Today’s knowledge and service-based economy offers innumerable opportunities for well-run companies to increase profits through strategic outsourcing.1 Emphasis is rapidly shifting from outsourcing parts, componentry, and hardware subsystems toward the even greater unexploited potentials that intellectually-based systems offer:2

• Obtaining higher value, more flexible, and more integrated services than internal sources can offer.
• Improving the company’s capacities to stay current and to innovate by interacting with “best in world” knowledge sources.
• Achieving cross-divisional coordination and shareholder value gains that the company — for internal structural or political reasons — could not otherwise achieve.

Outsourcing Knowledge-Based Services

The drivers for these trends are formidable. As the service sector has grown to embrace 80 percent of all U.S. employment, specialized service firms have become very large and sophisticated relative to the scale and expertise that individual staff and service groups have within integrated companies — whether in services or manufacturing (see Table 1).

These specialists can develop greater knowledge depth, invest more in software and training systems, be more efficient, and hence offer higher wages and attract more highly trained people than can the individual staff groups of all but a few integrated companies. Given this greater knowledge depth and wider range of customer interactions, they can also become much more innovative than their internal counterparts might. Companies as diverse as British Petroleum, DuPont, MCI, Dell Computer, Beaumont Hospital, Ford, State Street Bank, Ameritek, Nike, and Argyle Diamonds dramatically illustrate potentials. Properly developed, strategic outsourcing substantially lowers costs, risks, and fixed investments while greatly expanding flexibility, innovative capabilities, and opportunities for creating higher value-added and shareholder returns.3 Dell Computer provides a classic example of how strategic outsourcing can revolutionize an industry:

• Dell has grown at an 89 percent compounded rate for some years, achieving $700,000 of sales per employee in its fast-moving, competitive business. Dell concentrates its own resources on a superb customer knowledge and support system downstream and a shared information system that deepens its relationships with suppliers upstream. Outside suppliers provide virtually all Dell’s componentry design and innovation, software, and (non-assembly) production for its computers. It invests only where it sees an opportunity for unique value-added and avoids the huge inventory, facilities, and development risks assumed by more integrated competitors or supply specialists.

Knowledge management is at the heart of Dell’s strategy. By