Outsourcing Decision

1. Outsourcing Decision 2002.1.30 산업공학과 제조통합자동화 실험실 김해중

2. About Outsourcing • Outsourcing 정의 • 내부에서 수행하던 비핵심적인 업무를 전문적인 외부기관을 이용하여 전략적으로 수행하는 신 경영전략 • 미국,일본 등 선진국에서 시작되어 최근 10년간 빠르게 성장 • 광의 • 아웃(Out) + 소스(Source) • "내부에서 하던 일을 외부의 기능이나 자원을 활용해 하는 것 • 예) 외주, 하청, 도급, 근로자파견, 업무대행, 분사화 • 협의        • 전략적 아웃소싱(Strategic Outsourcing) • 외부의 전문성 도입 등 전략적 관심을 갖고 해당 업무의 설계, 기획은 물론 관리 운영까지 수행하는 것 • 예) 나이키사의 제조와 광고부문의 아웃소싱 MAI Lab

3. About Outsourcing • 도입이유 • 외부자원의 활용을 통해 비용을 절감할 수 있는 방안을 강구하면서 그 대안으로 도입 • 기업들의 리스트럭처링(Restructuring)이나, 리엔지니어링 (Reengineering)의 일환으로 사업내용을 재검토하는 과정에서 • 장점 • 인소싱의 경우보다 고정비용이 적게 들고 경영효율화를 도모 • 핵심역량에 내부자원을 집중 • 외부의 전문인력을 활용함으로써 내부인력으로 불가능한 업무를 수행 • 사례 • 미국기업에서는 1980년대부터 기업의 생존 및 발전을 위해 아웃소싱으로 다운사이징 (Downsizing)과 리스트럭처링, 리엔지니어링 등 경영혁신기법 등을 구사하고 있습니다. • 우리나라 기업의 경우 60%가 Outsourcing을 하고 있으며, 향후 벤처 기업들의 증가로 폭발적 수요가 예상 MAI Lab

4. About Outsourcing • 3 단계 발전론 • 1단계 • 기업조직의 합리화, 효율화를 목적으로 비용을 절감하기 위해 아웃소싱 시작 • 경제적 아웃소싱 (Boundary Outsourcing) • 2단계 • 핵심역량이 있는 전략적 부문을 제외하고는 외부의 전문기능을 활용하는 전략적 아웃소싱으로 발전 • 멀티 아웃소싱 (Multi Outsourcing), 오픈 아웃소싱 (Open Outsourcing) (Boundary Outsourcing) • 3단계 • 고객기업과 아웃소서로서 쌍방이 핵심역량을 제공하며 전략적으로 제휴 • 코소싱 (Co - sourcing)) MAI Lab

5. A Conceptual Framework for Understanding the Outsourcing Decision European Management Journal vol. 17, No. 6 (1999) pp. 645~654 Aidan Vining Simon Fraser University, Vancouver Steven Globerman Western Washington University, USA

6. Contents • Introduction • An efficiency perspective on outsourcing • The costs of outsourcing • The determinants of outsourcing costs • Outsourcing situations and some possible strategies • Conclusion MAI Lab

7. MAI Lab

8. Introduction • Extensive Outsourcing • Outsourcing has grown rapidly during the 1990s • IT, accounting system, distribution • Nike, Sun Microsystems, Mattel, CK, Dupont • A vague understanding as to outsourcing • “Vertical integration is the organization form not of first but of last resort” (Williamson, 1991) • ‘Strategic alliance’ vs. potentially conflicting interests • The firm must know both the benefits and risks of outsourcing and specific determinants of conflict • Objective • Outsourcing costs and the determinants of the costs • Clear conceptual framework to the outsourcing decision MAI Lab

9. An efficiency perspective on outsourcing • Several issues • The purpose of outsourcing must be clear • Framework must be developed • Such a framework can be applied to a real firm’s outsourcing problem • Strategic objective • Minimize the total costs(expenditure for goods + governing cost) • How can the firm assess the potential governance costs? • How can governance cost be reduced? MAI Lab

10. Governance cost The Costs of Outsourcing • Production cost • Directly generate by the opportunity costs of the resources • Bargaining cost • Costs arising from negotiating contract • Costs of negotiating changes to the contract in good faith • Costs of monitoring • Costs of disputes(contracting breaking) • Opportunism cost • Any behavior by a party to a transaction designed to change the agreed terms of a transaction in bad faith MAI Lab

