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
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.
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Outline – Continued
 Risks in Outsourcing
 Methodologies for Outsourcing
 Evaluating Multiple Criteria with
Factor Rating
 Break-even Analysis
© 2008 Prentice Hall, Inc.
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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.
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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.
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Learning Objectives
When you complete this supplement
you should be able to:
4. Use break-even analysis to
determine if outsourcing is costeffective
5. List the advantages and
disadvantages of outsourcing
© 2008 Prentice Hall, Inc.
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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
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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
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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
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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.
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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
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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.
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Strategic Planning and
Core Competencies
Sony,
An Outsourcing
Company
Outsourcers
could
provide
Post-sales
service
Financial
functions
Parts
manufacture
Marketing
Logistics
Core
Competency
Best in the world at
electromechanical
miniaturization
design
Employee
benefit
management
Distribution
Accounting
Maintenance
Real estate
management
Figure S11.1
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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
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Outsourcing Trends and
Political Repercussions
According to a survey of 53 major
corporations, the most important
reasons for outsourcing are:
Cost savings
Gaining outside expertise
Improving services
Focusing on core competencies
Gaining access to technology
© 2008 Prentice Hall, Inc.
77%
70%
61%
59%
56%
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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.
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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.
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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
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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
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Risks in Outsourcing
Outsourcing
Process
Examples of
Possible Risks
Identify non-core
competencies
Can be incorrectly identified as a
non-core competency
Identify non-core
activities that should be
outsourced
Just because the activity is not a
core competence for your firm
does not mean an outsource
provider is more competent and
efficient
Identify impact on
existing facilities,
capacity, and logistics
May fail to understand the
change in resources and talents
needed internally
Table S11.1
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Risks in Outsourcing
Outsourcing
Process
Examples of
Possible Risks
Establish goals and
draft outsourcing
agreement
specifications
Goals can be set so high that
failure is certain
Identify and select
outsource provider
Can select the wrong outsource
provider
Negotiate goals and
measures of
outsourcing
performance
Can misinterpret measures and
goals, how they are measured,
and what they mean
Table S11.1
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Risks in Outsourcing
Outsourcing
Process
Examples of
Possible Risks
Monitor and control
current outsourcing
program
May be unable to control product
development, schedules, and
quality
Evaluate and give
feedback to outsource
provider
May have non-responsive
provider (i.e., one that ignores
feedback)
Evaluate international
political and currency
risks
County’s currency may be
unstable, a country may be
politically unstable, or cultural
and language differences may
inhibit successful operations
Table S11.1
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Risks in Outsourcing
Outsourcing
Process
Examples of
Possible Risks
Evaluate coordination
needed for shipping and
distribution
May not understand the timing
necessary to manage flows to
different facilities and markets
Table S11.1
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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
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Methodologies for Outsourcing
 Evaluating Multiple Criteria with
Factor Rating
 Break-even Analysis
© 2008 Prentice Hall, Inc.
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Rating International
Risk Factors
Nine factors rated 0-3, 0 is no risk, 3 is high risk
Risk Factor
Economic: Labor cost/ laws
Economic: Capital availability
Economic: Infrastructure
Culture: Language
Culture: Social norms
Migration: Uncontrolled
Politics: Ideology
Politics: Instability
Politics: Legalities
Total risk rating scores
England
1
0
0
0
2
0
2
0
3
8
Mexico
0
2
2
0
0
2
0
1
0
7
Spain
2
1
2
0
1
0
1
2
2
11
Canada
1
0
0
0
2
0
2
2
3
10
Table S11.2
© 2008 Prentice Hall, Inc.
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Rating Outsourcing Providers
Seven factors rated 1-5 and an importance weight
Outsourcing Providers
Factor
(criterion)
Importance
Weight
BIM
(U.S.)
S.P.C.
(India)
Telco
(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
technology not in company
.1
5
3
5
6. Can create additional capacity
.1
4
2
4
7. Aligns with policy/
philosophy/culture
.1
2
3
5
Total and Averages
1.0
3.9
3.3
3.8
Table S11.3
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Break-Even Analysis
First define total cost in-house
TCin = Fin + (Vin x Xin)
where
TCin
Fin
Vin
Xin
© 2008 Prentice Hall, Inc.
is the total cost of an item produced in-house
is the total in-house fixed cost
is the variable cost/unit produced in-house
is the total number of units produced in-house
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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
X=
© 2008 Prentice Hall, Inc.
Fin – Fout
Vout – Vin
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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
© 2008 Prentice Hall, Inc.
Since
demand > break-even point,
produce in Toledo
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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
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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
Seek to do no harm to
indigenous cultures
Don’t use outsourcing in a
way that violates religious
holidays
Seek to do no harm to the
ecological systems of the
world
Don’t use outsourcing to
move pollution from one
country to another
Seek to uphold universal
labor standards
Don’t use outsourcing to take
advantage of cheap child
labor that leads to child abuse
Table S11.4
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Ethical Issues in
Outsourcing
Ethics Principle
Outsourcing Linkage
Seek to uphold basic human
rights
Don’t accept outsourcing that
violates basic human rights
Seek to pursue long-term
involvement in foreign
countries
Don’t use outsourcing as a
short-term arrangement to
reduce costs; view it as a
long-term partnership
Don’t think an outsourcing
agreement will prevent loss of
technology, but use the
inevitable sharing to build a
good relationship
Seek to share knowledge
and technology with foreign
countries
Table S11.4
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