MBA 502 SUPPLY CHAIN

MANAGEMENT
LESSON 5
OGANIVE CHINGAKULE
S11 OUTSOURCING AS A SUPPLY
CHAIN STRATEGY
Outline

 What is Outsourcing?  Advantages and Disadvantages of

 Outsourcing
Strategic Planning and Core Competencies
 Advantages of Outsourcing
 The Theory of Comparative Advantage
 Disadvantages of Outsourcing
 Risks in Outsourcing
 Audits and Metrics to Evaluate Performance
 Evaluating Outsourcing Risk with Factor
Rating  Ethical Issues in Outsourcing
Supply-Chain Management

 The objective is to build a chain of suppliers that focuses on

maximizing value to the ultimate customer
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
 What is Outsourcing?

 Procuring from external suppliers service or products that are normally part of an
organization
 Offshoring is moving processes to a foreign country but retaining control
 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

© 2011 Pearson Education, Inc. publishing as Prent

ice Hall
Examples of Outsourcing

 Call centers for Brazil in Angola

 Legal and finance service in the Philippines
 IBM providing travel and
payroll for P&G
 ADP processing payroll
for thousands of firms
 Blue Cross sending
patients to India
Types of Outsourcing

Common processes outsourced are  Finance/accounting

 Purchasing  Customer relations
 Logistics  Sales/marketing
 R&D  Training
 Operations  Legal processes
 Service management
 Human resources

 Outsourcing implies a legally binding

contract
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
 Strategic Planning and
Core Competencies
Post-sales
service

Financial
Logistics
Sony, functions

An Outsourcing Parts Core Distribution

Company manufacture Competency
Best in the world at
electromechanical
Outsourcers miniaturization design
Marketing Accounting
could
provide
Employee
benefit Maintenance
management

Real estate
management

Figure S11.1
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

g e o g r a phical
re g a r dl e ss of the
ie s
This appl location
When to Outsource

Kraljic
Matrix
Examples of Decisions
Criteria Example 1 Example 2 Example 3 Example 4

Customer Important Not important Important Important

Importance
Clockspeed High Slow High Slow

Competitive Competitive No advantage No advantage No advantage

Position Advantage
Capable X X Key variable
Suppliers to decide
strategy
Architecture X X Key variable
to decide
strategy
DECISION Inhouse Outsource Inhouse, Outsource
Acquire with modular;
supplier, Inhouse or
Partnership joint
development
with integral.
Outsourcing Trends and Political
Repercussions

According to a survey of 53 major

corporations, the most important
reasons for outsourcing are:

Cost savings 77%

Gaining outside expertise 70%
Improving services 61%
Focusing on core competencies 59%
Gaining access to technology 56%
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
Outsourcing Trends and Political
Repercussions

 Outsourcing includes specific business functions (computer help desks) and entire
departments (accounting, marketing, finance, etc.)
o t a ll o u t s o ur c in g e xperiences are
 N
 said they would continue or expand outsourcing
35% of businesses
 s a ti s f a ctory
40% said they would continue outsourcing but revise their arrangements
ti ll a lo t t o le a r n a bout
 re is
Thereduce
would s r ov e
Some said they outsourcing
e t h o d t o im p
outsourcing as a m
productivity
Outsourcing Trends and Political
Repercussions

 Political backlash can occur when jobs are outsourced to foreign

countries
 Backsourcing describes the process of returning work to the
original firm when outsourcing fails
Risks of 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 creates the impression of failure
Risks of Outsourcing

Outsourcing Examples of
Process Possible Risks
Identify non-core Can be incorrectly identified as a
competencies non-core competency
Identify non-core Just because the activity is not a
activities that should be core competence for your firm
outsourced does not mean an outsource
provider is more competent and
efficient

Identify impact on May fail to understand the

existing facilities, change in resources and talents
capacity, and logistics needed internally

Table S11.2
Risks of Outsourcing

Outsourcing Examples of
Process Possible Risks
Establish goals and Goals can be set so high that
draft outsourcing failure is certain
agreement
specifications
Identify and select Can select the wrong outsource
outsource provider provider

