Strategic Outsourcing: The Decision Process and the Influencing Factors

Creating a competitive advantage is a vital aspect of any company’s success which can be achieved by developing core competencies (David 2013, p.151). How do companies can develop and sustain that competitive advantage within with external changes in the business environment?

Scholars have developed different arguments. On the first hand, companies can analyse the external environment, in specific, five forces that were developed by Michael Porter to understand the attractiveness of a market and how they can create and sustain core competencies in that market. The five forces are: ‘threat of new entrants’, ‘bargaining power of suppliers’, ‘bargaining power of buyers’, ‘threats of new substitutes’ and ‘rivalry among existing competitors’ (Porter 1980; Porter 2008). On the other hand, companies can analyze their internal resources under what is called Resource Base view (RBV) theory (Barney 1991; Barney 1995). Later, a new argument has emerged under ‘Dynamic Capability’ theory which was first developed by Teece at al. (1997). Dynamic capability reflects the company’s ability to reconfigure its competencies, the internal and/ or the external ones, in response to external environmental changes (Helfat et al. 2007, p.2).

Whether the company is looking externally, internally or analyzing its strategies under rapidly changing business environment, internal resources are limited, therefore, outsourcing is one of the strategies that can be used extend the current resource base or acquire new ones (Barney 1995; Helfat et al. 2007, p.100; Teece 2014).

Previously, in this article, the outsourcing decision was defined as the act of securing a business function, a product or a service from third parties because they can provide it better than performing it internally (Chandra & Grabis 2007, p.29; Fawcett et al. 2007, p.282; Donald Waters 2010, p.165; Bowersox et al. 2010, p.10; Dawei 2011, p.34; Slack et al. 2013, p.157). Within this context, the strategic outsourcing in specific means that the aspect that is being outsourced is very significant and important to the company (Dawei 2011, p.34).

This article will be dedicated to illustrating the strategic outsourcing decision process, and the influencing factors that are associated with this process.

Strategic Outsourcing Decision Process

Different scholars studied the outsourcing- decision process and proposed detailed frameworks and approaches for a successful outsourcing. Fawcett et al. (2007) recommended three basic steps for any outsourcing decision which are: “establish the mission”, “conduct the outsourcing analysis” and “establish and manage the outsourcing relationship”.

In this article, the three steps will be amended and used as the basis for analyzing and grouping the body of literature in this area. The rest of this discussion will be arranged as the following:

  • Firstly, the steps that should be taken before conducting the make- or- buy decision,
  • Secondly, the frameworks and models that can be used for a systematic decision process, and
  • Finally, the steps that should be taken to manage and control the outsourcing relationship.

Phase 1: Prerequisite Steps

The outsourcing decision is like any strategic decision that should be carefully planned. Venkatesan (1992) recommended that the first step is to understand the strategic importance of the system or the subsystem that is being outsourced, the potential suppliers’ capabilities and the cost associated. The latter is formally known by Total Cost of Ownership’ (Ellram 1993). Platts (2002) recommend taking the external environment into consideration during the decision process such as prices fluctuating due to pressure from competitors. This is also agreed by Dawei (2011, p.37) who emphasized on the importance of understanding the competitive environment and the market where the company operates.

In addition to the external environment, van de Water & van Peet (2006) recommended looking internally at the whole ‘value-chain activities’ not only at a single activity. The purpose of that is to identify the factors that will be used in the evaluation process from customers’ point of view.

Needless to say that the team that will lead the decision process should be formulated (Platts et al. 2002). A mission statement that defines the required company’s objectives out of this outsourcing process should be documented here and tracked in the final stage (Fawcett et al. 2007; Dawei 2011, p.37) and a clear strategic intent or vision must be developed and communicated to everyone involved in the decision process (Vagadia 2012, p.104).

Equality important, Vagadia (2012, p.103) addressed the non-tangible aspects of the outsourcing decision such as communication, trust, conflict management, cultural differences and cooperation and the importance of setting the right expectations about them as early as possible during the decision process.

