DSC 2006 Operations Management
Outsourcing
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I. Introduction
Outsourcing is used extensively by both the manufacturing and service industries, and there are plenty of reasons to utilize outsourcing. Organizations make use of outsourcing usually in the interest of lowering cost and to make better use of time and energy costs, hence redirecting their energy to something more important or just to conserve energy. Outsourcing is essentially a division of labour. One simple example involves companies outsourcing their financial statements to accountancy firms to consolidate their expenditures, hence eliminating the need to hire an accountant. Another relevant example would be to hire the services of another company to manage all or parts of the services that otherwise would be otherwise rendered by an IT unit of the organization.
Some reasons for outsourcing include organizations being able to focus purely on their core business, for example an automobile factory. The raw materials required to manufacture an automobile are outsourced to other companies and hence the company itself can focus on just creating quality automobiles. By outsourcing the raw materials to companies who specialize in providing them, they can also ensure that the raw materials are of reasonably better quality and this can be done by contracting with a new service level agreement. Another reason being companies are able to access the wide pool of talent available through hiring agencies.
In layman terms, outsourcing involves transferring the management and day-to-day execution of an entire business function to an external service provider. Outsourcing is mostly attractive to smaller companies as it can help to reduce the cost of hiring addition manpower who might not be useful in their daily running of the business, or service industries such as hospitals where they obtain their supplies from external parties. I personally feel that the key to making use of outsourcing efficiently is to have precise planning beforehand and decisions on which types of services or products should be outsourced which will benefit the company in various ways.
In operations management, there is constantly a debate whether to outsource or to internalize. On one hand, internalization limits the flexibility of operations and increases cost but on the other hand, it usually results in more effective productions as compared to outsourcing as the quality of outsourced products and services are quite unpredictable. This is where the transaction cost theory (TCT) comes into play. The TCT is often used to evaluate the cost efficiency of outsourcing before operational managers make their choice of internalizing or outsourcing.
Operations can also be outsourced to overseas organizations, and this process is coined as Offshoring. Offshoring describes the relocation by a company of a business process from one country to another, typically an operational process, such as manufacturing, or supporting processes, such as accounting.
II. Literature Review (Summary)
Theoretical model and Hypotheses
The first paper, entitled ‘Unlocking the Business Outsourcing Process Model’ by Sean M. Handleya and W.C. Benton Jr., basically explains how there might be a troubling gap between expectations of outsourcing and what happens in reality, which according to surveys done, has demonstrated how organizations fail to recognize the benefits and usefulness of outsourcing. It introduces new concepts and gives a thorough explanation of how they might prove to be vital in achieving positive outsourcing results. Each of this concept plays a different role in ensuring the achievement of positive outsourcing results. Precise details regarding how they may have a direct or indirect effect on outsourcing results are also provided for clearer understanding. I realize a commonality amongst most of the articles that I have had the chance to review is that each consists of their own hypotheses and theories on various issues regarding outsourcing and making use of surveys and questionnaires to prove the accuracy of their theories. The results can prove to be rather subjective as the questionnaires were mostly sent to firms in general and cannot be narrowed down to a specific firm.
Comparing Outsourcing and Internalizing
The second paper, titled ‘Benchmarking and Monitoring International Warehouse Operations in Europe’ by M.B.M de Koster and Bert M. Balk compares and contrasts between the usage of outsourced public warehouses and own-account warehouses. The paper shows comparisons amongst warehouses in various countries and also the types of warehouses organizations utilize. I have concentrated more on the section of comparisons between the different types of warehouses, the types being outsourced or own-account warehouses. It uses a simple method of comparison called the Data Envelopment Analysis (DEA) which integrates a variety of performance metrics and provides a structured method for evaluating warehouse performances. Questionnaires and surveys were sent to approximately 400 warehouses all around the world regarding the storage of inventories and after consolidating the results, it shows that the efficiency of both outsourcing dedicated and public services prove greater than utilizing an own-account warehouse.
