In the aftermath of the dot-com crash, Warren Buffett once again is regarded as the "Oracle of Omaha" for his success as an investor. Buffett's philosophy of "value investing" is deceptively simple -- analyze the fundamentals, buy greatly undervalued businesses, buy only businesses you understand.

In recent columns, I have dealt with outsourcing -- the trend of corporations contracting functions such as information technology, payroll or call centers to specialized service providers. The reengineering of the Global Fortune 2000 during the past 15 years resulted in a large increase in the outsourcing of functions outside of a company's "core competence" or "value proposition."

According to a 2002 study by Michael F. Corbett & Associates in the firm's Global Outsourcing Market report, 14.8 percent of the typical business' operation was outsourced in 2001. Global spending on outsourcing was $3.78 trillion in 2001. The estimate for 2003 is $5.1 trillion. Two-thirds of outsourcing spending is by large U.S.-based companies.

What should corporations consider in deciding whether to outsource?

I would like to propose the concept of "value outsourcing" -- applying Warren Buffet's investment principles to making efficient and productive outsourcing decisions. They are rooted in the work of investment banker Benjamin Graham, Buffett's mentor and the author of "The Intelligent Investor," as well as several additions unique to Buffett.

How Buffett does it

The following are key principles of Buffett's investing philosophy:

• Invest in businesses you understand. Buffett is notorious for not investing in technology companies because he doesn't understand them. He focuses his powerful analytical abilities on the business fundamentals of relatively straightforward industries such as insurance and media.

• Analyze the fundamentals. Make investment decisions based on the underlying long-term performance of a company, not short-term trends or indicators. As Buffett famously said, "In the short term, the market is a popularity contest; in the long term, it is a weighing machine."

• Buy at a significant discount. No matter how rigorously you've worked to put a value on a business, there often are unforeseen complications. A large margin of safety will raise the odds that your investment will be profitable.

• Invest for the long term. Buffett has retained major equity holdings in companies such as Geico, Dairy Queen and the Washington Post for decades. His philosophy is that a good company, bought at a favorable price, will continue appreciating in value.

• Bet on people. Unlike Graham, who was strictly concerned with the long-term quality and stability of corporate earnings, Buffett also has focused on the executive team and corporate culture of the companies in which he invests. An owner/manager is much more likely to focus on long-term profitability rather than short-term manipulation of financial performance.

Similarly applied

The following are corresponding applications of Buffett's principles to corporate outsourcing:

• Understand it, then outsource it. Outsource only functions whose processes you understand. Outsourcers do something you can do, only more efficiently, because of a special focus or economies of scale. Payroll outsourcing is the classic example.

(If you can't efficiently manage the function yourself, then the service provider is a consultant -- not an outsourcer. You may want their help, but you won't save money on the transaction.)

• If you can't measure it, don't outsource it. Evaluate the total cost of the function, whether done internally or by an outsourcer. Avoid the temptation of using the cost savings of offshore outsourcers to avoid the hard work of process optimization; like adding technology to a mismanaged company, it will only spur disorganization.

• Don't outsource for the sake of change. Like any useful management innovation, outsourcing can be a valuable tool, or a thoughtless substitute for strategic action. If you are going to outsource based on cost efficiencies, there should be substantial savings involved -- along with a sizable margin of error as a hedge against the unexpected. The return on investment should be monumental, not incremental.

• Outsource strategically, not tactically. When possible, there should be a market-driven strategy for an outsourcing initiative, such as building an offshore call center to gain familiarity with a major foreign market.

Also, be careful to retain control of functions that harbor critical information for your company's success, such as customer satisfaction information from help desks or call centers. An outsourcer is responsible only for satisfying a service-level agreement, nothing more. And choose outsourcers based on their track record, focus and stability, not just price.

• Bet on people. In the case of outsourcing, this has several facets. First, make sure you have sophisticated executives planning and negotiating your outsourcing agreements. Outsourcers make their profits by negotiating complex agreements with contract changes for additional or reduced resource requirements. I have seen some companies hiring vice president-level "chief sourcing officers" to even the odds.

Pick the right partner

Next, beware of cultural differences when outsourcing offshore. Don't outsource to countries that violate author Ralph Peters' "Seven Signs of Non-Competitive States."

Briefly, these are restrictions on the free flow of information, the subjugation of women, inability to accept responsibility for individual or collective failure, the extended family or clan as the basic unit of social organization, domination by a restrictive religion, a low valuation of education and low prestige assigned to work.

India, for instance, passes all these tests. Some of its prominent neighbors fail them all. A company with a global brand and a knowledge-based strategy would be foolhardy to become partners with firms in such countries, however talented or inexpensive the services offered.

Outsourcing is here to stay; it is not a temporary management fad. But like the reengineering of the early 1990s, only some companies will leverage it successfully.