Phase 2: Make or Buy Decision

The body of literature in this area is filled with frameworks and models that can help the management to perform the make or buy decision in a systematic way. These models and framework can be classified as: descriptive and quantitative (van de Water & van Peet 2006). Below is a summary of the main frameworks and models in this literature review.

Descriptive Models and Frameworks

  • Venkatesan (1992) proposed a model that starts with classifying the subsystems into strategic and nonstrategic, and then grouping the components that have the same manufacturing process technology into ‘families’ which are: ‘strategic component’ family and ‘commodity component’ family. Each of these families has a different management strategy (Venkatesan 1992).
  • Probert (1997) developed a model that depends on analyzing two factors: the importance of the technology to business and the competitiveness that it provides to the company (Probert 1997, p.23).
  • Platts et al. (2002) proposed a model that depends on four areas which should be examined during the decision process namely, ‘technology and manufacturing processes’, ‘costing’, ‘supply chain management and logistics’, and ‘support systems’ (Platts et al. 2002).
  • Slack (2005) developed a linear model to explore the different management strategies for the outsourced activity (Slcak 2005 in Dawei 2011, p.37).
  • Kumar et al. (2010) suggested using a closed loop-outsourcing model for the decision process. The closed loop is to emphasize the importance of reviewing the outsourcing decision (Kumar et al. 2010).
  • Vagadia (2012) developed a ‘Governance Director Decision Modelling Framework’ that consists of 8 steps from sourcing readiness up to vendor selection (Vagadia 2012, p.110).

Quantitative Models and Frameworks

  • Saaty (1980) proposed a decision model using Analytic Hierarchy Process (AHP) which is also supported by a software to facilitate that analysis (Yang & Huang 2000).
  • Mclvor (1997) developed a model that starts by classifying the activities into a core and non-core activities. The model consists of four stages and developed based on AHP analysis (van de Water & van Peet 2006).
  • Yang and Huang (2000) analyzed the outscoring process in Information Systems companies and developed a model using AHP (Yang & Huang 2000).
  • Schniederjans and Zuckweiler (2004) developed a ‘linear static quantitative model’ to facilitate the decision process. The model calculates the number of units that the company wants to produce and then the model decides whether to outsource it or not based on analyzing the cost per unit (Schniederjans & Zuckweiler 2004).
  • van de Water & van Peet (2006) developed a model that combines the work of Platts et al. (2000) and McIvor (1997). The new model also utilizes AHP for the decision making (van de Water & van Peet 2006).

 Phase 3: Supplier’s selection, management and control

The make- or buy decision is not the ending point of the outsourcing process. Several steps should be followed to ensure the effectiveness of that process. For example Venkatesan (1992) suggested using a supplier grading system to make sure that contracts are awarded to the most qualified suppliers. In addition, he emphasized the importance of re-evaluating the outsourcing decision process to make sure that the benefits are still outweighing the threats in that process (Venkatesan 1992).

Platts (2002) suggested that the outputs of that decision, or what he called performance measures in his framework, are fed again to the external environment in order to be reassessed and compared against the agreed outsourcing objectives.

The suppliers’ relationship management starts at this phase. This includes selecting the appropriate relationship, contract negotiation and finally suppliers’ incentive and evaluation (Vagadia 2012, pp.110–112).

Dawei (2011, p.37) addressed the importance of identifying the key strategic suppliers and the best relationships with them. Suppliers relationships can vary from one-tire relationship to a joint venture (van de Water & van Peet 2006). Fawcett et al. (2007, pp.294– 297) discussed these relationships thoroughly and analyzed a range of relationships from a limited-scope supplier, niche provider, hybrid to a full-service supplier according to the nature and scope of the outsourcing process. These arguments confirm with Vagadia (2012, p.105) who also suggested using a systematic suppliers’ selection process taking into consideration all the inputs during the selection process.

