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© 2008 Prentice Hall, Inc. S11 – 1
Operations ManagementOperations ManagementSupplement 11 – Supplement 11 – Outsourcing as a Outsourcing as a Supply Chain StrategySupply Chain Strategy
PowerPoint presentation to accompany PowerPoint presentation to accompany Heizer/Render Heizer/Render Principles of Operations Management, 7ePrinciples of Operations Management, 7eOperations Management, 9e Operations Management, 9e
© 2008 Prentice Hall, Inc. S11 – 2
OutlineOutline
What is Outsourcing?What is Outsourcing? Types of OutsourcingTypes of Outsourcing
Strategic Planning and Core Strategic Planning and Core CompetenciesCompetencies The Theory of Comparative The Theory of Comparative
AdvantageAdvantage
Outsourcing Trends and Political Outsourcing Trends and Political RepercussionsRepercussions
© 2008 Prentice Hall, Inc. S11 – 3
Outline – ContinuedOutline – Continued
Risks in OutsourcingRisks in Outsourcing
Methodologies for OutsourcingMethodologies for Outsourcing Evaluating Multiple Criteria with Evaluating Multiple Criteria with
Factor RatingFactor Rating
Break-even AnalysisBreak-even Analysis
© 2008 Prentice Hall, Inc. S11 – 4
Outline – ContinuedOutline – Continued
Advantages and Disadvantages Advantages and Disadvantages of Outsourcingof Outsourcing Advantages of OutsourcingAdvantages of Outsourcing
Disadvantages of OutsourcingDisadvantages of Outsourcing
Audits and Metrics to Evaluate Audits and Metrics to Evaluate Outsourcing PerformanceOutsourcing Performance
Ethical Issues in OutsourcingEthical Issues in Outsourcing
© 2008 Prentice Hall, Inc. S11 – 5
Learning ObjectivesLearning Objectives
When you complete this supplement When you complete this supplement you should be able to:you should be able to:
1.1. Explain how core competencies Explain how core competencies relate to outsourcingrelate to outsourcing
2.2. Describe the risks of outsourcingDescribe the risks of outsourcing
3.3. Use factor rating to evaluate both Use factor rating to evaluate both country and provider outsourcerscountry and provider outsourcers
© 2008 Prentice Hall, Inc. S11 – 6
Learning ObjectivesLearning Objectives
When you complete this supplement When you complete this supplement you should be able to:you should be able to:
4.4. Use break-even analysis to Use break-even analysis to determine if outsourcing is cost-determine if outsourcing is cost-effectiveeffective
5.5. List the advantages and List the advantages and disadvantages of outsourcingdisadvantages of outsourcing
© 2008 Prentice Hall, Inc. S11 – 7
OutsourcingOutsourcing
Outsourcing can replace entire Outsourcing can replace entire purchasing, information systems, purchasing, information systems, marketing, finance, and operations marketing, finance, and operations departmentdepartment
Applicable to firms throughout the Applicable to firms throughout the worldworld
Making the right decision may be Making the right decision may be the difference between success the difference between success and failureand failure
© 2008 Prentice Hall, Inc. S11 – 8
What is Outsourcing?What is Outsourcing?
Procuring from external suppliers Procuring from external suppliers service or products the firms used to service or products the firms used to provide for itselfprovide for itself
Offshoring is moving processes to a Offshoring is moving processes to a foreign country but retaining controlforeign country but retaining control
Firms that outsource are called clients, Firms that outsource are called clients, the actual work is done by the the actual work is done by the outsourcing provideroutsourcing provider
Extension of the long-standing practice Extension of the long-standing practice of subcontractingof subcontracting
© 2008 Prentice Hall, Inc. S11 – 9
What is Outsourcing?What is Outsourcing?
