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1

Introduction



Outsourcing is defined in this study as the organizational practice of contracting for services from an external entity while retaining control over assets and oversight of the services being outsourced. The practice of contracting for, or outsourcing, services by industry and government is not new. The federal government, for example, has contracted with the private sector for facilities acquisition services, including planning, design, and construction services, for more than a century. In the 1980s, however, a number of factors led to a renewed interest in and emphasis on outsourcing. For private-sector organizations, outsourcing was identified as a strategic component of business-process “reengineering” designed to streamline their organizations and increase their profitability. In the public sector, growing concern about the federal government's budget deficit, the continuing, long-term fiscal crisis for some large cities, and other factors led to efforts to restrain the growth of government expenditures and accelerated the use of a wide range of privatization 1 measures, including outsourcing for services (Seidenstat, 1999).

OUTSOURCING AND BUSINESS-PROCESS REENGINEERING

The literature on business management has focused on business-process reengineering in the context of a private sector organization's financial,


1 Privatization has been defined as “any process aimed at shifting functions and responsibilities, in whole or in part, from the government to the private sector” (GAO, 1997). Privatization processes may include outsourcing for services, transfer of asset ownership, managed competition/competitive contracting, franchising, public-private partnerships, vouchers, grants, subsidies or other activities (Seidenstat, 1999).



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Page 11 1 Introduction Outsourcing is defined in this study as the organizational practice of contracting for services from an external entity while retaining control over assets and oversight of the services being outsourced. The practice of contracting for, or outsourcing, services by industry and government is not new. The federal government, for example, has contracted with the private sector for facilities acquisition services, including planning, design, and construction services, for more than a century. In the 1980s, however, a number of factors led to a renewed interest in and emphasis on outsourcing. For private-sector organizations, outsourcing was identified as a strategic component of business-process “reengineering” designed to streamline their organizations and increase their profitability. In the public sector, growing concern about the federal government's budget deficit, the continuing, long-term fiscal crisis for some large cities, and other factors led to efforts to restrain the growth of government expenditures and accelerated the use of a wide range of privatization 1 measures, including outsourcing for services (Seidenstat, 1999). OUTSOURCING AND BUSINESS-PROCESS REENGINEERING The literature on business management has focused on business-process reengineering in the context of a private sector organization's financial, 1 Privatization has been defined as “any process aimed at shifting functions and responsibilities, in whole or in part, from the government to the private sector” (GAO, 1997). Privatization processes may include outsourcing for services, transfer of asset ownership, managed competition/competitive contracting, franchising, public-private partnerships, vouchers, grants, subsidies or other activities (Seidenstat, 1999).

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Page 12 management, time, and staffing constraints. The goal of reengineering is to increase profitability by becoming more competitive and significantly improving critical areas of performance, such as quality, cost, delivery time, and customer service. The underlying premises of reengineering are: (1) the essential areas of expertise, or core competencies, of an organization should be limited to a few activities that are central to its current focus and future success, or bottom line; and (2) because managerial time and resources are limited, they should be focused on the organization's core competencies. The purpose of reengineering, then, is to streamline organizations by focusing on the core competencies required for them to compete successfully in the marketplace. Additional functions may be retained by the organization, or in-house, to keep competitors from learning, taking over, eroding, or bypassing the organization's core competencies (Pint and Baldwin, 1997). For private sector organizations, core competencies may be skills that are: (1) difficult to duplicate; (2) create a unique value; or (3) constitute the organization's competitive advantage (i.e., what it does better than anyone else). Core competencies have been also been defined as a “bundle of skills and technologies that enable a company to provide a particular benefit to customers” (Hamel and Prahalad, 1994). For example, at SONY, the benefit is “pocketability, and the core competence is miniaturization,” whereas at Federal Express, the benefit is on-time delivery, and the core competence is logistics management (Hamel and Prahalad, 1994). As part of business-process reengineering, support services required by the organization that are not core competencies can be outsourced to external organizations that specialize in those services. Ideally, by outsourcing noncore functions, an organization receives the best value or best performance for the resources expended. Surveys by the Outsourcing Institute (1998) have found that private-sector organizations outsource functions for the following primary reasons: Improving organizational focus. By outsourcing noncore activities or operational details to an outside expert, an organization can focus its in-house resources on the development and enhancement of its core competencies. Gaining access to world-class capabilities. By partnering with an outside entity that has access to new technologies, tools, and techniques, an organization can gain a competitive advantage without making a substantial capital investment. Sharing risks. In an environment of rapidly changing markets, regulations, financial conditions, and technologies, an organization can reduce risks by sharing them with external entities. Reducing and controlling operating costs. By contracting with a provider that can achieve economies of scale or other cost advantages based on