11. Production costs may be lower with outsourcing • In-house production of the good or activity often entails production at too low levels to be efficient – diseconomies of scale • There is a tendency for internal production units to act like monopolists – no competitions • Firms can experience diseconomies of scope in management of multiple firm activities • Internal production of an input may generate significant organizational negative externalities that can be reduced or eliminated by outsourcing • Empirical studies • Production cost savings are in the 20~30% if competitive bidding is used • Annual cost savings were 16~20% • Improved service quality by 24~27% • not included governing cost !!! • The firm should seek the regime that minimize the sum of costs MAI Lab

12. The determinants of outsourcing costs • Product/activity complexity • the degree of difficulty in specifying and monitoring the terms and conditions of a transaction • Determine the uncertainty surrounding the contact • Occurs the potential for information asymmetry • Information asymmetry raises that a pasty to the transaction can behave opportunistically  Product complexity raises the probability of internalization MAI Lab

13. The determinants of outsourcing costs • Contestability • How many firms can provide immediately? • A contestable market • Only a few firms are immediately to provide any given service • But many other firms would quickly become available if the price paid to exceed the average cost incurred by contractees • Affects opportunism costs • Low contestability can occur higher price and higher risk  Cross-national outsourcing  Make suppliers to own the (sunk cost) assets  Firms must retain a ‘core’ employee capacity MAI Lab

14. The determinants of outsourcing costs • Asset specificity • An asset is ‘specific’ if it make a necessary contribution to the production of a good and it has much lower value in alternative uses • Physical asset, location, human, temporal specificity • Contracts which require either party to employ assets that have little or no alternative use, raise the potential for opportunism MAI Lab

15. Outsourcing situations possible strategies • Low product/activity complexity and low asset specificity • Dominant problems • Few • Solution • Rely primarily on contestability via contract termination • Low product/activity complexity and high asset specificity • Dominant problems • Hold-up • Solution • For physical assets, outsourcing firm owns and leases assets MAI Lab

16. High product/activity complexity and low asset specificity • Dominant problem • Honest disagreements about quality and other performance • Solution • Where possible mutually agreed upon practice • High product/activity complexity and high asset specificity • Dominant problem • Opportunism by contractee • Solution • Harmonize outsourcing firm and contractee incentives through ‘rent-creation MAI Lab

17. Conclusion • Cost of outsourcing • Propose a simple framework that relates some alternative strategies for archetypal problem situation MAI Lab

18. Moving from Make/Buy to Strategic Sourcing:The Outsource Decision Process <Long Range Planning 34(2001) 605~622> Mike Tayles Bradford University School of Management, Emm Land, UK Colin Drury University of Huddersfield, Queensgate, UK

19. Contents • Introduction • Literature review • Research methodology • Case study • Background • The current structure and strategy • The sourcing decision process • Limitations • Conclusion MAI Lab

20. Introduction • Increasing of outsourcing • Survey of cost structures of manufacturing companies in the UK, US, EU : materials and components purchased from suppliers are the dominant costs averaging approximately 50% of total manufacturing cost • Seal et al. How reducing material costs can have an important gearing effect on profit: 5% reduction of material costs  40% profit increase • But the decision about in-house vs. outsourcing has not always been made on a very systematic basis • Objective • before: much literature on the content of capital budgeting decision but little on good process on how there decisions are implemented and managed • Strategic sourcing model for decision process • Strategies are integrated with purchasing MAI Lab

21. Cost-based Approach Policy Approach Literature review • Early( ~ 1990s) • Identification and comparison of the complex mix of incremental cost of the make or buy alternatives • An emphasis on short-term cost and profitability considerations • No relationship to any overall company strategy • Recent • A company’s technology strategy should drive its outsourcing strategy • Core competencies vs. neither critical nor something special (Quinn and Hilmer) • The Capital investment decision based on the NPV • Probabilistic risk assessment in outsourcing • Task of making sourcing decision should no be performed by manufacturing or purchasing officials alone. MAI Lab

22. Research methodology • Based on meetings and interviews with managers • Observer of the process • Offer comments on the iterations of the model MAI Lab