Outsourcing has become a major Outsourcing has become a major strategy as firms move toward strategy as firms move toward specializationspecialization Increasing expertiseIncreasing expertise
Reduced cost of reliable transportationReduced cost of reliable transportation
Rapid deployment of Rapid deployment of telecommunications telecommunications and computers and computers – the Internet– the Internet
© 2008 Prentice Hall, Inc. S11 – 10
Examples of OutsourcingExamples of Outsourcing
Call centers in French AngolaCall centers in French Angola
Legal and finance service in the Legal and finance service in the PhilippinesPhilippines
EDS handling information EDS handling information technology for Nexteltechnology for Nextel
IBM providing travel and IBM providing travel and payroll for P&Gpayroll for P&G
Solectron producing Solectron producing IBM computersIBM computers
© 2008 Prentice Hall, Inc. S11 – 11
Types of OutsourcingTypes of Outsourcing
Common processes outsourced areCommon processes outsourced are
PurchasingPurchasing
LogisticsLogistics
R&DR&D
OperationsOperations
Service managementService management
Human resourcesHuman resources
Finance/accountingFinance/accounting
Customer relationsCustomer relations
Sales/marketingSales/marketing
TrainingTraining
Legal processesLegal processes
Outsourcing implies a legally binding Outsourcing implies a legally binding contractcontract
© 2008 Prentice Hall, Inc. S11 – 12
Strategic Planning and Strategic Planning and Core CompetenciesCore Competencies
Strategic planning defines the mission Strategic planning defines the mission and goals for the organizationand goals for the organization
From this the organization determines From this the organization determines the role of each business activitythe role of each business activity
Core competencies are things the Core competencies are things the organization does better than its organization does better than its competitioncompetition
Non-core activities are good candidates Non-core activities are good candidates for outsourcingfor outsourcing
© 2008 Prentice Hall, Inc. S11 – 13
Core Competency
Best in the world at electromechanical
miniaturization design
Strategic Planning and Strategic Planning and Core CompetenciesCore Competencies
Figure S11.1Figure S11.1
Sony, Sony, An Outsourcing An Outsourcing CompanyCompany
Outsourcers Outsourcers could could provideprovide
Post-sales service
Logistics
Distribution
Accounting
Maintenance
Real estate management
Marketing
Parts manufacture
Financial functions
Employee benefit management
© 2008 Prentice Hall, Inc. S11 – 14
Theory of Comparative Theory of Comparative AdvantageAdvantage
If an external outsourcing provider can If an external outsourcing provider can perform activities more productively perform activities more productively than the client firm, the outsourcing than the client firm, the outsourcing
provider should do the workprovider should do the work
This applies regardless of
the geographical location
© 2008 Prentice Hall, Inc. S11 – 15
Outsourcing Trends and Outsourcing Trends and Political RepercussionsPolitical Repercussions
According to a survey of 53 major According to a survey of 53 major corporations, the most important corporations, the most important reasons for outsourcing are:reasons for outsourcing are:
Cost savingsCost savings 77%77%Gaining outside expertiseGaining outside expertise 70%70%Improving servicesImproving services 61%61%Focusing on core competenciesFocusing on core competencies 59%59%Gaining access to technologyGaining access to technology 56%56%
© 2008 Prentice Hall, Inc. S11 – 16
Outsourcing Trends and Outsourcing Trends and Political RepercussionsPolitical Repercussions
Outsourcing includes specific business Outsourcing includes specific business functions (computer help desks) and functions (computer help desks) and entire departments (accounting, entire departments (accounting, marketing, finance, etc.)marketing, finance, etc.)
35% of businesses said they would 35% of businesses said they would continue or expand outsourcingcontinue or expand outsourcing
40% said they would continue 40% said they would continue outsourcing but revise their arrangementsoutsourcing but revise their arrangements
Some said they would reduce outsourcingSome said they would reduce outsourcing
© 2008 Prentice Hall, Inc. S11 – 17
Outsourcing includes specific business Outsourcing includes specific business functions (computer help desks) and functions (computer help desks) and entire departments (accounting, entire departments (accounting, marketing, finance, etc.)marketing, finance, etc.)
