identify breakthroughs, by comparing their processes to those of the organisation that is recognised as the best; and
? helping organisations learn from each other whether it be in business, health care, government, or education.
Benchmarking can be classified as follows (Carpinetti and de Melo, 2002).
? Process benchmarking – is used to compare operations, work practices and business processes. Process benchmarking involves developing a detailed understanding of how a particular process is carried out and comparing it to how it is carried out and measuring it against performance levels in that process with other organisations.
? Product benchmarking – is used to compare products and/or services. This is similar to reverse product engineering that focuses on the analysis of specific components and functions of the products of competitors. Reverse engineering can also act as starting point for process benchmarking. For example, the analysis can be extended to include an examination of the processes that underpin the products of competitors.
? Strategic benchmarking – is used to compare organisational structures and management practices and business strategies. Organisations may have similar approaches or initiatives to achieve strategic objectives that are comparable.
Benefits and limitations of benchmark partners
1) Internal
Benefits: Breaking down internal barriers; improved communication and information sharing; ease of access to partner cost.
Limitations: Does not identify global ‘best practices’; internal politics/‘turf guarding’.
2) Competitor
Benefits: As part of consortium can share costs and effort; ease of identifying partners; opening up to ideas from outside.
Limitations: Legal, proprietary issues.
3) Related industry
Benefits: Study of ‘best practices’ in generic functional or business process management; as with competitors (above).
Limitations: Legal, proprietary issues: harder to identify partners.
4) Unrelated industry
Benefits: As for a related industry, but you may have a greater chance of discovering new ideas and breakthroughs.
Limitations: Harder to identify appropriate partners.
5) International
Benefits: Identifies global ‘best practices’; as with unrelated industry (above).
Limitations: Cost, time, effort; difficulty of identifying partners.
Classifications of benchmarking can also be based on the type of partner, as follows (Camp, 1989).
? Internal benchmarking – by comparison of performance of units or departments within one organisation. Even though not explicit in this definition, comparison can also be made of similar products or services of similar business units. Internal benchmarking is particularly valuable for multi-site organisations where similar activities are carried out at the different sites. Similar activities are normally found in other parts of the same organisation. For example, dealing with customer queries is a process that can be found not just in the one site but also across a number of sites that deal directly with customers. Therefore, it is useful in determining how the activity is carried out within the same organisation. A major advantage of this type of approach is that full access can normally be obtained to understanding how the process is carried out. Good practices and innovative approaches to activities can also be readily shared and transferred across sites. However, a limitation of internal benchmarking is that it is likely that most parts of the same organisation will be carrying out similar processes in much the same way. Therefore, this may limit the potential to learn and create radically improved processes.
? Competitive benchmarking – by comparison of performance with competitors. In this case, comparison can be made of products or services and business processes. If carried out effectively, competitive benchmarking can be particularly useful in discovering new and innovative approaches that can enhance service delivery and performance. However, a major limitation is gaining access to competitor information whether it be data on performance information on their processes. Performance levels can also be compared with other organisations that are not direct competitors. For example, customers will compare performance in areas such as call handling response times against other organisations even though they are not direct competitors. In this case, it is important to identify organisations that have high performance levels in the areas that are valued by customers. Once identified, it is then necessary to analyse how these activities are carried out and the performance levels achieved. The advantage of this approach is that benchmarking can lead to changes that can be implemented which directly contribute to customer satisfaction.
? Functional benchmarking – specific function comparison with best practice. It is an application of process benchmarking that compares a particular business function in two or more organisations. It involves comparing the structure and performance of a function in an organisation with comparable functions elsewhere. For example, the entire human resource function could be benchmarked rather than one of its key processes such as recruitment and training.
? Generic benchmarking – the search for the best practice irrespective of industry. It is similar to functional benchmarking but the aim is to compare with the best in class without regard to industry. It is also important to understand who customers of the organisation regard as best-in-class. For example, Xerox benchmarked against the following companies:
o Walt Disney – staff motivation and training;
o American-Express – accuracy of invoicing and billing;
o Marriott Hotels – dealing with customer complaints.