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Page 13 specialization, an organization can reduce and control its operating expenses. Accelerating reengineering benefits. By outsourcing a process to an external entity that has already reengineered its business processes to world-class standards and that can guarantee the improvements and assume the risks of reengineering, an organization can realize the benefits of reengineering in less time. Shifting capital funds to core business areas. By reducing the need to invest in capital (building) projects or technologies by outsourcing for them, an organization can redirect capital funds to its core business activities. Smoothing out workloads/matching personnel to the volume of work. At times of peak business activity, an organization can contract for personnel and other resources to handle peak or unique workloads and to meet the demands of multiple projects or shifting workloads and reduce the disruptions and costs associated with hiring and then laying off “permanent” staff. OUTSOURCING AND THE RESTRUCTURING OF GOVERNMENT SERVICES For the federal government and its agencies, and for state and local governments, “there is no single number or ‘bottom line' …comparable to the net worth of a business corporation” (OMB, 1997). In fact, there are fundamental differences between the objectives of governments and the objectives of businesses and, consequently, in the ways they operate. The primary goal of a business is to earn a profit. Government organizations, in contrast, are primarily concerned with and guided by issues of public health, safety, and welfare, such as providing national defense, conducting foreign policy, regulating goods and services, providing police and fire protection, and so on. One objective of governmental entities is to provide services cost effectively rather than for a profit. For these reasons, public practices are often very different from private sector practices; they entail different risks, different operating environments, and different management systems. Thus, the renewed interest in outsourcing among governmental entities that began in the 1980s was generated by factors other than increasing profitability. The growing federal budget deficit, the continuing long-term fiscal crisis in large cities, grassroots efforts to restrain the growth of tax revenue and limit government spending, and efforts to make government more cost effective placed increasing pressure on elected officials at all levels of government to cut budget growth and, in some cases, downsize government operations without substantially reducing services (Seidenstat, 1999). These factors contributed to a larger national debate about which services should be directly provided by government

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Page 14 and which should be provided by the private sector. “Once the government agenda focused on this issue of restructuring or ‘rightsizing,' then privatization became a major policy option as part of a restructuring program” (Seidenstat, 1999). As reported by Seidenstat, a 1993 report by the Council of State Governments found that, of the various privatization strategies—contracting out, grants, vouchers, volunteerism, public-private partnerships, private donations, franchises, service shedding, deregulation, and asset sales—78 percent of state agencies used contracting out as their primary strategy. Contracting out appeared to be favored because it allows: (1) government officials to retain substantial control over service production while seeking the lower costs promised by private-sector providers; (2) the public agency to have greater involvement in design, oversight, and production than other strategies; and (3) a relatively easy resumption of public production if the private provider proves to be unsatisfactory or goes out of business, particularly if the public agency retains some equipment or management expertise in the service area (Seidenstat, 1999). A 1997 report, Outsourcing of State Highway Facilities and Services, 2 surveyed state transportation agencies to determine the reasons for and extent of outsourcing, among other objectives (NRC, 1997). The report found that the primary factors that influenced the decision to outsource were: staff constraints, including an inability to maintain or increase staff in the face of growing workloads or to meet given schedules (40 percent of total responses) the need for specialized expertise or equipment (24 percent) policy directives (22 percent) comparison of cost effectiveness (8 percent) legal requirements (4 percent) other factors, such as quality, the need for a neutral third party, and political or other pressures from unions or private industry (2 percent). MAKING THE FEDERAL GOVERNMENT MORE BUSINESSLIKE Since 1991, Congress has enacted laws and the administration has launched special initiatives to make the operations of the federal government more “business-like” and to find an appropriate balance between functions performed by federal employees and functions performed by the private sector. This government-wide 2 This 1997 report defined outsourcing as “contracting with either private or public-sector vendors and service suppliers to obtain services that have traditionally been, or would otherwise be, performed by staff of the state transportation agency. Subject to contractual arrangements, the responsibility to the public for the quality, reliability, and cost-effectiveness of the services may still remain with the public agency. An alternative term used to describe the same function is ‘contracting out'” (NRC, 1997).

