Profitable Structures for Strategic Alliances 1
Outsourcing and Profitable Structures for
Strategic Alliances

By Michael Hugos

Article Abstract

A company delivers offerings to its customers that are worth more than the goods
and labor that went into creating the offerings. The difference in value is
accounted for by the company's own value added contribution and this value
added contribution is the company's main reason for being. Companies need to
find ways to focus most of their attention and resources on improving the
activities that deliver their value added contribution. Outsourcing of non-value
added activities to strategic alliance partners is one way to do this.

Every strategic alliance is unique, yet every such alliance has a common set of
four characteristics that must be present: 1) delivery of a customized package of
products and services to meet specific sets of business needs; 2) coordination of
inter-company operations so as to achieve predefined performance targets; 3)
longer term, 3 - 5 year, contract time frames for alliance partners to work
together; and 4) prospects for mutually profitable business growth over the life of
the contract.

Strategic alliances are strengthened when three interdependent conditions are
present: 1) all parties have easy access to relevant information and performance
measures that are updated on a real-time or near real-time basis so that they
know what the "score" is; 2) people know how their actions influence the score
and they have the skills and opportunity to act effectively; and 3) people have a
stake in the outcome so that they will act to achieve their performance targets
and continuously learn to improve.

In the demanding and high change economy that most companies live in it is
necessary for companies to form strategic alliances with key customers and
suppliers. As basic products and services become commoditized, the
opportunities for profit are increasingly in the form of customized packages of
products and services that one company can offer another. Strategic alliances
provide the framework for these opportunities to be realized.


Introduction

We live in a fast-paced and high change economy. For companies to succeed they
need to achieve and maintain high rates of productivity and they need to adapt quickly to
changing circumstances. Companies can do this through the use of strategic alliances
with other carefully selected partners. This article explores the foundations for successful
Center for Systems InnovationProfitable Structures for Strategic Alliances 2
strategic alliances and discusses ways to structure those alliances so that they are both
strong and sustainable. These ideas are then illustrated through the use of case studies of
actual business alliances formed by my company.


Strategic Organizational Alignment and Cost Management

Every company uses a collection of goods and services to create offerings for its
customers. These offerings are worth more than the cost of the goods and services that
make up those offerings because there is a value added component that each company
provides that makes its offering attractive to customers. This value proposition does not
necessarily have to be unique, but whatever it may be, it is the main reason why
customers do business with a company. It is where a company finds its profits and its
reason for being.
For example, the value proposition of a company like Wal-Mart or Kmart is that a
customer can find a wide selection of consumer products in a single store at the lowest
possible prices. The value proposition of a company like Nordstrom's or Tiffany's is that
a customer can get a carefully selected mix of products that are of high quality and which
can usually be tailored to meet exacting customer requirements. Most companies,
whether they are selling products or services, have value propositions that are some mix
of these two examples.
All strategic alignment starts with a clear definition of a company's value
proposition. Once the value proposition is defined that indicates where a company should
focus its main effort. Instead of trying to do a little of this and a little of that, a company
needs to figure out how to focus the majority of its resources on producing and improving
its value proposition. Most of a company's value is created by just a small handful of
activities. All other areas of the company should be aligned so as to play supporting roles.
While companies put their attention and their investments into the value added
activities of their business, supporting functions can be performed by outside suppliers.
Suppliers and service providers that could help a company to profitably increase its value
to customers should be looked upon as potential strategic partners. Strategic partners are
strategic because the company delegates to them the work involved in performing many
of its support functions.
It is this ability to delegate supporting tasks and know that they will be done
reliably and consistently that is the main reason to establish strategic alliances. Clearly,
the cost of any outsourced operation must be less than the cost of doing it in house. And
the price paid for a given bundle of products must be reasonable. But the motivation for a
successful strategic alliance does not lie exclusively in expense control.
For strategic alliances to succeed there must be an emphasis on strategic cost
management, as opposed to simple expense reduction. This means the continuous
balancing of costs and the benefits they enable. Alliances require an approach that is as
much focused on value creation as it is on cost control. Strategic alliances are not merely
for the purpose of reducing expenses.