Behavioral Factors Affecting a Manager’s Decision
Some of the research papers also delve into the behavioral factors that influence a supply manager’s decision to make or buy. The results gathered was that both strategic vulnerability and core competency of firms plays a part in influencing the decision to outsource, but the former has a greater influence than the latter. Thus results have concluded that firms can ensure a better decision made if they can understand the biases that influences the decision maker.
Risks and Benefits of Outsourcing
The fourth paper, titled ‘Outsourcing impact on manufacturing firms value: evidence from Japan’ is a research paper done by Jiang, Belohav and Young to study the relationship between market valuation of firms by investors based on announcements of outsourcing decisions and investigation is carried out using a cross-sectional valuation approach. This research paper views outsourcing effects on a firm’s future revenue-generation potential by using market value of the firm’s stock pricing as a guide.
The fifth paper, titled ‘Offshore outsourcing of professional services: A transaction cost economics perspective.’ is a research paper done by Ellram, Tate and Billington. Their research focuses on using a theory called Transaction Cost Economics (TCE) to determine the costs and risk which might be incurred during the process of offshoring. The paper basically explains how organizations will only invest in areas of low or manageable risk and that organizations will be more willing to pay a fixed cost to establish an excellent relationship with companies they have outsourced their business to. All this information is computed by interviews and surveys conducted for 10 supply management executives.
III. Review 1: Unlocking the Business Outsourcing Process Model
The first paper investigates the influence of three important concepts, or rather factors, which might make a difference in the form of projected outsource results. The three factors, as mentioned above, are Strategic Evaluation, Relationship Management and Contractual Completeness. The paper concluded that concrete data collected from executives and managers from various companies responsible for initiating outsourcing shows that extensive strategic evaluation is imperative in achieving better outsourcing performance, but performance is also bounded by the relationship shared between the parties and also the contract discussed between them. I’ll start off with a simple definition and usage for each factor.
Strategic evaluation means to perform a comprehensive evaluation of the strategic implications of outsourcing the business activity. The evaluation is prepared mainly from the capability and risk perspectives. Capability perspective is based upon the resources available and if outsourcing will be beneficial to the firm. Furthermore, firms must have a thorough understanding of their core competencies in order to decide which activities to outsource and if outsourcing that particular activity or activities will benefit the firm. Contractual completeness is simply the extent to which the outsourcing firm and chosen provider develop a contract which effectively coordinates resources and addresses identified inter-organizational risks. There are various clauses and regulations stated in a contract and it would be wise for the outsourcing firms to come up with a detailed and precise contract in order to ensure and control quality of services and products. The contract should include promises made, obligations to perform and process for resolution of disputes. Finally, Relationship management is all about establishing and maintaining a mutually beneficial relationship with the supplier or vendor. Commitment to a certain provider is crucial in cooperation because it shows a certain degree of trust and goodwill for the provider, increasing the chance for the provider to reciprocate with the same amount of commitment. This can pave the way to build long term beneficial relationships.
Next, the paper derived hypotheses interconnecting the three concepts and how they might influence one another. There are all together 5 hypotheses but for the purpose of this paper, I have decided to concentrate on the three most useful and supported hypotheses, based on the results of the questionnaire done by approximately 2000 procurement and outsourcing professionals. Firstly, strategic evaluation not only provides better knowledge about the control and coordination requirements to effectively achieve the outsourcing objectives, it is also used to evaluate the risk and implications involved regarding outsourcing. Being able to understand these risks and implications can allow firms to draw up a more thorough contract which will allow them to clarify responsibilities and formalize procedures involve to protect themselves. Hence, strategic evaluation has a significant positive effect on contractual completeness. Secondly, although a contract is crucial in achieving the control and coordination objectives, firms cannot just depend on contracts alone. Instead, these objectives must also be effectively achieved through relational mechanisms which foster trust and mutual commitment with the providers. Strategic evaluation forces the firms to consider all aspects of strategic implications brought about by outsourcing activities and therefore, they can clearly communicate and clarify with the providers regarding any issues that might occur. The paper states that when firms cannot deliver such clarity on their expectations, providers will find it difficult to satisfy the customers. Therefore with this clarity, firms can work better with the providers and build a healthy and beneficial relationship, which leads to the hypothesis that strategic evaluation has a significant positive effect on relationship management as well. The third hypothesis is that relationship management has a significant positive effect on overall outsourcing performances. Developing close supplier relationships is important and provides competitive advantages for the firms such as lower transaction costs and superior operational performance.