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Page 15 effort has been focused on improving the quality, reducing the cost, and accelerating the delivery time of services, as well as and on improving customer service; all of these objectives are shared by private sector organizations. The Government Performance and Results Act of 1993 (P.L. 103-62) mandated that federal agencies produce strategic plans and performance measures to “improve the confidence of the American people in the capability of the federal government by systematically holding federal agencies accountable for achieving program results” and to promote “a new focus on results, service quality, and customer satisfaction.” The Federal Acquisition and Streamlining Act of 1994 (P.L. 103-355) and the Clingher-Cohen Act of 1996 (P.L. 104-208) were enacted to cut government red tape so that services could be provided to the public faster and more cost effectively. To meet these objectives, federal agencies were given more flexibility in finding ways to perform their missions responsibly. During the same time period, the Base Realignment and Closure Process, the Federal Workforce Restructuring Act of 1994 (P.L. 103-226), and other legislation resulted in a substantial reduction of the federal workforce. Total federal employment declined from 2.2 million full-time equivalent positions in fiscal year (FY) 1993 to 1.9 million in FY 97 (GAO, 1999). In response to these various initiatives, federal agencies have been compelled to redefine their missions and to begin reengineering their practices and processes for conducting the business of government. Thus, although for different reasons, federal agencies, like private-sector organizations, are attempting to operate more efficiently and effectively and to obtain the best value or best performance for the resources expended. To assess these changes, the authoring committee developed and distributed a questionnaire to sponsoring agencies of the Federal Facilities Council. Thirteen agencies responded to the questionnaire, 3 which focused on agency policies and practices related to the outsourcing of planning, design, and construction-related services (see Appendix D). All 13 agencies had outsourced planning, design, or construction-related services for 10 years or more. Seven of the 13 agencies also had experience outsourcing the management of planning, design, or construction-related services. The respondents cited the following factors for outsourcing management functions: lack of in-house expertise or compensation for staff shortages (54 percent of responses) savings on project delivery time (15 percent) other factors, including statutory requirements (15 percent) 3 The responding agencies were the U.S. Air Force, U.S. Department of Energy, U.S. Department of State, U.S. Department of Veterans Affairs, Air National Guard, Bureau of Land Management, Bureau of Reclamation, Fish and Wildlife Service, Indian Health Service, International Broadcasting Bureau, National Institute of Standards and Technology, National Aeronautics and Space Administration, and Naval Facilities Engineering Command.

