1. 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

2. 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

3. Outline – Continued
 Risks in Outsourcing
 Methodologies for Outsourcing
 Evaluating Multiple Criteria with
Factor Rating
 Break-even Analysis
© 2008 Prentice Hall, Inc. S11 – 3

4. 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

5. 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

6. Learning Objectives
When you complete this supplement
you should be able to:
4. Use break-even analysis to
determine if outsourcing is cost-
effective
5. List the advantages and
disadvantages of outsourcing
© 2008 Prentice Hall, Inc. S11 – 6

7. 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

8. 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

9. 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

10. 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

11. Types of Outsourcing
 Common processes outsourced are
 Purchasing  Finance/accounting
 Logistics  Customer relations
 R&D  Sales/marketing
 Operations  Training
 Service management  Legal processes
 Human resources
 Outsourcing implies a legally binding
contract
© 2008 Prentice Hall, Inc. S11 – 11

12. 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

13. Strategic Planning and
Core Competencies
Sony,
An Outsourcing Post-sales
service
Company Financial
Logistics
functions
Outsourcers
could Parts
manufacture
Core
Competency Distribution
provide Best in the world at
electromechanical
miniaturization
Marketing design Accounting
Employee
benefit Maintenance
management
Real estate
management
Figure S11.1
© 2008 Prentice Hall, Inc. S11 – 13

14. 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
ga rdless of
This a pplies re n
hic al locatio
the geograp
© 2008 Prentice Hall, Inc. S11 – 14

15. 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%
© 2008 Prentice Hall, Inc. S11 – 15

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 – 16

17. Outsourcing Trends and
Political Repercussions
 Outsourcing includes specific business
functions (computer help desks) and
entire departmentsing experiences are
(accounting,
 Not all outsourc
marketing, tory
c finance, etc.)
satisfa
 35% of businesses saidlearn about
is still a lot to they wouldrove
 There or expand outsourcing p
continue urcing as a method to im
outso
 40% roductivity
p said they would continue
outsourcing but revise their arrangements
 Some said they would reduce outsourcing
© 2008 Prentice Hall, Inc. S11 – 17

18. 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

19. 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

20. Risks in 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 S11.1
© 2008 Prentice Hall, Inc. S11 – 20

21. Risks in 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 S11.1
© 2008 Prentice Hall, Inc. S11 – 21

22. Risks in Outsourcing
Outsourcing Examples of
Process Possible Risks
Monitor and control May be unable to control product
current outsourcing development, schedules, and
program 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 S11.1
© 2008 Prentice Hall, Inc. S11 – 22

23. Risks in 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 S11.1
© 2008 Prentice Hall, Inc. S11 – 23

24. 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

25. Methodologies for Outsourcing
 Evaluating Multiple Criteria with
Factor Rating
 Break-even Analysis
© 2008 Prentice Hall, Inc. S11 – 25

26. Rating International
Risk Factors
Nine factors rated 0-3, 0 is no risk, 3 is high risk
Risk Factor England Mexico Spain Canada
Economic: Labor cost/ laws 1 0 2 1
Economic: Capital availability 0 2 1 0
Economic: Infrastructure 0 2 2 0
Culture: Language 0 0 0 0
Culture: Social norms 2 0 1 2
Migration: Uncontrolled 0 2 0 0
Politics: Ideology 2 0 1 2
Politics: Instability 0 1 2 2
Politics: Legalities 3 0 2 3
Total risk rating scores 8 7 11 10
Table S11.2
© 2008 Prentice Hall, Inc. S11 – 26

27. Rating Outsourcing Providers
Seven factors rated 1-5 and an importance weight
Outsourcing Providers
Factor Importance BIM S.P.C. Telco
(criterion) Weight (U.S.) (India) (Israel)
1. Can reduce operating costs .2 3 3 5
2. Can reduce capital investment .2 4 3 3
3. Skilled personnel .2 5 4 3
4. Can improve quality .1 4 5 2
5. Can gain access to .1 5 3 5
technology not in company
6. Can create additional capacity .1 4 2 4
7. Aligns with policy/ .1 2 3 5
philosophy/culture
Total and Averages 1.0 3.9 3.3 3.8
Table S11.3
© 2008 Prentice Hall, Inc. S11 – 27

28. Break-Even Analysis
First define total cost in-house
TCin = Fin + (Vin x Xin)
where
TCin is the total cost of an item produced in-house
Fin is the total in-house fixed cost
Vin is the variable cost/unit produced in-house
Xin is the total number of units produced in-house
© 2008 Prentice Hall, Inc. S11 – 28

29. 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
Fin – Fout
X=
Vout – Vin
© 2008 Prentice Hall, Inc. S11 – 29

30. 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
Fin – Fout 2,000,000 – 1,000,000
X= =
Vout – Vin 4–3
= 1,000,000 units Since
demand > break-even point,
produce in Toledo
© 2008 Prentice Hall, Inc. S11 – 30

31. 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

32. 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

33. 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

34. Ethical Issues in
Outsourcing
Ethics Principle Outsourcing Linkage
Seek to do no harm to Don’t use outsourcing in a
indigenous cultures way that violates religious
holidays
Seek to do no harm to the Don’t use outsourcing to
ecological systems of the move pollution from one
world country to another
Seek to uphold universal Don’t use outsourcing to take
labor standards advantage of cheap child
labor that leads to child abuse
Table S11.4
© 2008 Prentice Hall, Inc. S11 – 34

35. Ethical Issues in
Outsourcing
Ethics Principle Outsourcing Linkage
Seek to uphold basic human Don’t accept outsourcing that
rights violates basic human rights
Seek to pursue long-term Don’t use outsourcing as a
involvement in foreign short-term arrangement to
countries reduce costs; view it as a
long-term partnership
Seek to share knowledge Don’t think an outsourcing
and technology with foreign agreement will prevent loss of
countries technology, but use the
inevitable sharing to build a
good relationship
Table S11.4
© 2008 Prentice Hall, Inc. S11 – 35