Outsourcing Strategies_230909

A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment Authored:

J Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM

Abstract: Outsourcing is a strategy increasingly being used by organizations to reduce costs and increase value. Outsourcing, however, has its risks. As organizations look to push out more of their custom needs to outsourcing partners, careful planning is required in terms of building stringent security requirements into contracts and creating a process to ensure that those requirements are met. The global sourcing management has become more risky, visible and productive position within many organizations. As companies implement operations with improvement strategies, the importance of developing and managing the service providers emerge as critical outsourcing strategies. In addition, competitive business processes and shorter product life cycles have caused executive management to recognize the significant leverage potential that exists within the sourcing organization on the company’s cash flow and profitability position. The objective of outsourcing strategies is to implement procurement and vendor operating policies that streamline material and/or service flows, reduce manufacturer and supplier costs, improve quality and customer service performances, and create longterm buyer/seller partnerships. In this current paper ‘A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment’ brief analysis is being done considering the outsourcing theme as engineering activities of an organization. The cost implications are analyzed as a typical case for an organization. This paper would be helpful for the Engineering managers who have leverage in opting of outsourcing with the analysis of how Out Sourcing strategy will benefit in improving project margins as well as optimizing the technology within the organization. A quick check list is detailed for guidance in selection of outsourcing partner. However, selection matrix and strategies of outsourcing partner is beyond this work as more emphasis laid on significance of savings from outsourcing by considering two projects and outsourcing work flow process. Keywords: Business System, Portfolio Optimization, Outsourcing

1. INTRODUCTION Any typical engineering department of any organization normally engages start from Front End Engineering, basic design, Detail engineering, site services, preparation of As built documents, services coordination. Besides documents delivery coordination with procurement, site services. The following shows a common setup. FEED

1. 2. 3. 4.

5.

BASIC DESIGN

Organization patented technology Data to be secured from competition Data security Related to the specialized process and linked to multi department data High risk

DETAIL ENG’G

AS BUILT

SITE SERVICES

1. CORE ENGINEERING

NON-CORE ENGNIEERING

Technology available with many domains/Users Data security non relevant from competitors Routine process Less Risk

2. 3. 4.

Fig.1. Typical Engineering department setup# The project life cycle starts from FEED study. Front-End Engineering Design refers to including robust planning and design early in a project's lifecycle at a time when the ability to influence changes in design is relatively high and the cost to make those changes is relatively low.

FEED various stages* STAGE 1 • • • •

Material Balance Energy Balance Project Charter Understanding scope

STAGE 2 • • • • •

Preliminary Equipment Design Preliminary Layout Preliminary Schedule Preliminary Estimate Preliminary Execution Strategy

STAGE 3 • • • • • • •

Purchase Ready Major Equipment Specifications Definitive Estimate Project Execution Plan Preliminary 3D Model Electrical Equipment List Line List Instrument Index

Then “Basic Design”, where the overall solution is developed and the engineering firm, system integrator or OEM brings their unique solution, technology to the scheme. The Basic design is future of the project in terms on cost, Quality and time. #Basic reference from ISA2002 Technical Conference Paper-Offshore Outsourcing: Survival Strategy of the New Millennium? By Theodore (Ted) Gibbon *Basic reference from http://en.wikipedia.org/wiki/Front_End_Loading A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 2 of 12

Next is “Detailed Engineering” which, is the most labor-intensive and represents some 60 to 65% of the total engineering effort. This is where engineering designs and puts on paper for equipment selection, collects data sheets, specifications and prepares a bill-ofmaterials, various routings, analysis, checks and balances, interferences etc. Critical documentation, maintaining key registers, deliverables planning, scheduling inline with project requirements are associated key factors for this phase. Generally this phase doesn’t require special engineering skills as core is covered at Basic design stage. This stage provides leverage in outsourcing philosophy. Next is “Site Services” which, covers installation, start-up, commissioning, project management, customer training. And, finally since no installation is ever as originally planned, the final “As Built Documentation” covers drawings, manuals, reports etc. Obviously these site services can be outsourced to the local where plants are being setup. It is not only saves money not only in team’s travel, living expenses but also facilitates in accommodation of local systems. 2. SIGNIFICANCE OF SAVINGS: Discipline weight age of a typical complete project of engineering a PF Boiler typically looks as below: Discipline %’age 4.0% Project Engineering 3.0% Performance & System Design 7.0% Control & Instrumentation 46.0% Hot structures, F&D, Cold Structures 9.0% Pressure parts 5.0% Protective Systems 4.0% Equipments, Balance items 5.0% Layout (3D) 17.0% Pipe work systems Table 1: weight age of a typical complete project

