Mc Graw-Hill Irwin 10 -1 Copyright 2010 by

Chapter 10 Outsourcing 10 -2

Key Concepts • Outsourcing: A Growth Industry • Strategic Issues » Core Competencies » Supplier Dominance » The Creation of Strategic Vulnerabilities » The Dangers of Vertical Integration • Horizontal Integration » New Product Development and Outsourcing » Lean Manufacturing • Tactical Decisions 10 -3

Key Concepts • Factors Influencing Make-or-Buy Decisions » Cost Considerations » Time » Capacity » Control of Production and Quality » Business Process Outsourcing » Technology Risk and Maturity » Unreliable Suppliers » Suppliers’ Specialized Knowledge and Research » Small-Volume Requirements » Limited Facilities 10 -4

Key Concepts • Factors Continued » Work Force Stability » Multiple-Source Policy » Managerial and Control Considerations » Procurement and Inventory Considerations • Netsourcing • The Volatile Nature of the Make-or-Buy Situation » Dangers of Outsourcing • Administration of Make-or-Buy Activities » Chief Resource Officer » Framework for Outsourcing » Executive Level Involvement 10 -5

Outsourcing and Supply Management • Outsourcing has become a way to increase an organization’s flexibility to meet rapidly changing market conditions, focus on core competencies and develop competitive advantage. • As a result, the need for world class Supply Management has intensified and positioned supply managers as agents of strategic change critical to supply chain success. 10 -6

Outsourcing: A Growth Industry • Outsourcing is increasing rapidly » Not just materials, many business functions are being outsourced • Outsourcing can enable: » Leveraging of the supplier’s expertise » Increases in innovation • And result in: » lower staffing levels » reduced costs » more flexibility 10 -7

Strategic Issues • Core Competencies • Supplier Dominance • The Creation of Strategic Vulnerabilities • The Dangers of Vertical Integration 10 -8

Horizontal Integration • Outsourcing all non-critical activities is a trend » The idea is to achieve significant cost leverage • To identify non-critical activities, the firm’s core competencies must be defined » All other activities are candidates for outsourcing 10 -9

From A Strategic Level: What Should Not Be Outsourced 1. An item that is critical to the success of the product 2. An item that requires specialized design, manufacturing skills or equipment 3. An item that fits well within the firm’s core competencies 10 -10

Strategic Analytic Procedure for Subsystems and Components Based on Figure 10 -1 Is the subsystem strategic? No Yes Can the subsystem be broken into families? No No Yes Outsource No Are families strategic? Yes Make In-House 10 -11

Make or Buy at Tactical Level • Poor supplier performance • Changing sales demand • Restricted manufacturing capability • Modification of product • Increased manufacturing capability • Improved supplier capability 10 -12

Considerations Which Favor Making 1. Cost considerations 2. Desire to integrate plant operations 3. Use of excess plant capacity 4. Control over production and/or quality 5. Design secrecy required 6. Unreliable suppliers 7. Desire to maintain a stable work force 10 -13

Considerations Which Favor Buying 1. Limited production facilities 2. Cost considerations (less expensive to buy) 3. Small-volume requirements 4. Suppliers’ specialized know-how 5. Stable work force (rising sales) 6. Multiple-source policy 7. Indirect managerial control considerations 8. Procurement and inventory considerations 10 -14

Major Elements Included in a “To Make” Cost Analysis 1. Delivered purchased material costs 2. Direct labor costs 3. Any follow-on costs stemming from quality and related problems 4. Incremental inventory carrying costs 5. Incremental factory overhead costs 6. Incremental managerial costs 7. Incremental purchasing costs 8. Incremental costs of capital 10 -15

Major Elements Included in a “To Buy” Cost Analysis 1. Purchase price of the part 2. Transportation costs 3. Receiving and inspection costs 4. Incremental purchasing costs 5. Any follow-on costs related to quality or service 10 -16

Cost Considerations • The time factor (two views) » Short-term view – Focus on direct measurable costs » Long-term view – Also measure hidden costs (storage, inspection, tooling, quality, etc. ) • The capacity factor (2 possibilities) » 1. We are at capacity – Fixed costs are an issue » 2. We are not at capacity – Fixed costs are not as much an issue 10 -17

Incremental Costs from “Make” Decision When Operating at 80% Capacity Figure 10 -2 10 -18

Other Factors Influencing the Make/Buy Decision • Production Requirements » To maintain control over ability to produce unique parts » Continuity of supply of critical parts • Quality Requirements » To control level of quality of difficult parts » To increase level of acceptable quality • Business Process Outsourcing Issues » Outsourcing complete business processes can speed up innovative change. » Organizations can outsource entire functions » Consideration must be given to secrecy issues when outsourcing aspects of a part or process design. 10 -19

Other Factors Influencing the Make/Buy Decision • Technology Risk and Maturity » Technology life-cycles » Developing or new technology • Unreliable suppliers • Suppliers’ Specialized Knowledge and Research » Take advantage of suppliers’ knowledge and expertise » Many industries/suppliers are highly specialized • Small Volume Requirements • Limited Facilities 10 -20

Other Factors Influencing the Make/Buy Decision • Workforce Stability » Stabilize the workforce » Retain a competent workforce • Multiple-Source Policy • Managerial Control Considerations » Data gained from outsourcing can be used to check internal processes and costs • Procurement and Inventory Considerations 10 -21

Netsourcing • Many companies are not readily staffed to keep a company competitive in e-business • As a result, companies are outsourcing infrastructure development and maintenance to “Netsourcers” • Netsourcing has become popular since it allows: » A quick e-business presence » Flexibility to make changes » Sustained performance » Support without the need to train or hire specialized personnel 10 -22

The Volatile Nature of the Make-or-Buy Decision • Beware of rigid formulas and rules of thumb • The make‑or‑buy question is influenced by a multitude of diverse factors constantly changing • Under such conditions, few easy decisions turn out well in both the short and the long run • Moreover, the relevant factors vary immensely from one firm to another • Every company should periodically evaluate the effectiveness of its past decisions to generate information helpful in guiding future decisions 10 -23

Dangers of Outsourcing • Loss of control • Loss of client focus • Loss of clarity • Loss of cost control • Ineffective management • Loss of confidentiality • Double outsourcing 10 -24

Administration of Make-or-Buy Activities • Chief Resource Officer » Manages and initiates outsourcing for direct support to the company’s bottom line • Framework for outsourcing » Information gathering » Strategic roadmap » Decision flowchart » Transition back plan » Review system • Executive level involvement 10 -25

Concluding Remarks • Firms are becoming more aware of the strategic dimension of the make-or-buy decision • As technology has advanced, most manufacturing firms have become much more specialized • Cost of materials has continued to increase in many industries 10 -26