Strategic benefits and problems
Outsourcing may face the organization with a range of benefits and problems. Cost reduction
Cost reduction has been the predominant motive for outsourcing (Ford et al., 1993), the decision taking the form of a make-or-buy decision that was largely addressed through accounting information. While outsourcing contracts commonly target a minimum of 15 percent cost saving and sometimes 20-25 percent (Lankford and Parsa, 1999) failure to achieve anticipated cost improvements is a frequently occurring aspect of outsourcing (Cross, 1999; Darling, 1999). The level of achieved saving may average 9 percent, although a large proportion of outsourcing clients may only break even or even find their costs increase (Embleton and Wright, 1998). Ketler and Walstrom (1993) provide further evidence for the underachievement of cost reduction targets, finding that initial vendor bills were usually 20 percent higher than anticipated due to a low vendor estimate and/or honest misunderstanding of the contract. On occasion in-house supply can provide lower costs (D’Aveni and Ravenscraft, 1994). Large organizations may find prospective suppliers unable to match their own internal economies of scale and many specialist suppliers may have an effective scale that is no greater than that of their customers (Alexander and Young, 1996). Even if outside suppliers possess greater efficiency, cost savings may not be obtainable when a few vendors dominate a specialized market (Greer et al., 1999). While outside supply can reduce cost, there are examples of organizations, such as Harley Davidson, that have reduced cost by reinstating in-house supply (The Economist, 1991). To achieve reduced cost while maintaining standards requires that the supplier has access to superior cost drivers, such as economies of scale, learning and low cost locations. However account also has to be taken of transaction costs, the costs of search, negotiation and contract enforcement, which may be greater for highly differentiated services and components. In addition there is the need to ensure that, following outsourcing, the outsourced activity’s associated overhead is reduced (Bettis et al., 1992). Consideration also needs to be given to the longer term effects of developments in the supply market, the implications of any increase in monopoly power and the developing knowledge possessed by successful bidders that may be used in future negotiation. Access to superior quality
In principle outsourcing can provide access to “best in the world” quality for particular activities or components (Quinn et al., 1990). However, in the absence of fully developed service level monitoring the development of quality may on occasion be illusory. On occasion organizations may experience a lowering of service standards requiring the service to be redeveloped in-house. Jennings (1996) cites the case of building society security services being repeatedly returned to in-house supply following disappointment with the standard of successive external providers. The use of external supply can also imply a reduction in the opportunities with which to achieve differentiation through the use of more widely available activities and components (Alexander and Young, 1996). Flexibility
Outsourcing presents organizations with the opportunity to avoid the constraints of their own productive capacity in meeting changes in the volume of sales. In situations where the pattern of sales displays seasonal or cyclical characteristics the penalties of under used in-house capacity may be avoided. However care has to be taken in ensuring that a viable supply base is maintained that is capable of meeting peak levels of demand. The adoption of lean supply by Boeing has at times resulted in the company being unable to meet cyclical increases in the demand for aircraft. Lacking sufficient in-house production capacity the company has found that attempts to increase capacity have resulted in...
References: • Technology development. Within the motor industry, three-quarters of the engineering for a new Toyota or Nissan is undertaken by suppliers (The Economist, 1998).
• Human resource management. While it is desirable to retain labour relations, employee relations and performance management in-house, a wide range of HR activities, such as training (but not its design) may be outsourced (Greer et al., 1999).
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