IV. Review 2: Outsourcing impact on manufacturing firms value: evidence from Japan
The next paper’s research is based upon 441 Japanese manufacturing firms that outsources to either domestic or overseas. The paper gives a general insight to what are some of the outsourcing decisions made by companies and how these decisions can affect the market valuation of the company. Firstly, the researchers came up with various accounting variables which relates to the market value of the firm, after which they derived a few hypotheses to examine the relationship between the variables and the market value of the firm. For the purpose of this paper, I have only provided a few hypotheses I feel are more relevant, namely H1: The outsourcing decision will demonstrate a positive signal to the stock market, H2b: Outsourcing core business will demonstrate a negative signal to the stock market compared to outsourcing non-core business, H3a: Offshore outsourcing will demonstrate a negative signal to the stock market compare to domestic outsourcing, and lastly H4a: Short duration outsourcing contract will demonstrate a positive signal to the stock market compared to long-term outsourcing.
After the analysis of results, they gather that the positive influence of outsourcing on the firm’s market value is obtained at 10% significance level, thus H1 is true. By outsourcing certain operations, the perspectives by investors is that this can improve the firms’ cost efficiency and therefore lead to a positive relation between outsourcing decision and the firms’ market value. However, H2b was proven to be untrue. Their research suggests that outsourcing firms’ executives have no reason to outsource their firm’s core competencies out as they are crucial to the company, hence if they were to outsource their core competencies to other vendors, these vendors are known to be the best there is in the market, providing high quality services and products. Hence, research reveals that core outsourcing core-competencies is absolutely relevant to the firms’ market value. H3a was proven to be wrong. Results from the analysis actually reveal that offshore outsourcing actually improves the firm’s market value. Base on the results shows, investors believe that most Japanese firms would prefer offshore outsourcing to domestic outsourcing because they believe that offshoring to overseas firms can increase the market value of the firm if it can provide better services and products compared to domestic firms. Lastly, feedbacks regarding short-term (less than 3 years) contracts have been statistically proven to be positive thus confirming H4a .Outsourcing firms have the tendency to amend contracts quite often to align with whatever strategies that they are adopting to and the tendency is that the vendors will refuse to make any changes that might affect their profit margins, hence having a short-term contract can prove to be a better choice for firms who require constant change and improvements to their contracts.
The paper has suggested a few scenarios in which the market value of the firms can be increased, namely 1. An increase in outsourcing 2. Increase in outsourcing of core-businesses 3.Increase in offshore outsourcing and finally 4. Having short-term outsourcing contracts. These 4 scenarios are just some of the suggestions on how outsourcing can be proven to be beneficial to increasing the market value of the firms.
V. Review 3: Offshore outsourcing of professional services: A transaction cost economics perspective
The third paper focuses on how firms use TCE to determine whether or not to outsource a certain activity. The transaction cost economics, or the TCE as it is commonly known, consist of elements such as transaction frequency, asset specificity and uncertainty to outsourcing situations. Transaction frequency simply means the number of transactions that occurred, which could in turn contribute to the cost incurred. Asset specificity is basically assets that are specific to a certain operations and cannot be used in another application or transferred to another customer. Uncertainty has various situations, and the paper discusses situations such as uncertainties in the external environment and internal uncertainties in requirements. The paper made a few propositions in relating TCE to outsourcing decisions, mainly P1. Firms will be more likely to offshore outsource larger volume professional service categories and find small volume categories “uneconomic”. P2. The higher the level of asset-specific investment required, the less likely the professional service category is to be offshore outsourced. P3. The more volatile the supply market environment, the less likely the professional services category is to be offshore outsourced. P4. The more uncertain the firm is about its requirements, the less likely the professional services category is to be offshore outsourced. The first proposition suggests that firms would prefer to outsource larger volume of services rather than a small volume to reduce transaction frequency and hence cost. The second proposition suggests that with a high level of asset-specific investments, firms would prefer to in source rather than outsource as they might become too dependent on the particular supplier for assets, causing suppliers to become opportunistic. The third proposition suggests that with high market volatility, firms would prefer to perform the operation internally in order to response to changes in the market more readily than their suppliers. The final proposition suggests that firms that outsource to suppliers services with uncertainties as to what it requires may limit its own flexibility and options, allowing the suppliers to be opportunistic as well.
