Think like buffett about how to value outsourcing.

Outsourcing, as we know it, is the trend of corporations contracting functions such as information technology, payroll or call centers to specialized service providers. The reengineering of the Global Fortune 2000 during the past 15 years has resulted in a large increase in the outsourcing of functions outside of a company's "core competence" or "value proposition."

According to a 2002 study by Michael F. Corbett & Associates in the firm's Global Outsourcing Market report, 14.8 percent of the typical business' operation was outsourced 2001. Global spending on outsourcing was $3.78 trillion in 2001. The estimate for 2003 is $5.1 trillion. Two-thirds of outsourcing spending is by large U.S.-based companies.

What should corporations consider in deciding whether to outsource?

I would like to propose the concept of "value outsourcing"--applying Warren Buffett's investment principles to making efficient and productive outsourcing decisions. These are rooted in the work of investment banker Benjamin Graham, Buffett's mentor and the author of The Intelligent Investor, as well as several additions unique to Buffett.

The following are applications of Buffett's principles to corporate outsourcing

1. Understand it, then outsource it. Outsource only functions whose processes you understand. Outsourcers do something you can do, only more efficiently, because of a special focus or economies of scale. Payroll outsourcing is the classic example. (If you can't efficiently manage the function yourself, then the service provider is a consultant--not an outsourcer. You may want their help, but you won't save money on the transaction.)

2. If you can't measure it, don't outsource it. Evaluate the total cost of the function, whether done internally or outsourced. Avoid the temptation of using the cost savings of offshore outsourcers to avoid the hard work of process optimization; like adding technology to a mismanaged company, it will only spur disorganization.

3. Don't outsource for the sake of change. Like any useful management innovation, outsourcing can be a valuable tool or a thoughtless substitute for strategic action. If you are going to outsource based on cost efficiencies, there should be substantial savings involved--along with a sizable margin of error as a hedge against the unexpected. The return on investment should be monumental not incremental.

4. Outsource strategically, not tactically. When possible, there should be a market-driven strategy for an outsourcing initiative, such as building an offshore call center to gain familiarity with a major foreign market. Also, be careful to retain control of functions holding critical information for your company's success, such as customer satisfaction information from help desks or call centers. An outsourcer is responsible only for satisfying a service-level agreement, nothing more. And, choose outsourcers based on their track record, focus and stability, not just price.

5. Bet on people, Make sure you have sophisticated executives planning and negotiating your outsourcing agreements. Outsourcers make their profits by negotiating complex agreements with contract changes for additional or reduced resource requirements. I have seen some companies hiring vice president-level "chief sourcing officers" to even the odds.

Also, beware of cultural differences when outsourcing offshore. Don't outsource to countries that violate author Ralph Peters" "Seven Signs of Non-Competitive States." Briefly, these are restrictions on the free flow of information, the subjugation of women, inability to accept responsibility for individual or collective failure, the extended family or clan as the basic unit of social organization, domination by a restrictive religion, a low valuation of education and low prestige assigned to work.

India, for instance, passes all these tests; some of its prominent neighbors fail them all. A company with a global brand and a knowledge-based strategy would be foolhardy to partner with firms in such countries, however talented or inexpensive the services offered.

Outsourcing is here to stay; it is not a temporary management fad. But like the reengineering of the early 1990s, only some companies will leverage it successfully.

Isaac Cheifetz is an executive recruiter who helps companies hire tech-savvy senior executives. He writes a monthly column for the Minneapolis Star Tribune on trends and best practices in the global economy. His Web site is www.opentechnologies.com.