When DIY doesn't make sense, small businesses send out their technology functions--or take others' in
Air Taser is a start-up based in Scottsdale, Ariz., that wants to bring criminals down without taking them out. CFData is a Dallas company dedicated to helping retailers get the rubber out of customers' checks. Both businesses are young. Both are successful. And both owe at least some of their success to the clever use of outsourcing.
Outsourcing, long a matter of megacontracts between megaplayers, is attracting a growing number of small businesses as well. While Fortune 1,000 companies bat around buzzwords like core competency to explain why they're shifting some of their functions to outside vendors, smaller firms generally focus on growing their businesses without adding resources. And while companies can outsource anything from payroll to maintenance, technology-intensive functions--given the requirements of capital and expertise--are among the likeliest candidates. "Companies want to invest in infrastructure," says Michael Corbett, president of Michael F. Corbett & Associates, an outsourcing consultant and market researcher in Poughkeepsie, N.Y. "But they can't invest in all the elements of infrastructure. They have to pick and choose."
Nor is the supply side solely the province of giants. But while companies like EDS offer soup-to-nuts technology management, small companies generally specialize. "Outsourcing is driven by skills and knowledge," says Corbett. "Smaller firms--if they select their niche carefully--can create as much value as the largest company in the world."
The benefits of good outsourcing arrangements are manifold. For customers, outsourcing can mean lower costs, a lighter load on management, and more capital for other investments. Vendors gain new markets, the opportunity to leverage technology investments over a number of clients, and the chance to compete against players that ordinarily are out of their league.
What follow are the stories of two small companies--one a customer, one a vendor--that are building their empires on outsourcing.
Tom and Rick Smith were away at college in 1988, when their father cut short his retirement and took a job in San Francisco. That left their mother all alone in their spacious Phoenix home for weeks on end, a worrisome situation that became downright nerve-racking when a neighbor was smothered to death by an intruder. Frightened for their mother, the brothers sent her to a class to learn how to fire a .357 magnum. Mom, however, turned out not to be the gun-toting type.
Then, a few years later, two of Rick's high school football teammates were shot and killed in a parking lot. In the brothers' minds, that incident crystallized the need for a product that, as Rick describes it, would "help people protect themselves without killing someone in the process."
By that time both brothers had graduated from business school and were hankering to run their own company. Self-defense was going to be the industry; an alternative to pepper spray and mace, the product. During four months of research into various devices, one came up repeatedly: the taser. The taser is a kind of stun gun that temporarily incapacitates the target's nervous system without causing permanent damage. But there was a hitch. The taser uses gunpowder, which is classified as a concealed weapon and can't be sold to the general public. So the Smiths turned to the weapon's inventor for help. Four months later the air taser was born.
The air taser uses compressed air to fire tiny cartridges (called probes) that are attached to 15-foot lengths of wire. The probes latch onto the target's clothing and transmit an electronic pulse that zaps the nervous system, disabling the target for several minutes.
Satisfied that they had found their product, the Smiths created a company--Air Taser Inc.--to manufacture and market it. Because keeping air tasers out of the wrong hands was almost as important as getting them into the right ones, they needed a computerized registration system that could track every store selling the product and every customer buying it. The most sensible approach, the brothers thought, would be to tie that system into their as yet nonexistent warehousing, shipping, and delivery operation, which would let them centralize information on the product from assembly through sale.
Wanting some expert advice, the brothers visited Insight, a local company that does direct sales and marketing of microcomputer products and services. But when Insight laid out the problem in all its complexity, the Smiths felt as though they'd been struck by one of their own probes. "We were completely unprepared for the enormity of the job," says Rick.
The Smiths' tasers are packaged in kits. Each kit contains the device itself, several cartridges, a nine-volt battery, a practice target, an instructional video, and an owner's manual in one of seven languages. The system would have to track not only code numbers for every part but also the contents of every kit shipped--making sure, for example, that Portuguese manuals go into the same kits as Portuguese videos. It would also have to register the serial numbers and bar codes of every component shipped as part of the customer-tracking program.
In addition to tracking technology, Air Taser would need warehouse space, several forklifts, and labor. All told, Insight estimated that the Smiths would have to shell out $200,000 the first year and $100,000 every year after that. "And then," says Rick, "we'd have to manage the program."
