It’s not what you don’t know that hurts you. It’s what you know that ain’t so.

Mark Twain.

Outsourcing, once a mere option, has today become a competitive imperative. The growth of the Internet, customer revolution, rise of mass customization, severe competition etc. has forced the companies to focus on core competencies instead of vertical integration. This means that original equipment manufacturers (OEMs) must ideally contract out part or all of manufacturing, assembly, distribution, and support operations. What to outsource has historically been decided by die question, “Is it strategic to my business?” If die answer is yes, you would keep it. If no, farm it out. Today, companies are asking a different question: Is it my core competency;’ Ifno, then it is ripe for outsourcmg, whether it is ^strategic’ or not. The ‘trendsetter barometer’ conducted by Coopers and Lybrand LLI’ contraction shows that 83 per cent of America’s fastest growing companies have turned to out-sourcing for one or more functions.

WHAT IS OUTSOURCING?

utsourcing is defined as the contracting of one or more of a company’s business processes to an outside service provider to help increase shareholder value, by primarily reducing operating cost and focusing on core competencies. CIO defines outsourcing as an arrangement in which one company provides services for another company that could also be or usually have been provided in-house. Automatic data processing Inc. (ADP) defines outsourcing as the contracting out of a company’s non-core, non-revenue-producing activities to specialists. It differs from contracting in that outsourcing is a strategic management tool that involves the restructuring of an organization around what it does best—its core competencies.

WHY DO COMPANIES OUTSOURCE?

There are several reasons why outsourcing is becoming a habit. The simplest reason to outsource is to alleviate administrative burdens and focus on strategic areas. As the companies move from non-outsourcing environment to an outsourcing environment the profile of the time spent by the executives on various activities change dramatically. According to Figure 12.1 in a non-outsourcing environment, executives spend 60 per cent of their time on administration matters, while 30 per cent on tactical issues and this leaves only 10 per cent of their time to

Figure 12.1 The time spent by companies on various activities in outsourcing and non-outsourcing environments focus on strategic matters. On the contrary when they switch to an outsourcing environment and outsource some of the activities they need to spend only 10 per cent of their time on handling administration issues, 30 per cent time they focus on tactical matters while 60 per cent of their time they can devote to thinking, strategizing and planning.

Some other reasons behind outsourcing are:

1. Reduce costs: A company may emphasize cost savings for a variety of reasons, such asbeing in a poor financial position, or because of a goal to increase profits. Reducing costs by using a supplier is possible, but not in all situations. A supplier has clearly lower costs, if it can centralize the work of several companies at one location, such as central truck maintenance facilities or a data processing centre. It can also lower costs if materials or supplies can be bought at lower costs by using volume purchasing. It can also purchase assets from a company and then lease the assets back as a part of an outsourcing deal, thereby giving the companies an upfront cash infusion. Otherwise, its costs will be higher than those of the company, for it must include a profit as well as sales and marketing costs in its budget—an internal department does not have to earn a profit, nor does it have a sales force. Thus, there are a few situations in which a company can reduce its costs by outsourcing, but there are many more cases where this is not a realistic reason for outsourcing.

2. Focus on core functions: A company typically has a small number of functions that are key to its survival while other functions or activities are required to be done but are non-core. It may want to focus all of its energies on those functions and distribute all other functions among a group of suppliers who are capable of performing them well enough that the company management will not have to be bothered with any of the details associated with running them. The company may even want to outsource those functions that are core functions at the moment, but which are expected to become less important in the near future due to changes in the nature of the business. In addition, a company could even outsource a function that is considered key to the company’s survival if it can find a supplier that can perform the function better—in short, only keep those functions that are core functions and which the company can q j do better than any supplier. For example, a company may be the low cost manufacturer in its industry, which allows it to maintain a large enough, pricing — advantage over its competitors, that it is guaranteed a large share of the market.

3. Acguire new skills: A company may find that its in-house skill set is inadequate for a given function. This is the most common reason and is used for outsourcing those functions that require high skill levels, such as engineering and computer services.

4. Acquire better management: A company may find that an in-house function is not performing as expected not because of any problem with the staff but because of inadequate management support or capability. Symptoms of this are high turnover, absenteeism, poor work products and missed deadlines. It can be very hard to obtain quality management, so outsourcing a function to a supplier just to gain access to the supplier’s better management can be a viable option. It may also be possible to rent management from the supplier. This can be a good option in all functional areas, though it is more common in areas requiring high levels of expertise such as engineering.

5. Assist a fast growth situation: If a company is rapidly acquiring market share, the management team will be stretched to its limit, building the company up so that it can handle the vastly increased volume of business. In such situations, the management team will desperately need additional help in running the company. A supplier can step in and take over the function so that the management team can focus its attention on a smaller number of core activities. For example, a company in a high growth situation may outsource its customer support function to a supplier, who already has the phone line “ capacity and trained staff available to handle the deluge of incoming calls.

