Vertical Integration and Diversification" discusses the boundaries of the firm and in particular transaction cost economics. This theory discusses "incomplete contracting" and "opportunism by other parties". Should you be concerned about a) "incomplete contracting" issues and b) "opportunism by other parties" issues in regard to Mr. Gupta's outsourcing proposal (Bharti case), if the proposal is accepted? Why/why not?

Case Analysis:

Supply Chain Management

Case Submission: Strategic Outsourcing at Bharti Airtel Limited

Executive Summary

Bharti Airtel Limited, formerly known as Bharti Tele-Ventures limited, is the country-wide market leader in wireless communication, with 25% market share. Initially a regulated sector, the wireless communication market saw an increase in subscribers from 4.2 Million in 1989 to 54 Million in 2003 due to liberalization and foreign direct investment.

As of now in 2005, the wireless communication network is highly commoditized where there is no difference in product offerings and low ARPU among competitors. Thus, the players try their best to provide value-added services which require more bandwidth in upcoming technologies like 2.5G and 3G. This, in-turn, requires heavy capital investment.

Bharti Airtel also faces issues in terms of keeping up with the pace of network expansion, frequent negotiations with vendors, hiring and retaining the best employees and obsolescence of equipment. Bharti Airtel has an inherent conflict with the vendors of 'boxes' like MSC, BSC etc. The vendors want to sell a high quantity of boxes to increase their profits while the operators want to maximize their coverage with minimum equipment requirement and reduce the risk of product obsolescence.

Faced with this situation Bharti Airtel has come with an option to strategically outsource its responsibility of build-up, maintenance and servicing of telecom networks to its vendors. This option is being discussed with different functions (IT, Operations, HR, etc.) and board of Bharti Airtel. The initial response has been negative. Also, this first of its kind option has also made its vendors hesitant. How Bharti Airtel is going to deal with the current challenge depends on how this negotiation would proceed.

1)

With the ramp-up of operations and the growing capital expenditures, it is the need of the hour to implement lean principles and invest in innovation.

1. To improve its operating margin, Airtel should focus on improving the operational metrics such as ARPU (Average monthly Revenue per customer). This can be done by providing value-added services (VAS) to the customers in the form of digital payments, wallets, caller tunes etc. Keeping the pricing competitive and increasing the VAS, will enable Bharti Airtel to capture a larger market share while maintaining cost leadership. Focusing on VAS with low prices will also be useful against local service providers like Spice in rural and semi-urban geographies.

2. Bharti leads the wireless market segment with a market share of 25%. Growth is expected to increase exponentially in the coming 18 months. Currently, Airtel has mobile operation licenses in 15 circles out of 23. To maintain its position as the market leader, Airtel can exploit first-mover advantage by expanding into states like Gujarat, Madhya Pradesh, and Eastern states where its presence is not prominent but where there is a growing and large user base (Exhibit 9).

3. Telecom industry is plagued with high debts due to huge capital expenditures. IT capital expenditures form a major part of the Capex which needs to be kept in control by developing a lean and predictable cost structure. By outsourcing its telecom network, Bharti Airtel will be able to convert their fixed costs into variable costs which is the key to become the lowest-cost producer of minutes. As this is going to be the first ever outsourcing plan by any telecom operator at such a scale, Bharti Airtel should invest in Vendor Management Systems to reduce lead time and bring in operational efficiencies. Relationship management with its vendors will also be crucial if Bharti goes forward with the outsourcing proposal.

4. As the industry becomes increasingly competitive, Bharti Airtel should also focus on developing a customer-centric approach to attract and retain its customers. Since mobile phones and mobile services are offered separately in India, switching costs of the consumer to other mobile networks is lower. Airtel should focus on increasing these switching costs by providing users with value-added services, increasing the involvement level of the consumer with the 'Airtel' brand will enhance brand loyalty and recall.

5. Finally, a step in the right direction would be to work towards outsourcing IT and communication technology to competent vendors which will allow Airtel to focus on network communications.

Core Competency

Airtel's core competency lies in its operations and a large customer base that will be difficult to replicate for any new entrant in the telecom industry. A diversified portfolio of mobile, broadband, individual and business services gives Airtel a competitive edge in the telecom industry. This also provides a sustainable core proposition against the competitors.

2)

To arrive at a decision, we need to see both, positives and negatives, of such agreements.

The advantages of outsourcing agreements are:

1.Transfer of risk/uncertainty to vendors: With the proposed outsourcing agreement, the responsibility of build-up, maintenance and servicing of the telecom network is transferred to the vendors. Therefore, any need to install excess capacity, to meet the uncertainty in demand, lies with the vendor.

2. Charges as per actual usage: As per the agreement, Bharti makes the actual payment only when the installed capacity is commissioned and used by the customers. Presently, Bharti follows industry practice of 40% excess capacity to compensate for any forecasting error. This outsourcing agreement would avoid the payment of unused excess capacity.

