Supply Chain Management: From Vision to Implementation

Chapter 9: Core Competencies and Outsourcing

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Chapter 9: Learning Objectives

1. Describe the notion of core competency. Identify an organization’s competencies and determine whether they pass the three-fold test of a core competency.

2. Define outsourcing and discuss reasons why companies outsource.

3. Describe the three phases to developing and executing an outsourcing strategy.

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Chapter 9: Learning Objectives

4. Identify and assess some of the potential risks associated with outsourcing.

5. Conduct a make-or-buy analysis to support an outsourcing decision.

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What is a Core Competence?

Core competency is the set of activities, skills, or advantages that distinguishes a company for its competitors.

“… the collective learning in the organization, especially how to coordinate diverse production skills and integrate multiple streams of technologies.”

- Prahalad & Hamel

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Core Competence

To compete and win in the global marketplace a company must be uniquely good at at least one thing that the customer values.

Most industry leaders build their core competencies around a handful of essential skills.

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Identifying Core Competencies Does the identified skill set contribute significantly

to what customers perceive as our organization’s value-added?

Is the skill set difficult for others to replicate or imitate?

Are we particularly good at the skill set, or willing to invest the resources to become excellent?

Is the skill set broad enough that it allows us to the opportunity to enter many diverse markets or businesses?

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Complementary Core Competencies

Once a company finds its core competency, it can design a supply chain to support its competitive strategy, value proposition, and competency development.

Outsourcing non-critical activities to supply chain partners allows companies to leverage complementary core competencies.

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Outsourcing Flowchart

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The Outsourcing Challenge

Outsourcing is the process of moving an aspect of production, service, or business function from within an organization to an outside supplier.

Government public agency outsourcing is called privatization.

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Outsourcing Trends

Contract Manufacturing (CM) – a third-party makes an end product or major component under another company’s brand.

Third-Party Logistics (3PL) – using a supplier to provide some combination of logistics activities.

Offshoring – outsourcing to a different country. Business Process Outsourcing (BPO) – outsourcing

support functions such as: HR, payroll, logistics, etc.

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Benefits of Outsourcing

By outsourcing non-strategic processes, an organization can focus its attention on those things it does best to satisfy the customer.

Other benefits include: Cost savings Capital conservation Performance improvement Access to low-cost labor and/or resources Benefit from outside expertise

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Top Reasons for OutsourcingConserve Capital,

3%

Grow Revenue, 4%

Increase Innovation, 3%

Improve Quality, 3%

Improve Skills, 9%

Focus on the Core Business, 17%

Reduce Operating Costs, 48%

Create a Variable Cost Structure, 13%

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Outsourcing Risks

Outsourcing is not without risk: Outsourcing strategic activities may cause a loss of

competitive position. Strategic risk – long-term, perhaps irreversible, risk

based on a loss of knowledge related to core activities.

Tactical risk – short-term risk based on use of supplier for capacity, not knowledge.

Increased dependence on suppliers for knowledge weakens the buyers relative bargaining power.

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Outsourcing RisksStrategic Risks Tactical Risks

Firm loses knowledge and/or technology to perform activity internally

Firm experiences:

Supplier develops unique, hard to replicate expertise

Short-term supply shortages

Supplied activities add unique value recognized by customer

Hidden transaction or management costs

Customer identifies more with the supplier than the original firm

Loss of schedule control

Firm loses sight of market trends Short term price fluctuations

Supplier shares knowledge with firm’s competitors

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Outsourcing Process Phases

Phases Key Participants

Establish mission, generate and screen ideas

Top management , business unit and functional leaders

Conduct an outsourcing feasibility study

Multi-disciplinary team of key stakeholders in the current process

Establish and manage the relationship with the supplier

Purchasing or relationship manager

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Established the Outsourcing Mission

A multidisciplinary team of high-level managers should: State the benefits it hopes to achieve by

outsourcing Nominate processes for outsourcing Screen those processes against key success

factors to determine which are best suited for outsourcing

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Outsourcing Projects - ScreeningProject Decision/Rationale

Laundry Outsource – internal support function

Forms Management

Outsource – internal support function

Information Technology

Outsource – important area, but do not excel in this area; could not invest to achieve excellence

Supply Management

Do not outsource – critical to internal analysis, maintaining key supplier relationships, and cost competitiveness

Food Service Outsource – although excellent cafeteria, does not add-value to the customers, nor would is it be difficult to replicate

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Conduct an Outsourcing Analysis

Multi-disciplinary team of key stakeholders in the current process evaluate each potential process to outsource as determined by the screening process.

