As the business press is buzzing about companies bringing back call centers and other services to the U.S., businesses should be thoughtful about what services they outsource and which they keep close to the vest.  Much has been written about keeping within a company’s core competency, but this trend is waning as evidenced by the rebirth of vertical integration. As margins are squeezed, companies are looking to recapture profit upstream and downstream.

In assessing which services to keep in-house, entrepreneurs need to look past their core competencies, and to those functions that their customers deeply value.  In the case of a call center, it is not only the quality of the service that needs to be considered but also the relevance of it.  If the purpose of a call center is for upselling and counseling customers, it has more inherent value than one that replaces warrantied parts. In the case of the former, it may make more sense for the business to insource. Services that require some specialized knowledge (known as “tailored services”) may require more finesse and are appropriate for insourcing.

One must also weigh the strategic consequences of such decisions.  Will any short-term savings in costs (through outsourcing) be countered by any long-term ramifications?  Costs cannot be considered in a vacuum. Cost savings can only be considered relative to any price premium that can be realized through more meaningful customer touches and the like. A vast majority of the time, when a business outsources a function, it loses uniqueness (as any provider could do the same).

The topic of what is “core” and what is not is somewhat misunderstood. Many businesses have tried to boil core competencies down to the bare minimum under the premise that to do so improves execution.  The premise may be correct, but the question becomes, execution against what? If the core offering is perceived to be the same as all other competitors in a given market space, there is no competitive advantage. Competitive advantage is realized when the tailored services provided are the ones that most deeply resonate with a client.

Thus the outsourcing question must be considered in the overall ecosystem of the business. Business owners are always looking to optimize the deployment of their resources but such considerations need to be made within the context of what services deliver unique benefits.

Adapted from Understanding Michael Porter by Joan Magretta

Google’s behemoth $12.5 Billion acquisition of Motorola’s phone business set a salvo across the bow in technology circles. Google’s largest acquisition raises the stakes in the quest for platform dominance. The trend towards vertical integration is clear, as Coke and Pepsi buy up their bottlers, and manufacturers such as General Motors and Boeing eat up suppliers.

Consider the plight of HP, who has no software dancing partner in the world of mobile computing and announced last week of their exit from the desktop business. Investors penalized the company (who bought competitor Compaq a decade ago) severely, erasing $12 Billion in market value with a matter of days. [i]

And then there is e-textbook publisher Kno, the VC backed darling of Silicon Valley, who recently shelved plans to create a tablet for the education market after realizing that they did not have the chops to compete on a global scale with tablet manufacturers. The company moved towards an App for iPad only to have their margins raided by Apple (who earns a 30% royalty). [ii] While Kno has enormous upside, it is unlikely to realize its vast potential unless it owns or is owned by a distribution partner.

Today’s turf wars are not with a single competitor, but with their entire distribution platforms (as in the case with mobile devices). So the consequences of globalization persist; the large get larger and the small find the right alliance or face considerable competitive disadvantage. Vertical integration provides a recipe for greater control of cycle time and quality and a significant cost advantage. At a time when margins are slimming, companies are looking to participate both up and down stream.

It appears that the swell of distribution channels has made distribution even more important, so those who can find unique methods of delivery are creating a first to market advantage, such as Amazon has with books. As private equity investors look for deal flow, and shrewd entrepreneurs look for bargain basement acquisitions, they should look not only at competition, but for suppliers or customers that present control and cost advantage throughout the entire supply chain.

With so much cash on the sideline, some sectors may be ripe for another round of consolidation. The choice many businesses face today is will they be the consolidator, or the consolidated?

Being Opportunistic in a Volatile World

Last week my post drew considerable attention, perhaps because of its shock value at a time when the news was truly shocking. While the tsunami was a natural disaster, the response on the part of the Tokyo Electric Company was a human calamity. Lack of preparation will invariably lead to unintended consequences, if you are managing a nuclear power plant or any other business.

