Strategic Outsourcing: Realizing the Benefits and Mitigating the Risks

July, 2015

Key Concept Explanation

According to Mohr, Sengupta, and Slater (2011),

Outsourcing is an arrangement in which one company (the client) hires another company (the service provider) to perform a particular function on its behalf. It involves the transfer of the management and/or day-to-day execution of an entire business function to an external service provider. (p. 42)

Outsourcing is one of many options within the realm of strategic sourcing. It can take many forms. The nature of the functions that are outsourced may be routine or transformational, and outsourcing may shift work to domestic or international firms. Outsourcing can be controversial, particularly if it entails the loss of domestic jobs. Nevertheless, outsourcing is such a dominant feature of the global business world that it is enabling new organizational forms, such as virtual corporations, to emerge.

Outsourcing is of interest because of its use in the operation of college and university libraries. Over the past 20 years, this researcher has witnessed the transformation of the library industry, as functions that were traditionally performed within individual libraries have been outsourced to outside providers. For a mid-career professional, the notion that this trend could eventually lead to a hollowing out of librarianship is a concern with significant practical implications.

Comparison

In their discussion of core capabilities, Meredith and Shafer (2013) singled out strategic and core activities as being unsuitable for outsourcing. Their discussion included the following statement:

If the firm outsources these parts and processes …, it soon finds that the engineering design talent follows the production of the part outside the firm, too, and its core capabilities have been lost. Then the firm has been hollowed out, becoming merely a distributor of its supplier’s products. (p. 40)

While there is certainly much truth in this assessment, a more nuanced analysis is in order. This thread seeks to interact with the literature so as to clarify critical issues entailed in realizing the potential benefits of outsourcing while mitigating its potential risks.

Meredith and Shafer (2013) cited a 1986 source in their description of a firm becoming hollow. The practice of offshoring—shifting production to other countries, typically to reduce labor costs—was a contentious issue in the late 1980s and early 1990s. Weidenbaum’s (1990) analysis represents one side of the debate concerning the long-term outcomes of offshoring. He espoused the position that the health of a firm, industry, or economy is not be measured simply by labor inputs, as alarmist interpretations of offshoring tended to do.

A generation later, offshoring and outsourcing have become even more entrenched in global business practice. Swift changes in the environment provide limited windows of opportunity, and virtual corporations, by connecting multiple firms that possess complementary capacities, are in a position to seize them (Arjonilla-Domínguez & Medina-Garrido, 2009). As they seek to serve global markets, today’s business leaders must understand that they can employ both intrafirm sourcing and outsourcing solutions, and that, at least in theory, each of these can be performed domestically or internationally (Kotabe & Murray, 2009). Sourcing decisions are to be made with a clear understanding of the nature of the business function, resources available within the firm, and the efficiencies that can be gained by outsourcing (Mohr, Sengupta, & Slater, 2011). Furthermore, the experiences of other firms—for example, Samsung’s success in internationalizing cell phone production—provide useful insights for those who seek to make wise sourcing choices (Lee & Jung, 2015). Sustainable competitive advantage is a function of strategic sourcing, which necessitates reducing costs as well as maintaining and cultivating unique capabilities.

Article Summary

Kotabe and Murray (2009) have produced a highly useful analysis of global sourcing. This section summarizes key insights from their analysis.

Achieving competitive advantage in today’s market requires firms to practice cyclical, responsive innovation and exert global reach in the distribution of their products and services. No single business function can accomplish these ends on its own; rather, the various functions (R&D, finance, procurement, manufacturing, marketing, etc.) must work in tandem. Firms often lack some of the capabilities needed to meet the demands of the global market. Therefore, successful firms have learned to employ diversified sourcing strategies. Toyota, for example, not only performs some functions in house, but engages in two very different forms of outsourcing. It employs arm’s-length (competitive) outsourcing when procuring inputs that are less than strategic. On the other hand, it partners with other suppliers to obtain “inputs that are of high value and provide differentiation” (p. 202).

Sourcing strategy involves decisions as to whether a firm should obtain inputs domestically or internationally (domestic vs. offshore sourcing), and also as to whether it should produce the inputs itself or purchase them from another firm (intrafirm sourcing vs. outsourcing). A firm is not necessarily hollow if it outsources functions to other firms. The key issue is to exploit internal competitive advantages and outsource to gain needed advantages. Thus emerges a virtual network: “A network of loosely coupled strategic alliances allows each participant to pursue its particular competence. Therefore, each network participant can be seen as complementing rather than competing with the other participants for the common goals” (p. 209). Fluctuations in the currency markets have threatened firms that are dependent on global sourcing. Firms have made various efforts to mitigate the effects of such fluctuations, achieving partial success.

Application

Achieving success in sourcing is dependent on many different contextual factors, and successful firms have taken divergent approaches. Samsung became the global market leader in cell phone production by building factories in other countries. However, it has not chosen to outsource production to other suppliers, and it has taken various measures to ensure that its domestic personnel retain their technological innovation. Toyota, on the other hand, has complemented its in-house operations with two very different forms of outsourcing. As the erosion of technological and political barriers continues to make outsourcing and offshoring more feasible, managers must learn to examine sourcing options with a strategic eye. The literature discussed here provides useful tools for approaching such decisions.

