Strategic sourcing from periphery to the core

BEST PRACTICE

Outsourcing has become strategic-yet many executives

remain unprepared. A new era of capability sourcing will

trigger organizational redesign and require a new set of

managerial skills.

Strategic Sourcing From Periphery to the Core by Mark Gottfredson, Rudy Puryear, and Stephen Phillips

FOR YEAR5, "sourcing" has been justanother word for procurement - a financially material, but strategically peripheral, corporate function. Now, globalization, aided by rapid technol- ogy innovation, is changing the basis of competition. It's no longer a company's ownership of capabilities that matters but rather its ability to control and make the most of critical capabilities, whether or not they reside on the company's bal- ance sheet. Outsourcing is becoming so sophisticated that even core functions like engineering, R&D, manufacturing, and marketing can -and often should- be moved outside. And that, in tum, is changing the way firms think about their organizations, their vaiue chains, and their competitive positions.

Forward-thinking companies are mak- ing their value chains more elastic and their organizations more flexible. And with the decline of the vertically inte-

grated business model, sourcing is evolv- ing into a strategic process for organiz- ing and fine-tuning the value chain.The question is no longer whether to out- source a capability or activity but rather how to source every single activity in the value chain. This is the new discipline of "capability sourcing."

Perhaps the best window on the new sourciiig landscape is a handful of van- guard companies that are transform- ing what used to be purely internal corporate functions into entirely new industries. Firms like United Parcel Ser- vice in logistics management, Solectron in contract manufacturing, and Hewitt Associates in human resource manage- ment have created new business models by concentrating scale and skill within a single function. As these and other function-based companies grow, so does the potential value of outsourcingto ail companies.

132 HARVARD BUSINESS REVIEW

It's not always obvious which func- tions have the most potential for devel- oping scale and skill. Virgin, for instance, has successfully extended its brand man- agement capabilities from planes and trains to music, mobile phones, personal finance, and even bridal wear. And you might still think of Nike as a sneaker and sportswear company. But as it lends its brand and merchandising expertise to an increasing array of products-from golf instruction centers to MP3 players to eyewear- it's evolving into a focused provider of marketing services to other companies.

Migrating from avertically integrated company to a specialized provider of a single function is not a winning strat- egy for everyone. But all companies need to rigorously assess each of their functions to determine in which they have sufficient scale and differentiated skills and in which they don't. Greater

focus on capability sourcing can im- prove a company's strategic position by reducing costs, streamlining the organi- zation, and improving quality. Finding more-qualified partners to provide crit- ical functions usually allows companies to enhance the core capabilities that drive competitive advantage in their industries.

Yet despite the enormous opportuni- ties available through capability sourc- ing, our research indicates that many executives remain unprepared for this transformation. A recent Bain survey of large and medium-sized companies reports that 82% of large firms in Eu- rope, Asia, and North America have out- sourcing arrangements of some kind, and 51% use offshore outsourcers. But almost half say their outsourcing pro- grams fall short of expectations, only 10% are highly satisfied with the costs they're saving, and a mere 6% are highly

satisfied with their offshore outsourc- ing overall.

The reason these efforts often fail to measure up to expectations, even purely in terms of cost savings, is that most companies continue to make sourcing decisions on a piecemeal basis. They have not put hard numbers against the potential value of capability sourcing, and they've been slow to develop a com- prehensive sourcing strategy that wiil keep them competitive in a global econ- omy. To realize the full potential of sourcing, companies must forget the old peripheral and tactical view and make it a core strategic function.

In this article, we'll describe how and why the role of sourcing is changing in the twenty-first-century economy and lay out a practical strategic framework to guide companiesthrough the transition.

The Changing Basis of Competitive Advantage For over a century, companies competed on the basis of the assets they owned. AT&T, with its direct control of the American telephone network; Bethle- hem Steel, with its large-scale manufac- turing plants; and Exxon, with its vast oil reserves, each dominated its respective industry. But in the 1980s, the basis of competition began to shift from hard assets to intangible capabilities. Micro- soft, for example, became the de facto standard in the computing industry through its skill in writing and market- ing software. Wal-Mart transformed re- tailing through its proprietary approach to supply chain management and its information-rich relationships with cus- tomers and suppliers.