Weightage Core Core Partly Partly Core NA Core Core Partly

A typical project of Renovation and Modification at a Petrochemical industry Discipline %’age 19.0% Project Engineering 10.0% Performance & System Design 16.0% Control & Instrumentation 16.0% Structures NA Pressure Parts 4.0% Protective Systems 12.0% Equipments, Balance items Incl. Layout 23.0% Pipe work systems Table 2: weight age of a typical R&M project

Weightage Core Core Partly Partly Core Core Partly

Now, critically examine the various scenarios. Assumptions: Total Manhours for Complete project Fully burden rate Outsource rate Total Manhours for R&M project

: : : :

125,000 hrs $50/Hour $35/Hour 6000 hrs

A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 3 of 12

Fully burden rate Outsource rate Inline with these assumptions, Total project cost : R&M project cost :

: :

$40/Hour $35/Hour

$ 6.25million $ 0.24 million

2.a SCENARIO 1: Complete new project case Discipline Project Engineering Performance & System Design Control & Instrumentation Hot structures, F&D, Cold Structures Pressure parts Protective Systems Equipments, Balance items Layout (3D) Pipe work systems

%’age 4.0% 3.0% 7.0% 46.0% 9.0% 5.0% 4.0% 5.0% 17.0%

Weight age Core Core Partly Partly Core NA Core Core Partly

Actual Cost ($) 250,000 187,500 437,500 2,875,000 562,500 312,500 250,000 312,500 1,062,500

Weight age Core Core Partly (30+70) Partly (20+80) Core NA Core Core Partly (30+70)

In-house Cost

Assuming the In House and o/s as below: Discipline

%’age

Project Engineering Performance & System Design

4.00% 3.00%

Control & Instrumentation

7.00%

Hot structures, F&D, Cold Structures Pressure parts Protective Systems Equipments, Balance items Layout (3D)

46.00% 9.00% 5.00% 4.00% 5.00%

Pipe work systems

17.00%

O/S Cost

250,000 187,500 131,250

214,375

575,000

1,610,000

562,500 312,500 250,000 312,500 318,750

520,625

Work Estimates considerations are as follows: Control & Instrumentation: Basic engineering inline with project requirements shall be done inhouse which could consume 20% of overall cost. Balance 80% work can be offloaded either to o/s companies or contract basis. Hot structures, F&D, Cold Structures Basic Engineering, STAAD analysis, Moments, support analysis, loads calculations commonly core engineering and could consume 20% of over all cost. Balance detailing, documentation can be offloaded either to o/s companies or resources sourcing on contract basis. Pipe work systems Basic engineering, line sizes, stress analysis, selection of items, support system being core shall consume 30% of overall cost and balance 70% comprising detailing, documentation can be offloaded either to o/s companies or resources sourcing on contract basis. These are typical estimates made on considering all inputs are fairly available, optimistic delivery period. However these are subjective of many variables that depends on the project execution philosophy. A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 4 of 12

Based on above the complete project cost workings are tabulated as below:

Discipline

%’age

Project Engineering Performance & System Design Control & Instrumentation Hot structures, F&D, Cold Structures

Actual cost($) 250,000

Inhouse 250,000

Core

187,500

187,500

Partly (30+70) Partly (20+80) Core

437,500

131,250

214,375

2,875,000

575,000

1,610,000

562,500

562,500

NA

312,500

312,500

Core

250,000

250,000

Core

312,500

312,500

1,062,500

318,750

520,625

2,900,000

2,345,000

O/s

3.00% 7.00% 46.00% 9.00%

Protective Systems

5.00%

Equipments, Balance items

4.00%

Layout (3D)