That was a little rich for the Smiths, who prefer to pour their money and energy into developing new products and marketing the ones they have. Everything pointed to one strategy: hire someone else to handle fulfillment. The brothers did some perfunctory vendor shopping, but they liked Insight, which already had much of the infrastructure in place. So in 1994 they signed a three-year contract awarding Insight 4% to 8% of each sale in exchange for its services. The system Insight developed would belong to the vendor, which could adapt parts of it for use by other clients. The brothers would have access to 10,000 feet of warehouse space at Insight and to the machinery and people they need to move their product.
Over the next several months, customer and vendor labored together on the antifelon identification (AFID) tracking program. The idea is to mark each kit's registration card, cartridges, and handle with serial numbers that are automatically recorded in a customized fulfillment package running at Insight. Whenever a kit is sold through a store, the retailer sends Air Taser a postage-paid registration card with the customer's name, driver's license information, and phone number. Those data are matched with the product information recorded in the database and can be retrieved as they're needed. Occasionally, it's the police that do the needing.
At the outset the only technology the Smiths had to buy was three networked Pentium PCs connected to Insight's computers via phone lines. Using Windows-based software supplied by Insight, Air Taser's staffers type in shipping orders and transmit them to Insight's data-processing center over leased lines. To get into the AFID program, they click on an icon that gives them instant read-only access to the database.
By December 1994, the system was ready and the Smiths started shipping. Since then they've sold about 250,000 of the $250 devices in more than 50 countries, earning revenues over $7 million.
The outsourcing arrangement has proceeded smoothly. Air Taser gets tech support from one dedicated Insight programmer; for special projects, Insight assigns more. The geographic proximity of the two companies has also been a boon: one of Air Taser's systems people swings by Insight every week to check in, and Tom meets with the vendor's management team every two months. Logistics are squared away in a daily get-together between Air Taser's information manager and Insight's warehouse manager.
The ability to offload such a consuming task has allowed Air Taser to move on without burning out. Recently, it introduced a new product: a steering wheel lock with built-in alarm. "Before the first shipment, we were here until 7 a.m.," says Rick. "If we'd also had to worry about shipping, it would have been too much."
Now that they've been around for a few years, would the Smiths consider building their own fulfillment capability? Rick ticks off the list of headaches concealed in that Trojan horse: "Do we need a bigger warehouse? How are we going to track the parts? Do we need a new inventory-control system?" By outsourcing, "all that is somebody else's problem," he says. "And we can focus on the next nifty new product."
Niches, the more mundane the better. That's where W. Harwood "Woody" Runner and his business partner, Gary Miller, saw their future. "We wanted to focus on something customers see as a nuisance, and really raise the level of play," says Runner.
Runner and Miller had founded a private investment firm, Cumberland Capital Corp., in 1989. In 1992 they acquired a wholesale office-products business and outsourced the IS operations. The next year a consultant involved in that outsourcing arrangement passed on some interesting information: Southland Corp., the parent company of 7-Eleven, was divesting itself of noncore businesses. Runner and Miller pounced on Southland's check-authorization and collection division, buying the unit for an undisclosed sum. "We had been on the other side of the table, as a customer, so we understood the benefits of outsourcing," says Runner.
Miller and Runner agreed to continue servicing 7-Eleven stores through their new company, CFData Corp. But juicier possibilities lay elsewhere. Most retailers, they knew, don't consider approving checks and collecting late payments as part of their core business. "It's just one of a hundred dogs barking at their door," says Runner.
The partners' idea was to collect customer-transaction information for retailers and then analyze it to reduce the incidence of bad checks. But that meant an overhaul of all of Southland's systems, right down to the postage meters. Fortunately Peter Bendor-Samuel, the consultant who had turned them on to Southland, had come on board as a partner. His expertise gave Runner and Miller, who two years before had been offloading their own IS work, the confidence to become a technology resource for others.
Just deciding what technology to buy ate up a year. The centerpiece would be software for using, storing, categorizing, and examining data. The partners eventually chose SAS, a database-management program from SAS Institute in Cary, N.C. To manage the collection process they went with an off-the-shelf program called Flexible Automated Collection System, from Ontario Systems Corp., in Muncie, Ind. Using its own programmers, CFData installed everything on a networked system of 60 IBM-compatible PCs. Total cost of the software and equipment: $2 million.