23. Case Study • Background • Engineering plc located in the UK, • Operates in a global market • The final products are complex, consisting of many components, systems and subassemblies • Many hundreds of components, each one of which could be either made or bought • Board of the company is responsible for establishing overall policies and strategies • Make/Buy Committee have dealt with outsourcing MAI Lab

24. The Current structure and strategy • Hierarchy of components • Based on their strategic importance • Category A component • Fundamental to product, vital to the product performance • Strategic advantage and high level of technical expertise • Design cannot be optimized without significant simultaneous engineering effort between design and manufacturing teams • Category B component • Less critical • It is not essential to made in in-house • It should be manufactured by one of a strategic supplier network, carefully vetted and controlled • Category C component • not fundamental and ban be source, somewhat routinely MAI Lab

25. Manufacturing Units • Competing directly with outside suppliers • Formally ranked in terms of actual and perceived potential performance • Level 1: world class • Policy: concentrate locations and experts and invest in capability and capacity • Level 2: not world class • Currently used to manufacture • Policy: gain maximum return for existing investment, but generally do not make new investment in capability • Level 3: No potential to be world class • Policy: exit MAI Lab

26. Decision Process • Supplier assessment: quality, delivery, cost, competitive position • A list of recommended suppliers • Strategic parts: only internal manufacturing unit • Non-strategic parts: internal manufacturing unit vs. external suppliers • Responsibilities for subcommittees: ongoing monitoring • Problems about decision • The uncertainty and ambiguity of the process and the decision criteria • There was a danger of making decision which would maximize the current reported profits • Major emphasis placed on the current or estimated standard cost of manufacture • Job security, job status, and unit performance. retain manufacture in-house in order to retain job MAI Lab

27. Sourcing Choice Change process or spec The sourcing decision process Core process /strategic component? Suppliers available Process in-house Review Strategy Resource available make < buy cost? make < buy cost? Review tradeoff Can resources be acquired? Capital spent? Tactical retention make < buy cost? Good return Suppliers available Second time here Competitive with more load Second time here Divest & buy Inload potential Make Invest & make Make Acquire resources & make Buy MAI Lab

28. Example • Component X • A major investment program is needed to protect regional employment and incorporate the latest manufacturing technology • The technology is advanced, but not considered core • These components have always been made in-house • The Board is prepared to consider outsourcing to a single-source accredited supplier MAI Lab

29. Sourcing Choice Change process or spec The sourcing decision process Core process /strategic component? Suppliers available Process in-house Review Strategy Resource available make < buy cost? make < buy cost? Review tradeoff Can resources be acquired? Capital spent? Tactical retention make < buy cost? Good return Suppliers available Second time here Competitive with more load Second time here Divest & buy Invest & make Inload potential Make Make Acquire resources & make Buy MAI Lab

30. Example • Component Y • On the boundary of category A and B • The technology for these components are changing • To move forward with the technology or in a strategic alliance with a dedicated supplier ? • There are some members of the strategic sourcing committee who advocate retention of the technology in-house MAI Lab

31. Sourcing Choice Change process or spec The sourcing decision process Core process /strategic component? Suppliers available Process in-house Review Strategy Resource available make < buy cost? make < buy cost? Review tradeoff Can resources be acquired? Capital spent? Tactical retention make < buy cost? Good return Suppliers available Second time here Competitive with more load Second time here Divest & buy Invest & make Inload potential Make Make Acquire resources & make Buy MAI Lab

32. Example • Process Z • This process has been performed on old plant • The Technology is old and demand has fallen over the last five years • Unit manufacturing cost is low MAI Lab

33. Sourcing Choice Change process or spec The sourcing decision process Core process /strategic component? Suppliers available Process in-house Review Strategy Resource available make < buy cost? make < buy cost? Review tradeoff Can resources be acquired? Capital spent? Tactical retention make < buy cost? Good return Suppliers available Second time here Competitive with more load Second time here Divest & buy Acquire resources & make Invest & make Inload potential Make Make Buy MAI Lab

34. Limitations • The Availability of new suppliers • It is sometimes difficult to know whether external suppliers exist or become available in the timeframe under consideration • Knowing when and how to exit in-house manufacture requires careful planning MAI Lab

35. Conclusion • The strategic sourcing model • It has contributed to more effective decision • The outsourcing was coincided to the strategy • The refinement of the organization • It has provided the company with greater visibility both of issues and of the process MAI Lab