Sample metrics for performance areas
1) Market share
Units
Revenue
2) Profitability
Margin contribution
Return on capital employed (ROCE)
3) Competitors’ growth Materials
Market share per segment
Proportion of total cost
Price/volume
Distribution costs
4) Direct/indirect human resource costs
Proportion of total cost
Number of employees per function
Productive hours per employee
5) Capital costs
Rate of turnover:
? Total assets;
? Fixed assets;
? Inventory.
Leasing costs
6) Service
Response time
Average time of service call
Order processing routines
Production planning
The benchmarking exercise should yield the one of the following three scenarios:
? parity – no significant difference in performance between the sourcing organisation and competitors or suppliers;
? internal more competent – in this scenario internal performance is superior to that of either competitors or suppliers;
? external more competent – the performance of either competitors or suppliers is superior to that of the sourcing organisation.
A number of recommendations were made in relation to both the benchmarks used and the selection of a firm to assist in benchmarking which included the following items.
? Involve senior management in the selection process – senior management are more likely to be convinced of the validity and results of the benchmarking exercise if they are involved in the selection of the benchmarking firm.
? Measure what is important to senior management – there is a tendency for many IS benchmarking exercises to employ benchmarks that are too technical. Moreover, the benchmarking exercise may focus on performance values that are not important to senior management.
? Select the most competitive company to benchmark – rather than select a large reference group, it is much more valuable to compare performance against the ‘best of breed’ in the particular area being benchmarked. It was found that senior management were much more impressed by the exercise when the ‘best of breed’ in the area was used as the reference.
? Gather data during peak times – measures of performance taken at peak times give a better indication of effectiveness and are more valuable to senior management. The data gathered should also be validated through consulting with the relevant people within the organisation.
? Repeat benchmarks – it was found that senior management placed more emphasis on the results of benchmarking if the measures were used and repeated on a periodic basis. This should assist in improving performance over time.
For more Information:
* The Outsourcing Handbook, Business Outsourcing Process, Business Benchmarking, Outsourcing Risks and Rewards *
* IT Computer Outsourcing, Outsourcing Management Information Systems *
The type of advantage
The advantage can be based on attributes such as lower costs, superior quality, service levels, etc.
Superior performance in an activity can also include a combination of these attributes. There are a number of elements of this analysis.
? Cost analysis – part of this analysis involves comparing the costs of sourcing the activity internally and from an external supplier. An assessment of the relative cost position of the sourcing organisation in relation to both suppliers and competitors in the activities under scrutiny should also be undertaken. An assessment of costs can form a significant part of capability analysis. The major drivers of cost associated with each activity should be identified. For example, for capital-intensive activities the major cost drivers are likely to be the cost of equipment and production volume. Alternatively, in highly labour-intensive manufacturing processes, the major driver of costs is labour rates.
? Benchmarking – can assist in determining performance levels in the activities under scrutiny. Organisations considering outsourcing must rigorously evaluate their capabilities in relation to suppliers and competitors. This analysis involves a structured benchmarking approach to assessing the organisation’s capabilities relative to potential suppliers and competitors. Benchmarking also involves consideration of the cost position relative to competitors and suppliers.
Cost analysis
Identifying cost drivers
At a general level, there are a number of drivers of costs that impact upon the relative cost position of the sourcing organisation in relation to suppliers and competitors.
? Factor costs – one of the most prominent influences in relation to cost analysis in outsourcing evaluation is that of factor costs. Factor costs refer to the inputs that are used to perform organisational activities and include labour, capital, land and raw materials. For example, external suppliers may have a significant cost advantage in a number of areas as a result of having lower factor costs. Perhaps, the most common influence in relation to factor costs is that of labour rates. Many organisations can realise significant cost reductions by outsourcing to suppliers that have much lower labour costs. As well as considering the labour cost per employee, Bruck (1995) argues that the total annual labour costs should be considered. Total annual labour costs – including ancillary costs such as unemployment insurance – divided by the number of hours worked will yield net labour cost per hour. In many cases, suppliers work longer hours than their counterparts in original equipment manufacturers (OEMs). If this is added to the lower annual labour cost per employee then the personnel cost advantage per hour reaches 30 to 40%. Organisations have realised significant cost savings in areas ranging from manufacturing to telephone call handling by outsourcing to either local suppliers or foreign supply sources.
