Supply Chain Management:
From Vision to Implementation
Chapter 9: Core Competencies and
Outsourcing
Chapter 9: Learning Objectives
1. Describe the notion of core competency.
Identify an organization’s competencies and
determine whether they pass the three-fold
test of a core competency.
2. Define outsourcing and discuss reasons why
companies outsource.
3. Describe the three phases to developing and
executing an outsourcing strategy.
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Chapter 9: Learning Objectives
4. Identify and assess some of the potential
risks associated with outsourcing.
5. Conduct a make-or-buy analysis to support
an outsourcing decision.
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What is a Core Competence?
 Core competency is the set of activities, skills,
or advantages that distinguishes a company
for its competitors.
“… the collective learning in the organization,
especially how to coordinate diverse
production skills and integrate multiple
streams of technologies.”
- Prahalad & Hamel
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Core Competence
 To compete and win in the global marketplace
a company must be uniquely good at at least
one thing that the customer values.
 Most industry leaders build their core
competencies around a handful of essential
skills.
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Identifying Core Competencies
 Does the identified skill set contribute significantly
to what customers perceive as our organization’s
value-added?
 Is the skill set difficult for others to replicate or
imitate?
 Are we particularly good at the skill set, or willing
to invest the resources to become excellent?
 Is the skill set broad enough that it allows us to the
opportunity to enter many diverse markets or
businesses?
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Complementary Core Competencies
 Once a company finds its core competency, it
can design a supply chain to support its
competitive strategy, value proposition, and
competency development.
 Outsourcing non-critical activities to supply
chain partners allows companies to leverage
complementary core competencies.
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Outsourcing Flowchart
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The Outsourcing Challenge
 Outsourcing is the process of moving an
aspect of production, service, or business
function from within an organization to an
outside supplier.
 Government public agency outsourcing is
called privatization.
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Outsourcing Trends
 Contract Manufacturing (CM) – a third-party makes
an end product or major component under another
company’s brand.
 Third-Party Logistics (3PL) – using a supplier to
provide some combination of logistics activities.
 Offshoring – outsourcing to a different country.
 Business Process Outsourcing (BPO) – outsourcing
support functions such as: HR, payroll, logistics, etc.
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Benefits of Outsourcing
 By outsourcing non-strategic processes, an
organization can focus its attention on those
things it does best to satisfy the customer.
 Other benefits include:





Cost savings
Capital conservation
Performance improvement
Access to low-cost labor and/or resources
Benefit from outside expertise
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Top Reasons for Outsourcing
Conserve Capital,
3%
Grow Revenue, 4%
Increase Innovation,
3%
Reduce Operating
Costs, 48%
Improve Quality, 3%
Improve Skills, 9%
Focus on the Core
Business, 17%
Create a Variable
Cost Structure, 13%
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Outsourcing Risks
Outsourcing is not without risk:
 Outsourcing strategic activities may cause a loss of
competitive position.
 Strategic risk – long-term, perhaps irreversible, risk
based on a loss of knowledge related to core
activities.
 Tactical risk – short-term risk based on use of
supplier for capacity, not knowledge.
 Increased dependence on suppliers for knowledge
weakens the buyers relative bargaining power.
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Outsourcing Risks
Strategic Risks
Tactical Risks
Firm loses knowledge and/or
technology to perform activity
internally
Firm experiences:
Supplier develops unique, hard to
replicate expertise
Short-term supply shortages
Supplied activities add unique
value recognized by customer
Hidden transaction or
management
costs
Customer identifies more with the
supplier than the original firm
Loss of schedule control
Firm loses sight of market trends
Short term price fluctuations
Supplier shares knowledge with
firm’s competitors
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Outsourcing Process Phases
Phases
Key Participants
Establish mission, generate and
screen ideas
Top management , business unit and
functional leaders
Conduct an outsourcing feasibility
study
Multi-disciplinary team of key
stakeholders in the current process
Establish and manage the
relationship with the supplier
Purchasing or relationship manager
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Established the Outsourcing Mission
A multidisciplinary team of high-level managers
should:
 State the benefits it hopes to achieve by
outsourcing
 Nominate processes for outsourcing
 Screen those processes against key success
factors to determine which are best suited for
outsourcing
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Outsourcing Projects - Screening
Project
Decision/Rationale
Laundry
Outsource – internal support function
Forms
Management
Outsource – internal support function
Information
Technology
Outsource – important area, but do not excel in this area; could
not invest to achieve excellence
Supply
Management
Do not outsource – critical to internal analysis, maintaining key
supplier relationships, and cost competitiveness
Food Service
Outsource – although excellent cafeteria, does not add-value to
the customers, nor would is it be difficult to replicate
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Conduct an Outsourcing Analysis
 Multi-disciplinary team of key stakeholders in
the current process evaluate each potential
process to outsource as determined by the
screening process.
