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An Unseen Peril of Outsourcing

By David Gumpert

LABOR INTENSIVE. "The company was doing well," recalls Rocci. "We rebuilt it from the brink of bankruptcy." It seemed as if the outsourcing was doing what it was supposed to do: improve the profitability of software-products area, thus helping to finance the expansion into new services.

In retrospect, however, Rocci now attributes most of the gains to improved product sales. "There were productivity issues over there (in India)," he recalls. "Here, one guy might do the work of five or six in India." And there were cultural issues that presented major hurdles. "It was difficult to get one guy to run one project. They work in teams and it takes a minimum of two people to do anything. I remember I was over there once and I was walking by a metal-stamping press, and there were two people sitting shoulder-to-shoulder -- the whole mindset was to create jobs." Even so, Rocci notes that some administrative jobs couldn't be handled in India and were sent back to the home office.

Walt Wilszewski, vice-president of sales and marketing at AM, had the same feeling. "I felt we needed one-and-a-half times the Indian programmers to do the same amount of work as U.S. programmers," he says.

PICKING OVER THE WRECKAGE. Regardless of the role of outsourcing in AM's rising fortunes, during fiscal 2003, AM lost a major customer and, combined with serious cash-flow problems, "the bottom fell out" of the business, says Rocci. During the first nine months (the last period for which financial results were reported), losses nudged $2 million, and there was a mad scramble for cash. Banks extended a special $1.25 million loan over and above the existing credit line, Hoffman poured in about $1.4 million, and Hassan about $2 million. It was all to no avail. By June, Hassan had resigned as president and CEO to become chairman. Last August, with all other avenues of hope exhausted, AM sought protection from its creditors under Chapter 11 bankruptcy laws.

During the last three months of 2003, AM's assets were sold to repay the bankers. Two service companies AM had purchased were reacquired by their original owners. A third area -- the products area that represented the original core of AM's business -- was put up for sale. Hassan wanted NeST to acquire it, and the creditor's committee designated him the favorite, the "stalking horse," in bankruptcy lingo. His offer of $4.5 million to $5 million consisted primarily of a renegotiation of AM's bank's obligations and between $1 million and $1.5 million of cash, he says.

A competing group entered the bidding process at the end of 2003 -- a group of former AM employees that included Rocci and Wilczewski. Their offer of between $4.5 million and $5 million essentially matched what Hassan was offering, they say.

BRAIN DRAIN. Last December, however, as the former employees assembled at the courthouse to make their offer, the plan fell apart. "Our investor got spooked and walked out, based on what he heard about AM," says Rocci.

What upset the potential backer? In large part, it was the sense that not only were the manufacturing and development services based in India, but that the company's most important knowledge -- software and engineering savvy, not to mention its development expertise -- also had departed the U.S. Says Rocci: "All the knowledge about how to do things had moved over to India." The investor's withdrawal scuttled the former employees' proposed deal to acquire AM's products business did so because he saw that outsourcing had essentially stripped the concern of perhaps the most important asset of them all -- its knowledge.

The lesson of this story: We need to understand that, as we send jobs to foreign businesses, we also send critical knowledge about processes, procedures, and development. When business conditions change, a company can't just go to the other side of the world and reclaim those things. The new owners aren't likely to give them up.

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