? Economies of scale – can be obtained through internal development or outsourcing to suppliers. Economies of scale in certain processes can be realised internally through the achievement of high relative market share in the sourcing organisation’s respective product markets. Alternatively, suppliers are often in a position to realise scale economies because they are supplying the same products to a number of customers. But what is often not realised is that economies of scale may also exist in material costs, especially if a manufacturer is paying more for all the various components together than it would for a complete outsourced system.
? Experience – costs can be reduced through experience built up over time that competitors can find extremely difficult to replicate.
? Complexity – the range of products and services offered by an organisation influences costs. Enhancing value for customers through adding unique product or service features is also likely to increase costs. Complexity can dilute the impact of reduced costs associated with other cost drivers such as scale economies. For example, introducing a constant stream of new and innovative products and services can make it extremely difficult to realise scale economies.
Procurement Cost drivers:
Location of suppliers
Relative bargaining power
Volume of purchases per supplier
Manufacturing Cost drivers:
Scale of facilities
Plant location
Level of automation
Labour rates
Capacity utilisation
Design Cost drivers:
Number and frequency of new product introductions per planning period
Average sales per new product introduction
Labour rates
Labour skills availability
Customer service Cost drivers:
Number of customers
Sales per customer
Service level offered
Benchmarking
The American Productivity and Quality Centre (1993) provides a comprehensive definition of benchmarking as the process of:
? comparing practices and results with the best organisations in the world, and adapting the key features of those practices to one’s own organisation;
? accelerating organisational learning, customer-driven quality and continuous improvement;
? helping organisations identify breakthroughs, by comparing their processes to those of the organisation that is recognised as the best; and
? helping organisations learn from each other whether it be in business, health care, government, or education.
Benchmarking can be classified as follows (Carpinetti and de Melo, 2002).
? Process benchmarking – is used to compare operations, work practices and business processes. Process benchmarking involves developing a detailed understanding of how a particular process is carried out and comparing it to how it is carried out and measuring it against performance levels in that process with other organisations.
? Product benchmarking – is used to compare products and/or services. This is similar to reverse product engineering that focuses on the analysis of specific components and functions of the products of competitors. Reverse engineering can also act as starting point for process benchmarking. For example, the analysis can be extended to include an examination of the processes that underpin the products of competitors.
? Strategic benchmarking – is used to compare organisational structures and management practices and business strategies. Organisations may have similar approaches or initiatives to achieve strategic objectives that are comparable.
Benefits and limitations of benchmark partners
1) Internal
Benefits: Breaking down internal barriers; improved communication and information sharing; ease of access to partner cost.
Limitations: Does not identify global ‘best practices’; internal politics/‘turf guarding’.
2) Competitor
Benefits: As part of consortium can share costs and effort; ease of identifying partners; opening up to ideas from outside.
Limitations: Legal, proprietary issues.
3) Related industry
Benefits: Study of ‘best practices’ in generic functional or business process management; as with competitors (above).
Limitations: Legal, proprietary issues: harder to identify partners.
4) Unrelated industry
Benefits: As for a related industry, but you may have a greater chance of discovering new ideas and breakthroughs.
Limitations: Harder to identify appropriate partners.
5) International
Benefits: Identifies global ‘best practices’; as with unrelated industry (above).
Limitations: Cost, time, effort; difficulty of identifying partners.
Classifications of benchmarking can also be based on the type of partner, as follows (Camp, 1989).
