Oursourcing Benefits and Risks

Overview

  • what went wrong
    • need fine-tuning
    • need more more effective IT
    • due to
      • technologies change rapidly
      • short life-cycle products
      • uncertainty in customer demand is enormous
  • main issues
    • buy/make decision process
      • identify the advantages/risks associated with outsourcing
      • present a framework for optimizing buy/make decisions
    • procurement process
      • independent, private, & consortium-based e-marketplaces
      • opportunities & challenges

Outsourcing

  • definition
    • outsourcing the manufacturing of key components, was used as a tool to rapidly cut costs
    • these benefits come with new & considerable risks
  • motivations
    • economies of scale (EOS)
      • reduce manufacturing costs through the aggregation of orders from many different buyers - allows suppliers to take advantage of EOS, both in purchasing and in manufacturing
    • risk pooling
      • allows buyers to transfer demand uncertainty to CEM (contract equipment manufacturer) who aggregates demand from many buying companies
    • reduce capital investment
      • transfer also capital investment to CEM that can make this investment because it is implicitly shared between many of the CEM's customers
    • focus on core competency
      • the buyer is able to focus on its core strength, the specific talent, skills, and knowledge sets that differentiate the company from its competitors
      • e.g., Nike - focuses on innovation, marketing, distribution, and sales, not on manufacturing
    • increased flexibility
      • the ability to better react to changes in customer demand
      • the ability to use the supplier’s technical knowledge to accelerate product development cycle time
      • the ability to gain access to new technologies & innovation
        • technologies change very frequently (e.g. high- tech) and short life cycle (e.g. fashion products)

New & considerable risks

  • loss of competitive knowledge
    • outsourcing critical components to suppliers may open up opportunities for competitors
      • e.g., IBM PC example
    • outsourcing implies companies lose their ability to introduce new designs based on their own agenda rather than the supplier’s agenda
    • outsourcing the manufacturing of various components to different suppliers may prevent the development of new insights, innovations & solutions that typically require cross-functional teamwork
  • conflicting objectives
    • buyers
      • increased flexibility, a key objective when outsource the manufacturing of various components - an ability to better match supply and demand by adjusting production rates as needed; fast product design
    • supplier
      • profit margins are relatively small and hence they have to focus on cost reduction, rather than flexibility which is in direct conflict with the suppliers’ objectives of long-term, firm, and stable commitment from the buyer
    • good times vs. slow economy

A Framework for Buy/Make Decisions

Overview

  • process
    • how can the firm decide on which component to manufacture and which to outsource
    • consultants and supply chain pundits typically suggest to focus on core competencies
    • how can the firm identify what is in the core, and hence should be made internally
  • reasons for outsourcing
    • the firm has the knowledge and the skills required to produce the component but for various reasons decides to outsource
    • the company does not have the people, skills, and knowledge required to produce the component; outsource to have access to these capabilities
  • product types
    • can be made by combining components whose different components
    • is a product made up from components whose functionalities are tightly related

Modular product

  • content
    • components are independent of each other
    • components are interchangeable
    • standard interfaces are used
    • a component can be designed or upgraded with little or no regard to other components
    • customer preference determines the product configuration
  • dependency on knowledge/capacity
    • capturing knowledge is important, whereas production capacity in-house is less critical
      • e.g., a PC manufacturer, capturing knowledge may refer to the design of the various components - outsourcing the manufacturing process provides an opportunity to reduce cost
    • on the other hand, if the firm has neither knowledge nor capacity, outsourcing may be a risky strategy as the knowledge developed by the supplier may be transferred to a competitor’s products

Integral product

  • content
    • not made from off-the-shelf components
    • designed as a system by taking a top-down design approach
    • evaluated based on system performance, not based on component performance
    • components perform multiple functions
  • dependency on knowledge/capacity
    • capturing both knowledge & capacity is important as long as it is possible to have both
    • if the firm has both the knowledge & the capacity, then in-house production is appropriate
    • on the other hand, if the firm does not have both, perhaps it is in the wrong business

A framework for buy/make decisions

  • table
  • hierarchical model to decide whether to outsource or not
    • customer importance
    • component clockspeed
    • competitive position
    • capable suppliers
    • architecture
  • examples of decisions
  • kraljic's supply matrix
    • top right quadrant
      • strategic items where supply risk and impact on profit are high
      • highest impact on customer experience
      • price is a large portion of the system cost
      • typically have a single supplier
      • focus on long-term partnerships with suppliers
    • bottom right quadrant
      • items with high impact on profit
      • low supply risk (leverage items)
      • many suppliers
      • small percentage of cost savings will have a large impact on bottom line
      • focus on cost reduction by competition between suppliers
    • top left quadrant
      • high supply risk but low profit impact items
      • bottleneck components
      • do not contribute a large portion of the product cost
      • suppliers have power position
      • ensure continuous supply, even possibly at a premium cost
      • focus on long-term contracts or by carrying stock (or both)
    • bottom left quadrant
      • non-critical items
      • simplify and automate the procurement process as much as possible
      • use a decentralized procurement policy with no formal requisition and approval process
  • supplier footprint
    • supply Strategies have changed over the years
      • American automotive manufacturers
        • 1980s: Suppliers either in the US or in Germany
        • 1990s: Suppliers in Mexico, Spain, and Portugal
        • 2000s: Suppliers in China
      • high-tech industry
        • 1980s: Sourcing in the US
        • 1990s: Singapore and Malaysia
        • 2000s: Taiwan and mainland China
    • challenge
      • framework that helps organizations determine the appropriate supplier footprint
      • strategy should depend on the type of product or component purchased

E-Procurement and E-Market

A Framework for Procurement Strategy