Supp 11 Outsourcing
Content
Operations Management
Supplement 11 – Outsourcing as a Supply Chain Strategy
PowerPoint presentation to accompany Heizer/Render Principles of Operations Management, 7e Operations Management, 9e
© 2008 Prentice Hall, Inc. S11 – 1
Outline
What is Outsourcing?
Types of Outsourcing
Strategic Planning and Core Competencies
The Theory of Comparative Advantage
Outsourcing Trends and Political Repercussions
© 2008 Prentice Hall, Inc. S11 – 2
Outline – Continued
Risks in Outsourcing
Methodologies for Outsourcing
Evaluating Multiple Criteria with Factor Rating Break-even Analysis
© 2008 Prentice Hall, Inc.
S11 – 3
Outline – Continued
Advantages and Disadvantages of Outsourcing
Advantages of Outsourcing
Disadvantages of Outsourcing
Audits and Metrics to Evaluate Outsourcing Performance Ethical Issues in Outsourcing
© 2008 Prentice Hall, Inc. S11 – 4
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
© 2008 Prentice Hall, Inc.
S11 – 5
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
© 2008 Prentice Hall, Inc.
S11 – 6
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
© 2008 Prentice Hall, Inc. S11 – 7
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
© 2008 Prentice Hall, Inc. S11 – 8
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
© 2008 Prentice Hall, Inc. S11 – 9
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
© 2008 Prentice Hall, Inc. S11 – 10
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
© 2008 Prentice Hall, Inc. S11 – 11
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
© 2008 Prentice Hall, Inc. S11 – 12
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
© 2008 Prentice Hall, Inc. S11 – 13
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
© 2008 Prentice Hall, Inc.
S11 – 14
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
© 2008 Prentice Hall, Inc.
77% 70% 61% 59% 56%
S11 – 15
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
© 2008 Prentice Hall, Inc. S11 – 16
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
© 2008 Prentice Hall, Inc. S11 – 17
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
© 2008 Prentice Hall, Inc. S11 – 18
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
© 2008 Prentice Hall, Inc. S11 – 19
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
© 2008 Prentice Hall, Inc. S11 – 20
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
© 2008 Prentice Hall, Inc. S11 – 21
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) County’s currency may be unstable, a country may be politically unstable, or cultural and language differences may inhibit successful operations
Table S11.1
© 2008 Prentice Hall, Inc. S11 – 22
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
© 2008 Prentice Hall, Inc. S11 – 23
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
© 2008 Prentice Hall, Inc.
S11 – 24
Methodologies for Outsourcing
Evaluating Multiple Criteria with Factor Rating Break-even Analysis
© 2008 Prentice Hall, Inc.
S11 – 25
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
© 2008 Prentice Hall, Inc. S11 – 26
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
© 2008 Prentice Hall, Inc.
S11 – 27
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
© 2008 Prentice Hall, Inc.
S11 – 28
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
S11 – 29
© 2008 Prentice Hall, Inc.
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
4–3
Since demand > break-even point, produce in Toledo
S11 – 30
= 1,000,000 units
© 2008 Prentice Hall, Inc.
Advantages of Outsourcing
Cost savings
Gaining outside experience
Improving operations and service Focusing on core competencies Gaining outside technologies Other advantages
© 2008 Prentice Hall, Inc.
S11 – 31
Disadvantages of Outsourcing
Increased transportation costs
Loss of control
Creating future competition Negative impact on employees Longer-term impact
© 2008 Prentice Hall, Inc.
S11 – 32
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
© 2008 Prentice Hall, Inc. S11 – 33
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 Don’t use outsourcing in a way that violates religious holidays Don’t use outsourcing to move pollution from one country to another Don’t use outsourcing to take advantage of cheap child labor that leads to child abuse
Table S11.4
© 2008 Prentice Hall, Inc. S11 – 34
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 Don’t accept outsourcing that violates basic human rights Don’t use outsourcing as a short-term arrangement to reduce costs; view it as a long-term partnership Don’t think an outsourcing agreement will prevent loss of technology, but use the inevitable sharing to build a good relationship
Table S11.4
© 2008 Prentice Hall, Inc. S11 – 35
Supplement 11 – Outsourcing as a Supply Chain Strategy
PowerPoint presentation to accompany Heizer/Render Principles of Operations Management, 7e Operations Management, 9e
© 2008 Prentice Hall, Inc. S11 – 1
Outline
What is Outsourcing?