Center for Systems InnovationProfitable Structures for Strategic Alliances 3
Cultivate Strong Alliances

Let's start with a working definition of what a "strategic alliance" is. An effective
company must find ways to outsource activities not part of its core value proposition. In
this way it can focus more attention and investments on improving its ability to deliver
value to customers. Therefore a strategic alliance is a relationship with another
organization that enables a company to better fulfill its core value proposition to its
customers. Strategic alliances can be formed with companies that perform a whole range
of support activities that are necessary but do not directly contribute to the value
proposition.
The first step in creating a strong alliance is to define the areas where an alliance
is needed. Do this by identifying the major business processes in your company and how
they relate to your company's value proposition. It is best to avoid lumping your business
processes into generic categories such as sales, finance, purchasing, accounting, etc. Be
specific about how your company operates. Define the actual workflows that create your
company's value proposition.
For example, instead of saying sales creates value, be more specific and perhaps it
is actually sales to large national account customers who generate more than $10 million
in annual revenue that are the key to your value proposition. And perhaps sales to other
smaller customers are not really part of your value proposition. It may also be the case
that the attention provided to these customers by teams of people from customer service,
credit, and accounting is what maintains and grows the customer relationships. Some
accounting functions such as payroll, expense report processing, etc. may not be part of
delivering your company's value. You might also find that these value creation activities
are enabled by certain types of technology and not by other types of technology. It may
be critical to provide easy access to real-time customer sales data and to quickly connect
your company's systems with systems from your customers and suppliers. But it may not
be much of a competitive advantage to run your own purchasing, inventory control, or e-
mail systems.
By going through this kind of process you identify the activities that can be
performed by strategic alliance partners. All activities not labeled as directly contributing
to your company's value proposition are candidates for outsourcing. There are companies
who can take on these activities and do them more efficiently than your company can do
them in-house. Companies that configure their product and service offerings to meet your
specific operating requirements are the ones that potentially could become strategic
partners.
When choosing strategic partners, look for companies that understand your
business model and with whom you can establish good communications. The success of
any strategic alliance will depend on good communication to enable effective inter-
company coordination. The coordination between your company and your alliance
partners is what enables them to consistently deliver the levels of performance you
require. This concept of strategic alliances is illustrated in Figure 1.
It is important to note that a heavy-handed focus on cost reduction will prevent a
true strategic alliance from emerging. An effective alliance partner can certainly perform
the functions you outsource to them more efficiently than if they were performed by your
own company, yet keep in mind that strategic alliances are guided more by considerations
Center for Systems InnovationProfitable Structures for Strategic Alliances 4
of cost management rather that expense reduction and considerations of sustainable value
creation rather than short term gain.

Figure 1


A Company and Its Strategic Alliance Partners



Company focuses its

attention on core
Alliance
functions that
Partner 'A'
produce the value
Customer
add for its customers



Support
Alliance
Support Function
Partner 'B' Function Core
Core
Function
Customer
Function
Core
Function

Support
Each alliance
Company Functions Function
partner provides a

customized offering

of products and
Company out Customer
services designed
Alliance sources support
to meet company
Partner 'C' functions to alliance
requirements
partners





Top-Line Sustainable Growth and Productivity

If a company merely leverages its buying power to ratchet down the prices it pays
to its suppliers there comes a point where the suppliers will no longer make money in the
relationship. They will then either go broke or resign the business because of lack of
profits. Then the company has to find new suppliers and it may be hard to find new
suppliers if the business was so unprofitable to the previous suppliers. Relationships of
this sort are common enough in business, but they are not to be confused with what we
are calling strategic alliances.
Strategic alliances require sustainable growth and productivity. And that calls for
a process that generates rewards in the form of cost savings and/or revenue growth for
both parties. In addition to generating rewards, this process must preserve and nurture the
underlying source of these rewards. Earlier we said that strategic cost management means
managing a ratio of costs versus benefits so as to achieve a desired result. This means
costs can actually rise as long as the result is still a favorable ratio of costs and benefits.
Center for Systems InnovationProfitable Structures for Strategic Alliances 5
It is this reality - that costs can rise as long as a favorable cost/benefit ratio is
achieved - that is the foundation of a sustainable strategic alliance. If the alliance is
beneficial it should result in your company being able to reduce operating expenses in
non-core areas so as to concentrate on operations that produce your central value
proposition. If your company is successful and grows that results in increased operating
costs to support the growth. These increases in operating costs are the increases in
revenue and profits that your strategic partners need in order to make the alliance work
for them.
The key to sustainable alliances is to define a set of performance targets that, if
achieved, will clearly generate measurable benefits such as increased revenue, decreased
operating costs, growth of market share, etc. Make sure that the benefits can be measured
and that a monetary value can be assigned to them. The purpose of the alliance then
becomes to coordinate activities between companies so as to achieve these benefits. And
the alliance is sustained because both your company and the alliance partner share in the
benefits that are produced.
The alliance makes money every month from a hundred small adjustments that
fine-tune operations so as to achieve performance targets. Since the business environment
is constantly changing, constant small adjustments are required to deliver the best
possible operating results. In effect, the agreement between two companies to cooperate
is the capital in the strategic alliance. And the continuous steam of cost savings and
revenue enhancements that come from this cooperation is the interest earned on this
capital.
In the rush to get as much profit from a situation as quickly as possible, it is
possible for companies to fall into a pattern of behavior that in effect "kills the golden
goose." A strategic alliance cannot be a relationship where the only real objective is
expense reduction. All strategic alliances provide a mix of benefits. Make sure the mix of
benefits is clearly defined and their value is understood. Then make sure the benefits are
accurately tracked and the rewards shared between both parties.


