Lecture Purchasing and supply chain management (3rd/e): Chapter 9 - W. C. Benton

Strategic outsourcing is addressed in Chapter 9. Outsourcing is the complete transfer of a business process that has been traditionally operated and managed internally to an independently owned external service provider.

Purchasing and Supply Chain Management

3rd edition

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Chapter 9:

Strategic Outsourcing

Purchasing and Supply Chain Management, 3rd edition, Copyright  © 2013, 

W. C. Benton Jr., All rights reserved

• Complete transfer of a business process to an 

independent external organization

• Once the process is outsourced, assets are no longer  maintained

• People, facilities

• Equipment, technology 

• A departure from subcontracting, joint venturing, and 

Current Outsourcing Trends

• Popularity of outsourcing

• By 2005, global business process outsourcing surpassed the 

US$6 trillion

• 25~34 % of a typical executive’s budget is outsourced

• Composition of outsourcing contracts 

• 76% of announced outsourcing contracts represented new deals

• 24% represent a combination of contract extensions, expansions, 

or renewals

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• Expected strategic benefits:

• Cost minimization

• Refocus on core competencies

Realizing Outsourcing Benefits

• 20~25% of all outsourcing relationships fail within two  years 

• Nearly half fail within five years

• Conditions needed to realize expected outsourcing  benefits:

• Extensive strategic assessment of the case

• True commitment to a cooperative relationship

• Training and recruitment within outsourcing organizations 

focused on relationship building and management

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1 Quality costs

3 Internal coordination

4 Implementation of external sourcing model

5 Government and politics­related expenses

7 Miscellaneous financial considerations

1. Quality Costs

• The costs associated with ensuring quality

• Categories of quality costs:

1 Preventative cost

• i.e., designing quality into products and processes

2 Appraisal cost

• e.g., inspections, audits, monitoring mechanisms

3 Internal failure cost

• e.g., scrap, rework, internal downtime

4 External failure cost

• i.e., failure perceived by the external customer

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2. Supplier Vendor  Relationship Management

• The high cost of relationship building and coordination

• External sourcing of strategic products and services

• Costs of relationship 

• At least 3~10% of the annual contract value

• High labor and travel expenses of purchasing personnel

• IT infrastructure and management costs

• Supplier development programs costs

3. Internal Coordination

• The overhead expenses incurred solely due to the 

decision to internally source a product or service

• Payroll, benefits management

• Utility, IT

• Thus, external sourcing is expected to eliminate this  cost.

significant reduction in internal coordination costs.

• In many cases, outsourcing is unable to free up the anticipated 

Model

• Activities associated with switching sources:

• Supplier search, evaluation, and contracting

• The transfer of physical assets

• Domestic and international travel during startup

• Training of the new source

5. Product Service Design and Development

• The intertwined relationship between:

• Product or service architecture 

• Cost of coordination

• Tightly coupled or integrated product designs are 

associated with: 

• Tacit and less easily codified knowledge

• Higher knowledge sharing requirements

• Higher coordination cost

• Therefore, it may not be appropriate for external 

sourcing.

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Expenses

governmental laws, regulations, and even local  business customs

• Includes:

• Legal expenses incurred to learn about a foreign 

location’s laws and regulations

• Lobbying efforts and travel

7. Supply Chain Risk Management

• Outsourcing as one of the key factors driving increased  levels of supply chain risk

• 4 iterative phases of risk management:

1) Risk assessment

2) Risk mitigation

3) Risk monitoring

4) Contingency planning

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• Cost improvement from the learning curve associated  with cumulative volume

• External suppliers can aggregate the demands of their multiple  customers

• Cost improvement by outsourcing firm is determined by: 

• Competitive conditions in the supply market

• Power structures

Evaluating the Business Case

1 Strategic evaluation

• Understand the strategic value of the activity or system

2 Financial evaluation

• Short­ and long­term financial evaluation

• Evaluation of conditional factors 

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Questions?