3. Low cost of Human Resource: The development of IT and network infrastructure require huge human capital which is a scarce resource. With the outsourcing agreement, the burden of human resource is eliminated. Also, the transfer of 1000 present employees to vendor companies would significantly bring down the cost of HR.

4. Quality control: To ensure better quality service to end consumers, the Service Level Agreements (SLA) lay down several quality checks which are linked to penalties and rewards for vendors.

5. Easy adaptation to new technologies: The telecom equipment vendors can utilize their industry experience and expertise to upgrade to technologies such as 2.5G or 3G services. This outsourcing agreement can bring efficient technologies in future.

The disadvantages of outsourcing agreements are:

1. Dependence on vendors: Outsourcing a business activity, especially one in which the company has operating expertise (here, operations and network management) would create excessive dependence on vendors.

2.Concern for transferred employees: The cultural differences between the companies and the unwillingness of employees to transfer to vendor companies would pose difficulties in managing around 1000 employees within the company.

3.Limited flexibility: Outsourcing to IT equipment vendor would restrict the usage of hardware and software technologies provided by other vendors. This will lead to restricted innovation.

4.Security and confidentiality threats: Since the vendors would be providing services to multiple telecom companies, there could be a chance of critical information leakage.

5.Efficient outsourcing concerns: It is for the first time that these kinds of outsourcing agreements related to network management and operations have been proposed. Since there is no reference, it is uncertain whether such an arrangement will yield the desired results.

A careful evaluation of both, positives and negatives of the proposed agreements, shows that even though there are risky elements in the contracts, the positives outweigh the negatives and thus, Bharti must go ahead with the contracts. Their focus at this point must be on expanding the network infrastructure into different geographic locations, which requires huge capital outlay. Hence, it is logical to go ahead with the proposal made by Gupta.

For Bharti Airtel, outsourcing the business activities makes sense if it can increase their supply chain value. Outsourcing will help Bharti to divert its resources and expertise to focus on building its core competencies. The overall cost of operation is expected to come down by outsourcing since the vendors aggregate capacity and achieve economies of scale. Hence, Bharti can free up their capital as there is no need to invest in excess capacity and maintenance of the equipment. Another benefit of outsourcing is that the human resource issue would be resolved. Also, by having multiple vendors for outsourcing, the risk in business activities would be diversified. Thus, the possibilities of building upon core competencies would be spread out.

3)

Outsourcing to giants like IBM and Nokia, Siemens or Ericson comes with its own set of challenges. Some of them are:

1. Intellectual Property Concerns: In a country like India where IP regulations are not stringent and often not followed, there is always the risk of proprietary information getting leaked.

2. Hidden Costs: Forecasting costs is currently a challenge for Bharti Airtel. It needs to ensure that long-term outsourcing costs are not underestimated.

3. Increased Dependence: Dependence on the vendors may prove to be risky in future for the company as it will be hard to survive if it loses the vendors' services. Handing over the network management and operations of the company is also a source of concern as it will lead to loss of internal capabilities of the company

4. Limited Availability of New Technology: One of the major concerns about entering an outsourcing agreement with IBM is the limitation to available software and applications that IBM does not provide. Bharti Airtel needs to discuss this with IBM so that outsourcing to IBM does not result in the unavailability of third-party software and hardware that have worked well and may work well for Bharti Airtel.

5. Human Resource Management: Provided the environment of India's job sectors, it will be very difficult to transfer as many as 270 IT staff and 800 network staff to the vendors' companies. There is a huge cultural difference in working methods and work environments of the Indian companies and worldwide companies like IBM, Nokia etc. which will also be a concern to all the employees and Bharti Airtel in this transfer of employees to vendors. Bharti Airtel needs to ensure that this transition and integration of different work cultures is in coherence with Bharti Airtel's strategy of providing a good working environment to its employees

4)

Agreement Structure

1. Payment Structure: Bharti Airtel should break down the costs into fixed and variable components. Instead of an upfront fixed payment for network capacity, Bharti Airtel should reach an agreement to pay the vendor when the network capacity is up and running and is being used by the subscribers, effectively eliminating payment for unused capacity.

2. Revenue Sharing Agreement: An agreement that clearly states the revenue sharing terms would reduce uncertainty in an unpredictable market. Bharti should clearly articulate that (keeping in line with the very encouraging growth predictions), the percentage of shared revenue will decrease as the overall revenue increases.

3. Personnel Management: Bharti employees performing tasks that would be outsourced, would need to be transferred to the vendor. Thus, staffing of the new employees must be taken care of by the vendor. Proper arrangements should be in place to ensure the smooth transfer and assimilation of Bharti Airtel employees who get transferred. Care should be taken that jobs are not lost in the process.

