Operations Management Supplement 11 Outsourcing as a

Operations Management Supplement 11 – Outsourcing as a Supply Chain Strategy Power. Point presentation to accompany Heizer/Render Principles of Operations Management, 7 e Operations Management, 9 e © 2008 Prentice Hall, Inc. S 11 –

Outline þ What is Outsourcing? þ Types of Outsourcing þ Strategic Planning and Core Competencies þ Theory of Comparative Advantage þ Outsourcing Trends and Political Repercussions © 2008 Prentice Hall, Inc. S 11 – 2

Outline – Continued þ Risks in Outsourcing þ Methodologies for Outsourcing þ Evaluating Multiple Criteria with Factor Rating þ Break-even Analysis © 2008 Prentice Hall, Inc. S 11 – 3

Outline – Continued þ Advantages and Disadvantages of Outsourcing þ Advantages of Outsourcing þ Disadvantages of Outsourcing þ Audits and Metrics to Evaluate Outsourcing Performance þ Ethical Issues in Outsourcing © 2008 Prentice Hall, Inc. S 11 – 4

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. S 11 – 5

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. S 11 – 6

Outsourcing þ Outsourcing can replace entire purchasing, information systems, marketing, finance, and operations department þ Applicable to firms throughout the world þ Making the right decision may be the difference between success and failure © 2008 Prentice Hall, Inc. S 11 – 7

What is Outsourcing? þ Procuring from external suppliers service or products the firms used to provide for itself þ Offshoring is moving processes to a foreign country but retaining control þ Firms that outsource are called clients, the actual work is done by the outsourcing provider þ Extension of the long-standing practice of subcontracting © 2008 Prentice Hall, Inc. S 11 – 8

What is Outsourcing? þ Outsourcing has become a major strategy as firms move toward specialization þ Increasing expertise þ Reduced cost of reliable transportation þ Rapid deployment of telecommunications and computers – the Internet © 2008 Prentice Hall, Inc. S 11 – 9

Examples of Outsourcing þ Call centers in French Angola þ Legal and finance service in the Philippines þ EDS handling information technology for Nextel þ IBM providing travel and payroll for P&G þ Solectron producing IBM computers © 2008 Prentice Hall, Inc. S 11 –

Types of Outsourcing þ Common processes outsourced are þ Purchasing þ Logistics þ Finance/accounting þ Customer relations þ R&D þ Operations þ Sales/marketing þ Training þ Service management þ Human resources þ Legal processes þ Outsourcing implies a legally binding contract © 2008 Prentice Hall, Inc. S 11 –

Strategic Planning and Core Competencies þ Strategic planning defines the mission and goals for the organization þ From this the organization determines the role of each business activity þ Core competencies are things the organization does better than its competition þ Non-core activities are good candidates for outsourcing © 2008 Prentice Hall, Inc. S 11 –

Strategic Planning and Core Competencies Sony, An Outsourcing Company Outsourcers could provide Post-sales service Financial functions Logistics Parts manufacture Competency Distribution Marketing Best in the world at electromechanical miniaturization design Accounting Employee benefit management Figure S 11. 1 © 2008 Prentice Hall, Inc. Maintenance Real estate management S 11 –

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 f rdless o ga n pplies re This a l locatio ca ographi the ge © 2008 Prentice Hall, Inc. S 11 –

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% S 11 –

Outsourcing Trends and Political Repercussions þ Outsourcing includes specific business functions (computer help desks) and entire departments (accounting, marketing, finance, etc. ) þ 35% of businesses said they would continue or expand outsourcing þ 40% said they would continue outsourcing but revise their arrangements þ Some said they would reduce outsourcing © 2008 Prentice Hall, Inc. S 11 –

Outsourcing Trends and Political Repercussions þ Outsourcing includes specific business functions (computer help desks) and entire departmentsing experiences are (accounting, outsourc þ Not all marketing, tfinance, etc. ) satisfac ory þ 35% of businesses saidlearn about still a lot to they wouldrove is þ There or expand outsourcingmp continue cing as a method to i outsour þ 40% roductivity psaid they would continue outsourcing but revise their arrangements þ Some said they would reduce outsourcing © 2008 Prentice Hall, Inc. S 11 –