? Internal benchmarking – by comparison of performance of units or departments within one organisation. Even though not explicit in this definition, comparison can also be made of similar products or services of similar business units. Internal benchmarking is particularly valuable for multi-site organisations where similar activities are carried out at the different sites. Similar activities are normally found in other parts of the same organisation. For example, dealing with customer queries is a process that can be found not just in the one site but also across a number of sites that deal directly with customers. Therefore, it is useful in determining how the activity is carried out within the same organisation. A major advantage of this type of approach is that full access can normally be obtained to understanding how the process is carried out. Good practices and innovative approaches to activities can also be readily shared and transferred across sites. However, a limitation of internal benchmarking is that it is likely that most parts of the same organisation will be carrying out similar processes in much the same way. Therefore, this may limit the potential to learn and create radically improved processes.
? Competitive benchmarking – by comparison of performance with competitors. In this case, comparison can be made of products or services and business processes. If carried out effectively, competitive benchmarking can be particularly useful in discovering new and innovative approaches that can enhance service delivery and performance. However, a major limitation is gaining access to competitor information whether it be data on performance information on their processes. Performance levels can also be compared with other organisations that are not direct competitors. For example, customers will compare performance in areas such as call handling response times against other organisations even though they are not direct competitors. In this case, it is important to identify organisations that have high performance levels in the areas that are valued by customers. Once identified, it is then necessary to analyse how these activities are carried out and the performance levels achieved. The advantage of this approach is that benchmarking can lead to changes that can be implemented which directly contribute to customer satisfaction.
? Functional benchmarking – specific function comparison with best practice. It is an application of process benchmarking that compares a particular business function in two or more organisations. It involves comparing the structure and performance of a function in an organisation with comparable functions elsewhere. For example, the entire human resource function could be benchmarked rather than one of its key processes such as recruitment and training.
? Generic benchmarking – the search for the best practice irrespective of industry. It is similar to functional benchmarking but the aim is to compare with the best in class without regard to industry. It is also important to understand who customers of the organisation regard as best-in-class. For example, Xerox benchmarked against the following companies:
o Walt Disney – staff motivation and training;
o American-Express – accuracy of invoicing and billing;
o Marriott Hotels – dealing with customer complaints.
Sample metrics for performance areas
1) Market share
Units
Revenue
2) Profitability
Margin contribution
Return on capital employed (ROCE)
3) Competitors’ growth Materials
Market share per segment
Proportion of total cost
Price/volume
Distribution costs
4) Direct/indirect human resource costs
Proportion of total cost
Number of employees per function
Productive hours per employee
5) Capital costs
Rate of turnover:
? Total assets;
? Fixed assets;
? Inventory.
Leasing costs
6) Service
Response time
Average time of service call
Order processing routines
Production planning
The benchmarking exercise should yield the one of the following three scenarios:
? parity – no significant difference in performance between the sourcing organisation and competitors or suppliers;
? internal more competent – in this scenario internal performance is superior to that of either competitors or suppliers;
? external more competent – the performance of either competitors or suppliers is superior to that of the sourcing organisation.
A number of recommendations were made in relation to both the benchmarks used and the selection of a firm to assist in benchmarking which included the following items.
? Involve senior management in the selection process – senior management are more likely to be convinced of the validity and results of the benchmarking exercise if they are involved in the selection of the benchmarking firm.
? Measure what is important to senior management – there is a tendency for many IS benchmarking exercises to employ benchmarks that are too technical. Moreover, the benchmarking exercise may focus on performance values that are not important to senior management.
? Select the most competitive company to benchmark – rather than select a large reference group, it is much more valuable to compare performance against the ‘best of breed’ in the particular area being benchmarked. It was found that senior management were much more impressed by the exercise when the ‘best of breed’ in the area was used as the reference.
? Gather data during peak times – measures of performance taken at peak times give a better indication of effectiveness and are more valuable to senior management. The data gathered should also be validated through consulting with the relevant people within the organisation.
? Repeat benchmarks – it was found that senior management placed more emphasis on the results of benchmarking if the measures were used and repeated on a periodic basis. This should assist in improving performance over time.
For more Information:
* The Outsourcing Handbook, Business Outsourcing Process, Business Benchmarking, Outsourcing Risks and Rewards *
* IT Computer Outsourcing, Outsourcing Management Information Systems *
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