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BEST PRACTICE • Strategic Sourcing: From Periphery to the Core

A similar shift occurred iti the world- wide auto industry. When U.S. auto- makers began losing market share to Japanese companies, they were forced to confront a growing gap in both cost and quality. Recognizing that upstream component quality was critical to their end product and seeing the success of the Japanese keiretsu model of net- worked suppliers, the Big Three began to move design, engineering, and man- ufacturing work to specialized partners. They hammered out strategic sourcing relationships for complex subassemblies

orative sourcing relationships. That re- quired the company to train and pro- mote a different kind of manager who was capable of understanding system economics, not just one who knew how to nickel-and-dime the supplier base.

The same dynamics were also at work in the credit card industry, which re- structured in response to a dramatic change in the basis of competition fu- eled by technological innovation, in the 1970S, most banks that issued credit cards also processed their own transac- tions in a very labor-intensive manner.

It's no longer ownership of capabilities that matters but rather a company's ability to control and make the most of critical capabilities.

such as seats, steering columns, and braking systems. To win a significant share of their business, chosen suppliers had to meet tough cost and quality spec- ifications. More important.to ensure the long-term success of a partnership, both parties had to open their books, sharing detailed information that became the basis for continual quality and cost im- provements over many years. Both par- ties shared in the savings generated from improved efficiency, which pro- vided ongoing incentives to identify and remove unnecessary costs.

This new approach to sourcing had profound effects on the automakers' operations and management. For ex- ample, Chrysler established what it called "value managed relationships," in which it consolidated component pur- chases with the few suppliers it believed could sustain competitive costs, high quality, and efficient delivery. The car- maker and its key suppliers set a com- mon goal of achieving the lowest total systems cost. Before it could reach this goal, however, Chrysler had to refocus its entire procurement function so that it could manage the new, highly collab-

But as computers automated transac- tion processing, tbe economies of scale grew significantly, and individual issu- ers started to pool their transactions to drive down costs. The industry began to separate into those companies that issued cards and managed customers, on the one hand, and those that pro- cessed transactions, on the other, as transaction-processing underwent rapid commoditization.

For example, despite having enviable scale in its own transaction-processing operations, American Express, in a pre- scient strategic move, spun off its trans- action-processing business in 1992. Then the company negotiated a long-term service contract with the newly inde- pendent entity. First Data. Although Amex executives considered transaction processing a strategic capability-with- out reliable and efficient processing, it was very difficult to make money in the credit card business-they also saw that commoditization was eliminating any proprietary advantage. As a spin-off, First Data could aggregate Amex's vol- ume with that of other companies (is- suing banks would have been reluctant

Mark Gottfredson (work.gottfredson@bain.com) in Dallas, Rudy Puryear (rudy .puryear@bain.com) in Chicago, and Stephen Phillips (stephen.phiUips@bain.com) in London are partners in Bain & Company.

to outsource processing to Amex as a competitor), in that way, American Ex- press could gain additional scale advan- tages while ensuring long-term cost ef- fectiveness. Going forward, Amex was able to focus on the issuing side of the credit card business and enhance its core capabilities in marketing and risk management.

The decisions Chrysler and American Express made required them to chal- lenge one of the basic tenets of business strategy: that you should always keep strategic capabilities within your walls. As globalization and technology trans- form more industries, all companies will eventually have to let go of that com- fortable but simplistic guideline. A se- ries of geopwlitical, macroeconomic, and technological trends has opened the world's markets, made business capa- bilities much more portable, and pro- duced a level of discontinuity that has no precedent in modern economic his- tory. These events include the fall of the Berlin wall, China's embrace of capital- ism, the advent of worldwide tariff re- duction agreements, and the spread of cheap, accessible telecommunications infrastructure. In the new era of capa- bility sourcing, companies' value chain decisions will increasingly shape their organizations and determine the kinds of managerial skills they need to acquire and develop in order to survive amid increasingly fluid industry boundaries.

Capability Sourcing at 7-Eleven To illustrate the power of capability sourcing, let's take a detailed look at one dramatically successful practitioner, which began as a most traditional, ver- tically integrated company.

Back in 1991, when 7 Eleven's current CEO Jim Keyes was named vice presi- dent of planning and chairman of tbe executive committee, the retailer was losing both money and market share. As the major oil companies added mini- marts to more and more of their gas stations, the convenience store indus- try was becoming crowded and cut- throat, putting both revenue and mar- gins under intense pressure. To attract

134 HARVARD BUSINESS REVIEW

strategic Sourcing: From Periphery to the Core • BEST PRACTICE

more customers, 7-Eleven needed to cut its operating costs substantially, expand the range of its products and services, and increase the freshness of food items.