Annotated Bibliography

Arjonilla-Domínguez, S. J., & Medina-Garrido, J. A. (2009). Virtual corporations. In M. Khosrow-Pour (Ed.), Encyclopedia of information science and technology (2nd ed., Vol. 8, pp. 3992–3996). Hershey, PA: Information Science Reference. Retrieved from http://search.ebscohost.com.ezproxy.liberty.edu:2048/login.aspx?direct=true&db=nlebk&AN=228959&site=ehost-live&scope=site

Arjonilla-Domínguez and Medina-Garrido (2009) introduced the concept of the virtual corporation, noting both the diversity with which this term was used and the common elements that most uses of the term presumed. Generally, a virtual corporation was said to exhibit (a) excellence through the contribution of multiple firms’ core competencies; (b) heavy reliance on information and technology to maintain communication between firms; (c) a high degree of trust stemming from mutual interdependence; (d) opportunism that reflects responsiveness to changing customer demands; and (e) fluid organizational borders. Significantly, the authors distinguished the virtual corporation from “a ‘hollow’ firm” (p. 3992) whose relationship with foreign firms is based primarily on cost reduction. Finally, the authors asserted that the theory of the virtual corporation is as yet ill-defined and unsupported by empirical evidence.

Kotabe, M., & Murray, J. Y. (2009). Global sourcing strategy and sustainable competitive advantage. In Czinkota, M., Ronkainen, I., & Kotabe, M. (Eds.), Emerging trends, threats, and opportunities in international marketing: What executives need to know (pp. 199–217). New York: Business Expert Press. Retrieved from http://site.ebrary.com.ezproxy.liberty.edu:2048/lib/liberty/detail.action?docID=10364229

Kotabe and Murray (2009) examine the issue of global sourcing strategy. This entails making production sourcing decisions so as to serve the global market, while ensuring that manufacturing decisions do not overlook the competing interests of R&D and marketing. More than the other articles cited here. Kotabe and Murray’s analysis supports outsourcing to the extent that it can be used to achieve and maintain competitive advantage. Successful global strategy is exemplified by Toyota’s use of a mixture of outsourcing (both at arm’s length and via strategic partnerships) and in-house production. The authors pay particular attention to making sourcing decisions in the context of fluctuating currency rates.

Lee, K., & Jung, M. (2015). Overseas factories, domestic employment, and technological hollowing out: A case study of Samsung’s mobile phone business. Review of World Economics. Advance online publication. doi:10.1007%2Fs10290-015-0219-8

Lee and Jung (2015) authored a case study of detailing the impacts of Samsung’s offshoring of cell phone production from the company’s home country, South Korea. Data presented in the article primarily focus on the firm’s Vietnam factory, which was founded in 2008 and produces for a global market. In the strictest sense, Lee and Jung’s study is not about outsourcing, as Samsung’s experience has been one of internationalizing production (offshoring) rather than contracting with other companies to produce on its behalf. Nevertheless, the study is relevant because (a) outsourcing decisions often entail offshoring and (b) it focused on the “hollowing out” phenomenon that is often a concern in outsourcing decisions.

Significantly, Lee and Jung found that Samsung took conscious measures to avoid being hollowed out when offshoring. Lower foreign labor costs enabled it to achieve a competitive advantage that propelled the company into mobile phone market leadership by 2012. While foreign workers were substituted for domestic production employees in the process, growth in the scale of production enabled the firm to increase the size of its domestic workforce in non-production areas with relatively high compensation such as R&D and marketing.

Mohr, J. J., Sengupta, S., & Slater, S. F. (2011). Mapping the outsourcing landscape. The Journal of Business Strategy, 32(1), 42–50. doi:10.1108/02756661111100319

Mohr, Sengupta, and Slater (2011) analyzed the range of sourcing options that are available to firms needing to fulfill a particular business function. They present a series of three Yes/No questions designed to determine whether it is appropriate to outsource, what risks and rewards are associated with outsourcing, and how to manage specific outsourcing relationships. The questions are as follows:

  • Is the business function critical to the company’s mission?
  • Does the company have the assets and capabilities to organize the function in-house?
  • Do cost-efficiencies arise due to economies of scale?

Responses to these three questions lead to eight possible scenarios, each with a distinctive sourcing prescription. Potential approaches range from simple procurement contracts to transformational outsourcing. The latter approach can enable innovation and lead to competitive advantage. However, because it entails changing the firm’s business model, it requires careful cultivation of “trust and operational linkages between client and service provider” (p. 46).

Weidenbaum, M. L. (1990). The myth of the hollowed-out corporation. Corporate Board, 11, 1+. Retrieved from http://go.galegroup.com.ezproxy.liberty.edu:2048/ps/i.do?p=ITOF&u=vic_liberty&id=GALE|A8618530&v=2.1&it=r&userGroup=vic_liberty&authCount=1

Weidenbaum’s (1990) analysis represents one side of the debate that raged a generation ago concerning the significance of trends in American industry. It has continued to be cited since its original publication. Weidenbaum argued that the prospects for American manufacturing in the early 1990s were much better than expected by those who simply saw the industry being hollowed out by foreign competition. Different metrics of the industry’s strength led to widely divergent interpretations. For those who focused on labor inputs, the sector was in poor shape; nevertheless, productivity, innovation, and quality were rising rapidly. Weidenbaum predicted that the number of manufacturing jobs was unlikely to grow, but that pay for these jobs would increase. (Nonetheless, this claim seemed to be mitigated by his assertion that compensation increases were slowing.) For Weidenbaum, public policy was an important key to continued success in American manufacturing. Minimizing tax burdens and regulation would tend to foment industrial development, while failure to curtail government power over business would achieve the opposite.

Reference

Meredith, J. R., & Shafer, S. M. (2013). Operations management for MBAs (5th ed.). Hoboken, NJ: Wiley.

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