6. Avoid labour problems: If a company is constantly bogged down by labour problems which start affecting its productivity and performance, outsourcing becomes a viable option. Companies can in such cases use suppliers infrastructure, manpower and facilities for production and concentrate on marketing or getting business.

7. Focus on strategy: A company’s managers typically spend the bulk of each day handling the detailed operations of their functional areas—the tactical aspects of the job. By outsourcing a function while retaining the core management team, a company can give the tactical part of each manager’s job to supplier, which allows the management team to spend far more time in such strategy related issues as market positioning, new product development, acquisitions, and long-term financing issues.

8. Avoid major investments: A company may find that it has a function that is not as efficient as it could be, due to lack of investment in the function. If the company keeps the function in-house, it will eventually have to make a major investment in the function in order to modernize it. Outsourcing this function can avoid any major investments. For example, by outsourcing transportation activity, the company that owns an ageing transportation fleet can sell the fleet to a supplier, who then can provide an upgraded fleet to the company as part of its service. 

9. Handle overflow situations: A company may find that there are times of the day or year when a function is overloaded for reasons that are beyond its control. In these situations it may be cost effective to retain a supplier to whom the excess work will be shunted when the in-house staff is unable to keep up with demand. This is a reasonable alternative to the less palatable option ofoverstaffing the in-house function in order to deal with overflow situations that may only occur a small percentage of time. This is a popular option for help desk services as well as customer support, where excess incoming calls are sent to the supplier instead of having customers wait on line for an excessively long time.

10. Improve flexibility: This is similar to using outsourcing to handle overflow situations, except that the supplier gets the entire function, not just the overflow business. When a function experiences extremely large swings in the volume of work it handles, it may be easier to eliminate the fixed cost of an internal staff and move the function to a supplier who will only be paid for the actual work done. This converts a fixed cost into variable cost—the price of the supplier’s services will fluctuate directly with the transaction volume it handles. 

11. Improve ratios: Some companies are so driven by their performance ratios that they will outsource functions solely to improve them. For example, outsourcing a function that involves transferring assets to the supplier will increase the company’s return on assets (which is one of the most important measurements for many companies). The functions most likely to improve this ratio are those heavy in assets, such as maintenance, manufacturing and computer services. Another ratio that can be improved is profitability per person. To enhance this, a company should outsource all functions involving large numbers of employees, such as manufacturing or sales. 

12. Jump on to the bandwagon: A company may decide to outsource a function simply because everyone else is doing it, too. Also, a large amount of coverage of outsourcing in various national or industry specific publications will give company management the impression that outsourcing is the trend, and they must use it or fail. For example, due to the large amount of publicity surrounding some of the very large computer services outsourcing deals, the bandwagon effect has probably led to additional outsourcing deals for the computer services function.

13. Enhance credibility: A small company can use outsourcing as a marketing tool. It can tell potential customers the names of its suppliers, implying that since its functions are being maintained by such well-known suppliers, the company’s customers can be assured of a high degree of quality service. In these instances, the company will want to hire the best known suppliers, since it wants to draw off of their prestige. Also, for key functions, the company may even want to team up “with a supplier to make joint presentations to company customers, since having the suppliers staff present gives the company additional credibility.

14. Maintain old functions: A company may find that its in-house staff is unable to maintain its existing functions, while transitioning to new technology or to a new location. Outsourcing is a good solution here, for it allows the company to focus its efforts on implementing new initiatives while the supplier maintains existing day-to-day functions. This reason is most common in computer services, where suppliers are hired to maintain old ‘legacy’ systems while the in-house staff works on transitions to an entirely new computer system.

15. Improve performance: A company may find that it has a function that has bloated costs or inadequate performance. To shake up the function, company management can put the function out to bid and include the internal function’s staff in the bidding process. The internal staff can then submit a bid alongside outside suppliers that commits it to specific service levels and costs. If the bid proves to be competitive, management can keep the function in-house, but hold the functions staff to the specific cost and performance levels noted in its bid. As long as suppliers are told upfront that the internal staff will be bidding and that the selection will be a fair process, they should not have a problem with this type of competition. This approach can be used for any functional area.

16. Begin a strategic initiative: A company’s management may declare complete company reorganization and outsourcing can be used to put an exclamation point on its determination to really change the current situation. By making such a significant move at the start of the reorganization, employees will know that management is serious about the changes and will be more likely to assist in making the transition to the new company structure.

Usually one of the above reasons dictates an oufSoufeing decision. But before finally taking the plunge, company should exhaustively evaluate the working and functioning of the department/function concerned. Many a time there is a deeper problem where the function in question is not doing a good job of presenting its benefits to management. In such a case, the function manager may not be able to showcase its accomplishments, or showing management that the cost of keeping the function in-house is more favourable.

If the management suspects that this may be the reason why outsourcing is being considered, it is useful to bring in a consultant who can review the performance of the In-house employees and see if they are, in fact doing a better job than they are saying. Sometimes investigating the ability of in-house staff prior to outsourcing functions will keep the outsourcing from occurring.