35% of businesses said they would 35% of businesses said they would continue or expand outsourcingcontinue or expand outsourcing
40% said they would continue 40% said they would continue outsourcing but revise their arrangementsoutsourcing but revise their arrangements
Some said they would reduce outsourcingSome said they would reduce outsourcing
Outsourcing Trends and Outsourcing Trends and Political RepercussionsPolitical Repercussions
Not all outsourcing experiences are
satisfactory
There is still a lot to learn about
outsourcing as a method to improve
productivity
© 2008 Prentice Hall, Inc. S11 – 18
Outsourcing Trends and Outsourcing Trends and Political RepercussionsPolitical Repercussions
Political backlash can occur when jobs Political backlash can occur when jobs are outsourced to foreign countriesare outsourced to foreign countries In the U.S. state and federal laws have been In the U.S. state and federal laws have been
enacted to limit or prevent outsourcing enacted to limit or prevent outsourcing activitiesactivities
Recent data suggests more foreigners Recent data suggests more foreigners outsource jobs to the U.S. than American outsource jobs to the U.S. than American companies outsource offshorecompanies outsource offshore
Backsourcing describes the process of Backsourcing describes the process of returning work to the original firm when returning work to the original firm when outsourcing failsoutsourcing fails
© 2008 Prentice Hall, Inc. S11 – 19
Risks in OutsourcingRisks in Outsourcing
Outsourcing can be riskyOutsourcing can be risky
As many as half of all outsourcing As many as half of all outsourcing agreements fail because of inappropriate agreements fail because of inappropriate planning and analysisplanning and analysis
Erratic power grids, government Erratic power grids, government difficulties, inexperienced managers, and difficulties, inexperienced managers, and unmotivated labor can create problemsunmotivated labor can create problems
Failure to achieve unrealistic goals Failure to achieve unrealistic goals sometimes create the impression of sometimes create the impression of failurefailure
© 2008 Prentice Hall, Inc. S11 – 20
Risks in OutsourcingRisks in Outsourcing
Table S11.1Table S11.1
OutsourcingOutsourcing Examples ofExamples ofProcessProcess Possible RisksPossible Risks
Identify non-core Identify non-core competenciescompetencies
Can be incorrectly identified as a Can be incorrectly identified as a non-core competencynon-core competency
Identify non-core Identify non-core activities that should be activities that should be outsourcedoutsourced
Just because the activity is not a Just because the activity is not a core competence for your firm core competence for your firm does not mean an outsource does not mean an outsource provider is more competent and provider is more competent and efficientefficient
Identify impact on Identify impact on existing facilities, existing facilities, capacity, and logisticscapacity, and logistics
May fail to understand the May fail to understand the change in resources and talents change in resources and talents needed internallyneeded internally
© 2008 Prentice Hall, Inc. S11 – 21
Risks in OutsourcingRisks in Outsourcing
Table S11.1Table S11.1
OutsourcingOutsourcing Examples ofExamples ofProcessProcess Possible RisksPossible Risks
Establish goals and Establish goals and draft outsourcing draft outsourcing agreement agreement specificationsspecifications
Goals can be set so high that Goals can be set so high that failure is certainfailure is certain
Identify and select Identify and select outsource provideroutsource provider
Can select the wrong outsource Can select the wrong outsource providerprovider
Negotiate goals and Negotiate goals and measures of measures of outsourcing outsourcing performanceperformance
Can misinterpret measures and Can misinterpret measures and goals, how they are measured, goals, how they are measured, and what they meanand what they mean
© 2008 Prentice Hall, Inc. S11 – 22
Risks in OutsourcingRisks in Outsourcing
Table S11.1Table S11.1
OutsourcingOutsourcing Examples ofExamples ofProcessProcess Possible RisksPossible Risks
Monitor and control Monitor and control current outsourcing current outsourcing programprogram