Keyes launched a business review aimed at tightening operations, re- building competitive advantage, and perhaps divesting a few noncore busi- nesses. The deeper he and his team got, however, the more apparent it became that 7-Eleven was trying to do too many things and was not good enough at any of them. The core of the business, Keyes believed, was merchandising skill-the pricing, positioning, and promotion of gasoline, ready-to-eat food, and sundries for consumers driving cars. But 7-Eieven had always been vertically integrated, controlling most of the activities in its value chain. The company operated its own distribution network, delivered its own gasoline, made its own candy and ice. It even owned the cows that pro- duced the milk it sold. Managers were required to do lots of things other than merchandising - store maintenance, credit card processing, payroll, and IT systems management. Keyes found it hard to believe that the company could be best-in-class in every one of those functions.

As part ofhis initial assessment, Keyes studied the company's bighly successful Japanese unit, whose keiretsu model of tight partnerships with suppliers was unique within 7-Eieven. By relying on an extensive and carefully managed web of suppliers to carry out many day- to-day functions, the Japanese stores were able to reduce their costs and en- hance the quality of tbeir operations, spurring rapid growth and strong prof- its. After considering many options, Keyes concluded that the best way to save the U.S. company was to adopt the Japanese model. The goal he set was to "outsource everything not mission crit- ical." This marked an abrupt and delib- erate break with the company's verti- cally integrated past.

All activities were on the table. Keyes's team even evaluated strategic functions such as product distribution, advertis- ing, and procurement, attempting to identify outside partners with greater

expertise and scale. Simply put, if a part- ner could provide a capability more effectively than 7-Eleven could itself, then that capability became a candidate for outsourcing. Over time, the com- pany relinquished direct ownership of many parts of its business, including HR, finance, IT management, logistics, distribution, product development, and packaging. Yet despite moving at a rapid pace, Keyes remained cautious about losing control and avoided the tempta- tion to take a one-size-fits-all approach to outsourcing.

The way 7-Eleven has structured each partnership depends on how important each function is to the company's com- petitive distinctiveness. For routine ca- pabilities like benefits administration and accounts payable, 7-Eleven picks providers that can consistently fulfill

cost and quality requirements. More strategic capabilities require more com- plex arrangements. Gasoline retailing, for example, represents an Important source of revenue tor many 7-Elevens, as gas is often the reason customers come to the stores. So while the firm out- sources gasoline distribution to Citgo, it maintains proprietary control over gas pricing and promotion - activities that could differentiate its stores if done well.

The company has paid similarly close attention to its relationship with Frito- Lay, since snack foods are one of the most important product tines for con- venience stores. By allowing Frito-Lay to distribute its products directly to the stores, 7 Eleven has been able to take advantage of the chip maker's vast ware- housing and transport system. But un- like other convenience store companies.

The Endgame: Dynamic Sourcing

%

GIVEN rHE RAPIDLY SHIFTING c o N r o u R S of the global

economy, companies need to be able to anticipate changes

in the economics and geography of outsourcing. It wasn't

long ago, for example, that most big companies had to own

their own warehouses and operate their own distribution systems. Third-

party logistics specialists had neither the skill nor the scale to handle

those functions. But today, suppliers like UP5 and FedEx are competing

fiercely to offer full-service logistics networks, and even the largest com-

panies can now outsource warehousing, distribution, and related activi-

ties. Such trends will only accelerate in the future, and those companies

that have recognized and prepared for them will be the first to capitalize

on them.

So, to ensure that it doesn't quickly become obsolete, a sourcing strat-

egy needs to consider not only present circumstances but aiso future

alternative scenarios. What trends will influence the sourcing options

available for each key capability? Is the supplier base growing rapidly,

and are innovative new outsourcers emerging? Are different regions of

the world investing heavily in particular capabilities-like contract man-

ufacturing or customer service-and will they offer greater cost or qual-

ity advantages in the future? The answers to such questions may encour-

age a company to pursue certain sourcing opportunities that might not

be highly attractive based on current numbers but could offer dramatic

benefits in the coming months and years. Or they may lead a company

to negotiate short-term sourcing contracts to keep options open, rather

than enter into long-term relationships. Ultimately, a company's skill

in quickly remolding its sourcing arrangements in response to market

conditions and rivals' moves may be its strongest competitive advantage,

FEBRUARY 2 0 0 5 135

BEST PRACTICE • Strategic Sourcing: From Periphery to the Core

7'Eleven doesn't allow Frito-Lay to make critical decisions about order quantities or shelf placement. Instead, the retailer mines its e.xtensive data on local cus- tomer purchasing patterns to make those decisions on a store-by-store basis.