The paper uses interviewing as a research method. 10 high ranking professionals were interviewed and their results were consolidated. Results show that P1 is supported. P2 is only partially supported. The results suggest that firms do go to great lengths to avoid outsourcing specific physical assets but not specific knowledge assets because the risk involved is not great enough to deter the companies from outsourcing. Next, all of the firms concentrate offshore outsourcing to areas of low market risk. An example was given that some organizations ‘follow’ only when they deem its safe, meaning that they allow other firms to go ahead first. If results prove to be successful, then will they quickly follow suit to outsource activities to that particular area. All the studies done showed that companies are all cautions of various risks involved, hence P3 is supported. P4 was supported as well, partly due to firms realizing that it’s a risk to outsource activities which they are not entirely sure about, hence leading to lack of precise specifications and increasing the need to update and make changes, allowing the providers to take advantage of the situation by increasing cost. Hence firms, who are unsure of their requirements, will have less probability of outsourcing.
VI. Discussion
The first paper focuses on the concepts of strategic evaluations, relationship management and contractual completeness, how are they related and how they can contribute to better outsourcing performances. The paper suggests that firstly, organizations must focus on developing close commitment and cooperation with suppliers in order to maximize their performance expectations. Secondly, the effect of strategic evaluation on outsourcing performance is more of an indirect rather than a direct influence, and that the key point is that strategic evaluation creates a great influence on relationship management with the suppliers which in turn directly influences outsourcing performance and finally, a more complete contract does not necessary promise a better outsourcing performance. The second paper concur that a complete contract does not necessary promise a better outsourcing performance, hence the idea of having a short-term contract. One limitation of this paper is that it only considers about 3 factors when it is possible that there are various other factors that play a major role in obtaining better outsourcing performances such as advancements in information technology. Outsourcing is an ever-evolving field that offers more complexities that must be fully understood in order to utilize this tool to our advantage.
The second paper is rather useful for companies exploring options in outsourcing because not only does it provide the pros of outsourcing, the paper provides cons as well. Making good outsourcing plans may have been proven to be beneficial to most organizations but for some companies, making wrong outsourcing decisions might result in dire consequences. Operational managers are hence required to evaluate both pros and cons of outsourcing. For example, the paper came up with a proposition saying that firms might favor domestic outsourcing to offshoring due to the fact that offshoring might create supply chain implications and communications problems. However, statistics have defied this proposition and upon further studies done by the researchers, they discovered that firms who outsource to competitive vendors, or rather vendors, who are direct competitors of the outsourcing firms, are not able to collaborate well with the vendors due to competition and hence creating a negative impact on the firm’s market value. This particular proposition is therefore untrue and highlights the point in the first article that being able to build a good relationship with the vendors will definitely contribute to improving outsourcing and hence increasing market value of the firm in this case. Again, this is just one of the outsourcing situations which can cause a decrease in market value of the firm and by reviewing this paper thoroughly, companies can incorporate some of the useful propositions in its blueprints for future outsourcing plans and avoid the proposition that are detrimental to the market value.
