Outsourcing is the latest buzzword and most talked about phenomenon that has taken the world by storm. Outsourcing can be viewed at two levels – outsourcing of products and outsourcing of processes. This two part article explores both these phenomenon in detail.

Outsourcing has been in existence for decades/ what has changed however is the dimension – outsourcing has assumed. Outsourcing is no longer a tactical option that can help a firm save a few hundred dollars. Rather it has emerged as a strategic necessity in an era when opportunities offered by “low-cost” countries, such as China, India or Mexico, are abound. By allowing the companies to focus on their core competencies, outsourcing allows faster turn around of resources thereby improving overall health of the economy. For countries to which the non-core activities have been outsourced to, the benefits are immense as this not only generates employment opportunities but also brings in foreign currency thereby helping its economy. It is because of these reasons that the outsourcing Juggernaut will continue to move forward, despite occasional mishaps and backlash, and transform national economies in both the developed and developing worlds in the process. According to an IDC report, in 2001, U. S. manufacturers spent $7.8 billion on outsourcing and estimate that this will increase to $12 billion a year by the end of 2006.

Outsourcing in Manufacturing Industries 

Outsourcing is nothing but the classic “Make vs. Buy” question. Do I make something internally or buy it in the marketplace, and how do I add value most effectively? This is not a new issue; however what has changed is that more companies are engaged in more outsourcing than before. The scope of outsourcing has increased and companies are moving to outsourcing processes along with the products. Outsourcing of products includes assemblies or sub assemblies in an engineering industry or drug formulations in pharmaceutical industry etc. Outsourcing of products is not a new phenomenon but now we are moving to a situation where processes or functions are being thought of as being outsource able.

Though cost saving advantage is usually the major impetus behind an outsourcing decision, other benefits include superior service customization, getting to market faster, compression of the product development cycle, and increased market share through competitive pricing, access to high technology and efficient management procedures also access to superior knowledge and capability.

Companies in sectors like apparel, footwear and consumer electronics – were among the earliest firms to shift many of their operations to low cost countries. For instance, Nike decided long time ago that its core competency was marketing high end sneakers, not making them. Other sectors – such as electrical equipment, household appliances, and computer equipment – are among the fast growing segments that are penetrating low cost countries today. But migration to outsourcing has just begun for firms in many other industries such as measuring and controlling devices, heating and ventilation equipment, fabricated metal products and motor vehicle parts.

Several companies that began early are already at an advanced stage in the outsourcing spectrum while some others are just beginning to test the waters buoyed by the success of veterans who not only have achieved an edge over their competitors by bringing the product fast to the market but also have increased the shareholder value. It is important to understand this process which starts with outsourcing a small part of the production to establishing strategic relationships with ones outsourcing partner.

Outsourcing Continuum 

At the lowest end of the spectrum are the firms which are merely testing the water. These firms recognize that outsourcing is important as they have witnessed the success achieved by some others from their industry or other companies. They even outsource some basic commodities, but only on a trial basis. There may be incremental benefits from this cautious approach but no real competitive advantage is gained.

In the next stage are the firms that have advanced to the point where they are purchasing components or complete products. This trend is particularly seen in retain sector where big retailers like America’s Wal-Mart and France’s Carrefour for example purchase billions of dollars worth of goods from China and India each year. The obvious advantage is reduced cost. This model however can be easily replicated and imitated. There is no long term competitive advantage from this model.

The next stage is where firms develop comprehensive outsourcing strategy. This strategy involves much more than mere procurement of products and something that produces a real competitive edge. Firms in this stage of the spectrum collaborate with the outsourcing partner for “design” and together they make products with higher value added; at the same time they can reduce their dependence on higher cost countries and speed up product development cycles.

For example, by 2006, Motorola aims to have made $10 billion in accumulated purchases from China and to be producing $10 billion a year in goods there. By the same year Motorola also wants to have made investments totaling $10 billion inside China, including the construction of a global research and development center and hiring of 5,000 researchers.

In the next stage of the spectrum are the companies that have adopted an integrated sourcing strategy. Major auto makers, once viewed countries like China and later India primarily as places to make cars for sale domestically given the big market size. Today however car makers see low cost countries not just as an important market or as a principal supply base for goods sold elsewhere, but as both. An integrated strategy is required so that each business line can outsource components for products that will be exported and produce goods to be sold in the domestic market. Firms that have reached this stage are reaping major benefits. An integrated approach produces a variety of advantages not easily copied by competitors, such as being able to use plants to realize true economies of scale and broadening the opportunity to increase sale. Making a presence felt in more than one country has its own advantages.

And finally along the spectrum are the firms (though only a handful) who recognize that they must capture global advantage using a sound and long term outsourcing strategy. These firms recognize that if they manage their business across multiple low cost countries, they can achieve more growth at all levels – local, regional and global. For example, Toyota out sources vehicle sub assemblies from many Asian countries, allowing it to keep costs low and achieve just in time delivery. Capturing global advantage – achieving the lowest costs while making use of the best people and practices – is the holy grail of low cost countries. It is hard to achieve but it is also difficult for the competitors to replicate. To capture global advantage, “you need to think about where you can best source competitive advantage. This needs to be done dynamically so that you can constantly update your knowledge as to what to source from where, to know the risks from one country, and to balance the exposure of risk in any one country.

Achieving Global Advantage 

Ultimately all the companies would aim to reach a stage wherein they will want to reap the maximum benefits from outsourcing. There are three steps required to move towards the goal of achieving global advantage. In the first stage companies must analyze opportunities and determine what should be outsourced rather can be outsourced. This can be a result of analyses of what is core for the company and what is non-core. In the second stage, companies decide on their outsourcing philosophy i.e. whether companies want to offshore or near shore. This is then followed by choosing a country to which company will outsource to. From the chosen country, a company is chosen who understands its requirements, exigencies and challenges. Several times a company is chosen based on its reputation and its experience of handling such projects in the past. Once this is done the next step is to establish an infrastructure to support the outsourcing operation; and overcome barriers many times from within the company itself. This involves a set of processes, policies, skills, data and supplier relationships.

Outsourcing is having a tremendous impact on the way a firm is organized. It is not only altering the structure of the company but also the way relationships are handled and managed. And this trend is spurring the trend towards outsourcing of processes and functions. Business Process Outsourcing involves outsourcing of live processes to an outside vendor. The next part of this article will look at outsourcing of processes and functions.