The choice 7-Eleven has made to main- tain control over product selection and stocking illustrates a critical issue in strategic sourcing partnerships: when to keep vital data confidential and when to share them with a partner. Similarly key was 7-Eleven's decision to rely on an outside vendor, IRI, to maintain and format detailed customer purchas- ing behavior data while keeping the data themselves proprietary. This gives 7-Eleven a picture ofthe mix of products its customers want indifferent locations without relying on outside decision makers like Frito-Lay for such informa- tion. In this way, 7-Eleven is able to struc- ture its supplier relationships to gain a capability without relinquishing control over decisions that could make or break its business.

For a few targeted product segments, 7-Eleven has Identified opportunities

The Measure of Success

that call for an even deeper level of col- laboration. Company executives figured out that their traditional, do-it-yourself approach to creating branded products was cutting the company otf from the superior scale, resources, and creativity of major food suppliers. So they began sharing information with a select group ofmanufacturers, allowing them to cre- ate custom products for 7-Eleven stores. For example, 7-Eleven worked with Her- shey to develop an edible straw based on the candy maker's popular TWizzler treat. In retum, Hershey gave 7-Eleven the exclusive right to sell the straw for its first 90 days on the market. To further promote the unique product, 7-Eleven ioined with its syrup supplier, Coca-Cola, to come up with a Twizzler- flavored version of its proprietary Slur- pee drink. Such exclusive arrangements reduce the strategic risk of sharing cus- tomer information while greatly ex- panding the set of unique products 7-Eleven can offer.

Likewise, when the data on beer sales showed that certain packaghig options were more successful than oth-

For 7-Eleven, strategic sourcing has translated into industry dominance. In the

past two years, the mini-mart retailer has led all major rivals in same-store

merchandise growth, inventory turn rate, and revenue per employee.

Same-Store Merchandise Sales Growth (first half 2004 overfirst half 2003)

Merchandise Inventory Turns Oune 2003 tojune 2004)

22.2

3.5%

Merchandise Sales Per Employee (June 3003 t o j u n e 2004)

$239K

7-Eleven Rest of Industry

7-Eleven Rest of tndustry

7-Eleven Rest of Industry

Sources: Annuat and quarterly SEC filings

ers, 7-Eleven forged a tight partnership with Anheuser-Busch to build sales in those categories. Anheuser-Busch helped 7-Eieven develop a product assortment and establish merchandising standards for a new display. The beer giant also agreed to give 7-Eleven first-look op- portunities at new products. In retum, 7-Eieven shares its customer informa- tion so together the two companies can develop innovative marketing pro- grams, such as a cobranded NASCAR promotion targeting 7-Eleven's core cus- tomers and a Major League Baseball promotion campaign. Anheuser-Busch is also using 7-Eleven store data, pro- vided daily by IRI, to test a new order- forecasting system that would link the retailer's orders more tightly with de- liveries from the brewer's wholesalers.

In addition to restructuring and en- hancing existing activities, 7-Eleven has used creative sourcing partnerships to pioneer entirely new capabilities. It re- alized, for example, that by being a one- stop source for a broad range of prod- ucts and services, it could gain a leg up on more narrowly focused competitors. So it has set up a consortium to provide multipurpose kiosks in its stores. Amer- ican Express supplies ATM functions, Western Union handles money wires, and CashWorks furnishes check-cashing capabilities, while EDS integrates the technical functions ofthe kiosks. Here, too, 7-Eleven maintains control over the data-in this case, information on how customers use the kiosks-which it views as critical to its competitive edge.

Some of 7-Eleven's outsourcing rela- tionships tie suppliers' financial inter- ests to its own. The company took an equity stake in Affiliated Computer Ser- vices, for instance, one of its major IT outsourcers. 7-Eleven also agreed to share productivity gains from a services agreement with Hewlett-Packard. In an even deeper collaboration, the company created a joint venture with prepared- foods distributor E.A. Sween: Combined Distribution Centers (CDC) is a direct- store delivery operation that supplies 7-Elevens with sandwiches and other fresh goods. By drawing on the skills and scale of a specialist, 7-Eleven was able to

136 HARVARD BUSINESS REVIEW

Strategic Sourcing: From Periphery to the Core • BEST PRACTICE

cut its distribution costs from more than 15% of revenues to 10% and eventually hopes to cut that figure in half again. But cost reduction is only a secondary benefit. The real gains have come in ser- vice. When it owned its own distribu- tion network, 7-Eleven delivered fresh goods to its stores only a couple of times a week. CDC now makes deliveties to stores once, and soon twice, a day. More frequent deliveries mean fresher prod- ucts, which draw more customers into the stores.