Negotiate goals and Can misinterpret measures and

measures of goals, how they are measured,
outsourcing and what they mean
performance

Table S11.2
Risks of Outsourcing

Outsourcing Examples of
Process Possible Risks
Monitor and control May be unable to control
current outsourcing product development,
program schedules, and quality

Evaluate and give May have non-responsive

feedback to outsource provider (i.e., one that ignores
provider feedback)

Evaluate international County’s currency may be

political and currency unstable, a country may be
risks politically unstable, or cultural
and language differences may
inhibit successful operations
Table S11.2
Risks of Outsourcing

Outsourcing Examples of
Process Possible Risks
Evaluate coordination May not understand the timing
needed for shipping and necessary to manage flows to
distribution different facilities and markets

Table S11.2
Risks of 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
Evaluating Outsourcing

 Factor rating method

 Country risk
problems
 Provider
selection
problems
 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
 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 Outsourcing Linkage

Do no harm to indigenous Avoid outsourcing in a way
cultures that violates religious
holidays

Do no harm to the ecological Don’t use outsourcing to

systems move pollution from one
country to another

Uphold universal labor Don’t use outsourcing to take

standards advantage of cheap child
labor that leads to employee
abuse
Table S11.5
Ethical Issues in Outsourcing

Ethics Principle Outsourcing Linkage

Uphold basic human rights Don’t accept outsourcing that

violates basic human rights
Pursue long-term involvement Don’t use outsourcing as a
short-term arrangement to
reduce costs; view it as a
long-term partnership
Share knowledge Don’t think an outsourcing
and technology agreement will prevent loss of
technology, but use the
inevitable sharing to build a
good relationship with Table S11.5
outsourcing firms
Procurement THE HOW OF IT ALL
Strategies
How to procure

Kraljic
Matrix
Appropriate Procurement Strategy

 Depends on:
 type of products the firm is purchasing
 level of risk
 uncertainty involved
 Issues:
 How can the firm develop an effective purchasing strategy?
 What are the capabilities needed for a successful procurement function?
 What are the drivers of effective procurement strategies?
 How can the firm ensure continuous supply of material without increasing its risks?
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
Kraljic’s Supply Matrix

 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
Fisher’s Functional vs. Innovative Products

Functional Products Innovative Products

Product clockspeed Slow Fast

Demand Characteristics Predictable Unpredictable

Profit Margin Low High

Product Variety Low High

Average forecast error at the Low High

time production is committed

Average stockout rate Low High

Supply Chain Strategy

 Functional Products
 Diapers, soup, milk, tiers
 Appropriate supply chain strategy for functional products is push
 Focus: efficiency, cost reduction, and supply chain planning.
 Innovative products
 Fashion items, cosmetics, or high tech products
 Appropriate supply chain strategy is pull
 Focus: high profit margins, fast clockspeed, and unpredictable demand, responsiveness,
maximizing service level, order fulfillment
Procurement Strategy for the Two Types

 Functional Products
 Focus should be on minimizing total landed cost
 unit cost
 transportation cost
 inventory holding cost
 handling cost
 duties and taxation
 cost of financing
 Sourcing from low-cost countries, e.g., mainland China and Taiwan is
appropriate
Procurement Strategy for the Two Types

 Innovative Products
 Focus should be on reducing lead times and on supply flexibility.
 Sourcing close to the market area
 Short lead time may be achieved using air shipments
E-Procurement

 Mid to late 90s: B2B automation was considered a trend that would have a profound
impact on supply chain performance.
 1998-2000:
 Multiple e-markets established in various industries
 Promised:
 increased market reach for both buyers and suppliers
 reduced procurement costs
 paperless transactions
 Processing cost per order proposed to be reduced to $5/order from as high as $150/order
Business Environment in the 1990s

 Many manufacturers desperately looking to outsource their procurement functions.

