Agency Risks in Outsourcing Corporate Real Estate Functions

Article excerpt

Abstract

Firms outsource business functions to focus on core competencies and cut operating expenses. However, companies must consider agency costs in determining the optimal staffing/ outsourcing balance. Analysis of the views of corporate real estate managers and real estate service providers indicate that although they share a common vision of the role of corporate real estate, providers focus more on traditional real estate tasks than on corporate business strategy. The optimum balance of staffing/outsourcing may consist of a corporate real estate staff that understands the overall corporate strategy and devotes its resources to strategic planning, program development, contracting and monitoring outsourced tasks.

Introduction

Throughout the 1990s, management experts preached the need for businesses to focus on their core competencies, relegating support functions nonessential to their competitive differential to outside service providers. The reasoning is that specialists can provide such services in a more cost-effective manner than corporate staff can. One area that most companies consider non-core is real estate. all companies require space to house employees, goods and productive processes; however, most corporations do not specialize in real property. They must choose between whether to maintain a corporate real estate staff to manage real property, outsource all real estate and facilities management activities, or hire a core real estate staff to handle critical strategic and managerial decisions while overseeing the outsourcing of specific real estate tasks to service providers.

The decision of whether and how to outsource can have major financial impact. The return of firms to specialization follows research that indicates that firms operating in multiple lines of business tend to have lower values than portfolios of focused firms (Berger and Ofek, 1995; Lang and Stulz, 1994; Comment and Jarrell, 1995; Servaes, 1996; and Aggarwal and Samwick, 2003) and that spinning off unrelated units increases the value of the parent firm (Daley, Mehrotra and Sivakumar, 1997; and Desai and Jain, 1999). Commercial real estate accounts for at least 30% of real estate assets in the United States and corporations control approximately one-fifth of U.S. real estate (DiLuia, Shlaes and Tapajna, 1991). In some industries, real estate may comprise up to three-fourths of the firm's assets (Johnson and Keasler, 1993). Outsourcing of real estate and other services has grown to at least a $340 billion dollar industry in the U.S. according to the Outsourcing Institute (2000).

While outsourcing may produce an increase in short-term returns, it also may result in lower investment in development of internal skills necessary for the firm's long-term competitive advantage. Internal cross-functional integration is not possible when tasks are performed outside the firm. Once a firm limits or ceases investment in any competence, it may be difficult and time consuming to renew that competence. Prolonged extensive outsourcing may denigrate the firm's existing skill set and, thereby, its long-term competitiveness. Reliance on outside providers decreases the company's operational control. Thus, short-term savings reflected in financial measures may not reflect all the long-term strategic costs of the outsourcing decision (Lei and Hitt, 1995).

For outsourcing to assist in achieving corporate goals, the client/principal must work closely with provider/agent to ensure that the interests of each party are being fulfilled. Companies need to find loyal, reliable vendors who can be trusted and who share a common vision with the client company (Dess, Rasheed, McLaughlin and Priem 1995). The client must effectively communicate the company's objectives and expectations to the provider to ensure understanding. In addition, the provider must agree to support the client's objectives and assist the client in using real estate to achieve the corporation's goals. …