 Evaluation includes:
 Developing a better understanding of the
organization’s needs
 Gathering detailed cost, performance, and risk
information
 Total cost of ownership analysis
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Outsourcing Analysis - Suppliers
Assessment of the supply market capabilities,
considering:
 Are supply sources available?
 Do potential supply sources meet capacity,
quality, and other organizational needs?
 Are the suppliers interested?
 What risks are present in outsourcing?
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Outsourcing Analysis - Suppliers
 Reverse Marketing is the process of
recruiting a supplier to provide an item or
service that the supplier not currently
providing, or unable to provide.
 Restating Need and Expected Benefit
considers the scope and scale of outsourcing
required providing new insight on ways to
achieve the desired benefit.
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Identifying & Mitigate Potential Risks
 Most organizations are good at recognizing tactical
risk.
 A larger issue is strategic risk; by ceding power
through outsourcing, a supplier might be able to
capture a larger share of the overall chain’s margin.
 Contingency plans should be developed to deal with
identified risks associated with outsourcing.
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Outsource Risk & Mitigation Strategy
Risk Issue
Safeguard
Capacity or shortages
Identified alternative sources for key parts, keeping in mind that
all distributors use the same manufacturers, so shortage is
difficult to avoid in an industry-wide shortage
Loss of competitive pricing
information
• Right to audit manufacturers’ bills built into contract
• Right to “test market and go out to receive competitive bids for
comparable services
• Most favored customer clause in contract to ensure that
Image’s price meets or beats the price offered to other
customers receiving the same service
Hidden transaction or
management fees
• Cap fees in contract
• Right to audit distributor’s cost allocations built into contract
• Contractual clause requiring distributor’s bills itemized into
major cost categories for management fees, rather than one
lump sum
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IT Outsourcing - Risk Mitigation Plans
Risk Issue
Safeguard
Poor service to internal customers
• Establish internal user survey that links service
provider’s pay to performance
Poor communication or management
of service provider
• Dedicated relationship managers at Image
• Advisory Board to meet with relationship manager,
service provider, key users to provide feedback,
discuss technology needs and trends
Difficulty in controlling costs
• Hire a third party to audit service provider, compare
rates with other like companies
Loss of internal expertise
• Loss in support level expertise could not be
avoided. However, relationship manager, CIO and
others would retain enough strategic knowledge to
replace the service provider effectively if needed
Short contract duration/high turnover
would be expensive for supplier and
frustrating for internal users
• Established a five year contract with annual reviews
and contract extension clauses
Transitioning own employees out of
IT and training new employees by
service provider
• Virtually all current Image IT employees were
offered and accepted jobs with service provider to
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remain at Image
Outsourcing Analysis - TCO
 A cross functional team should analyze all
direct and hidden costs associated with the
current and perspective outsourced activity.
 Cost included: materials, labor, energy,
overhead, transportation, inventory, quality,
obsolescence, and capital.
 Sensitivity analysis should be performed to
determine on a total cost of ownership basis
whether there is a cost incentive for
outsourcing.
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Manage the Outsourcing Relationship
 Outsourcing arrangements exist on a continuum
from minimum service to full service turnkey
operations.
 Limited-scope suppliers are less unique and
therefore easy to replace.
 Full-service suppliers provide unique value and are
therefore more closely integrated.
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Supplier Relationships: Arm’s-Length
 Best suited for “routine” purchases of goods
or services.
 No long-term commitment or special valueadded by this supplier.
 Non-recurring purchases of items that aren’t
critical
 Supply market is very competitive
 Switching costs are low
 Suppliers are not differentiated.
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Supplier Relationships: Niche
 Providers are generally specialized, providing
a very specific, limited good or service.
 May be more difficult to replace than armslength suppliers due to their specialized
nature.
 In general, these are specialized, nonrecurring purchases.
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Supplier Relationships: Hybrid
 Provide an intermediate level of service.
 Provide items of moderate importance that are somewhat
integrated into the organization’s operations.
