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 long-
term 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 BASIC DETAIL SITE AS BUILT

DESIGN ENG’G SERVICES

1. Organization patented 1. Technology available

technology with many
2. Data to be secured CORE NON-CORE domains/Users
from competition ENGINEERING ENGNIEERING 2. Data security non
3. Data security relevant from
4. Related to the competitors
specialized process 3. Routine process
and linked to multi 4. Less Risk
department data
5. High risk

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 STAGE 2 STAGE 3

• Material Balance • Preliminary • Purchase Ready

• Energy Balance
• Project Charter
• Understanding scope
Equipment Design Major Equipment
• Preliminary Layout Specifications
• Preliminary Schedule • Definitive Estimate
• Preliminary Estimate • Project Execution
• Preliminary Execution Plan
Strategy • 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-of-
materials, 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 Weightage

Project Engineering 4.0% Core
Performance & System Design 3.0% Core
Control & Instrumentation 7.0% Partly
Hot structures, F&D, Cold Structures 46.0% Partly
Pressure parts 9.0% Core
Protective Systems 5.0% NA
Equipments, Balance items 4.0% Core
Layout (3D) 5.0% Core
Pipe work systems 17.0% Partly
Table 1: weight age of a typical complete project

A typical project of Renovation and Modification at a Petrochemical industry

Discipline %’age Weightage

Project Engineering 19.0% Core
Performance & System Design 10.0% Core
Control & Instrumentation 16.0% Partly
Structures 16.0% Partly
Pressure Parts NA
Protective Systems 4.0% Core
Equipments, Balance items 12.0% Core
Layout Incl.
Pipe work systems 23.0% Partly
Table 2: weight age of a typical R&M project

Now, critically examine the various scenarios.

Assumptions:
Total Manhours for Complete project : 125,000 hrs
Fully burden rate : $50/Hour
Outsource rate : $35/Hour
Total Manhours for R&M project : 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 : $40/Hour
Outsource rate : $35/Hour
Inline with these assumptions,
Total project cost : $ 6.25million
R&M project cost : $ 0.24 million

2.a SCENARIO 1: Complete new project case

Weight Actual
Discipline %’age
age Cost ($)
Project Engineering 4.0% Core 250,000
Performance & System Design 3.0% Core 187,500
Control & Instrumentation 7.0% Partly 437,500
Hot structures, F&D, Cold Structures 46.0% Partly 2,875,000
Pressure parts 9.0% Core 562,500
Protective Systems 5.0% NA 312,500
Equipments, Balance items 4.0% Core 250,000
Layout (3D) 5.0% Core 312,500
Pipe work systems 17.0% Partly 1,062,500

Assuming the In House and o/s as below:

Weight In-house
Discipline %’age O/S Cost
age Cost
Project Engineering 4.00% Core 250,000
Performance & System Design 3.00% Core 187,500
Partly 131,250 214,375
Control & Instrumentation 7.00% (30+70)
Partly 575,000 1,610,000
Hot structures, F&D, Cold Structures 46.00% (20+80)
Pressure parts 9.00% Core 562,500
Protective Systems 5.00% NA 312,500
Equipments, Balance items 4.00% Core 250,000
Layout (3D) 5.00% Core 312,500
Partly 318,750 520,625
Pipe work systems 17.00% (30+70)

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:

Weight Actual Cost ($)

Discipline %’age
Age cost($)
Inhouse O/s
Core 250,000 250,000
Project Engineering 4.00%
Performance & System Core 187,500 187,500
Design 3.00%
Partly 437,500 131,250 214,375
Control & Instrumentation 7.00% (30+70)
Hot structures, F&D, Cold Partly 2,875,000 575,000 1,610,000
Structures 46.00% (20+80)
Core 562,500 562,500
Pressure parts 9.00%
NA 312,500 312,500
Protective Systems 5.00%
Core 250,000 250,000
Equipments, Balance items 4.00%
Core 312,500 312,500
Layout (3D) 5.00%
Partly 1,062,500 318,750 520,625
Pipe work systems 17.00% (30+70)
Sub Total 2,900,000 2,345,000

Total 6,250,000 5,245,000

Table 3: complete project cost workings

Notable Savings: $ 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-in-
Class” 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

Weight Total
Discipline %’age
age Cost ($)
Project Engineering 19.0% Core 45,600
Performance & System Design 10.0% Core 24,000
Control & Instrumentation 16.0% Partly 38,400
Structures 16.0% Partly 38,400
Protective Systems 4.0% Core 9,600
Equipments, Balance items 12.0% Core 28,800
Layout Incl.
Pipe work systems 23.0% Partly 55,200

Assuming the In House and o/s as below:

In-
Weight Total o/s
Discipline %’age house
age Cost ($) Cost Cost

19.0% Core
Project Engineering 45,600 45,600
10.0% Core
Performance & System Design 24,000 24,000
Partly
16.0%
Control & Instrumentation (50+50) 38,400 19,200 16,800
Partly
16.0%
Structures (50+50) 38,400 19,200 16,800
4.0% Core
Protective Systems 9,600 9,600
12.0% Core
Equipments, Balance items 28,800 28,800

Layout Incl.
Partly
23.0%
Pipe work systems (50+50) 55,200 27,600 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:

Weight Actual Cost ($)

Discipline %’age
Age cost($)
Inhouse O/s
Core
19.0%
Project Engineering 45,600 45,600
Performance & System Core
10.0%
Design 24,000 24,000
Control & Partly
16.0%
Instrumentation (50+50) 38,400 19,200 16,800
Partly
16.0%
Structures (50+50) 38,400 19,200 16,800
Core
4.0%
Protective Systems 9,600 9,600
Equipments, Balance Core
12.0%
items 28,800 28,800

Layout Incl. 55,200 27,600 24,150

Partly
Pipe work systems 23.0% (50+50) 45,600 45,600
Sub Total 174,000 57,750

Total 240,000 231,750

Notable Savings: $ 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

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-right-
outsourcing-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