Brief overview of Outsourcing Theory.

1. Outsourcing: What’s the Theory?
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Gordon M. Groat
PhD (abd), MSc, BGS, ASc

2. Predominant Theory
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 Resource Based View (RBV)
 Transaction Cost Economics (TCE)
 Total Cost of Outsourcing (TCO)
 Agency Theory
 Negative Curvilinear Model (Adjusting Outsourcing on the X and Y axis)
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3. Lit Review: Outsourcing Advantages
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 Strategic Focus / Reduction of Assets
 Complimentary Capabilities / Lower Production Costs
 Strategic Flexibility
 Avoiding Bureaucratic Costs
 Relational Rent
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4. Lit Review: Outsourcing Disadvantages
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 Interfaces / Economies of Scope
 Hollowing Out
 Opportunistic Behaviour
 Rising Transaction & Coordination Costs
 Limited Learning & Innovation
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5. Strategic Focus & Reduction of Assets
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 Shifting cost of production leveraging an outsourcing
model frees up assets that the outsourcer now
provides… i.e. the infrastructure costs, etc.
 Why is this a good thing?
 It allows the organization to redeploy freed up assets to other
strategic areas or the organization can redistribute savings to
shareholders – in either event, a win with the investing
community (share price)
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6. Complimentary Capabilities & Lower Production Costs
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 Outsourcing can remove a fixed cost from production
thus raising profitability
 Outsourcers often have more efficient production
processes – allowing them to produce at a cost
savings compared to internal production… enhanced
profitability PLUS core competency… i.e. it’s what
the Outsourcer does best.
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7. Strategic Flexibility
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 By using outsourcers – it’s easier to switch from one
outsourcer to another
 Organization can increase or decrease supplies from various
outsourcers (supply channels) in response to “external shock”
 Reduces the need to “retool” or “restructure” due to economic
changes and market changes
 European – flexibility reservoir
 Japanese – Inimitable supply chain where there is an obligation to
the well being of the supplier
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8. Avoiding Bureaucratic Costs
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 There is no competitive incentive associated with
internal production and thus – rising price base is
associated with internal production
 Lack of Price Mechanism
 Lack of Economic Incentives
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9. Relational Rent
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 Building Idiosyncratic and valuable relationships
with suppliers enables Innovation and Learning,
which in turn, produces efficiencies that reduce
transaction costs
 SEE TOYOTA PRODUCTION
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10. Toyota Supplier Relations
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 Toyota Supplier Relations are widely studied as a
model with a sustainable advantage where the
relationship is deep and extensive… often including
the following ties:
 Historical
 Social
 Interpersonal
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11. Interfaces / Economies of Scope
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 Sometimes there is a point in the value chain that
manifests at key strategic intersections, for example
R&D, Manufacturing, and Marketing
 If there are important interfaces adding to the Value Chain –
then splitting up these processes to Outsourcing may not be
the best course of action
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12. Hollowing Out
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 Firms that outsource many activities can sometimes
give up their competitive edge.
 Firms can loose bargaining power vis-à-vis suppliers
because the capabilities of suppliers increase relative
to those of the firm
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13. Opportunistic Behaviour
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 Opportunistic behaviour allows suppliers to extract
greater rents from a relationship than they would
normally do
 i.e. Gaming the Contract
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14. Rising Transaction & Coordination Costs
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 External Span of Control issues
 Managers have a limited amount of time to dedicate to
managing relationships with outsourcers
 Too much outsourcing throws this issue into a TCE/TCO
discussion as the value of outsourcing is chipped away by
managerial costs to run the business
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15. Limited Learning & Innovation
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 If the firm itself is not able to do the business
process, how is it able to derive learning from the
process?
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16. Transaction Cost Economics (TCE)
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 Production costs are lower in “markets” than in
organizations because of allocative efficiencies – this
leads to inter-firm division of labour
 Transaction Costs are the costs of “running” the
economy… in the case of BPO, the cost of monitoring
mechanisms to prevent opportunistic behaviour
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17. Total Cost of Outsourcing
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 Extrapolates TCE to include the perspective of
Williamson and then captures the costs of managing
the economy… this elevates the “Make or Buy”
decision to a different level apart from the basic
contractual “cost” of service items.
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18. Resource Based View
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 Competitive Advantage is present when controlling
resources that have certain characteristics:
 Valuable
 Rare
 Inimitable
 Hard to Substitute
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19. Agency Theory
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 Outsourcer commissions work from the supplier
(agent)
 Works well when there is strong alignment between both
parties
 Where alignment is not possible, Vertical Integration is
preferred
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20. Negative Curvilinear Model
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Activity A B C D E F G H I
Performance Gain
-4 -3 -2 -1 0 1 2 3 4
from Outsourcing
Negative Curvilinear xy Performance Graph
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Number of Outsourced
5
4
Activities
3
2
1
0
0 2 4 6 8 10
Perform ance
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21. Projections
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 BPO market posting continued growth
 Shifting regional patterns
 Increased competition proliferates alternatives
 Value add shift from simple BPO to more complex
relationships (i.e. BPO to BTO)
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22. World Class Partners
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Asia Pacific Contact Center India’s Most Respected
Vendor of the Year 2007 BPO Company
Best in Show Awards for Best Offshore Solutions
Provider - 14th Annual International Call Center
Management Conference & Exposition
Best Outsourcer 14th Annual
International Call Center Management
Conference & Exposition
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23. Outsoucing Costs // TCE
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 Call Center Employee Cost
2006 Data Set (collected 2005)
 USA US$ 19,000 annually
 Australia US$ 17,000 annually
 Philippines US$ 9,050 annually
 India US$ 7,500 annually
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24. What does it mean for ME?
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 By enabling internal Core Competencies to shine we
set ourselves up to deliver a better product to market
more efficiently
 By managing our Outsourcing arrangements well, we
are able to enhance our profitability
 The more money the enterprise earns- the more
money there is to grow the business
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25. Core Activities in an Outsourcing Decision Model
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(1) the company core (all activities
which are necessarily connected
with a company's existence)
(2) core-close activities (directly
linked with core activities)
(3) core-distinct activities (supporting
activities)
(4) non core activities (activities with
general availability)
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26. Questions
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