The manager who is making the outsourcing decision should also consider that it is not necessary to outsource an entire functional area—instead the manager can cherry pick only those tasks within the function that are clearly worthy of being outsourced and keep all other tasks inhouse. This reduces the risk to the company of having the chosen supplier do a bad job of handling its assigned tasks, since fewer tasks are at risk, and it allows the company to hand over the remaining functional tasks to the supplier as it becomes more comfortable with the supplier’s t-^performance. For example, a company can outsource just the maintenance of its computer services function, or it may add network services, telephone services, application development, or data centre operations task to one or more suppliers. These options are all available to the manager who is edging into a decision to outsource. The typical path that a company follows starts with a function that has minimum strategic value and will not present a problem even if the supplier does a poor job of providing the service. If the company’s experience with these low-end functions prove successful, then company management will be more likely to advance to outsourcing those functions with more strategic value or with more company threatening consequences, if the provided service is inadequate. These functions include accounting, HR and materials management. Finally, if the company continues to perform well with all or part of these functions; typically these are manufacturing, computer services and engineering (though this may vary by industry). Only by considering the reasons in favour of outsourcing alongside the associated risks can a manager arrive at a considered decision to outsource a function.

OUTSOURCING RISKS

These can range from pricing issues to nonperformance by a supplier of a key function. The person making the outsourcing decision must be aware of these risks before making the decision to hand over a function to a supplier. Broadly, these risks can be classified into short-term risks and long-term risks. Companies indulging in outsourcing have to guard against both of these risks. Short-term risks can include among others operational issues at supplier’s end, while long-term risks can be nonalignment of company’s goals with supplier s goals in the long term.

Supplier’s situation may change in the future, causing problems in the outsourcing relationship. For example, the supplier may have financial difficulties, be bought out by a company that does not want to be in the outsourcing business, or undergo a shift in strategy that forces it to provide different services. Also, the technology needed to service the company’s needs may change over time and the supplier may no longer be able to service that new technology. These risks can be lowered by ensuring that there is a termination clause in the outsourcing contract that allows the company to back out of the contract if any of the above circumstances occur. Also, these risks are less important if there is a large number of competing suppliers to whom the business can be shifted. Alternatively, the risk is greater if there are few competing suppliers to whom the company’s business can be shifted. Supplier’s inability to grow in the same proportion as the company, can be another big risk. But this is a long-term risk and can be gauged and understood beforehand.

OUTSOURCING IN SCM

0utsourcing logistics has been a favourite with companies since several years. It is only recently that companies have started thinking about outsourcing other aspects of SCM.

Despite the wide acceptance of outsourcing logistics functions, a variety of organizational concerns inhibit the outsourcing of logistics processes, including:

1. Fear of losing control. Companies are hesitant to hand over important logistics processes to a third party. As the third party might also be managing the logistics processes of competitors, companies are afraid that trade secrets might be misused, mismanaged, or lost—or in the worst case, pass through the third-party provider into the hands of competitors.

2. Lack of confidence. Compounding the fear of loss of control is the lack of confidence companies feel about the ability of third-party providers to meet dieir needs.

3. Lack of outsourcing education. Many companies are familiar with outsourc-ing, in terms of the IT and business-process enhancements that logistics service providers can offer. However, they lack a thorough understanding of the experience of managing the outsourcing service provider throughout the life … of the relationship.

4. Management philosophy and tradition. Many companies simply resist change. They may reject the concept of outsourcing logistics activities due to a perceived potential negative effect on their business model and operations. In addition, these companies may have had poor outsourcing relationships in the past and may be less inclined to initiate new outsourcing contracts. Furthermore, they may believe that the geographical separation between them and their outsourcer could cause service management issues.

For example, some companies feel that an outsourcer may not be sensitized to the unique logistics needs of their product lines. Others feel that outsourcers are not equipped to deal with dynamic or mission-critical operations. Due to this lack of confidence, companies are cautious about getting locked into a long-term contract with an outsourcer and are concerned about the associated legal fees and penalties that would be incurred if disputes arose.

LEAN COMPANIES: NEW OPPORTUNITIES IN SCM OUTSOURCING

In todays global economy, companies are making their best attempt at shedding their flab and becoming lean and trim. This new avatar can ensure a faster response, agility and better ability to handle pressure. These companies often find it much more cost effective to outsource rather than build a proprietary infrastructure. They believe in having no production facility, no warehouse, no loading dock, no boardroom—just office space, a handful of employees, and a great idea for a product or service and marketing strength.

In this case, outsourcing SCM can ensure that the entire necessary infrastructure is in place, without actually having to spend on any infrastructure. This can save a lot of working capital from getting locked. Moreover, companies can then focus on core activity of getting the customers and servicing them efficiently.

Through the use of outsourced services, enterprises can avoid all or some of the costs associated with physical plant, specialized IT systems and equipment, telephone lines and bodies—and best of all—no distractions from the carrying out of their core competencies. Especially young companies or new companies should not waste their time focusing on building these operational infrastructures when their primary business is to create.aud sell products and services—and not man, aging supply chain activities.