Outsource or Buy: What's Right for Your Business
When deciding whether to outsource, it's important for the client to consider how comfortable they are with other people coming on site and operating equipment.
Manufacturers who utilize water or need to treat wastewater as part of their operations will probably, at some point, need to decide whether or not to outsource their water operations. Douglas Gillen, director of marketing for Evoqua's Industrial Division, and Rod McNelly, vice president and general manager of Evoqua's General Industry segment, offer guidance on weighing the options.
WATERWORLD: Is outsourcing a common dilemma amongst manufacturers and industrial producers?
Doug Gillen: Absolutely, outsourcing is a question that a lot of folks have to face: What do they buy? Do they buy the equipment or just buy the water that the equipment produces? To find the answer, a company must look at its core competencies and decide where they should focus their two biggest resources -- people and money. Is water a core competency? Think about photocopiers, for example. Companies don’t see making photocopies as a core competency that they need to master in order to manufacture their product -- but they do need access to having photocopies done. So they outsource photocopiers. Water can fall into this category, albeit in a more complex contract.
WW: What are some of the benefits of outsourcing?
DG: One of the benefits is that you end up buying water, typically, in a volume basis. Often there is a minimum 'take or pay' with that, but essentially you are buying the amount of water that you want. So your utility costs start to align with your production volume. Also since you are not buying the assets, you're not spending capital money and you have preserved that capital money for other things -- things that may improve your EBITDA. For example, if you have only enough money to either buy a reactor or upgrade a water treatment system, you need to consider which would be most beneficial to your business. Upgrading a water system is an important utility, but it's not going to have the same impact as an investment in operations or production.
WW: Are there other drivers for outsourcing, like tax implications, for example?
DG: When we develop outsourcing contracts with customers we are very conscious of whether the customer wants to treat them as an operating lease or an equipment lease. In an operating lease, you don’t have to have the assets on your books -- it creates an opportunity for possible off-balance-sheet financing. However, in an equipment lease, you have to show those assets on the books and they get different tax treatment.
We still provide operating leases but less often than a decade ago before Sarbanes-Oxley. The accounting changes have been reflected in FASB guidance (Financial Accounting Standards Board) since the SEC designated them as the group setting accounting standards for public companies in the U.S.
Originally, the decision to outsource was heavily based on getting the assets off your balance sheet. Now, companies are still very interested in outsourcing but today it’s about better management of their people and financial resources as well as the transfer of risk.
WW: What do you mean by transfer of risk?
DG: If you run the water system yourself, you have all the risk associated with it. So, the expertise to operate the system is on your engineering, operations, and maintenance teams. But if you contract with a provider, you move some of this risk to them because you enter into a supply agreement with them for a certain quantity and quality of water.
ROD MCNELLY: A plant manager has a financial obligation to the corporation, so the decision to outsource requires evaluation of his operations and staff: Do I have the capability to manage my water operations? Do I have the core competency needed as a manufacturing or production facility? Determining the best commercial and operations arrangement is truly an individual facility decision.
WW: Is there any standardization amongst water treatment providers?
RM: At one point, the water and wastewater sector tried to move down a standardization path, and that's good for very high-transaction, repeating events. But our world doesn’t really work that way from a water supply standpoint. Virtually every time you take a water sample at a plant, you are going to get a slightly different influent water condition that needs to be addressed by a manufacturer in a flexible format. Some standardization might be possible, but you are trying to optimize the condition around that individual facility, how they make decisions, and most importantly how they want to make water for that facility.
WW: Are there benefits to the industrial facility owning its own water/wastewater treatment assets?
RM: At times there are benefits. Asset ownership with a comprehensive, full service O&M type of approach still gives the company complete control over the equipment but mitigates operational risk and when you do that, it means you may not even need full time staff. You pay only for the amount of human resources that are needed.
WW: What are the top things an industrial customer should consider when trying to decide whether or not to outsource?
RM: The first thing to consider -- and this is uncomfortable at times for management -- is how do they handle money and how do they want to pay for the project. And they will need to partner with their financial partners to determine that answer. Then they will need to determine whether they want to lease, whether they want to buy and capitalize, whether they want to capitalize the equipment and contract fully, or whether they just want to self-perform. Those scenarios all determine how the company will pay for it: Lease; rent; rent with option to buy; short-term operating contract; or a long-term operating contract.
Answering those questions upfront will save you a lot of time, energy, scope discussions, and engineering discussions. Then any vendor can come out of the gate with a proposal and not have to do discovery.
DG: They also need to consider how comfortable they are with other people coming on site and operating equipment. Some clients are very comfortable with that, its part of their business DNA, but others, due to security issues or just tradition, are uncomfortable having full-time operating staff working at their site but not being directly managed by them.
RM: A third consideration would be bandwidth of their maintenance staff. If the bandwidth is strong, then they may want to self-perform. If the bandwidth is narrow, outsourcing may be the best way to ensure the facility gets the water quality and quantity it needs.
A multiple technology approach is also important. It’s very difficult to predict what might go wrong so having a vendor with access to multiple technologies enables the plant manager to apply a wide range of technologies to fix a problem that might occur over the 5-, 10-, or 20-year project life cycle.
DG: I would add one final consideration: engineering capability. If you hire a third party EPC, then you have access to experienced engineers that understand the water systems and their unit operations. But if you don’t have either the time or financial resources to hire an EPC then an outsourcing arrangement can provide a higher level of engineering and technical support. You are signing an agreement that will provide you with a set quantity of water at a specified quality on a continuous basis. This removes the need for technology evaluation, understanding how the unit operations need to work together, the purchasing cycle, project management and startup. You can apply your company’s engineering resources to plant production issues. It changes the entire dynamic since you’re just buying the product.
WW: How long does a typical outsourcing arrangement last?
RM: That is a really great question. Initially, when you think of outsourcing, you definitely think of a structured, formal contract over an extended period. But there is also outsourcing on mobile equipment: if you just hire someone to come in and bring you mobile equipment, you really are outsourcing water treatment from them, and it might only be for 30 days. Yet, even though it's for a relatively short period of time, this kind of outsourcing has a lot of impact on a company: it reduces manpower requirements and allows you to spend capital money on other things such as reducing your engineering costs.
Traditional outsourcing arrangements have been in the 10-year range. But today, companies need speed, they need accuracy, they need reliability and they need all of that done in a certain timetable at a competitive price. That brings the 10-year average on outsourcing down to about 5 years -- and in some cases 3 years -- because many vertical markets are not making long-terms strategic plans like they used to.
If you don’t have credit worthiness as a plant or location, then you are not going to be able to outsource.
WW: But doesn't outsourcing lock you into a certain arrangement? Is there any flexibility?
RM: Outsourcing has been traditionally thought of as contract-driven -- and it is --but that wrongly implies that you're locked into something and don’t have any flexibility. It's quite the opposite actually and here’s why: in a capital environment you have equipment on your site, you have to take care of it or someone else has to take care of it, whatever “it” is. Well, in an outsourcing arrangement most of the time, there are clauses that say, if my flow changes, if my quality changes, if circumstances changes, then as long as I give 60-90 days notice, the contract needs to change upon that conditional change. So, the flexibility that is built into outsourcing based on changing demands in the workplace is actually more forgiving than it is in a capital environment.