By almost any measure, 7-Eleven's sourcing strategy has transformed the company. In narrowing its focus to a small, strategically vital set of capabili- ties-in-store merchandising, pricing, or- dering, and customer data anaiysis-the

company has reduced its capital assets and overhead while streamlining its organization. It reduced head count 28% from 43.000 in 1991 to 31,000 in 2003 and fiattened its organizational struc- ture, cutting managerial levels in half from 12 to six.

Today, 7-Eleven consistently outper- forms competitors. Same-store sales have grown in four out of the last five years. In the past two years, it has dom- inated the industry's vital statistics, with same-store merchandise growth at al- most twice the industry average, reve- nue per employee at just about two- and-a-half times higher, and inventory turns at 72% more than the industry av- erage. (See the exhibit "The Measure of Success") Furthermore, after its ac-

Should you always keep strategic capabilities within your walls? As globalization and technology transform more industries, all companies will eventually have to let go of that comfortable but simplistic guideline.

quisition of two regional U.S. chains (Christy's Markets in the Northeast and Red D Mart in the Midwest), the firm's new business model helped grow sales by more than 30% and increase gross profit margins by 2%. 7-Eleven's stock appreciation over the past five years has outpaced all major competitors, includ- ing Casey's General Stores, the Pantry, and Uni-Mart.

A Framework for Capability Sourcing As companies like Chrysler, American Express, and 7-Eleven have discovered, a strategic approach to sourcing can dra- matically improve your company's com- petitive position. So how do you make something that's always been tactical more strategic? You need to stop focus- ing on incremental cost improvement targets, step back, and reevaluate your strategy and your capabilities. In work- ing through this process with clients, we've found that three steps can ensure that decisions are made objectively and are based on facts.

The first step is to identify the com- ponents of your business that represent the core of the core. These are the activ- ities that your company does better and cheaper than its rivals. For 7-Eleven, the core of the core is in-store merchandis- ing and product ordering. For drug maker Pfizer, it's developing and mar- keting pharmaceutical compounds. For American Express, it's identifying cus- tomer segments and creating card of- ferings tailored to them. Everything else exists to support the core of the core.

in deciding what to outsource and what to keep inside, 7-Eleven considered two factors: whether a capability was proprietary and whether it was com- mon enough that outside suppliers could achieve scale or other advantages by supplying it to multiple companies. To determine proprietary value, execu- tives asked themselves two questions: Did 7-Eieven carry out the capability in a way that generated measurably more value than its competitors could deliver? And would the company suffer a high degree of strategic damage if rivals could imitate that capability? To deter-

I-FIBRUARY 2005 137

BEST PRACTICE • Strategic Sourcing: From Periphery to the Core

What Should You Outsource?

Using this sourcing opportuni-

ties map, you can determine

which functions have the high-

est outsourcing potential and

which should remain under your

company's control. The vertical

axis measures how proprietary

a capability is for your company.

The horizontal axis plots how

common the capability is within

or outside your industry. The

less proprietary and the more

common a function is, the

stronger a candidate it is for

outsourcing,

o

ic ti '

a o

a.

"S it u rt

c >.

ie ta

a. o

1 ^

proprietary

Data are proprietary

Business process is proprietary

Profit model is proprietary

High Priortty: ^ Strong outsourcing l l candidates

Medium Priority: Outsourcing opportunities deiiendent on industry and company dynamics

Low Priority: " ^ Captive sou candidates

Unique to self

rcmg "

Common * across

industries

Uniqueness of business process or function

How Strong Are Your Capabilities?

Once you've determined which

capabilities offer the highest po-

tential value from outsourcing,

you need to see how well, and

how efficiently, your company

currently performs each one

of them. This exercise may sur-

prise you: If your cost per trans-

action is low enough and your

quality high enough, you should

be thinking of selling that func-

tion as a new business in itself

I

Better than it needs to be

Sufficient

Q Not good enough

Source to reduce cost; sacrifice capability if necessary

Source to reduce cost

Source to increase capability at lower cost

Above median

Consider creating a new business (if adjacent to core business)

Source to increase capability even at higher cost if necessary

At industry median

Cost per transaction

Below industry median

138 HARVARD BUSINESS REVIEW

strategic Sourcing: From Periphery to the Core • BEST PRACTICE

mine commonality, they had to look outside their company - even outside their industry. They tried to identify capabilities in which outside suppliers were building scale across their indus- try, or across several industries, because these common business processes or ca- pabilities could pose an immediate or future threat to 7-Eleven's cost position.