 Procurement process highly complex, significant expertise required and expensive
 B2B transactions an enormous portion of the economy (much larger
 B2B marketplace highly fragmented
 a large number of suppliers
 competing in the same marketplace
 offering similar products.
 Opportunities and challenges
 Lowered procurement costs (Suppliers)
 Significant expertise in procurement process absent (Buyers)
Opportunities for the Marketplaces

 Initial offerings of independent e-marketplaces

 Either a vertical-industry focus or a horizontal-business-process or a functional focus.
 Companies offered:
 expertise in the procurement process
 ability to force competition between a large number of suppliers.
Value Proposition to Buyers

 Serving as an intermediary between buyers and suppliers.

 Identifying saving opportunities.
 Increasing the number of suppliers involved in the bidding event.
 Identifying, qualifying, and supporting suppliers.
 Conducting the bidding event.
The Result

 Reduction in procurement costs from 15-40%

 Buyers focused on the spot market or on leverage component
 Long term relationships with suppliers not important
 Value proposition to suppliers not clear
Benefits of e-markets to Suppliers

 Relatively small suppliers could expand their market horizon

 Allows suppliers to access spot markets. Advantageous in:
 Fragmented markets
 Reducing marketing and sales costs
 Increasing ability to compete on price.
 Allows suppliers to better utilize their available capacities and inventories.
Issues of the Benefits

 Do the benefits compensate for a reduction in revenue?

 Average 15%, sometimes as high as 40%.
 Many suppliers may not feel comfortable competing on price alone.
 Suppliers, especially those with brand-name recognition, may resist selling their services
through e-markets.
What about the e-markets Themselves?

 Revenue generation through transaction costs

 Typically 1-5% of price paid by buyer
 Transaction fees pose serious challenges to the market maker:
 Sellers resist paying a fee to the company whose main objective is to reduce the purchase price.
 Revenue model needs to be flexible enough so that transaction fees are charged to the party that
is more motivated to secure the engagement.
 Buyers also resist paying a fee in addition to the purchase price.
 Low barriers to entry created a fragmented industry
Challenges Lead to Evolution of the e-markets

 Changes in the way clients are charged

 Licensing fee
 software vendor licenses its software so that the company can automate the access to the marketplace
 Subscription fee
 marketplace charges a membership fee
 Fee depends on the size of the company, the number of employees who use the system, and the number
of purchase orders
Challenges Lead to Evolution of the e-markets

 Modification of value proposition

 Initial proposition was market reach
 Changed through creation of four types of markets.
Value-Added Independent Public e-Markets

 Expanded value proposition by offering additional services:

 inventory management
 supply chain planning
 financial services
 Examples:
 Instill.com focuses on the food service industry
 Provides an infrastructure that links together operators
 Additional services like forecasting, collaboration, and replenishment tools.
 Pefa.com services the European fresh fish market
 Offers buyers access to a large number of independent fresh fish auctions.
 Provide visibility on price from many European ports
 Provide information on product quality
Private e-markets

 Many companies have established their own private e-markets

 Key activities:
 to run reverse auctions
 on-line supplier negotiation.
 Examples:
 Subway restaurant franchise
 16,000 members in over 70 countries
 Allows the different restaurants to purchase from over 100 suppliers.
 Motorola
 Implemented supplier negotiation software
 Allows firm to conduct bids, negotiate and select an effective procurement strategy.
Consortia-Based e-markets

 Similar to public e-markets

 Established by a number of companies within the same industry.
 Examples:
 Covisint in the automotive industry
 Exostar in the aerospace industry
 Trade-Ranger in the oil industry
 Converge and E2Open in the electronic industry.
 Provides suppliers with a standard system that supports all the consortia’s buyers
 Some of the consortia have exited the auction business
 Focus on technology that enables business collaboration between trading partners (Examples: Covisint and
E2Open)
Content-Based e-markets

 Two types of markets

 Maintenance, repair, operations (MRO) goods
 Industry-specific products.
 Focus on content
 Achieved by integrating catalogs from many industrial suppliers.
 Unify suppliers’ catalogs
 Provide effective tools for searching and comparing suppliers’ products.
 Example:
 Aspect Development (now part of i2) offers electronics parts catalogs that integrate with CAD
systems.