In order to monitor the supplier’s performance, Fawcett et al. (2007, pp.294– 297) and Dawei (2011, p.37) suggested using Key Performance Indicators (KPIs) in areas such as quality, timely performance and completeness of the job awarded. In addition, a post-audit can be conducted before contract renewal to make sure that all the requirements are going to be fulfilled in the future Fawcett et al. (2007, p.300).

Shall the company find that the outcome of the outsourcing process does not confirm the intended objectives, it may decide to insource the activities back under its custody under what is called Insourcing (Fawcett et al. 2007, p.300)

A summary for the three phases is shown in the figure below.A or B as concept of choice

The Influencing Factors for the Strategic Outscoring Decision Process

Some of the influential factors that may impact the outsourcing decision process positively are:

  • Company’s capability in overcoming the risks to achieve the benefits of the outsourcing process: the company should conduct thorough analysis for the expected benefits (such as reducing costs, increasing focus, improving flexibility, improve responsiveness, extending the current resource base) and the expected risks (such as the hidden costs, losing control and competitiveness, creating competitors, increasing supplier’s dependability, violating Intellectual Property Rights, reducing innovation and finally losing agility and flexibility). The results of such analysis might slow or speed up the decision process.
  • The availability of previous sourcing decisions: in some business sectors, the outsourcing process is still new, therefore, the decision might take more time. For example decision makers in charity and SMEs (Small and Medium size Enterprises) are usually reluctant due to lack of previous experience (Díaz-mora & Triguero 2006; Vagadia 2012, p.55).
  • Culture in the original company: culture influences the outsourcing decision in many ways. For example: the management style in insurance companies tends to be risks averse (Vagadia 2012, p.200), Indian managers are usually unwilling to take risks compared to UK and USA (Vagadia 2012, p.200) and finally, the negotiation skills tend to be lower in India comparing than other countries (Vagadia 2012, p.202). These differences might slow down the outsourcing process.
  • Country: the location of the outsourced company might determine the availability of the resources needed for a successful outsourcing. Vagadia (2012, p.192) discussed some of the influential factors for any outsourcing to China such as the availability of the required infrastructure there, talent capabilities for the Chinese personnel, language, government and demographics. These factors are different from one country to another so the outsourcing decision process that might be quick and smooth in Spain might not be the same in the UK (Vagadia 2012, p.200).
  • Industry: industry type might determine the willingness to go for the outsourcing process, for example, banking and telecom sector are usually adopters, while insurance companies are usually reluctant to outsourcing (Vagadia 2012, p.55).

Conclusion and Limitations

Before concluding this discussion, the limitations of the proposed frameworks and models shall be addressed. Firstly, some of these models were coming from a manufacturing background (Venkatesan 1992; Probert 1997) or information system background (Saaty 1980; Yang & Huang 2000) therefore, the application of them in other industries should be further examined. Moreover, these models are coming mostly from cases in Developed Countries. Deeper researches are needed for outsourcing in developing countries where differences such as technology, legal and cultural ones might provide new insights and directions.

Secondly, using descriptive models rather than qualitative models holds some advantages and limitations too. On the first hand, the descriptive models are fast and easy to implement yet they could be judgemental. On the other hand, the qualitative models can provide better results but also prioritizing the decision factors includes a certain degree of bias, in addition to the possibility of not having enough data to conduct the qualitative analysis (van de Water & van Peet 2006). A combination of more than one model is recommended to compare and contrast the results before getting the final decision.

Thirdly, the decision factors that were used to build the decision criteria should be further examined to ensure that they are still valid in today’s business environment. For example, what was a supporting activity according to Porter’s Value Chain model is no longer a supporting one. In fact, IT, for example, is a primary activity in e-commerce business (Chaffey 2011, p.326). Accordingly, IT department, which was used to be outsourced, might give a better competitive advantage if it is performed internally.

Finally, the literature reviewed does not provide a clear direction on when to stop the outsource process and insource the business activity again. More empirical research is needed in this area to identify the right triggers, steps and actions that should be followed.

References

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Yang, C. & Huang, J.-B., 2000. A decision model for IS outsourcing. International Journal of Information Management., 20(3), pp.225–240.

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