Supply Chain Outsourcing

One of the first steps for sourcing is the recognition of the need for outsourcing. In other words, sourcing is not needed if the company decides to make its own products and create its own services all by itself, without resorting to outside help or resources. The company can justify its decision to use its own resources if such a decision can bring numerous benefits that may outweigh the potential advantages of outsourcing. The choice between in-housing and outsourcing often hinges on the assessment of the following factors: costs (including start-up investments), added value, time (response time), production capacity, financial capacity, control over production schedules, quality

control, workforce stability, technology transfer risk, production volume, know-how, and patent rights.

Factors Favoring In-Housing Factors Favoring Outsourcing

• If the needed material and part can be less expensively obtained and/or made within the organization than outside the organization.
• If the production and distribution schedules need to be controlled by the organization to maintain supply chain flexibility.
• If the organization excels at innovation and therefore needs to maintain its know-how or design secrecy without a risk of technology transfer.
• If a product or its part is vital and requires extremely close quality control.
• If a product or its part can be produced on existing equipment and is of the type in which the firm has considerable manufacturing experience and expertise.
• If the organization does not need to make extensive start-up investment in facilities and equipment because it has already sufficient production capacity.
• If requirements or demands for a product and its part are projected to be both relatively large and stable. Thus, the organization can create economies of scale for its own production.

Factors Favoring Outsourcing

• If the organization has limited resources and financial capacity and therefore cannot afford to make additional investment of its capital in developing new products or markets.
• If the organization would like to focus on its core competency and improve its overall supply chain efficiency by contracting out its costly and inefficient non-
• core business functions.
• If the organization’s existing personnel skills and technological know-how cannot be readily adapted to making a product or its parts within the organization.
• If patents or other legal barriers preclude the organization from making a product or its parts.
• If the anticipated demand for a product or its parts are either temporary or seasonal.
• If the anticipated demand for a product or its parts are small in volume.
• If the organization does not want to deal with potential labor-management conflicts and work stoppages (or labor strikes).
• If the organization would like to have contingency plans in case of emergencies and unexpected supply chain interruption.

Outsourcing Principles

Generally, outsourcing refers to the act of moving the company’s “noncore” business activities and related decision responsibilities to outside providers. Its main goal is to enhance the organization’s flexibility and competitiveness in rapidly changing marketplaces. Because outsourcing frees up the company’s key resources, such as cash, personnel, time, equipment, and facilities, it is a popular way to make the company’s supply chain operations lean. The business functions that are often outsourced include call center services, logistics services, janitorial services, payroll and secretarial services, information technology services (e.g., website development, web hosting, cloud support services, data entry, data warehousing), fabrication and assembly, audit and payment, bookkeeping and invoicing, tax management, sales and marketing, and health and safety compliances.

Once the outsourcing decision is made, the next step for outsourcing is to determine the scope of outsourcing. Depending on its scope, outsourcing can be implemented at

four different stages (Sanders and Locke, 2005)

• Out-tasking—Without tasking, a specific task with a narrow scope, such as the delivery of finished goods to retailers in a certain area, can be contracted out to an outside supplier (outsourcer), such as a trucking firm. In other words, out-tasking is characterized by the outsourcing of one or a few tasks that are considered primarily tactical and standardized.
• Co-managed services—Co-managed service is another form of outsourcing in which the scope of subcontracted work performed by the outside supplier is greater than out-tasking, but the outsourced tasks are still controlled by the customer. It is characterized by outsourcing of multiple tasks that are mostly tactical and partially standardized. An example of a co-managed service is the arrangement of vendor managed inventory (VMI) between the manufacturer and its supplier.
• Managed services—With managed services, an outside supplier is responsible for the design, implementation, and management of end-to-end supply chain solutions for the customer. Managed services often involve the customization of outsourced tasks. An example is the use of a third-party logistics provider for handling a full range of integrated logistics activities, such as staffing, equipment purchase/maintenance, facility management, software development, materials management, inventory management, and traffic/carrier management.
• Full outsourcing—In full outsourcing, the outside supplier takes full responsibility for the customized design, implementation, management, and often the determination of the strategic direction of the entire business function. Full outsourcing can make the company virtual because the outsourced tasks are completely in the hand of an outside supplier. An example is the outsourcing of the full spectrum of information technology (IT) services encompassing day-to-day execution, equipment purchase and maintenance, staff development/training, payroll, and strategic planning. Because the client heavily depends on its outside supplier and has no control over its operation, full outsourcing can be riskier than other forms of outsourcing.

Cost Analysis

To get the best possible value for each purchase, supply chain professionals need to ensure that the price they are paying is fair and reasonable. Such an assurance cannot be made without knowing the exact costs of products or services to be sourced outside. Therefore, cost analysis is one of the most important tools for sourcing. In a nutshell, cost analysis is an attempt to obtain the “lowest fair and reasonable” price of outsourced products or services. That attempt includes the breakdown and examination of current and anticipated costs associated with the purchase of those products or services. Cost analysis is particularly useful for answering the following questions related to sourcing

• Are we paying more than what the product or the service is really worth?
• Are we being charged the same as another buyer would be charged?
• How does the current price compare to a price paid in the past for the same or similar goods or services?
• Is the quoted price a discounted price or a list price? Is there room for price haggling?

Key principles of cost analysis

• Capture cost drivers, not cost elements. Answer “what incurs costs,” not just “what comprises cost.”
• Build commodity-specific cost drivers. Inherent differences in products will cause different cost drivers.
• Consider the total cost of ownership. Few sourcing decisions should be based solely on the product or service’s purchase price.
• Start simply and then add complexity to the cost analysis only as needed. Focus on the most important cost drivers.

Total Cost of Ownership – The total cost of ownership (TCO) is a management accounting philosophy that includes all supply chain–related costs expected to be incurred throughout the entire life of product. These costs are composed of three components

• Acquisition costs—Costs associated with the purchase of a product or service
• Ownership costs—Costs associated with the ongoing use of a purchased product or service

Post-ownership costs—Costs associated with the disposal and quality assurance of a product or service