Industrial Services: Trends and Benefits of Subcontracting

By Beroe Inc.

April 08, 2014 at 7:43 AM

By Moumita Sen 

Abstract: 

Chemical and other process industries face the challenge of maintaining their industrial services in-house as they lack proper technical expertise and knowledge. In the past decade, subcontracting of services have gained popularity as they allow the company to focus on the core business and also to save the cost of maintaining a skilled in-house maintenance team. This article deals with the need for subcontracting and the industry best practices adopted while subcontracting services to a third-party service provider.

Introduction 

In the past few decades, subcontracting has become increasingly important for companies to manage services that are not their core competencies. Companies engage with a service provider who in turn employs a subcontractor who is entrusted with responsibilities necessary for the completion of the final product. This allows the main contractor to attain higher levels of specialization in the designated field and scope.

Types of Subcontracting

Capacity Subcontracting

This type of subcontracting is carried out when the main contractor does not have the required capacity to carry out the desired function. The main contractor has arrived at a capacity limit in its production process and in order to meet the market demand, the function has to be subcontracted to an external specialized party for a temporary period of time. 

Specialist Subcontracting

  • Labor Contracting. For predictive contracts, the trend is to have a blend of service providers in-house laborers and contract laborers, in which 70–80% are in-house laborers. 
  • Service Contracting. The main contractor relies on a set of subcontractors who have access to specialized equipment or machinery and experienced labor to undertake precision tasks. In this scenario, the main contractor may not have the capability to undertake such highly complex tasks.

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There is an increasing focus towards training in-house employees as clients are emphasizing speedy delivery of services.

Mid-size service providers are making big investments to establish training centers for their internal staff to stay competitive.

Large service providers have a robust in-house maintenance team and only 25% invest in establishing training centers for their employees

Benefits of Subcontracting to Main Contractors 

  • Cost Reduction. Production or purchasing abroad is cheaper than domestic production or buying due to lower labor wages and cost of material. This brings down the overall cost of the product/service.
  • Higher quality. Subcontractors have high degrees of competency and specialized skills and hence are capable of providing higher quality products which can be missing with the in-house team of the contractor.
  • Robust mechanism to address demand fluctuations. Companies turn to international sourcing for availability of raw material. International subcontractors can act as a hedge against fluctuations in demand.
  • Evaluating regions with potential growth prospects. International subcontracting gives the opportunity to penetrate into new markets. It helps in establishing a link with a new location and have growing outlets and purchasing power such as the automobile and electronic industry in China and India.

Benefits of Subcontracting to Subcontractors

 
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The numbers, in the finest detail possible, must be used to back up the opinions expressed in the article and also to quantify the level of impact a particular trend will have on the industry. Graphs, charts, etc. can be used to represent the same. 

Key services that can be subcontracted are:

  • Regular services – not highly technical.
  • Not a core competency of the company.
  • When the company lacks in-house experience or when the service to be availed is expensive. 

Points to be kept in mind by the buyer/client while subcontracting:

  • Proper documentation and technical capabilities of the subcontractor.
  • Availability of in-house resources, technical and commercial to be able to subcontract properly.
  • Strict enforcement of statutory and safety, health and environment regulations. Principal employer will be accountable for any violation.
  • Agreement should have involvement of technical, commercial and legal experts. Clauses ensuring company’s interest and penalty for not adhering to clauses should be put on contractor.
  • The union should be taken into confidence before awarding any new contract to prevent industrial relations problems.
  • Subcontractors having base close to the factory should be preferred to ensure availability and servicing on time.
  • For a large project, two subcontractors should be hired so that one can replace the other in case of a default. On long-term contracts, the contractor should be replaced periodically to avoid making any common interest with the plant staff.
  • The subcontractor should be able to converse and understand the language of the area where the job is being done.

Ideal Engagement Practices

What are the key questions to be kept in mind before engagement?

  • Nature of the project – One time or recurring every year/period?
  • Will the central team or the local team deal with the project?
  • Who is deciding for the quantum of job – local or central?
  • Is it in line with the policies of the company for other subcontracting services? Role of local team

If the job is recurring in nature and frequency varies from time to time, the task of entrusting the contract lies with the local body 

  • The subcontract should be awarded locally. It should be local due to difference in language, local setup, local competitors of subcontractors.
  • Same contractor can have different rates as per local condition.

If the job is one time basis, and same project team is supervising at multiple locations

  • One service provider can be engaged. The volume of the region where the service provider should not be larger than the regions where he has reach. 
  • The buyer’s central team will find it easier to manage one service provider with entire responsibility.

Scenario 1:- Location specific

If the contract value is less and the service provider does not give any discount, then should the contract be awarded regionally or on a local basis?

  • It will be better to engage a regional player if the service provider does not provide any discount if following conditions are met.
  • A local player should be found who can give quote lower by the margin usually charged for subcontracting which ranges from 3-5%.

However for a contract value over 5 million, where a discount of 10% can be availed, what should be the ideal engagement practice?

  • Ideal engagement practice on the face of it could be to engage single subcontractor for value over 5 million Euro as 10% discount looks attractive.
  • The share of the local job should be low so that the 3-5% margin for the local job does not affect substantially the 10% discount.
  • Awarding big contracts to single contractor should not block the way for other similar contractors, as for healthy competition and also to reduce vulnerability of the company.
  • In case of default by one company,  it may be better to engage at least two contractors.

subcontracting_2.png

 






The client can engage with two service providers: One global supplier that can cater to industrial services across the client’s locations and the other service provider that is experienced in providing IFM services in the client’s locations.

For example, in Europe, clients can engage with Bilfinger Berger or Interserve for Industrial Services and Johnson Controls or Vinci Facilities for IFM – Hard Services.

Conclusion

The idea of subcontracting is increasingly getting popular over time due to the fact that companies want to focus on their core business and outsource these additional services to a specialized player that is capable of providing better quality service with higher technical expertise and skilled workforce. A recent survey has revealed that in the European region, almost 50-60% of companies outsource their indirect services to subcontractors to be able to focus more on their core competencies.



Tags: purchasing MRO indirect Supply chain management Procurement sourcing subcontracting
Category: News Article

Beroe Inc.

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Beroe is a global provider of customized procurement services specializing in sourcing, supply chain visibility, financial risk analysis and environmental impact to Fortune 500 organizations. With nearly 400 dedicated procurement specialists in 38 domains, across 9 industries, Beroe proactively invests in knowledge assets to build valuable, real-time procurement insight. For more information, visit  Beroe Inc. online.


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