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Page 16 intermittent need for services (8 percent) improved product quality (8 percent) None of the seven agencies cited cost effectiveness or deliberate downsizing as a factor in outsourcing management functions. Although this survey of federal agencies contained a smaller sample than the survey of state transportation agencies cited earlier, in both instances, staff constraints in some form were cited as the primary factor influencing the decision to outsource. REENGINEERING OF FACILITIES ENGINEERING ORGANIZATIONS Private corporations and the federal government have invested billions of dollars in facilities and infrastructure to support the services and activities necessary for conducting their businesses or carrying out their missions, respectively. The federal government alone owns more than 500,000 buildings and facilities worldwide valued at more than $300 billion and spends more than $20 billion per year on the design, construction, and renovation of facilities (NRC, 1998). Until the 1980s, owners of large inventories of buildings usually maintained in-house facilities engineering organizations staffed by hundreds, sometimes thousands, of architects and engineers who were responsible for designing, constructing, operating, and managing buildings, manufacturing and industrial plants, and other constructed facilities, sometimes over a wide geographical area. In the last 20 years, “nearly every owner engineering and project management organization in the United States has been reorganized, sometimes repeatedly” as a result of business process reengineering (BRT, 1997). Organizations “are restructuring their central engineering organizations, shifting project responsibilities to business units or operating facilities, and outsourcing more work to contractors” (CII, 1996). These findings are echoed in Impact of Reengineering on Corporate Real Estate, a 1997 benchmarking study that concluded that corporate reengineering has profound impacts on corporate real estate. “The corporate real estate department's basic mission, the services it provides, its performance and its organization and reporting are subject to intense examination. The result is often reorganization, outsourcing, performance metrics, and staff reduction” (Deloitte and Touche, 1997). In many cases, in-house facilities engineering organizations have been reduced significantly in size and scope or eliminated altogether. One chemical firm, for example, downsized its central engineering staff from 7,000 to 1,100 positions between 1991 and 1999; a pharmaceutical firm's engineering staff was reduced from 225 to 33 engineers between 1993 and 1999 (CCIS, 1999). As part of its reengineering, an oil firm reduced its engineering staff from 1,100 to 800 positions (FFC, 1998). “Owner project skills reduced or eliminated include

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Page 17 detailed design, project management, process engineering, construction management, technical expertise, and project controls” (CII, 1996). The outsourcing of engineering functions is attractive to organizations because of the cyclical nature of facilities projects. Large, in-house facilities engineering groups carry substantial cost penalties when the workload is minimal, whereas large contractor firms can be hired on an as-needed basis (BRT, 1997). In addition, contractor firms might have greater expertise in new technologies, such as three-dimensional, computer-aided design software. Sometimes, these organizational changes have unexpected results. “The engineering costs for major projects have continued to grow just as the amount of work performed in-house has declined.” The reasons vary, and, “engineering costs as a percentage of total installed costs, have often not been a good indicator of project execution efficiency” (BRT, 1997). Still, “many companies are drifting because they are uncertain about the appropriate size and role of their in-house capital projects organization” (BRT, 1997). More important, reorganizations “may leave owners inadequately structured to develop and execute capital projects” because: (1) owner personnel continue to perform the same functions with fewer resources; (2) institutional knowledge is being lost through retirements; and (3) remaining personnel may not have the skills, experience, or decision-making authority necessary to perform effectively (CII, 1996). Thus, the “technical competence to assist the businesses in arriving at the most appropriate project to meet the business need has been lost along with the competence to execute the project effectively” (BRT, 1997). Recently, the Center for Construction Industry Studies found that, even though owner organizations recognize that the “skill set required to manage and work on projects from the owner's side has changed dramatically,” they are “doing little to address this issue” (CCIS, 1999). Contractor companies are also subject to organizational change as they attempt to reduce their fixed costs, increase their competitiveness, and adapt to changes in owner approaches to facilities delivery. Some contracting firms are reducing personnel despite increasing workloads, adding project skills that owner organizations are reducing or eliminating, adding skills in project phases that represent nontraditional work, and providing new services generated by advances in process, design, and construction technologies. Contractor skills that have been added include computer/software capabilities, project management, project controls, team building, project finance, project scope development, and process engineering (CII, 1996). All of these changes have contributed to a dynamic environment. Both public and private owner organizations are trying to identify the best ways to structure their staffs and processes to acquire and renew facilities and the best ways to make owner/contractor relationships work. The Construction Industry Institute has found that “most owners do not have a process to determine owner/contractor work structure, particularly one that identifies project core competencies,

