Outsourcing & Offshoring: Some Key Factors Guiding the Academic & Research

Questions Risk Identification, Analysis &

Management Research & Instructional

Opportunities

Abstract Academic inquiry using industrial organization theories from

economics, law and strategy have developed some useful conceptual frameworks for the study of outsourcing and the design of related research streams. Provisionally, outsourcing is the sub-contracting by organizations to external component suppliers for product supply or service organizations for expertise or work that is either unavailable internally or where internal capacity is planned for elimination. Offshoring is the outsourcing of various services, including IT, to nations outside the organization's host country.

Significant research questions are raised by domestic outsourcing and these are further complicated by offshore outsourcing. This presentation examines the identification and valuation of transactions cost risks attendant to outsoruce agreement negotiations. Research issues are discussed concerning due diligence failures, service level performance metrics, dispute resolution risks, ownership and control of data and intellectual property as well as risks in maintenance of confidentiality and the protection of privacy. In practice, there are inevitable difficulties triggered by widespread ignorance of key cultural and infrastructure differences that increase the risk of these transactions.

Outsourcing What Activities?

n  Traditional Outsourced Services of Expertise throughout the 20th Century: •  Accounting, Advertising, Auditing, Law, Management

Consulting, Investment Banking, IT Services, Transaction Agency, Employee Recruitment

n  1970s Wave: Manufacturing: components 1st then finished goods assembly

n  1990s the Modern Wave: BPO •  Business Process Outsourcing •  HR, Call Centre/HelpDesks, S/W programming, ERM/

EDD, ASP, Medical Diagnosis (xRay) n  Contrast with Traditional InSourcing

•  Vertical Integration of 19th Century n  EX: Japanese Keiretsu

Outsourced Activities

(Out)Sourcing Destination? n  Autonomous Internal Unit n  Independent Domestic Service Provider

(traditional outsourcing a/k/a homeshoring)

n  Int’l: Mandatory Offshore Local (Captive) Agent

n  Int’l: Offshore Independent Service Provider (offshore outsourcing)

n  Multi-Nat’l Service Provider (pre-Enron MDPs)

(Out)Sourcing Destination!

Some Persistent Theoretical Constructs for Outsourcing Analysis n  Theory of the Firm & Transactions

Costs n  Agency Costs, Moral Hazard n  Labor Economics n  Contracting n  Core vs. Comparative Advantage,

Specialization n  International Relations

• Forcing interdependencies

Theory of the Firm & Transactions Costs

n  Adam Smith’s “Division of Labour” n  Coase, Berle & Means, Oliver

Williamson n  Optimal Form of Organization

• In-house vs. Out-House n  Firms are “Bundles of Contracts” n  Government Agencies Traditionally

InSource but Increasingly OutSource

Agency Costs

n  Moral Hazard n  Conflicts of Interest n  Monitoring n  Incentive Alignment n  How do Insource Agency Costs Differ

from Outsource Agency Costs n  Do Any Additional Agency Costs Arise

in OffShore Outsourcing

Labor Economics n  Anti-Unionism

• Runaway shops, plant closing restrictions n  United Textile Workers v. Darlington

(S.Ct.’65) • Union lose “Jurisdiction” over “Work”

n  Classic “Race to the Bottom:” • Job loss & relocation of work • Labor standards

n  Wages n  Terms & conditions of employment

•  90s EX: Maquiladora (Maquila)

Contracting Theory

n  Form, virtual & long-term contracting • Alan Blinder, “Offshoring: the Next

Industrial Revolution,” Foreign Affairs Mar/Apr ’06 @ p.113

n  Restrictions on Delegation or Assignment of contract rights • Personal Services: NO w/o permission • Generic Services: YES

International

n  Competitive/Comparative Advantage n  Cross-Cultural Ignorance Obscures

Outsourcing Vulnerabilities n  Trade Barriers, Protectionism, Local

Content Limits Degrees of Freedom n  Interdependency Reduces Risk of

Conflict

Incentives to Outsource or Offshore

n  In-House Expertise (In)Sufficiencies •  Demand Cyclicality: Under/Over-Capacity

n  Supply-Demand Imbalances •  Whose Core Competencies

n  ID, evaluate then locating competencies n  Comparative Advantage

n  Scale Economies •  Cost Effectiveness:

n  In-House Capacity vs. Outside Provider

n  Scale Economies & Scarce Supply

Justifying an Outsourcing

Some Key Outsourcing Variables

n  Locus of Specialization n  Costs of Activity, Monitoring/QC n  Control over Work Performed n  Ownership of Work Product n  Quality of Work Product n  Backups, Substitution, Scalability,