CFData's eight employees spent the next year making sure all the software and hardware pieces played well together. Finally, they had an effective system -- and a process for using it. First CFData works with retailers to identify what check information the system should capture. Whenever a customer makes a purchase, the sales clerk transmits that information electronically to CFData's central server or, if the customer has one, to its own network. Using the Geryon Verification System, a check-authorization program from Magic Software Development, in Albuquerque, the computer looks for any past problems with that customer. If it finds something, the clerk gets a message nixing the purchase.
When a check bounces, data-entry staff at CFData record key information in the collection system, which runs on a Hewlett-Packard 9000. A collection agent then hits the phone to start the payment chase.
But CFData's real selling point is analysis. Data from the authorization and collections systems are integrated regularly into the SAS database, and CFData can extract that information and study the patterns of bounced checks. One clothing store using CFData's services was plagued by forgeries. The system determined that most of the trouble stemmed from a department selling clothes for teenagers and staffed by teenage clerks. At Runner's suggestion the store put the department in more-experienced hands, and the number of losses due to forgeries dropped by more than 50%.
CFData's fees vary, depending on the volume of checks being processed and the length of the contract (anywhere from 1 to 10 years). Because it incurs certain costs whether or not it manages to collect payment, the vendor rewards merchants that do a good job policing bad checks. Some contracts include a mechanism that reduces fees if the retailer improves its processes--verifying a customer's identity at the register, for example.
Outsourcer-client relations are informal. CFData account representatives use phone, fax, and E-mail to touch base daily with retail managers; higher-level meetings accommodate customers' schedules. The company doesn't dedicate systems staff; instead clients in trouble call a general number for tech support. The nitty-gritty--for example, expunging Ms. Jones from the database when she finally pays up--is processed through the regular payments function.
CFData currently has sales of about $7 million a year and 12 large retail customers, including JCPenney and KFC. In addition to a new marketing push, the company is improving its technology. Recently, for example, it bought a Windows-based interface from SAS to make its system easier to use. And it is launching a Web site, which it hopes will eventually give clients password-protected access to analyses of their check-processing trends. "It's just another way we can digest the data for them," says Runner.
Anne Field is a freelance writer based in Pelham, N.Y.
Get It in Writing
Good contracts make good partners. Here are five issues critical to any outsourcing contract:
Pricing and compensation. Spell out how services will be priced. Will the customer pay by the hour? By unit of computing power? By number of items handled? Vendors should make provisions for changes in their own costs over the long term. Include payment schedules based on clearly defined criteria. Small businesses, especially, should keep it simple. "Try anything too fancy, and you'll spend more time on the accounting than on anything else," says Air Taser's Rick Smith.
Description of services. Define in detail the service(s) being offered and which side eats the costs in case of a problem. Vendors should stipulate which tasks are part of the core service and which are extras.
Performance standards. Describe what metrics--transaction times, reporting cycles, and the like--both sides will use to measure performance. Be sure to build in flexibility. "These are long-term relationships," says CFData's Woody Runner. "The world isn't likely to look the same five years from now."
Management plans. Large companies can have whole departments supervising outsourcing relationships; small companies can't afford that. So both customers and vendors need some mechanism--a dedicated liaison or some kind of employee colocation, for example--to keep partnerships on an even keel.
Escape routes. Plan for the end at the beginning. When the relationship is over, what happens to inventory, equipment, and mailing lists? What must the vendor hand over to the new outsourcer or to the customer itself? How much notice must one party give the other before terminating services?
Good-Bye to All That
Dying to unload something but not sure what? Most companies want to hang on to what they do best. Just about anything else is up for grabs. Some possibilities:
Historically troublesome areas. These could include functions requiring an inordinate capital investment or involving onerous regulations.
Areas that lend themselves to economies of scale. An outsourcer with a dozen clients may be able to handle your payroll better--and more cheaply--than you can.
Areas that will save you the most money. If your most pressing problem is cost cutting, then outsource functions that will drive down costs. If you want access to expensive assets without buying them, then outsource the money gobblers.