Structuring Strategic Alliances

Although the details of every alliance are unique, there is still a common set of
characteristics that all strategic alliances have in common. A relationship that does not
exhibit all of these characteristics is not a strategic relationship. The structure of an
alliance must effectively address four requirements: 1) delivery of a customized blend of
products and services to meet a specific set of business needs; 2) coordination of inter-
company operations so as to achieve predefined performance targets; 3) longer term, 3 to
5 year, contract time frames for the alliance partners to work together; and 4) prospects
for mutually profitable business growth over the life of the contract.
The requirement for delivery of a customized blend of products and services to
meet a specific set of business needs is the foundation of any strategic alliance. A
strategic alliance starts when a company has a set of needs that go beyond short-term cost
reduction. This creates the opportunity for an alliance partner to configure and deliver a
customized offering to meet these needs. It is the customized offering that provides the
greatest value to the company receiving it and also the best profit margins for the
Center for Systems InnovationProfitable Structures for Strategic Alliances 6
company delivering the offering. If there is no need for a customized offering and simple
commodity products or services will suffice, then there is no basis or need for a strategic
alliance.
Coordination of inter-company operations so as to achieve predefined
performance targets indicates that both companies consider the relationship to be
important and not just an arms length business transaction. It also indicates that the
performance targets are challenging and require more effort to achieve that merely
negotiating a reduction in the prices that one company charges the other. Once the
business requirements of the first company are clearly defined, then key performance
indicators (KPIs) should be identified to measure the efficiency of the alliance partner in
filling these requirements.
A longer-term, 3 to 5 year, contract means that both companies agree to make a
commitment to the alliance that will provide time for learning to work together and for
improving the efficiency of the alliance. The extended time commitment allows the
alliance partner to invest in staff and technology for delivering the customized offering
and meeting the required performance targets. Unless there is a longer-term time frame
for the relationship, there will not be much incentive for the two companies to make the
effort or the investments that are part of a successful strategic alliance.
Prospects for mutually profitable business growth over the life of the contract are
the reasons why two companies go to the trouble of forming an alliance. If there are
prospects of profitable business growth for only one company then whatever the
relationship may be it certainly cannot be called an alliance. In a strategic alliance one
company out sources support functions in order concentrate more on its core value
proposition. An alliance partner takes on support functions and delivers a customized
package of goods and services that best fits the first company's business requirements.
The alliance is motivated by the prospect of growth for each partner. As the first
company grows its core business the alliance partner grows its outsourcing business.


Strengthening Alliances

Structure alliances so as to address the four points discussed above. Then
strengthen alliances by making sure three conditions are present. These conditions are
interdependent and all three must exist in order for any of them to truly be effective.
These three conditions are: 1) all parties have easy access to relevant information and
performance measures updated on a real-time or near real-time basis so they know what
the "score" is; 2) people know how their actions influence the score and they have the
skills and opportunity to act effectively; and 3) people have a stake in the outcome so that
they will act to achieve the performance targets and continuously learn to improve.
Strategic alliances depend on close coordination between companies and effective
coordination can only happen when all parties have easy access to the information they
need to do their jobs. Strategic alliances are much like a game whose goal is to achieve
the predefined performance targets. In order to play this game people need to know what
the score is at all times. They need to know if they are moving toward the goal or away
from it. They need current information that reflects events as they happen, not batch
Center for Systems InnovationProfitable Structures for Strategic Alliances 7
reports delivered 30 days after the end of the last quarter. This allows them to make good,
timely decisions and coordinate effectively.
Once people are able to see the score and track events as they happen they need to
understand how their actions influence the score. If operating results are trending away
from performance targets people need to know what to do to bring operations back on
track. If results are on target people need to know how best to sustain them. That means
people get the training they need to do their jobs well. It also means that people have the
opportunity and authority to act as they see fit when the need arises. If no action can
happen until requests and permissions are passed up and down a chain of command, then
responses will be too slow and people will become frustrated with the poor results.
When people can see the score at all times and when they know how to act in
order to achieve predefined performance targets there is one more condition that must be
present in order for a strong alliance to emerge. That condition is that people have a stake
in the outcome. Often this is in the form of a monetary reward when performance targets
are achieved. Without a stake in the outcome, people become bored or indifferent and
they will not make the effort to constantly improve and adjust operations to respond as
the world changes. And without this constant effort challenging performance targets
cannot be achieved.
Strategic alliances need to be structured and strengthened so as to encourage open
collaboration and initiative on both sides. That means that both parties clearly profit from
the value that they create together. A relationship where one side merely extracts value
from the other will only encourage secrecy and discourage innovation because innovation
is risky and when there is no reward, there is no reason to take risks. Ideas for structuring
and strengthening strategic alliances are summarized in Figure 2.