Outsourcing Trends and Political Repercussions þ Political backlash can occur when jobs are outsourced to foreign countries þ In the U. S. state and federal laws have been enacted to limit or prevent outsourcing activities þ Recent data suggests more foreigners outsource jobs to the U. S. than American companies outsource offshore þ Backsourcing describes the process of returning work to the original firm when outsourcing fails © 2008 Prentice Hall, Inc. S 11 –

Risks in Outsourcing þ Outsourcing can be risky þ As many as half of all outsourcing agreements fail because of inappropriate planning and analysis þ Erratic power grids, government difficulties, inexperienced managers, and unmotivated labor can create problems þ Failure to achieve unrealistic goals sometimes create the impression of failure © 2008 Prentice Hall, Inc. S 11 –

Risks in 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 S 11. 1 © 2008 Prentice Hall, Inc. S 11 –

Risks in 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 S 11. 1 © 2008 Prentice Hall, Inc. S 11 –

Risks in 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 S 11. 1 © 2008 Prentice Hall, Inc. S 11 –

Risks in 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 S 11. 1 © 2008 Prentice Hall, Inc. S 11 –

Risks in Outsourcing brings other issues: þ þ Employment Changes in facilities and processes needed to receive components in a different state of assembly þ Vastly expanded logistics issues © 2008 Prentice Hall, Inc. S 11 –

Methodologies for Outsourcing þ Evaluating Multiple Criteria with Factor Rating þ Break-even Analysis © 2008 Prentice Hall, Inc. S 11 –

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 3 8 Mexico 0 2 2 0 0 2 0 1 0 7 Spain Canada 2 1 1 0 2 0 0 0 1 2 2 2 2 3 11 10 Table S 11. 2 © 2008 Prentice Hall, Inc. S 11 –

Rating Outsourcing Providers Seven factors rated 1 -5 and an importance weight Factor (criterion) 1. Can reduce operating costs 2. Can reduce capital investment 3. Skilled personnel 4. Can improve quality 5. Can gain access to technology not in company 6. Can create additional capacity 7. Aligns with policy/ philosophy/culture Total and Averages Importance Weight. 2 Outsourcing Providers BIM S. P. C. Telco (U. S. ) (India) (Israel) 3 3 5 . 2. 2 4 5 3 4 3 3 . 1. 1 4 5 5 3 2 5 . 1. 1 4 2 2 3 4 5 1. 0 3. 9 3. 3 3. 8 Table S 11. 3 © 2008 Prentice Hall, Inc. S 11 –

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 S 11 –

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 © 2008 Prentice Hall, Inc. Fin – Fout X= Vout – Vin S 11 –

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 – 1, 000 X= = Vout – Vin 4– 3 = 1, 000 units © 2008 Prentice Hall, Inc. Since demand > break-even point, produce in Toledo S 11 –

Advantages of Outsourcing þ Cost savings þ Gaining outside experience þ Improving operations and service þ Focusing on core competencies þ Gaining outside technologies þ Other advantages © 2008 Prentice Hall, Inc. S 11 –

Disadvantages of Outsourcing þ Increased transportation costs þ Loss of control þ Creating future competition þ Negative impact on employees þ Longer-term impact © 2008 Prentice Hall, Inc. S 11 –

Audits and Metrics þ Outsourcing agreements must specify results and outcomes þ Evaluation necessary to ensure satisfactory performance þ If the outsourced product or service is strategically important, the relationship needs continuing communication, understanding, trust and performance þ Services may require imaginative metrics © 2008 Prentice Hall, Inc. S 11 –

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 Don’t use outsourcing to take standards advantage of cheap child labor that leads to child abuse Table S 11. 4 © 2008 Prentice Hall, Inc. S 11 – 34

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 S 11. 4 © 2008 Prentice Hall, Inc. S 11 – 35