4. Service Level Agreements: To ensure that the quality of Bharti Airtel's service is not compromised, it is imperative that quality controls be in place. Bharti Airtel should sign an SLA that clearly delineates the service quality levels in terms of network quality measures like the percentage of dropped calls and incomplete calls. It is the vendor's responsibility to ensure that the service provided is top-notch. An incentive program should be designed with rewards and penalties built into the contract.

5. Network Compatibility: IBM must cooperate with other vendors to support the network operations of Bharti. The agreement should entail that IBM must upgrade its systems to accommodate software or hardware applications (especially those used by Bharti Airtel's marketing and IT) not compatible with IBM. Bharti Airtel should prevent the loss of supply chain visibility.

6. Time to Market: Bharti should clearly lay down that the time to market for new IT services should not go up, at the same time, steps in the development process should not be skipped lest a substandard service should be rolled out.

7. Data Compliance: Outsourcing will open the possibilities of compromising sensitive data, especially if the vendors serve Bharti Airtel's competitors. A strict onsite server access policy should be formulated to prevent leakage of data. IP breaches must be avoided by all means.

8. Ownership and Maintenance of Assets: It should be clarified that the ownership of assets on completion would be transferred to Bharti Airtel, but the responsibility for maintaining the network rests with the vendor.

Governing Mechanism

A governing coalition is necessary to ensure that the decision-making stays with Bharti Airtel.It will also be the go-to authority in case of any conflict. Here is our proposed governing mechanism:

5)

IBM's Concerns

Revenue Sharing and Heavy Investment: IBM will have to enter an initial contract of 5-year revenue sharing with Bharti (extendable for 5 more years). The estimation of Bharti's revenues over the 5 to 10 years will be very crucial for IBM as it has to estimate its revenues accordingly and invest in software, human resources, hardware. Also, IBM will have to upgrade the existing software facilities of Bharti Airtel, which would demand heavy investments from IBM.

Quality Controls: IBM will be subject to a number of quality controls as specified in the SLAs (ex: hotline satisfaction of customers). In line with these controls, IBM will be under a penalty and reward system which may prove costly for IBM.

No Scope for Price Negotiations: A fixed contract for 5 years implies no or very little scope for price negotiations for this duration. It is very unlikely that IBM would be able to raise the prices of equipment.

Human Capital: IBM would also be burdened with costs of retraining and cross training as it must accommodate former Bharti Airtel's employees into its organization.

Nokia's Concerns

Risk of Under-Utilization and Over-Investment: Bharti wants to transfer the risk of investing in equipment by outsourcing to vendors like Nokia. Airtel would be paying Nokia for the actual erlangs used. This transfers the risk of unused and excess capacity to Nokia. Although a one-time fee will be paid by Bharti for the installed capacity to Nokia, this would not cover Nokia's investments. The highly volatile customer demand coupled with potent competition from other players places Nokia at higher risk.

Forecasting Costs and Demand Uncertainty: In the vendor-managed inventory model proposed by Bharti, the threats of inventory management and forecasting are passed on to the vendors like Nokia. But actual demand forecasting is done by Bharti. Nokia cannot challenge Airtel's estimations and is entitled to install the equipment for the given estimated capacities. There is a possibility of Airtel spiking the safety margins and transferring the risk to Nokia.

Low Bargaining Power of Vendors: Outsourcing to multiple vendors may decrease the bargaining power of vendors and increase their costs. Also, lack of operations experience puts the vendors on the back foot in negotiating SLAs.

Saturation of Revenues: Falling ARPUs and increased competition in India would lead to saturation in the number of subscribers. This will force Airtel to operate at lower rates leading to a sag or dip in Airtel's revenues, ultimately this will affect the revenues of Nokia.

Nokia is also subject to Quality Controls and Human Resource Costs as was the case of IBM.

Agreement:

1. As the work cultures are very different, mandatory training classes for employees that require certifications should be in place.

2. A complete understanding of financial obligations, investment risks and rewards should be achieved. A payment structure with two components; fixed, for equipment and training costs, and variable i.e. revenue sharing based should be implemented. This will reduce the unlimited risk to vendors and make Bharti cautious of the expenses.

3. The SLA should have well-defined parameters and it should also allow some flexibility in certain criteria, as the contract period is large. A system must be put in place for the long-term and skill-based resource management and performance management for quality and SLA management.

4. Policies regarding renewal of employee contracts and transferring back of employees to Bharti if they don't meet expectations and standards should be laid down clearly.

5. Full corroboration and collaboration between the two parties to share their innovations and benchmarking practices should be established.

6. There should be a clause based and periodic review for risk assessment.

7. There should be a strategic alignment between all the verticals for best practices for value delivery which is a vital ingredient for customer satisfaction.