Case Study: Building Successful Strategic Alliances

Over the last five years in my capacity as chief information officer for my
company I have closely observed strategic alliances from two sides. The first side is that
of an alliance partner seeking to take on an outsourced support activity from one of our
customers. The other side is that of a company who is itself seeking to outsource a
support activity to an alliance partner. In both cases I have seen a strong consistency in
the way successful alliances operate.
My company, Network Services Company, is a nationwide network of wholesale
distributors who provide national account customers with customized offerings of
products and services. The products we provide are foodservice disposables such as paper
cups, plastic forks, and food containers. We also provide janitorial equipment and
sanitary supplies and paper products such as paper towels and tissue and printing paper.
We wrap these commodity products in a package of supply chain services that is
customized to meet the specific needs of each individual customer.
We have found that our offering constitutes an important support function for
certain kinds of companies such as national restaurant chains, grocery store chains, and
large industrial and property management companies to name a few. Before approaching
a prospective customer we verify that their business requirements call for the kind of
customized supply chain service offering we provide. We have learned that if a company
Center for Systems InnovationProfitable Structures for Strategic Alliances 8
does not need these services then they will only be interested in product prices and there
is no value to us in taking on that kind of business.

Figure 2


Structuring and Strengthening Strategic Alliances


The structure of any strategic alliance is molded by four basic
requirements:


1) Demand for a customized offering of products and services to
meet business needs
2) Close coordination between companies to achieve specific
performance targets
3) Longer term (3 - 5 year) contractual agreements between
companies
4) Prospects of profitable growth for all companies
A strategic alliance is strengthened when three interrelated
conditions are present:

People can
access to up to
date information
so they always
know what the
"score" is
People know how People have a
to act to influence stake in the
the score and outcome so they
achieve their are motivated to
performance act and learn to
targets improve
Center for Systems InnovationProfitable Structures for Strategic Alliances 9

