External Resource Management Requires Further Development

Investment in external resource management could raise profits by 10-20 percent, says Kari Iloranta from Aalto University

Heidi Hammarsten, 04.10.2017

Finnish industrial companies are markedly less profitable than they could be because management teams’ actions and decision-making are largely based on production-focused thinking and related beliefs that go back a century. Investment in external resource management could raise profits by 10-20 percent, says Kari Iloranta, who completed his doctoral thesis on the topic at Aalto University.

Iloranta successfully defended his doctoral thesis, "Cognitive Barriers to External Resource Management – Top Management Perspective", in early 2017. In his thesis, Iloranta called for a pragmatic change in thinking, from operational purchasing to strategic external resource management. Such a change would have a significant impact on issues such as a company’s profitability, reporting practices and strategic processes. It would require investment in education at vocational qualification level and in the training of management and professionals.

Iloranta, who has previously worked in management positions, is now a business coach who provides training on Aalto PRO's DGS program, for example. He expressed concern about poor external resource management in an interview on Aalto PRO's website as long ago as June 2015. Read the original article (in Finnish), or an updated version of the interview below.

Improvements needed in external resource management

In the Finnish industrial sector, management teams are overlooking up to 80 percent of their operations if they neglect external resources. Silo-based purchase management doesn't get the job done, says Kari Iloranta, who has completed a doctoral thesis on the topic at Aalto University.

In just a few decades, cost structures in the industrial sector have been turned on their head. Where outsourcing once accounted for around 20 percent of turnover, the opposite is now true: internal resources account for just 20 percent or less of costs, with the other 80 percent coming from outside.

"When you ask executives about this cost structure, they estimate the share of outsourcing to be 30 percent, which covers the visible costs associated with direct purchases only. They take no account of indirect purchases and various services, such as marketing, ICT management, premises, estate management, HR systems and banking services," says Doctor of Science (Technology), Kari Iloranta.

Iloranta has completed a PhD thesis on external resource management for Aalto University. He is also a business coach and has written books on the subject.

External resource management is characterized by a distorted and outdated idea held by executives. When no one understands the importance of the issue, they view it as a purchasing management matter and delegate it.

Fordism is alive and kicking

"Because executives don't appreciate how important it is, external resource management is being downplayed and starved of resources and investment. In many cases, senior managers still base their thinking on the Fordist mass production model of a century ago," comments Iloranta.

"The entire management team needs to be aware of the strategic importance of external resources. Investment in this area can improve the bottom line by 10 to 20 percent. But this can't be achieved through competitive tendering and wrangling over prices."

Iloranta points out that efficient external resource management requires changes in both thinking and organizational models.

"Just look at startups – very few have production-oriented organizations."

Networks instead of production chains

The traditional image of the production chain is the wrong place to start – it leads into the blind alley of thinking about how to optimize the various links in the chain through trimming.  

"Nowadays, we're really talking about an external resource network. You have to start thinking about how to identify the best elements, get them to work together and how to innovate alongside them. A company is really an integration node where a wide range of resources are brought together."

As well as understanding the importance of external resources in general, management teams need special skills in the area.

"How many management teams have even one person who has any training in modern purchasing operations? In most cases, the answer is that nobody specializes in the management of 80 percent of a company's resources. The same goes for Boards of Directors."

Careful segmentation of various external resources to create a manageable whole lies at the heart of modern purchasing. For the purchaser, segmentation differentiates strategically important purchases from routine ones, large-volume buys from small-volume purchases, and genuinely competitive from seller's markets.

"The result is a matrix, with traditional purchasing accounting for only a small part. Genuine competition occurs in just a small area of the supplier market and switching suppliers is easy."

How to exploit the global supplier market?

Iloranta points out that the issue of how each company can get the most out of international supplier markets is a key question in strategic external resource management.

"You should seek suppliers in a professional manner from around the world, rather than just sticking with familiar providers. Taking account of each market and competitive environment is also part of the new way of thinking. It makes sense to try and maintain continuous competition between suppliers. On the other hand, you should never forget the importance of open cooperation in all human interaction."

Companies also need to re-evaluate their own needs proactively.

"All key improvements involve the re-evaluation of needs: what does the customer need, what should we do ourselves and what's on offer externally."

Product development should be involved in this conversation.

"Product development should be in the mix when figuring out how to combine the customer's needs with the company's own strengths and expertise, and opportunities in the supplier market."

Kari Iloranta works as a trainer for programs such as Aalto PRO’s Diploma in Global Sourcing and has written books on the subject.

Currently reading: Aalto Leaders' Insight: External Resource Management Requires Further Development

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