By plotting each of your required ca- pabilities on a 5Owra>3̂ opportt(n/f/e5;Tjnp like the one in the exhibit "What Should You Outsource?" you can judge the rela- tive merits of your company's outsourc- ing possibilities. The vertical axis of the map measures how proprietary a pro- cess or function is; the horizontal di- mension assesses the degree of com- monality, both within and outside your industry. Capabilities that fall in the upper right portion of the map are strong candidates for outsourcing. Those that appear in the lower left section are potential prospects for captive sourcing. Such capabilities may even be candi- dates for"insourcing"-that is, if you de- termine that your company is really the best at a given function, you may have an opportunity to perform this function for other companies. One example of successful insourcing is FedEx, which plans and manages inbound transpor- tation for more than 1,500 product sup- pliers into 26 General Motors power train facilities.Thiscapability puts FedEx at the leading edge of the $225 billion logistics-outsourcing industry.

Opportunities that fall in the middle of the sourcing opportunities map gen- erally require more detailed analysis of both your company and your industry. You will need to consider such factors as regulation, standards, and alternative products to figure out what will happen to those capabilities in the future. To provide a quick sense of the relative fi- nancial stakes involved, and highlight the biggest opportunities, the sourcing opportunities map should be populated with bubbles scaled to represent the cost dollars at stake for each capability.

Once you've discovered which capa- bilities promise high potential for alter- native sourcing, the next question is: How should you source them? You need

to figure out how your capabilities stack up to what's required. Do you meet, exceed, or fall short of cost and quality requirements? A capability assessment map like the one in the exhibit "How Strong Are Your Capabilities?" plots each capability according to its cost and quality relative to top-performing com- petitors or suppliers. This map will help you determine which key capability gaps your company needs to fill. Per- haps equally important, it will identify any current activities that you could perform with less rigor without incur- ring any strategic penal^.

7-Eleven had always been a vertically integrated company, delivering its own gasoline, making its own candy and ice. It even owned the cows that produced the milk it sold.

Where capabilities fall on this grid establishes appropriate goals for an out- sourcing relationship. Functions that fall, for instance, in the upper left (rela- tively high-cost functions whose quality levels exceed requirements) should be outsourced to low-cost providers-even if it means a reduction in quality. Capa- bilities that fall in the lower left (high- cost functions performed relatively poorly) require outsourcing partners that can both reduce costs and improve quality. The capability assessment map also gives you another way to identify insourcing opportunities. Capabilities that fall in the upper right (low-cost, high-quality functions) could become the basis for attractive new businesses.

Following the first two steps of our framework can help you determine what type of control you need over each of your capabilities. The third step is a kind of reality check in which you de-

termine whether a capability that is a strong candidate for strategic sourcing can be carried out at a distance without any loss of quality.

The issue of physical proximity may not seem very strategic, but globaliza- tion and advances in technology ensure that it's a constantly moving target. For many functions, including transaction processing, design, engineering, and cus- tomer service, the Internet and an in- creasingly sophisticated telephone infra- structure have made physical proximity much less relevant, at least from a cost perspective. The necessary infonnation and outputs can be transferred elec- tronically at high speed and low cost. For tangible products that must be shipped, however, proximity plays a large role in both cost and timeliness considerations; it may not be feasible to manage the movement of such prod- ucts from afar. There may also be cus- tomer service constraints. Certain prod- uct development, sales, and service tasks, for example, may require local in- teractions. Capabilities that do not re- quire physical proximity are good can- didates for offshoring, whether through a traditional outsourcing arrangement or, for proprietary capabilities, through a captive operation.

If you go through this three-step analysis, your company should have the outline of a comprehensive capability sourcing strategy. You will know which capabilities you need to own and pro- tect, which can be best performed by what kind of partners, and how to struc- ture a productive relationship. Formu- lating the strategy is, of course, only the first stage of a sourcing effort: Partners then have to be chosen, contracts nego- tiated, and management structures es- tablished and monitored. As 7-Eleven found, the success of the strategy often hingeson the creativity with which part- nerships are organized and managed. But only by first taking a broad, strate- gic view of capability sourcing can your company make the most of its sourcing choices. ^

Reprint R0502J; HBR OnPoint 8878 To order, see page 151.

FEBRUARY 2 0 0 5 139

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