Adaptability n  Hoarding Incentive: Size Buffers External

Threats

Negotiating Service Level Agreements

n  RFPs Typically Start the Process n  Must Negotiate Commitment Levels n  Must Design Effective Metrics n  Foolhardy NOT to Predict Capacity Needs,

Costs, Future Expansion & Scalability n  SLAs Create Thresholds of Reward &

Penalty •  Define Rights of Termination & Post-

Termination Transitions

SAS 70: An Achilles Heel? n  Customer (user) of “Service

Organizations” must submit to audit of outsourced services incl IT services

n  Service Provider should be obligated under engagement contract of could simply refuse to submit or cooperate

n  Type I: service auditor’s opinion of provider’s description of controls & their design suitability

n  Type II: Type I + testing n  Sarbanes Oxley’s Internal Controls (but

only) for publicly traded cos

Are there OffShoring Problems? n  Cost Focus Myopia

•  Unwarranted due diligence suspension •  Cultural Ignorance

n  Identifying Scalability Challenges n  Adequacy of Remedies for Service Failure n  Retrieving Hosted Assets n  Transitioning to Substitute Service Provider n  Designing Service Level Metrics n  Incompatible Functions (security) n  Lou Dobbs engenders grassroots political

pressure to advance policy reactions: •  Protectionism, Xenophobia, Nationalism

Diagnosing Problems

n  Unrealistic Expectations Trigger Most Problkems • Lack of Due Diligence

n  Persistent Cultural Differences Contribute to UnMet Expectations

n  Expanding Role of Outsourcing &/or Offshoring Consultants & Intermediaries

Intellectual Property n  Ownership: client, vendor, employees, 3d

parties n  Pricing: n  Control & Form of Transfer n  Creation/Authorship: n  Basic Distinction:

•  Generic Engine vs. Customized Deployment •  Who Owns the Data? •  Unique Patentable BMP/Process •  Improvements

n  Open Source n  Cultural Respect for IP

Privacy

n  THE Model: EU Private Data Directive • Constrains Int’l trans-border data flows

n  American Perceptions: PII Offshoring: • http://www.whitecase.com/

outsourcingandprivacy • Sensitivity by Data Type, OffShore

Destination

Outsourcing Security

n  A Most Challenging Risk Analysis • Internal security competence vs.

external security vendor trustworthiness n  Classic Expertise v. Expense Tradeoff

• Scale economies if outsourced n  Constrained by High Costs of Failure n  Int’l IT Security Standards

• BS 7799, ISO 17799 & ISO 27001

Overcoming Outsourcing Offshoring Difficulties

n  Risks in Rush for Cost Containment •  Due Diligence Failure Arguably Key •  Reputation Raises Both Costs & Reliability

n  Complex Negotiations Pre-Empt Difficulties •  EX: Asian ceremonial negotiations:

n  Emphasizes: predictions of harmony, develops trust & tolerance for uncertainty

n  Presumes: collectivism, avoidance of shame, power distance

n  Might Policy Issues Predominate?

What Are the Likely Policy Approaches?

What Are Useful Policy Approaches?

n  Policy Arguments •  Review the underlying evidence •  Use critical thinking & philosophy of science to

link evidence to arguments n  Predict & verify policy argument source

•  Proponents: employers, providers •  Opponents: labor, protectionists

n  Why do Policy Analysis of Outsourcing? •  Synthesize, integrate, resolve some conflicts

Academic Research of the Top Problems Confronting OffShoring

n  Scalability & Adaptation to Changing Business Models

n  Service Level Quality Metrics/Rewards n  Service Failure Dispute Resolution n  Recovering Stranded Data n  Ownership of IP, Data n  Classic Lock-in Tradeoffs n  Political Morass – “Lou Dobbs” Effect

Some Academic Research Applications to OffShoring

n  Social Psych, Management, Strategy •  Interviews, Questionnaires, Self-Reported

Behaviors & Attitudes n  Artifact, System Design

•  Develop Standards, Best Practices, Applications n  Economic Modeling (macro & micro)

•  Improve prediction & decision rules •  ID problems, remediate with process (re)design

n  Public Policy Analysis •  Satisfy constraints •  Pre-empt or soften onerous policy changes

Developing my OutSourcing & OffShoring Research Agenda

n  Public Policy Analysis n  Process Design Standardization n  Service Level Commitment Ontology n  OutSourcing Curricular Component in

Services Science Program Development n  Multi-National & Cross-Cultural Risk

Assessment & Response Model n  Multi-Disciplinary Practice (MDP)

Perspectives