Slide: 1Slide 1

Defining Outsourcing Topic 2

In this Topic we will understand Some of the key economic issues in the make or buy decision to

outsource. Some of the key risk issues in managing the selection of outsource

processes. The process of identification of services and products that can be

sourced from the market

Slide: 2Slide 2

Recap: the outsourcing decision is basically a make or buy choice

Reasons to buy

Cost efficiencies Technology uncertainty Non core process (or

declining) Access to expertise

Reasons to make

Core competency Competitive edge Asset specificity high Critical process Dependent on core or

critical process Risk Difficult to measure

Slide: 3Slide 3

Outsourcing is about setting the Boundary of the Organisation

In HouseService

Offshore

Outsource

Internal Governance Vendor

Org

an

isa

tio

na

l b

ou

nd

ary

In source

External Division

Back source Market Governance

Slide: 4Slide 4

The make or buy decision driven by cost of doing something externally or internally

Transaction cost economics– (offers an) Explanation of the boundary choice

Model– Hierarchical decomposition (form of governance)– Asset specificity– Externality

Behavioural assumptions– Bounded rationality– Opportunism

Point of departure from classical economics– Economic agents under classical model act to maximise profit– Economic agents from a TC perspective act to minimise cost

Slide: 5Slide 5

Boundary where the costs internally and the costs of the market just balance

Costs are all aspects of the control and monitoring of the performance of the activity

Make– Training– Management Time– Direct cost– Facilities– Payroll etc.

Buy– Negotiating– Monitoring– Writing agreements

Accounting

Distribution

Customer Service

Information Systems

Manufacturing

$ $ $

Purchasing

Quality Assurance

Research & Development

Warehouse

Sales

Board of Directors

Shipping

Organisation Boundary

Slide: 6Slide 6

These core aspects define the boundary

HierarchicalDecom-position

Asset Specificity

Externality

Frequency

Uncertainty or risk Specific

investments

Quality compliance

IPR

Confidentiality

Measurement risk

OrganisationStructure

Bounded Rationality Opportunism

Agents act to serve own interests

Agents a rationale but in a limited way can’t do everything!

Slide: 7Slide 7

Basic principles of market sourcing

Market is favoured if relative demand client is less that of the market– Vendors can aggregate all the clients demands – Offering wider scale…

… and wider scope– Can specialise in the delivered service (competence)

The advantage of the market dissipates if the service becomes (too) specific to the client– The more specific a service is the less a vendor is able to ‘pool’ demand

Slide: 8Slide 8

Specialisation and learning drive specificity

Specificity arises when specialisation of an asset means it cannot be used outside the context of the service.– Vendor cannot realise scale effects as will need services to be generic

and spread across several clients– Can reduce room for cost reduction (so left with just labour cost

arbitrage)– This process inhibits switching of the client and locks the supplier in

The process of service delivery acts to increase specificity– knowledge transfer and …

…Learning by doing locks out competition

Slide: 9Slide 9

Summary

Value of market sourcing reduces as human and physical assets become more specialised

Specialism leads to single use– Which is less transferable to other clients– Can drive re-integration as economies of scale cannot be realised (and

client can do just as well)

Slide: 10Slide 10

Reflection

Research has shown that clients prefer to have service that is customised to their needs.

What is the consequence of this for the outsource deal?

How might a vendor respond to this?

Slide: 11Slide 11

Evidence from the field

Large outsource deals typically tailored (100% according to Deloittes survey)

Corollary– Vendors find it difficult to standardise services– As need to tailor a solution increases the ability to deliver savings

decreases

‘if a project needs customising, it should not be the subject to outsourcing’ (Deloittes (2005) survey quote)

Slide: 12Slide 12

The High Level Make or Buy Choice

Project type services(legal, consulting)

Specific investments needed that makes transfer to other clients difficult

Joint governance or partner models to manage complex services

Commodity type Services (desktop, payroll, transport)

Mixed ‘basket’ of services - selective sourcing may be favoured

Unified management(highly embedded services)

Occ

asio

nal

Fre

qu

ent

Generic Mixed Highly Specific

Ser

vice

Fre

qu

enc

y

Need to sustain relationship

Service Characteristics

Slide: 13Slide 13

The High Level Make or Buy Choice

Project type servicesSpecific investment transfer difficult

Joint governance Partner models Joint ventures

Commodity type Services (desktop, payroll, transport)

Selective sourcing may be favourable

Unified management(highly embedded services)

Occ

asio

nal

Fre

qu

ent

Generic Mixed Highly Specific

Ser

vice

Fre

qu

enc

y

Need to sustain relationship

Service Characteristics

Ma

rke

t s

ou

rcin

g

No

rma

l c

on

tra

cti

ng

Ru

les

Sta

nd

ard

SL

A

Relational contractingcontinuous interaction and evaluation of value created

Independent oversight extends formal contracting

Demands integrated approach

supplier/buyer

Slide: 14Slide 14

Reflection

Suggest what circumstances might lead to insourcing?

Review the advantages and disadvantages of Outsourcing

Slide: 15Slide 15

Just some of the problems with outsourcing relationships

Breakdown of relationships Failure to meet service levels Constant contractual wrangles Unforeseen charges Poor contracting Losing control Selecting the wrong vendor Overlooking hidden cost No exit strategy Forgetting about personnel issues

Slide: 16Slide 16

“...there's the unmeasurable aspect of what happens when a company is no longer a culture but an amalgamation of outsourcing partners. They may add great efficiency into the business, but they generally add nothing to the long-term vision. As most companies that have been around awhile are aware, great ideas don't always come from the people at the top. Outsourcing can eliminate an entire interaction layer that is impossible to measure with objective tools. Cultures are inextricably linked to innovation and quality, and the less there is of the former the more the latter two will suffer in the long term.”

Ed Sperling Forbes November 2009

What about outsourcing everything?

Slide: 17Slide 17

We will review in future topics why these problems occur and hopefully how we might tackle them!

Management Preparation

NegotiationTransition

Scoping

RelationshipFormation

Relationship Maturity

Relationship Engagement

The Outsource Lifecycle

Definition

Interpretation

Renegotiation

Terminate

Selection

Reconnaissance