5.00% 17.00%

Partly (30+70)

Sub Total Total Table 3: complete project cost workings Notable Savings:

Cost ($)

Core

4.00%

Pressure parts

Pipe work systems

Weight Age

6,250,000

5,245,000

$ 1,005,000

Whenever Project can save one million dollars by outsourcing, any manager will not take a second chance usually. This typical scenario shows considerable savings figure while in practical more or less this can be reachable. While the potential savings are compelling, there have been more failures than successes. There are a number of reasons why this has been the experience: Æ Far too often, outsourcing is done on an opportunistic basis rather than strategic -Let’s do this project offshore to save money. Or, reduce our price to win -- Without spending enough time to clearly specify the work content, work flow, project control and communication process between the engineering service provider and the user’s engineering team. Æ Not enough thought has been given to deploy an over arching quality process to ensure defect free deliverables. Æ Not enough time and effort is spent on evaluating (due diligence) the engineering service provider’s infrastructure, staffing, skill sets, training, technology-based tools employed, engagement terms and conditions. Æ Some seek a full service-engineering provider covering all disciplines: Civil, structural, mechanical, electrical, instruments and control rather than engaging the “Best-inClass” provider in each of these major engineering disciplines. “Sourcing is not a strategy in itself – it has to be the business strategy that drives the sourcing decision,” says Bob Carlson, former group head of IT and telecommunications at HSBC, with 25 years experience at the bank – a major user of outsourced IT. A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 5 of 12

2.b Scenario 2: A typical project case of Renovation and Modification at a Petrochemical industry Discipline Project Engineering Performance & System Design Control & Instrumentation Structures Protective Systems Equipments, Balance items Layout Pipe work systems

%’age 19.0% 10.0% 16.0% 16.0% 4.0% 12.0% Incl. 23.0%

Weight age Core Core Partly Partly Core Core Partly

Total Cost ($) 45,600 24,000 38,400 38,400 9,600 28,800 55,200

Assuming the In House and o/s as below: Discipline

%’age

Weight age

Project Engineering

19.0%

Core

Performance & System Design

10.0%

Core

Control & Instrumentation

16.0%

Structures

16.0%

Protective Systems Equipments, Balance items Layout Pipe work systems

Partly (50+50) Partly (50+50)

4.0%

Core

12.0%

Core

Total Cost ($)

Inhouse Cost

o/s Cost

45,600

45,600

24,000

24,000

38,400

19,200

16,800

38,400

19,200

16,800

9,600

9,600

28,800

28,800

55,200

27,600

Incl. 23.0%

Partly (50+50)

24,150

Work Estimates considerations are as follows: Control & Instrumentation: being a R&M works, basic engineering inline with project requirements shall be done in-house which could consume 50% of overall cost. Balance 50% work can be offloaded by deputing resources on contract basis. Structures Being R&M job which have more intricacies basic Engineering, STAAD analysis, Moments, support analysis, loads calculations, interference checks etc could consume 50% of over all cost. Balance detailing, documentation can be offloaded by resources sourcing on contract basis. Pipe work systems Basic engineering, line sizes, stress analysis, selection of items, support system, interference checks, pipe line routing, schedules etc shall consume 50% of overall cost and balance 50% comprising detailing, documentation can be offloaded to resources sourcing on contract basis. These are typical estimates made on considering all inputs are fairly available, optimistic delivery period. However these are subjective of many variables that depend on the project execution philosophy. A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 6 of 12

Based on above the complete project cost workings are tabulated as below:

Discipline

%’age

Project Engineering Performance & System Design Control & Instrumentation

19.0% 10.0% 16.0% 16.0%

Structures Protective Systems Equipments, Balance items Layout

4.0% 12.0%

Weight Age

23.0%

Core

Inhouse

O/s

Partly (50+50) Partly (50+50) Core

45,600

45,600

24,000

24,000

38,400

19,200

16,800

38,400

19,200

16,800

9,600

9,600

28,800

28,800

55,200

27,600

45,600

45,600 174,000

Core

Partly (50+50)

Sub Total Total Notable Savings:

Cost ($)

Core

Incl.