The third paper concentrates on offshore outsourcing, which means to outsource overseas. It uses the elements of transaction cost, asset specificity and uncertainty in outsourcing situations to form propositions to indicate how these elements affect decisions made on offshoring. The paper concludes that offshoring process is a sophisticated process and then it requires more intricate planning and evaluation before settling down on a decision. There are many risks involved in offshoring and firms must be able to understand and find a solution to best handle the risks. One way this research could have been improved will be to increase the number of interviewees. Although all 10 interviewees are considered in the highest regard and are the best in the business, there may still be some implications that they have not experienced before. Increasing the number of interviewees will provide the researchers with a broader spectrum of answers and hence improving the accuracy of their results.
In conclusion, the three articles suggest that it is important for organizations to plan carefully about the implications that might occur to either domestic outsourcing or offshoring, and this is where strategic evaluation plays a vital role. Other than implications, the most important consideration would be how outsourcing can be utilized by organizations as a tool to benefit them and how beneficial is outsourcing to them. To ensure that outsourcing brings about more benefits than problems, operational managers have to be prudent in their planning and they can definitely refer to these articles for guidance and sound advice. The only limitation that I’ve discovered is that the results gathered from these surveys and questionnaires are subjective, meaning to say, the results cannot represent what each specific firm think about outsourcing, the results generates a general opinion. A good proposal for further research will be to study the benefits and risks of outsourcing for a specific type of firm which the operational managers are interested in. By zooming into specific firms/sectors, the research information will come in even more informative and useful for operational managers working in their specific sectors. They can then use the research results to accurately determine if make or buy is the right decision to make for their organization.
VII. Reflections
My decision to choose outsourcing as a topic was because outsourcing is a rather unique topic which not many are doing on. Although other factors are vital to operations, being able to utilize outsourcing appropriately can benefit the organizations tremendously as well. The whole process has not been smooth due to my shallow knowledge of this topic and during the analysis of the journals, I realized that there were many business terms and theories that have proven to be too complex for me to comprehend. I have to admit that this project has been rather time consuming, but the information gathered will be good for discussion among friends. Operations management is not an easy topic and more self-learning is definitely required.
References
http://en.wikipedia.org/wiki/Outsourcing

Outsourcing impact on manufacturing firms’ value: Evidence from Japan By: Jiang, Bin; Belohlav, James A.; Young, Scott T.. Journal of Operations Management, Jun2007, Vol. 25 Issue 4, p885-900, 16p; DOI: 10.1016/j.jom.2006.12.002; (AN 25107401)

Unlocking the business outsourcing process modelCitation Only Available By: Handley, Sean M.; Benton, W.C.. Journal of Operations Management, Oct2009, Vol. 27 Issue 5, p344-361, 18p; DOI: 10.1016/j.jom.2008.11.002; (AN 43874441)

Offshore outsourcing of professional services: A transaction cost economics perspectiveCitation Only Available By: Ellram, Lisa M.; Tate, Wendy L.; Billington, Corey. Journal of Operations Management, Mar2008, Vol. 26 Issue 2, p148-163, 16p; DOI: 10.1016/j.jom.2007.02.008; (AN 29961116)

A survey of third party logistics in Mexico and a comparison with reports on Europe and USA.Citation Only Available By: Arroyo, Pilar; Gaytan, Juan; De Boer, Luitzen. International Journal of Operations & Production Management, 2006, Vol. 26 Issue 6, p639-667, 29p; (AN 21327849)

Effective strategies for internal outsourcing and offshoring of business services: An empirical investigationCitation Only Available By: Zeynep Aksin, O.; Masini, Andrea. Journal of Operations Management, Mar2008, Vol. 26 Issue 2, p239-256, 18p; DOI: 10.1016/j.jom.2007.02.003; (AN 29961122)

Productivity effects of outsourcing.Citation Only Available By: Broedner, Peter; Kinkel, Steffen; Lay, Gunter. International Journal of Operations & Production Management, 2009, Vol. 29 Issue 1/2, p127-150, 24p; (AN 36650450)

Name: Ong Kar Hian
Matric Number: U098481J
Class: F2