Our business strategy is to actively seek out customers where we can become a
strategic alliance partner. In our current strategic plan we recognize that we cannot
succeed in business relationships where the customer is primarily interested in getting the
lowest item price. Because of our organizational structure we are very good at customer
intimacy and product knowledge but we do have higher operating costs than some of our
competitors and cannot compete on price alone. We need to find customers who value
and will pay for a customized mix of products and supply chain services.
In addition to our bundle of physical products we offer a package of supply chain
services that enable our customers to better plan and manage their usage of the products
we provide them. Over the longer three to five year term, we can clearly show that our
services allow customers to lower their total cost of use for our products even though we
do not offer the lowest item prices.
Our supply chain services include the ability to take any kind of electronic order
the customer may wish to send us or we can provide the customer with a customized,
web-based product catalog and order entry system. We also provide customers with daily
updated, web-based sales history reporting, electronic statement billing using any
electronic format the customer specifies, and a dedicated customer service team who will
handle issues needing special attention. We use business process management (BPM)
software to monitor our operations and post daily updated performance score cards for
each customer showing key performance indicators (KPIs) such as order fill rate, line
item fill rate, number of back orders and substitutions, and invoices without errors.
Customers have access to their scorecards and other reports online through our web site.
We structure our business with our customers based on the four requirements for
strategic alliances presented earlier. When we determine that a company has a need for
our customized offering we work with them to define the exact configuration of services
they need to maximize the value of the relationship. We build service level agreements
(SLAs) into the contract with the customer and measure the relevant key performance
indicators. We negotiate three to five year agreements with these customers to provide
enough time for our two companies to create the electronic connections and the personal
connections required for an effective alliance.
We find that the customer service group is the best group to take the lead in
building the relationship after the initial sale has been made. We empower our customer
service group by using our systems to automate handling routine transactions such as
purchase orders, advance ship notices, and invoices. We also use our business process
management system to flag non-routine transactions and bring them to the attention of an
appropriate customer service person. This way our customer service group is not bogged
down handling routine work so they are very responsive to customer problems. They
proactively address issues with customers so as to resolve problems as soon as possible.
Building these kinds of longer-term alliances with customers takes time and
requires an investment on our part in the form of systems enhancements and electronic
connections to effectively link up with our customers. To cover these costs there must be
good prospects for profitable business growth during the length of our contract with a
customer. We seek out companies that are either growing their business rapidly or
customers that are already well established and can provide us with a large annual
volume of business. At times we have declined to do business with large companies that
Center for Systems InnovationProfitable Structures for Strategic Alliances 10
are in a process of contracting because those companies are often interested only in
getting the lowest item prices and even though our business volume with them could be
large, the profit margins would be small or even non-existent.
In the last few years we have actively collaborated with a select group of
customers to find ways to strengthen our alliances and improve our value to our
customers. What we find is that transparency in the business relationship is the
foundation for strengthening the alliance. By this I mean that when people in our
company and in our customer's company know what is going on in the relationship on a
daily basis they have the information they need to collaborate and coordinate their actions
more effectively.
The service level agreements we negotiate with our customers are the
performance targets we all strive to achieve. And the automated score cards showing key
performance indicators on a daily basis tell everyone what the score is that day. When
people know what the score is they also know what they need to do to improve the score.
We have begun to build performance incentives into our contracts as a way to
give people motivation to continue to learn and improve the service levels we provide. If
we reach or exceed certain quarterly performance levels then our company shares in the
money that this generates for our customer. We are experimenting with ideas such as the
right to raise prices by a small percentage if we achieve or surpass our performance
targets. We are seeing some very promising results from this.
When my company looks to bring on an alliance partner to handle a support
function for us, we apply the same principles that we use when evaluating potential
customers. One area where we have a need for a customized offering of products and
services is in the design and development of electronic business systems. I have formed a
strategic alliance with a software development firm in Chicago that does our systems
development work.
Our two companies have been working together since 2001 and the many
different personal connections that have been established enable close coordination
between our companies to design and deliver the systems we need. As our business
grows, my need for systems work grows and my alliance partner is the recipient of this
business. I do not go out for competitive bids on each new project as long as they
continue to deliver results as expected and as long as the prices they charge us are
reasonable.
In this alliance I also apply the three conditions for strengthening the alliance that
we use with our customers. There is an IT project office that puts out updated project
plans and budgets every week for every project under way. Thus everybody involved in
these projects knows what the score is and whether a project is ahead of or behind
schedule and whether it is on budget or over budget. With this information, people know
what to do to keep projects on track. I work with my alliance partner on a fixed bid basis
(not hourly time and materials) so they are very motivated to bring in a project on time or
even early. If they bring in a project early they still earn the same amount as if they had
taken longer to finish.

Center for Systems InnovationProfitable Structures for Strategic Alliances 11
Conclusion

When a company forms strategic alliances with its important customers it gains
longer term revenue stability and an opportunity to further develop its core value
proposition. When a company forms strategic alliances with alliance partners to whom it
out sources non-core support functions it lowers its cost of operations and increases the
resources available to invest in its core functions. The results of both kinds of alliances
provide significant competitive advantages.
In the economy we live in today learning to form strategic alliances with both
customers and suppliers is a necessity. Rare is the company so dominant or so entrenched
that it can afford to pay only lip service to strategic alliances. As basic products and
services become commoditized the opportunities for profit increasingly lie in the
customized packages of products and services that one company can offer to another.
Strategic alliances provide the framework for these opportunities to be realized.


Author's Note
I wrote this article in 2005 when I was Chief Information Officer at Network Services Co.
These principles are even more relevant and timely to businesses today.

This article was first published in the Journal of Cost Management,
ISSN 1092-8057, Vol. 19, Nº 5, 2005, pgs. 5-12




Professional Profile

Michael Hugos is a mentor and practitioner in business agility at the Center for Systems
Innovation in Chicago, Illinois. Prior to this, he was the chief information officer (CIO) of a
$7.2 billion distribution cooperative where he designed and built the suite of supply chain
and e-commerce systems that changed its business model from old-line distributor to
provider of products and value added supply chain services.

In 2003 and 2005 he was awarded the CIO 100 Award for bold and resourceful use of
information technology for business advantage. He holds an MBA from Northwestern
University's Kellogg School of Management. Mr. Hugos is a speaker and also author of
nd
several books including, Essentials of Supply Chain Management, 2 Edition and
Building the Real-Time Enterprise: An Executive Briefing both published by John Wiley &
Sons.

He can be contacted at: www.MichaelHugos.com


Center for Systems Innovation