The reverse is also true. The entrepreneur capable of understanding seemingly unrelated external forces, and weaving them into a thoughtful strategy, will clearly realize strategic advantage. How might the strategist consider social, technological, economic, ecological and political factors to gain insight on how to take advantage of ever changing market conditions?

Scenario planning is a methodology whereby the entrepreneur considers converging factors that (in combination) creates a tipping point. Consider some of the following predictions, based on facts already in evidence today.

In the next decade, we are likely to see:

Predicative Modeling-Cloud computing enables the migration and cross-referencing of large institutional databases.  For example, actuaries, using sophisticated algorithms are able to model ailments based on lifestyle choices monitored in real time. They are able to calculate your risk of a heart attack based on which smoothie you tend to order at Jamba Juice, your frequency of exercise, prescriptions you use, etc. Offered as a benefit of a health care plan, the member is offered incentives to opt-in and receive preferential rates. Such tools slow down rampant health care inflation.

A Cashless Society-The majority of transactions amongst big banks are managed by exchanges where no money actually changes hands. Coins of small denomination are nearing extinction. Today, you can download an iPhone app that serves as a debit card, and can be swiped within Starbucks locations.  For most transactions, cash is already irrelevant.

Smart Infrastructure- Automobiles come preinstalled with all of the features of an iPad (the 2011 Hyundai Equus will come with one) and all the benefits of the internet. Smart grids control the flow of traffic, directing drivers to particular lanes at a given speed to optimize drive time and reduce accidents. Traffic signals are regulated based on traffic volume. Sensors predict bridge and rail failures.

Of course, rapid change will occur in every industry, and the strategist must weigh various opportunities based on an organization’s ability to take advantage of them. As a general rule, organizations should seek to achieve scale and reach within its core (at least 30% market share) before expanding into new endeavors. As Jim Collins points out in his sequel to Good to Great (How the Mighty Fall), many companies fail because of an “Undisciplined Pursuit of More”.  In their zeal for diversification they often leap too far from their core competency.

Each opportunity must be assessed within the context of the organization’s resources, bandwidth, and human capital.  For every opportunity there is a cost, and an opportunity cost. To pursue any new opportunity an organization must leverage resources which dilutes focus on the core business.  Choose your opportunities carefully.

Here are some random thoughts on various regulatory trends and business items in the news:

States are moving towards greater enforcement of payroll tax laws, assisting the IRS in identifying companies who misclassify independent contractors.  Companies caught with their hands in the cookie jar also face other consequences such as a greater likelihood of audits. [i] Too many companies are still too lax in their policies. Error on the side of employing people in lieu of treating them as contractors.

The FDA is waging a war with the food industry on labeling guidelines, as non-partisan medical and nutrition experts gain more clout. Expect an overhaul to include more information on calories, fats and sodium in 2011.[ii] Consumers demand transparency.

The EEOC is looking to expand rules on pre-employment credit checks. [iii] My mother taught me if you don’t have anything nice to say……

The environmentalists should be ecstatic about the development of “The Enviropig”, a genetically engineered pig whose manure creates less polluting gases (I am not making this stuff up).[iv] Green is still popular but in a post recession world, will it pick up steam again?

The unpredictability of health care reform is causing concern. Yet stagnation on the part of legislators is predictable.  Republicans, facing a certain veto have little or no chance of repealing the Health Care bill. The medical establishment is gearing up for the 30% of Americans who don’t have health insurance.

Venture Capital investment has exploded - Private Equity firms and private investors are still on the hunt for positive cash flow businesses showing growth, and are paying an average of 6x EBITDA.

Electronics stay hot, as iPad is the fastest growing new product release in history and Blackberry will be releasing its highly anticipated tablet in early 2011. Tablets may take over as a preferred device over laptops.  Verizon, with access to iProducts poses an even more competitive threat to AT&T.

Breaking News-American workers will get practically nothing done this week in anticipation of the New Years Day holiday.

[ii] The Kiplinger Letter Nov. 5, 2010

[iii] The Kiplinger Letter Dec. 17, 2010

[iv] The Kiplinger Letter October 22, 2010