Evaluation includes: Developing a better understanding of the

organization’s needs Gathering detailed cost, performance, and risk

information Total cost of ownership analysis

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Outsourcing Analysis - Suppliers

Assessment of the supply market capabilities, considering:

Are supply sources available? Do potential supply sources meet capacity,

quality, and other organizational needs? Are the suppliers interested? What risks are present in outsourcing?

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Outsourcing Analysis - Suppliers

Reverse Marketing is the process of recruiting a supplier to provide an item or service that the supplier not currently providing, or unable to provide.

Restating Need and Expected Benefit considers the scope and scale of outsourcing required providing new insight on ways to achieve the desired benefit.

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Identifying & Mitigate Potential Risks

Most organizations are good at recognizing tactical risk.

A larger issue is strategic risk; by ceding power through outsourcing, a supplier might be able to capture a larger share of the overall chain’s margin.

Contingency plans should be developed to deal with identified risks associated with outsourcing.

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Outsource Risk & Mitigation StrategyRisk Issue Safeguard

Capacity or shortages Identified alternative sources for key parts, keeping in mind that all distributors use the same manufacturers, so shortage is difficult to avoid in an industry-wide shortage

Loss of competitive pricing information

• Right to audit manufacturers’ bills built into contract• Right to “test market and go out to receive competitive bids for

comparable services• Most favored customer clause in contract to ensure that

Image’s price meets or beats the price offered to other customers receiving the same service

Hidden transaction or management fees

• Cap fees in contract• Right to audit distributor’s cost allocations built into contract• Contractual clause requiring distributor’s bills itemized into

major cost categories for management fees, rather than one lump sum

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IT Outsourcing - Risk Mitigation PlansRisk Issue Safeguard

Poor service to internal customers • Establish internal user survey that links service provider’s pay to performance

Poor communication or management of service provider

• Dedicated relationship managers at Image• Advisory Board to meet with relationship manager,

service provider, key users to provide feedback, discuss technology needs and trends

Difficulty in controlling costs • Hire a third party to audit service provider, compare rates with other like companies

Loss of internal expertise • Loss in support level expertise could not be avoided. However, relationship manager, CIO and others would retain enough strategic knowledge to replace the service provider effectively if needed

Short contract duration/high turnover would be expensive for supplier and frustrating for internal users

• Established a five year contract with annual reviews and contract extension clauses

Transitioning own employees out of IT and training new employees by service provider

• Virtually all current Image IT employees were offered and accepted jobs with service provider to remain at Image

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Outsourcing Analysis - TCO

A cross functional team should analyze all direct and hidden costs associated with the current and perspective outsourced activity.

Cost included: materials, labor, energy, overhead, transportation, inventory, quality, obsolescence, and capital.

Sensitivity analysis should be performed to determine on a total cost of ownership basis whether there is a cost incentive for outsourcing.

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Manage the Outsourcing Relationship

Outsourcing arrangements exist on a continuum from minimum service to full service turnkey operations.

Limited-scope suppliers are less unique and therefore easy to replace.

Full-service suppliers provide unique value and are therefore more closely integrated.

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Supplier Relationships: Arm’s-Length

Best suited for “routine” purchases of goods or services.

No long-term commitment or special value-added by this supplier.

Non-recurring purchases of items that aren’t critical

Supply market is very competitive Switching costs are low Suppliers are not differentiated.

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Supplier Relationships: Niche

Providers are generally specialized, providing a very specific, limited good or service.

May be more difficult to replace than arms-length suppliers due to their specialized nature.

In general, these are specialized, non-recurring purchases.