Types of Outsourcing
Strategic Planning and Core Competencies
The Theory of Comparative Advantage
Outsourcing Trends and Political Repercussions
© 2008 Prentice Hall, Inc. S11 – 2
Outline – Continued
Risks in Outsourcing
Methodologies for Outsourcing
Evaluating Multiple Criteria with Factor Rating Break-even Analysis
© 2008 Prentice Hall, Inc.
S11 – 3
Outline – Continued
Advantages and Disadvantages of Outsourcing
Advantages of Outsourcing
Disadvantages of Outsourcing
Audits and Metrics to Evaluate Outsourcing Performance Ethical Issues in Outsourcing
© 2008 Prentice Hall, Inc. S11 – 4
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
© 2008 Prentice Hall, Inc.
S11 – 5
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
© 2008 Prentice Hall, Inc.
S11 – 6
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
© 2008 Prentice Hall, Inc. S11 – 7
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
© 2008 Prentice Hall, Inc. S11 – 8
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
© 2008 Prentice Hall, Inc. S11 – 9
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
© 2008 Prentice Hall, Inc. S11 – 10
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
© 2008 Prentice Hall, Inc. S11 – 11
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
© 2008 Prentice Hall, Inc. S11 – 12
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
© 2008 Prentice Hall, Inc. S11 – 13
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
© 2008 Prentice Hall, Inc.
S11 – 14
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
© 2008 Prentice Hall, Inc.
77% 70% 61% 59% 56%
S11 – 15
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
© 2008 Prentice Hall, Inc. S11 – 16
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
© 2008 Prentice Hall, Inc. S11 – 17
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
© 2008 Prentice Hall, Inc. S11 – 18
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
© 2008 Prentice Hall, Inc. S11 – 19
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
© 2008 Prentice Hall, Inc. S11 – 20
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
© 2008 Prentice Hall, Inc. S11 – 21
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) County’s currency may be unstable, a country may be politically unstable, or cultural and language differences may inhibit successful operations
Table S11.1
© 2008 Prentice Hall, Inc. S11 – 22
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
© 2008 Prentice Hall, Inc. S11 – 23
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
© 2008 Prentice Hall, Inc.
S11 – 24
Methodologies for Outsourcing
Evaluating Multiple Criteria with Factor Rating Break-even Analysis
© 2008 Prentice Hall, Inc.
S11 – 25
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
© 2008 Prentice Hall, Inc. S11 – 26
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
© 2008 Prentice Hall, Inc.
S11 – 27
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
© 2008 Prentice Hall, Inc.
S11 – 28
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
S11 – 29
© 2008 Prentice Hall, Inc.
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
4–3
Since demand > break-even point, produce in Toledo
S11 – 30
= 1,000,000 units
© 2008 Prentice Hall, Inc.
Advantages of Outsourcing
Cost savings
Gaining outside experience
Improving operations and service Focusing on core competencies Gaining outside technologies Other advantages
© 2008 Prentice Hall, Inc.
S11 – 31
Disadvantages of Outsourcing
Increased transportation costs
Loss of control
Creating future competition Negative impact on employees Longer-term impact
© 2008 Prentice Hall, Inc.
S11 – 32
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
© 2008 Prentice Hall, Inc. S11 – 33
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 Don’t use outsourcing in a way that violates religious holidays Don’t use outsourcing to move pollution from one country to another Don’t use outsourcing to take advantage of cheap child labor that leads to child abuse
Table S11.4
© 2008 Prentice Hall, Inc. S11 – 34
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 Don’t accept outsourcing that violates basic human rights Don’t use outsourcing as a short-term arrangement to reduce costs; view it as a long-term partnership Don’t think an outsourcing agreement will prevent loss of technology, but use the inevitable sharing to build a good relationship
Table S11.4
© 2008 Prentice Hall, Inc. S11 – 35