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Page 18 competencies to retain in-house, and those needing to be outsourced” (CII, 1996). The Business Roundtable has found that the organizations that have lost owner engineering competence eventually find the business person directly across the table from the contractors negotiating project changes, schedules, and other conditions. Because the parties do not have a common base of expertise in construction delivery, they may find it difficult to communicate (BRT, 1997). Underlying all of these issues is the critical, but often unrecognized, fact that owners and contractors have different, sometimes conflicting, goals and business objectives. Therefore, the “owner-contractor relationship needs to be structured so that each party can meet their separate goals” (CCIS, 1999). Federal agencies, as owners of capital facilities, have been experiencing changes similar to those affecting private-sector owner organizations. A report of the Federal Construction Council noted that “due to budget cuts, agencies have had to reduce the number of project managers, design reviewers, inspectors, and field supervisors they employ” (FCC, 1987). A survey by the Federal Facilities Council found that, by 1999, in nine federal agencies, in-house facilities engineering staffs had been reduced by 20 to 65 percent, with an average of about 50 percent (FFC, 2000). An earlier study found that procurement specialists trained primarily in contract negotiation and review, rather than in design and construction, have been playing increasingly greater roles in facilities development (NRC, 1994). Thus, like private-sector facilities owners, federal agencies are faced with the challenge of identifying the essential technical and management skills that should be retained by the agency to ensure effective oversight of outsourced services. STATEMENT OF TASK Federal agencies have outsourced for facility planning, design, and construction services for decades. Most facility design work and almost all building construction are performed by private-sector firms. Federal agencies have traditionally relied on in-house architects and engineers to manage the design and construction of new facilities or outsourced the management to another federal agency, such as the U.S. Army Corps of Engineers (USACE), the Naval Facilities Engineering Command (NAVFAC), or the General Services Administration (GSA). Since the mid 1980s, some federal agencies have begun outsourcing some management functions for facilities acquisition, including planning, design, and construction, to the private sector. The reliance on nonfederal entities to provide management functions for federal facility acquisition has raised concerns about the level of control, responsibility, and accountability being transferred by federal agencies to nonfederal entities. Outsourcing of management functions has also raised concerns about the long-term implications for federal agencies' capabilities to plan, guide, oversee, and evaluate facility acquisitions effectively when contracting for planning, design, and construction services.

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Page 19 To address these concerns, the sponsoring agencies of the Federal Facilities Council 4 requested that the National Research Council (NRC) develop a guide, or road map, to help federal agencies determine which management functions for planning, design, and construction-related services may be outsourced. In response, the NRC established a committee of recognized experts in architecture, engineering, construction management, outsourcing of services, procurement and contracting, facilities management, and federal policy and procedures under the auspices of the NRC's Board on Infrastructure and the Constructed Environment (see Appendix A for biographical sketches). In carrying out its charge, the committee was asked to: (1) assess recent federal experience with the outsourcing of management functions for planning, design, and construction services; (2) develop a technical framework and methodology for implementing a successful outsourcing program; (3) identify measures to determine performance outcomes; and (4) identify the organizational core competencies necessary for effective oversight of outsourced management functions while protecting the federal interest. The committee members, drawn from the public sector, the private sector, and academia, met three times over a 10-month period. The committee received briefings by representatives of federal agencies and private sector organizations and by invited individuals. The briefings focused on recent federal experiences with outsourcing management functions, federal policies and programs related to outsourcing and inherently governmental functions, outsourcing practices in the private sector, and related issues (see Appendix B for a list of briefings). The committee also developed and distributed a questionnaire to the sponsoring agencies of the Federal Facilities Council to gather additional information. The questionnaire focused on agency practices and experiences related to the outsourcing of planning, design, and construction services (see Appendix D for a copy of the questionnaire). ORGANIZATION OF THIS REPORT Chapter 2, Outsourcing Management Functions, describes how the federal government has historically acquired facilities, identifies the roles of federal agencies in acquisitions, and describes a general process and contract methods for acquiring facilities. Chapter 2 also reviews federal policies and procedures related to outsourcing and inherently governmental functions and assesses recent 4 The federal agencies that contributed to the funding of this study through the Federal Facilities Council are the U.S. Air Force, Air National Guard, U.S. Army, U.S. Department of Energy, U.S. Navy, U.S. Department of State, U.S. Department of Veterans Affairs, Food and Drug Administration, General Services Administration, Indian Health Service, National Aeronautics and Space Administration, National Institutes of Health, National Institute of Standards and Technology, National Endowment for the Arts, National Science Foundation, Smithsonian Institution, and the U.S. Postal Service.