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Supplier Relationships: Hybrid Provide an intermediate level of service. Provide items of moderate importance that are somewhat

integrated into the organization’s operations. May be responsible for a whole subsystem or process rather

than one clearly defined piece, as do limited scope providers. Standard “turnkey” solutions, and may even run some of the

company’s internal processes with their own people. Boundaries between the provider and the firm may begin to

blur. Ongoing communication is critical Higher degree of reliance and switching costs

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Supplier Relationships: Full-Service

Provide strategic items and processes that are entrenched in the firm’s own processes.

Custom solutions Often engaged in Business Process Outsourcing of

critical functions. These providers have a very high level of

responsibility and accountability. Have a significant presence in the organization,

working side-by-side with the organization’s employees.

Difficult to evaluate and manage.

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Outsourcing Relationships

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Outsource Relationship: Oversight Routine relationships are named for traditional contract

management. The contract terms are clear and the deliverables are simple to use and measure. Routine relationships are best suited to arms-length and niche arrangements.

Cooperative relationships are suited to hybrid outsourcing arrangements. The contract defines the relationship, but the suppliers also cooperate on an on-going basis to redefine expectations and goals based on changing business needs.

Committed relationships are common between buyers and solutions integrators. The two parties have committed a great deal of resources and efforts to the relationship, and their management style should reflect this.

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Outsourcing Relationship: OversightType of Relationship Routine Cooperative Committed

Arms-Length X

Niche Provider X

Hybrid X

Solutions Integrator X X

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Oversight CharacteristicsIssue Routine Cooperative Committed

Level of management oversight after relationship is established

Low Low to medium

High

Strategic importance of item/process outsourced Low Medium High

Need to interface with supplier closely to understand processes

Low Medium to high

High

Anticipated change/improvement over lifecycle of relationship

Low Medium to high

High

Interdependence of our process with supplier Low Medium Medium to high

Our need to be a “preferred customer” to this supplier

Low Low to medium

High

Level of ambiguity and change in expectations Low Low to medium

Medium to high

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Ongoing and Post-Audit Evaluation Routine relationships - feedback often is complaining to the

supplier when it performs poorly. If a significant supplier, may receive a standard “report card” of key performance indicators (KPIs). The report compares actual to expected performance on key KPIs.

Cooperative relationships - supplier likely receive a semi-customized report card capturing data regarding the value the supplier adds.

Committed relationships – supplier likely to receive a customized report card based on establishing performance indicators for key issues. In addition, much of the performance feedback would be verbal, as this is a close day-to-day interaction.

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Typical Outsourcing Report CardPerformance Indicator Rating Goal Comments

Completes Key Tasks on Time

90% 98%Was late on transitioning to new inventory system

Meets Service levels to internal customers

95% same day response92% same day response

Excellent; keep up the good work!

Follows up on missed service levels within a week

99% 95%Thanks for your good work!

Client perception survey- Quality

88% meets/exceeds quality expectations

90% meets/exceeds quality expectations

Need to perform a root cause analysis and identify weak area(s) to target improvement

Client perception survey- Technology leadership

95% meets/exceeds Technology leadership expectations

90% meets/exceeds Technology leadership expectations

Good work!

Within budgeted costs unless prior approval given

100% 100% Good work

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Buyer Skills

“Traditional” buyers manage contractual relationships that are clearly defined, with clear expectations and performance measures.

Outsourcing requires that supply professionals master creating and managing complex relationships due to the more fluid and less clearly defined supply environment.

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Insourcing

The outsourcing decision is not permanent or irreversible; the structure of the firm must adapt to changing business environment.

Companies may bring outsourced activities back in-house due to a number of reasons: Failure to achieve expected benefits Increase control over key processes Changing business priorities and core competence

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A Return to the Opening Story

Based on what you have now read and discussed:1. Do you think that the task force member’s concerns

are warranted? Why or why not2. How do you suggest that Doug keep the task force

members focused on the topic of outsourcing as a legitimate SC decision, rather than their fears related to their own functional areas?

3. Is this a strategic issue, tactical issue or both? Explain your answer, and how the task force should address this?

4. What activities and analysis should the task force undertake to address the Executive Committee’s questions?