Operations Management

Supplement 11 Outsourcing as a Supply Chain Strategy

PowerPoint presentation to accompany Heizer/Render Principles of Operations Management, 7e Operations Management, 9e
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Outline
What is Outsourcing?
Types of Outsourcing

Strategic Planning and Core Competencies

The Theory of Comparative Advantage

Outsourcing Trends and Political Repercussions

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Outline Continued
Risks in Outsourcing
Methodologies for Outsourcing
Evaluating Multiple Criteria with Factor Rating Break-even Analysis

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Outline Continued
Advantages and Disadvantages of Outsourcing
Advantages of Outsourcing
Disadvantages of Outsourcing

Audits and Metrics to Evaluate Outsourcing Performance Ethical Issues in Outsourcing

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Learning Objectives
When you complete this supplement you should be able to:
1. Explain how core competencies relate to outsourcing
2. Describe the risks of outsourcing

3. Use factor rating to evaluate both country and provider outsourcers

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Learning Objectives
When you complete this supplement you should be able to:
4. Use break-even analysis to determine if outsourcing is costeffective 5. List the advantages and disadvantages of outsourcing

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Outsourcing
Outsourcing can replace entire purchasing, information systems, marketing, finance, and operations department Applicable to firms throughout the world
Making the right decision may be the difference between success and failure
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What is Outsourcing?
Procuring from external suppliers service or products the firms used to provide for itself Offshoring is moving processes to a foreign country but retaining control

Firms that outsource are called clients, the actual work is done by the outsourcing provider Extension of the long-standing practice of subcontracting
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What is Outsourcing?
Outsourcing has become a major strategy as firms move toward specialization
Increasing expertise
Reduced cost of reliable transportation Rapid deployment of telecommunications and computers the Internet
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Examples of Outsourcing
Call centers in French Angola
Legal and finance service in the Philippines EDS handling information technology for Nextel IBM providing travel and payroll for P&G Solectron producing IBM computers
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Types of Outsourcing
Common processes outsourced are
Purchasing
Logistics R&D Operations Service management Human resources

Finance/accounting
Customer relations Sales/marketing Training Legal processes

Outsourcing implies a legally binding contract

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Strategic Planning and Core Competencies

Strategic planning defines the mission and goals for the organization From this the organization determines the role of each business activity Core competencies are things the organization does better than its competition Non-core activities are good candidates for outsourcing
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Strategic Planning and Core Competencies

Sony, An Outsourcing Company
Outsourcers could provide
Post-sales service Financial functions Logistics

Parts manufacture

Marketing

Core Competency Best in the world at electromechanical miniaturization design

Distribution

Accounting

Employee benefit management Real estate management

Maintenance

Figure S11.1
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Theory of Comparative Advantage

If an external outsourcing provider can perform activities more productively than the client firm, the outsourcing provider should do the work

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Outsourcing Trends and Political Repercussions

According to a survey of 53 major corporations, the most important reasons for outsourcing are:
Cost savings Gaining outside expertise Improving services Focusing on core competencies Gaining access to technology
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77% 70% 61% 59% 56%

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Outsourcing Trends and Political Repercussions

Outsourcing includes specific business functions (computer help desks) and entire departments (accounting, marketing, finance, etc.) 35% of businesses said they would continue or expand outsourcing 40% said they would continue outsourcing but revise their arrangements Some said they would reduce outsourcing
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Outsourcing Trends and Political Repercussions

Outsourcing includes specific business functions (computer help desks) and entire departments (accounting, marketing, finance, etc.) 35% of businesses said they would continue or expand outsourcing 40% said they would continue outsourcing but revise their arrangements Some said they would reduce outsourcing
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Outsourcing Trends and Political Repercussions

Political backlash can occur when jobs are outsourced to foreign countries
In the U.S. state and federal laws have been enacted to limit or prevent outsourcing activities

Recent data suggests more foreigners outsource jobs to the U.S. than American companies outsource offshore Backsourcing describes the process of returning work to the original firm when outsourcing fails
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Risks in Outsourcing
Outsourcing can be risky
As many as half of all outsourcing agreements fail because of inappropriate planning and analysis Erratic power grids, government difficulties, inexperienced managers, and unmotivated labor can create problems Failure to achieve unrealistic goals sometimes create the impression of failure
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Risks in Outsourcing
Outsourcing Process Identify non-core competencies Identify non-core activities that should be outsourced Examples of Possible Risks Can be incorrectly identified as a non-core competency Just because the activity is not a core competence for your firm does not mean an outsource provider is more competent and efficient May fail to understand the change in resources and talents needed internally

