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Chapter 8 Outsourcing and risk management. Program. Outsourcing as a business concept Definitions and concepts Rationales for outsourcing The outsourcing process Risk assessment Success factors Conclusions. Outsourcing as a business concept. Previously:
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Program Outsourcing as a business concept Definitions and concepts Rationales for outsourcing The outsourcing process Risk assessment Success factors Conclusions
Outsourcing as a business concept • Previously: • mainly outsourcing of activities • trend • Currently: • complete business functions are outsourced • Viable business strategy
Definitions and concepts • Characteristics of outsourcing: • in-house performed activities are transferred to a third party • Assets, knowledge and sometimes employees are send to the external party • Extended and long term relationship • Buyers from both parties experience new costs and risk profiles
Forms of outsourcing services Chandrashekar, 2000
Definitions en concepts Offshoring: Offshoring relates to the commissioning of work to a provider in a low cost country. In many cases offshoring is concerned with outsourcing of (IT) services. Partial outsourcing: only a part of an integrated function is outsourced. The coordination of the function and activities still lies with the client (the buyer). Here a major problem is of course how to demarcate the responsibility between the parties involved. Turnkey outsourcing: applies when the responsibility for the execution of the entire function (or activities) lies with the external provider. This includes not only the execution of the activities, but also the coordination of these activities.
Definitions en concepts Two different types of outsourcing: • Turnkey (integral) outsourcing:responsibility for the execution and the coordination of the entire function (or activities) lies with the external supplier. • Partial outsourcing:Only a part of an integrated function is outsourced. The coordination of the function still lies with the outsourcer.
Rationales for outsourcing All these reasons underlie one overall objective: to improve the overall performance of the outsourcing firm
Rationales for outsourcing Maintain / invest (opportunistically) Competencies are not strategic but provide important advantages; keep in-house as long these advantages are (integrally) real In-house / invest Competencies are strategic and world-class; focus on investments in technology and people; maximize scale and stay on leading edge High Level of competitiveness relative to suppliers Outsource Competencies have no competitive advantage Collaborate / maintain control Competencies are strategic but insufficient to compete effectively; explore alternatives such as partnership, alliance, joint-venture, licensing, etc. Low Low (non-core) High (core) Strategic importance of competence Savelkoul, 2008
Success of outsourcing Lyons (2001): 76% of outsourcers rate their outsourcing as good or extremely good. Gartner (2003): Satisfaction with the business benefits from outsourcing contracts fell from 86 percent in 2001 to 50 percent in 2002 among executives in Europe. Monczka e.a (2005) reported that 9 to 31 percent of the companies reported that outsourcing initiatives were falling short of their expectations and goals.
The outsourcing process Strategic phase Transition phase Operational phase Competence analysis Contract negotiation Contract termination Assessment & approval Project execution & transfer Managing relationship • Three phases: • Strategic phase (why, what, who?) • Transition phase (how?) • Operational phase (how to control?) Figure 8.4 Adapted from Momme, 2002
Strategic phase • Motives for outsourcing • Focus on core competences • Focus on cost efficiency/ effectiveness • Focus on service • Which activities or functions are outsourced • Transaction cost approach • Core competence approach • Qualifications of the supplier • Technicaland managerial qualities to achieve demanded level of performance
Four phase model Identification and assessment • Phase 1 • Market search • Preliminary assessment • Potential supplier list Market benchmark Performance management Audit and approval • Phase 4 • Supplier report card • Post contract review • Continuous improvement • Supplier validation • Phase 2 • Detailed audit • Confidentiality agreement • Approved supplier list Customer focus • Phase 3 • Contract negotiation • Order issue • Kick-off meeting • Execution Continuous improvement opportunities Project execution Adapted from Momme, 2002
The Transition phase • Contract negotiation • Contract forms a legal basis for relationship • Contracts depends on characteristics of outsourced activity • The contract type has a great impact on the success of the joint operation • Project execution and transfer • Outsourcing transition can be very complex • The transfer should be conducted using project management principles • Test phase before going ‘life’
Transitionphase • The type of contract is just one of many issues to be discussed. Other ‘ingredients’ in an outsourcing agreement are: • The scope of the service • Terms of agreement • Rates, fees, incentives • Termination plan • Conflict resolution • Communication • Management and control • Other (warranty, confidentiality etc.)
The operational phase • It is in the operational phase that the outsourcing will deliver its expected results • Successful outsourcing depends heavily on close cooperation with the supplier • McQuiston (2000) identifies six core values as being critical to a successful outsourcing relationship McQuiston (2000)
Risk assessment • In cases where trust and interpersonal relationships are not present, parties try to arrange for dealing with these risks and uncertainties by detailed outsourcing contracts • These contracts are associated with the following kinds of risks: • Technical risks: related to the extent to which the supplier is able to provide the desired functionality and performance • Commercial risk: related to the uncertainty with regard to the price we will pay and the costs that we will incur when having outsourced our activities to the supplier • Contractual risks: e.g. does the contract in sufficient detail describe the performance that is expected from the supplier? • Performance risks: related to the chance that the supplier is not capable of doing the job he was hired for. • Trust and partnership are more important to solve the problem.
Critical success factors of outsourcing Understanding company goals and objectives A strategic vision and plan Selecting the right vendor A properly structured contract Open communication with the individual groups involved Ongoing management of the relationship Senior executive support and involvement Careful attention to personnel issues The way the company is strategically positioned vis-à-vis its supplier. Can it still exert some control over its supplier, or not? www.theoutsourcinginstitute.com
Conclusions Outsourcing has become very popular as a business strategy in many industries around the world. The new strategy involves the decision to move an activity, that was conducted in house, to an outside provider. A careful outsourcing process is crucial for its success. The outsourcing strategy should be in line with the overall corporate strategy.