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Page 20 federal experiences with outsourcing management functions for planning, design, and construction services. Chapter 3, Ownership Functions and Core Competencies, focuses on owner and management functions, the characteristics and core competencies of “smart owners,” “smart customers/users,” and providers of facilities. Chapter 3 also addresses the development and retention of core competencies for facility acquisitions in federal agencies. Chapter 4, Decision Framework, describes a management/decision framework for considering the outsourcing of management functions for facility acquisitions and discusses the development of performance measures for evaluating the results of outsourcing. REFERENCES BRT (The Business Roundtable). 1997. The Business Stake in Effective Project Systems. Washington, D.C.: The Business Roundtable. CCIS (Center for Construction Industry Studies). 1999. Owner/Contractor Organizational Changes Phase II Report. Austin, Texas: University of Texas Press. CII (Construction Industry Institute).. 1996. Owner/Contractor Work Structure: A Preview. Austin, Texas: Construction Industry Institute. Deloitte and Touche. 1997. Impact of Reengineering on Corporate Real Estate. Chicago, Ill.: Deloitte and Touche LLP. FCC (Federal Construction Council).. 1987. Quality Control on Federal Construction Projects. Technical Report No. 84. Washington, D.C.: National Academy Press. FFC (Federal Facilities Council).. 1998. Government/Industry Forum on Capital Facilities and Core Competencies. Washington, D.C.: National Academy Press. FFC. 2000. Adding Value to the Facility Acquisition Process: Best Practices for Reviewing Facility Designs. Washington, D.C.: National Academy Press. GAO (General Accounting Office). 1997. Privatization: Lessons Learned by State and Local Governments. Letter Report. GGD-97-48. Washington, D.C.: Government Printing Office. GAO. 1999. Federal Workforce: Payroll and Human Capital Changes during Downsizing. Report to Congressional Requesters. GGD-99-57. Washington, D.C.: Government Printing Office. Hamel, G., and C.K. Prahalad. 1994. Competing for the Future. Boston, Mass.: Harvard Business School Press. NRC (National Research Council). 1994. Responsibilities of Architects and Engineers and Their Clients in Federal Facilities Development. Board on Infrastructure and the Constructed Environment, National Research Council. Washington, D.C.: National Academy Press. NRC. 1997. Outsourcing of State Highway Facilities and Services: A Synthesis of Highway Practice. Transportation Research Board, National Research Council. Washington, D.C.: National Academy Press. NRC. 1998. Stewardship of Federal Facilities: A Proactive Strategy for Managing the Nation's Public Assets. Board on Infrastructure and the Constructed Environment, National Research Council. Washington, D.C.: National Academy Press. OMB (Office of Management and Budget). 1997. Analytical Perspectives, Budget of the United States Government, Fiscal Year 1998. Washington, D.C.: Government Printing Office. Outsourcing Institute. 1998. Survey of Current and Potential Outsourcing End-Users. Available on line at: http://www.outsourcing.com Pint, E.M., and L.H. Baldwin. 1997. Strategic Sourcing: Theory and Evidence from Economics and Business Management. Prepared for the United States Air Force, Project AIR FORCE. Santa Monica, Calif.: RAND. Seidenstat, P., ed. 1999. Contracting Out Government Services. Westport, Conn.: Praeger Publishers.