Identify impact on existing facilities, capacity, and logistics

Table S11.1
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Risks in Outsourcing
Outsourcing Process Establish goals and draft outsourcing agreement specifications Identify and select outsource provider Negotiate goals and measures of outsourcing performance Examples of Possible Risks Goals can be set so high that failure is certain

Can select the wrong outsource provider Can misinterpret measures and goals, how they are measured, and what they mean

Table S11.1
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Risks in Outsourcing
Outsourcing Process Monitor and control current outsourcing program Evaluate and give feedback to outsource provider Evaluate international political and currency risks Examples of Possible Risks May be unable to control product development, schedules, and quality May have non-responsive provider (i.e., one that ignores feedback) Countys currency may be unstable, a country may be politically unstable, or cultural and language differences may inhibit successful operations
Table S11.1
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Risks in Outsourcing
Outsourcing Process Evaluate coordination needed for shipping and distribution Examples of Possible Risks May not understand the timing necessary to manage flows to different facilities and markets

Table S11.1
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Risks in Outsourcing
Outsourcing brings other issues:
Employment
Changes in facilities and processes needed to receive components in a different state of assembly Vastly expanded logistics issues

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Methodologies for Outsourcing

Evaluating Multiple Criteria with Factor Rating Break-even Analysis

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Rating International Risk Factors

Nine factors rated 0-3, 0 is no risk, 3 is high risk
Risk Factor Economic: Labor cost/ laws Economic: Capital availability Economic: Infrastructure Culture: Language Culture: Social norms Migration: Uncontrolled Politics: Ideology Politics: Instability Politics: Legalities Total risk rating scores England 1 0 0 0 2 0 2 0 3 8 Mexico 0 2 2 0 0 2 0 1 0 7 Spain 2 1 2 0 1 0 1 2 2 11 Canada 1 0 0 0 2 0 2 2 3 10
Table S11.2
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Rating Outsourcing Providers

Seven factors rated 1-5 and an importance weight
Outsourcing Providers

Factor (criterion)
1. Can reduce operating costs 2. Can reduce capital investment 3. Skilled personnel

Importance Weight
.2 .2 .2

BIM (U.S.)
3 4 5

S.P.C. (India)
3 3 4

Telco (Israel)
5 3 3

4. Can improve quality

5. Can gain access to technology not in company 6. Can create additional capacity 7. Aligns with policy/ philosophy/culture Total and Averages

.1
.1 .1 .1 1.0

4
5 4 2 3.9

5
3 2 3 3.3

2
5 4 5 3.8 Table S11.3

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Break-Even Analysis
First define total cost in-house

TCin = Fin + (Vin x Xin)

where

TCin Fin Vin Xin

is the total cost of an item produced in-house is the total in-house fixed cost is the variable cost/unit produced in-house is the total number of units produced in-house

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Break-Even Analysis
The total cost under outsourcing is TCout = Fout + (Vout x Xout)
At break-even Xin = Xout and TCin = TCout Fin + (Vin x X) = Fout + (Vout x X) Solving for X X= Fin Fout Vout Vin
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Outsourcing Break-Even Example

Fixed cost at Toledo plant = $2 million Variable cost/toy = $3 Fixed cost at Astro plant = $1 million Variable cost/toy = $4 Annual demand = 1.1 million toys

X=

Fin Fout

Vout Vin

2,000,000 1,000,000

43
Since demand > break-even point, produce in Toledo
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= 1,000,000 units

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Advantages of Outsourcing
Cost savings

Gaining outside experience

Improving operations and service Focusing on core competencies Gaining outside technologies Other advantages

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Disadvantages of Outsourcing
Increased transportation costs

Loss of control
Creating future competition Negative impact on employees Longer-term impact

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Audits and Metrics

Outsourcing agreements must specify results and outcomes Evaluation necessary to ensure satisfactory performance If the outsourced product or service is strategically important, the relationship needs continuing communication, understanding, trust and performance Services may require imaginative metrics
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Ethical Issues in Outsourcing

Ethics Principle Seek to do no harm to indigenous cultures Seek to do no harm to the ecological systems of the world Seek to uphold universal labor standards Outsourcing Linkage Dont use outsourcing in a way that violates religious holidays Dont use outsourcing to move pollution from one country to another Dont use outsourcing to take advantage of cheap child labor that leads to child abuse
Table S11.4
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Ethical Issues in Outsourcing

Ethics Principle Seek to uphold basic human rights Seek to pursue long-term involvement in foreign countries Seek to share knowledge and technology with foreign countries Outsourcing Linkage Dont accept outsourcing that violates basic human rights Dont use outsourcing as a short-term arrangement to reduce costs; view it as a long-term partnership Dont think an outsourcing agreement will prevent loss of technology, but use the inevitable sharing to build a good relationship
Table S11.4
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