May be unable to control May be unable to control product development, product development, schedules, and qualityschedules, and quality
Evaluate and give Evaluate and give feedback to outsource feedback to outsource providerprovider
May have non-responsive May have non-responsive provider (i.e., one that ignores provider (i.e., one that ignores feedback)feedback)
Evaluate international Evaluate international political and currency political and currency risksrisks
County’s currency may be County’s currency may be unstable, a country may be unstable, a country may be politically unstable, or cultural politically unstable, or cultural and language differences may and language differences may inhibit successful operationsinhibit successful operations
© 2008 Prentice Hall, Inc. S11 – 23
Risks in OutsourcingRisks in Outsourcing
Table S11.1Table S11.1
OutsourcingOutsourcing Examples ofExamples ofProcessProcess Possible RisksPossible Risks
Evaluate coordination Evaluate coordination needed for shipping and needed for shipping and distributiondistribution
May not understand the timing May not understand the timing necessary to manage flows to necessary to manage flows to different facilities and marketsdifferent facilities and markets
© 2008 Prentice Hall, Inc. S11 – 24
Risks in OutsourcingRisks in Outsourcing
EmploymentEmployment
Changes in facilities and processes Changes in facilities and processes needed to receive components in a needed to receive components in a different state of assemblydifferent state of assembly
Vastly expanded logistics issuesVastly expanded logistics issues
Outsourcing brings other issues:Outsourcing brings other issues:
© 2008 Prentice Hall, Inc. S11 – 25
Methodologies for OutsourcingMethodologies for Outsourcing
Evaluating Multiple Criteria with Evaluating Multiple Criteria with Factor RatingFactor Rating
Break-even AnalysisBreak-even Analysis
© 2008 Prentice Hall, Inc. S11 – 26
Rating International Rating International Risk FactorsRisk Factors
Nine factors rated Nine factors rated 0-3, 00-3, 0 is no risk, is no risk, 33 is high risk is high risk
Risk FactorRisk Factor EnglandEngland MexicoMexico SpainSpain CanadaCanada
Economic: Labor cost/ lawsEconomic: Labor cost/ laws 11 00 22 11
Economic: Capital availabilityEconomic: Capital availability 00 22 11 00
Economic: InfrastructureEconomic: Infrastructure 00 22 22 00
Culture: LanguageCulture: Language 00 00 00 00
Culture: Social normsCulture: Social norms 22 00 11 22
Migration: UncontrolledMigration: Uncontrolled 00 22 00 00
Politics: IdeologyPolitics: Ideology 22 00 11 22
Politics: InstabilityPolitics: Instability 00 11 22 22
Politics: LegalitiesPolitics: Legalities 33 00 22 33
Total risk rating scoresTotal risk rating scores 88 77 1111 1010
Table S11.2Table S11.2
© 2008 Prentice Hall, Inc. S11 – 27
Rating Outsourcing ProvidersRating Outsourcing Providers
Table S11.3Table S11.3
Seven factors rated Seven factors rated 1-5 1-5 and an importance weightand an importance weight
Outsourcing ProvidersOutsourcing Providers
FactorFactor(criterion)(criterion)
Importance Importance WeightWeight
BIM BIM (U.S.)(U.S.)
S.P.C. S.P.C. (India)(India)
Telco Telco (Israel)(Israel)
1.1. Can reduce operating costsCan reduce operating costs .2.2 33 33 55
2.2. Can reduce capital investmentCan reduce capital investment .2.2 44 33 33
3.3. Skilled personnelSkilled personnel .2.2 55 44 33
4.4. Can improve qualityCan improve quality .1.1 44 55 22
5.5. Can gain access to Can gain access to technology not in companytechnology not in company
.1.1 55 33 55
6.6. Can create additional capacityCan create additional capacity .1.1 44 22 44
7.7. Aligns with policy/ Aligns with policy/ philosophy/culturephilosophy/culture
.1.1 22 33 55
Total and AveragesTotal and Averages 1.01.0 3.93.9 3.33.3 3.83.8
© 2008 Prentice Hall, Inc. S11 – 28
Break-Even AnalysisBreak-Even Analysis
First define total cost in-houseFirst define total cost in-house
TCTCinin = F= Finin + (+ (VVinin x x X Xinin))
wherewhere
TCTCinin is the total cost of an item produced in-houseis the total cost of an item produced in-house
FFinin is the total in-house fixed costis the total in-house fixed cost
VVinin is the variable cost/unit produced in-houseis the variable cost/unit produced in-house
XXinin is the total number of units produced in-houseis the total number of units produced in-house
© 2008 Prentice Hall, Inc. S11 – 29