 May be responsible for a whole subsystem or process rather
than one clearly defined piece, as do limited scope providers.
 Standard “turnkey” solutions, and may even run some of the
company’s internal processes with their own people.
 Boundaries between the provider and the firm may begin to
blur.
 Ongoing communication is critical
 Higher degree of reliance and switching costs
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Supplier Relationships: Full-Service
 Provide strategic items and processes that are
entrenched in the firm’s own processes.
 Custom solutions
 Often engaged in Business Process Outsourcing of
critical functions.
 These providers have a very high level of
responsibility and accountability.
 Have a significant presence in the organization,
working side-by-side with the organization’s
employees.
 Difficult to evaluate and manage.
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Outsourcing Relationships
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Outsource Relationship: Oversight
 Routine relationships are named for traditional contract
management. The contract terms are clear and the
deliverables are simple to use and measure. Routine
relationships are best suited to arms-length and niche
arrangements.
 Cooperative relationships are suited to hybrid outsourcing
arrangements. The contract defines the relationship, but the
suppliers also cooperate on an on-going basis to redefine
expectations and goals based on changing business needs.
 Committed relationships are common between buyers and
solutions integrators. The two parties have committed a great
deal of resources and efforts to the relationship, and their
management style should reflect this.
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Outsourcing Relationship: Oversight
Type of Relationship
Routine
Arms-Length
X
Niche Provider
X
Cooperative
Hybrid
X
Solutions Integrator
X
Committed
X
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Oversight Characteristics
Issue
Routine
Cooperative
Committed
Level of management oversight after
relationship is established
Low
Low to
medium
High
Strategic importance of item/process
outsourced
Low
Medium
High
Need to interface with supplier closely to
understand processes
Low
Medium to
high
High
Anticipated change/improvement over lifecycle
of relationship
Low
Medium to
high
High
Interdependence of our process with supplier
Low
Medium
Medium to
high
Our need to be a “preferred customer” to this
supplier
Low
Low to
medium
High
Level of ambiguity and change in expectations
Low
Low to
medium
Medium to
high
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Ongoing and Post-Audit Evaluation
 Routine relationships - feedback often is complaining to the
supplier when it performs poorly. If a significant supplier,
may receive a standard “report card” of key performance
indicators (KPIs). The report compares actual to expected
performance on key KPIs.
 Cooperative relationships - supplier likely receive a semicustomized report card capturing data regarding the value the
supplier adds.
 Committed relationships – supplier likely to receive a
customized report card based on establishing performance
indicators for key issues. In addition, much of the
performance feedback would be verbal, as this is a close dayto-day interaction.
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Typical Outsourcing Report Card
Performance Indicator
Rating
Goal
Comments
Completes Key Tasks on
Time
90%
98%
Was late on transitioning
to new inventory system
Meets Service levels to
internal customers
95% same day response
92% same day
response
Excellent; keep up the
good work!
Follows up on missed
service levels within a
week
99%
95%
Thanks for your good
work!
Client perception surveyQuality
88% meets/exceeds
quality expectations
90% meets/exceeds
quality expectations
Need to perform a root
cause analysis and
identify weak area(s) to
target improvement
Client perception surveyTechnology leadership
95% meets/exceeds
Technology leadership
expectations
90% meets/exceeds
Technology
leadership
expectations
Good work!
Within budgeted costs
unless prior approval
given
100%
100%
Good work
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Buyer Skills
 “Traditional” buyers manage contractual
relationships that are clearly defined, with
clear expectations and performance measures.
 Outsourcing requires that supply professionals
master creating and managing complex
relationships due to the more fluid and less
clearly defined supply environment.
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Insourcing
 The outsourcing decision is not permanent or
irreversible; the structure of the firm must
adapt to changing business environment.
 Companies may bring outsourced activities
back in-house due to a number of reasons:
 Failure to achieve expected benefits
 Increase control over key processes
 Changing business priorities and core competence
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A Return to the Opening Story
Based on what you have now read and discussed:
1. Do you think that the task force member’s concerns
are warranted? Why or why not
2. How do you suggest that Doug keep the task force
members focused on the topic of outsourcing as a
legitimate SC decision, rather than their fears related
to their own functional areas?
3. Is this a strategic issue, tactical issue or both? Explain
your answer, and how the task force should address
this?
4. What activities and analysis should the task force
undertake to address the Executive Committee’s
questions?
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