Pipe work systems

Actual cost($)

240,000

24,150

57,750

231,750

$ 8,250

Whenever Project can save 3% on overall project cost in a R&M by outsourcing, any manager will not take a second chance usually. This typical scenario shows considerable savings figure while in practical more or less this can be reachable subjected to available of proper inputs, effective coordination with internal & external clients. 3. Evaluation of outsourcing partner An outsourcing partner should be evaluated and selected based on providing engineering deliverables at a cost significantly below the same work done by the user’s engineering staff. However, cost savings can be lost, if the provider does not deliver services of equal (or better) performance in terms of user management and administration time, productivity, quality, timeliness, etc. Commonly two typical cases arise during engineering projects execution. 1. Outsourcing of Non-core and less risk areas 2. Outsourcing due to lack of resources, infrastructure though possessing technology In the following sections of this paper will suggest methodology and steps that can be taken to ensure outsourcing is a success. Observe the typical engineering process flow for project execution. The following figure depicts the typical process flow of Engineering on Projects execution, where multiple disciplines are involved in pre order stage as well as post order stage.

A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 7 of 12

Now as shown in the typical examples on Complete project and R&M project, examine various stages where the outsourcing philosophy could be fit into the Engineering process flow have better use and avoid any pitfalls.

1

4

2

3

5

7

6

Fig 1: Key points of Outsourcing in Engineering process flow A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech,

MBA, MPhil, PGDIBM, DExM

Page 8 of 12

Work Scope can range from green field to revamp projects, standard to special engineering, small stand alone to complex integrated projects to name a few. Work Package content, that is, specific activities will vary from user client-to-client, site-to-site as every customer’s requirements are different. A clear understanding and up-front definition of the user’s Work Scope helps the engineering service provider plan and allocate resources to meet the user’s and user client’s project requirements. Referring to the above identified areas where critical attention is needed, it is mere evident that the outsourcing is not so easy as it uttered. The major areas are as below: 1. Define scope of supply

: Scope of supply covers the entire work package that is indentified for pre determined quality checks passed outsourcing source. This scope have a provision of accommodating any minor changes or deviations in scope of work due to any unexpected changes from project End user

2. Project engineering coordination team : A smart team for coordination with O/S vendor for inputs sharing, reviewing documents, planning and for other activities. This team could be comprises of the vendor engineering members so that the flow can be at par 3. Engineering execution plan : A strategy document reflects that execution process to suit the overall the project requirement. It refers to the planning, contract requirements, review process, design freeze etc. 4. Engineering Program

: A deliverable based program covering the outsourcing package and its links with the main packages.

5. Interface

: Interface management is key area where mutually improving the confidence levels. The design reviews, various issues, general queries shall be handled.

6. Deliverables

: Delivering the deliverables meeting the project requirements and procedures

7. Post design support

: It covers any NC issues, design changes, site issues, as built, final contract reviews etc.

8. Close out

: A close report shall be submitted by the O/S covering the areas attended and unattended, issues balance, Client side comments/ reviews, future references, pros & cons etc. This document is live document and shall be freeze till entire project closed.

9. Site visits Consolidating these above areas the process flow for o/s activities shall be as follows:

A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 9 of 12

Fig 2. Typical process flow for outsourcing activities A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM

Page 10 of 12

Once the Core team gives acceptance to proceed and releases the execution plan and design inputs, the provider can commence preparing their work plan, review inputs and submit inquiries, if required, for user for clarification. Once the clarification process is done, the engineering service provider can commence detail engineering and implementation. The provider performs internal quality checks, then releases the Work Package deliverables to the user’s engineering center. The interface management accountable for the engagement relationship, resolving relationship issues, handling commercial aspects. And, for overseeing such activities as estimating, work authorization, project status reports, meeting, quality, project close out, etc. This is crucial to the engagement’s long term success and team productivity. However, the project business is people intensive and cyclic. Set baseline-engineering staff levels too low. And, one is constantly sub-contracting engineering people usually at a premium, often not as competent as one’s own staff. And, not with out some slippage risks if sub-contractor resources are not readily available. Set staffing levels too high. And, one is stuck with non-billable labor, unabsorbed overhead, lower margins, worse a loss unless dramatic action is taken to reduce staff. Outsourcing in the context of this paper, is the process of transitioning fixed engineering costs to a variable cost component by sub-contract to a qualified, low cost off-shore engineering service provider ie either to company or deputing resources to own place using available infrastructure and applications of skill sets. It involves a thorough evaluation of the user’s own engineering staff, deciding those who are critical and represent core competencies. It involves positioning and selling the existing engineering staff, who may fear outsourcing, that reducing costs is crucial to long term company success, winning more business. And, creating more challenging work, opportunities and stability for those critical people who remain. 4. Examination of contributing functions Final examination, over all project costs of any type if function of land, labour, technology and productivity Project Cost = f (land, labour, technology, productivity) However, outsourcing is a process of reducing total cost of ownership through a combination of Offshore Leverage and Process Adoption. Total Cost-of-Ownership = f (Offshore Leverage + Process Adoption) Where: Æ Offshore Leverage is a combination of the amount of engineering outsourced and the provider’s ability to deliver comparable results Æ Process adaptation is the engineering service provider’s deployment and use of best practices, performance metrics, continuous improvement processes, work force maturity. In the final evaluation, working to increase productivity and reduce cost should be ultimate aim of any outsourcing engagement. It helps win more business, which means more business for the service provider, which translates into a “Win/Win” strategy. Further to this let us look on broad check list and cautious notes to consider while outsourcing. A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 11 of 12

5. Outsourcing checklist3 • Business strategy is the key driver in the outsourcing decision • Don’t outsource a problem – re-engineer your processes before outsourcing them • Don’t allow outsourcing to dangerously deskill your company in vital competencies • Outsourcing risk increases with the distance of the outsourcer • Costs must factor in the outsourcer’s marketing costs and profit margins • Any cost savings will eventually be passed on to customers thanks to competition • Business and requirements will change, so build in flexibility and re-negotiability • Detailing work, service levels and price are less important than setting out partnership, relationship and problem resolution terms • The contract and the relationship must be designed to be independent of those that initiate them, because people will move on • Engage your own marketing people in contract negotiation – they will be able to spot the supplier’s ploys • All contracts will terminate – write your exit clause before you agree any other clause, when you still have power to negotiate strongly • All outsourcing is a joint venture – insist on both sides having skin in the game. 6. Conclusions: Outsourcing is an important strategy decision particularly for engineering departments. It involves a lot of homework that will need to take a decision keeping in view many factors like internal work load, skills, competencies, Client acceptances and more besides cost. Hope this paper explores overall idea on outsourcing savings and its effects in overall project costs considering complete project and R&M project. Thus this paper analyses the outsourcing strategies improves Business system and portfolio optimization through Outsourcing strategies in complex environment. Selection of service provider is a qualitative task which needs lots of due diligence of its capabilities. The further work of this paper can lead to selection on service providers while framing various matrices that evolve statistical tools and analysis in provider’s selection. 7. References: 1. Basic reference from ISA2002 Technical Conference Paper-Offshore Outsourcing: Survival Strategy of the New Millennium? By Theodore (Ted) Gibbon 2. Basic reference from http://en.wikipedia.org/wiki/Front_End_Loading 3. http://www.computerweekly.com/Articles/2006/11/30/220240/identifying-the-rightoutsourcing-strategy.htm 4. Best Practices in Front-End Design, A Bentley White Paper, Arvind Patel, Business Development Manager, Conceptual Design and FEED Applications. A theoretical analysis on how to improve Business system and portfolio optimization through Outsourcing strategies in complex environment- By J.Phani Krishna, B.Tech, MBA, MPhil, PGDIBM, DExM Page 12 of 12