Break-Even AnalysisBreak-Even Analysis
The total cost under outsourcing isThe total cost under outsourcing is
TCTCoutout = = F Foutout + (+ (VVoutout x x X Xoutout))
At break-even XAt break-even Xinin = = X Xoutout and TC and TCiinn = = TCTCoutout
FFinin + ( + (VVinin x x XX) = ) = FFoutout + ( + (VVoutout x x XX))
Solving for XSolving for X
X X ==FFinin – – FFoutout
VVoutout – – VVinin
© 2008 Prentice Hall, Inc. S11 – 30
Outsourcing Break-Even Outsourcing Break-Even ExampleExample
Fixed cost at Toledo plant Fixed cost at Toledo plant = $2= $2 million millionVariable cost/toy Variable cost/toy = $3= $3
Fixed cost at Astro plant Fixed cost at Astro plant = $1= $1 million millionVariable cost/toy Variable cost/toy = $4= $4
Annual demand Annual demand = 1.1 = 1.1 million toysmillion toys
2,000,000 – 1,000,0002,000,000 – 1,000,000
4 – 34 – 3X X = == =
FFinin – – FFoutout
VVoutout – – VVinin
= 1,000,000= 1,000,000 units units Sincedemand > break-even point,
produce in Toledo
© 2008 Prentice Hall, Inc. S11 – 31
Advantages of OutsourcingAdvantages of Outsourcing
Cost savingsCost savings
Gaining outside experienceGaining outside experience
Improving operations and serviceImproving operations and service
Focusing on core competenciesFocusing on core competencies
Gaining outside technologiesGaining outside technologies
Other advantagesOther advantages
© 2008 Prentice Hall, Inc. S11 – 32
Disadvantages of OutsourcingDisadvantages of Outsourcing
Increased transportation costsIncreased transportation costs
Loss of controlLoss of control
Creating future competitionCreating future competition
Negative impact on employeesNegative impact on employees
Longer-term Longer-term impactimpact
© 2008 Prentice Hall, Inc. S11 – 33
Audits and MetricsAudits and Metrics
Outsourcing agreements must specify Outsourcing agreements must specify results and outcomesresults and outcomes
Evaluation necessary to ensure Evaluation necessary to ensure satisfactory performancesatisfactory performance
If the outsourced product or service is If the outsourced product or service is strategically important, the relationship strategically important, the relationship needs continuing communication, needs continuing communication, understanding, trust and performanceunderstanding, trust and performance
Services may require imaginative Services may require imaginative metricsmetrics
© 2008 Prentice Hall, Inc. S11 – 34
Ethical Issues in Ethical Issues in OutsourcingOutsourcing
Seek to do no harm to Seek to do no harm to indigenous culturesindigenous cultures
Don’t use outsourcing in a Don’t use outsourcing in a way that violates religious way that violates religious holidaysholidays
Seek to do no harm to the Seek to do no harm to the ecological systems of the ecological systems of the worldworld
Don’t use outsourcing to Don’t use outsourcing to move pollution from one move pollution from one country to anothercountry to another
Seek to uphold universal Seek to uphold universal labor standardslabor standards
Don’t use outsourcing to take Don’t use outsourcing to take advantage of cheap child advantage of cheap child labor that leads to child abuselabor that leads to child abuse
Ethics PrincipleEthics Principle Outsourcing LinkageOutsourcing Linkage
Table S11.4Table S11.4
© 2008 Prentice Hall, Inc. S11 – 35
Ethical Issues in Ethical Issues in OutsourcingOutsourcing
Seek to uphold basic human Seek to uphold basic human rightsrights
Don’t accept outsourcing that Don’t accept outsourcing that violates basic human rightsviolates basic human rights
Seek to pursue long-term Seek to pursue long-term involvement in foreign involvement in foreign countriescountries
Don’t use outsourcing as a Don’t use outsourcing as a short-term arrangement to short-term arrangement to reduce costs; view it as a reduce costs; view it as a long-term partnershiplong-term partnership
Seek to share knowledge Seek to share knowledge and technology with foreign and technology with foreign countriescountries
Don’t think an outsourcing Don’t think an outsourcing agreement will prevent loss of agreement will prevent loss of technology, but use the technology, but use the inevitable sharing to build a inevitable sharing to build a good relationship good relationship
Ethics PrincipleEthics Principle Outsourcing LinkageOutsourcing Linkage
Table S11.4Table S11.4