2Program Outsourcing as a business concept Definitions and concepts Rationales for outsourcingThe outsourcing processRisk assessmentSuccess factorsConclusions
3Outsourcing as a business concept Previously:mainly outsourcing of activitiestrendCurrently:complete business functions are outsourcedViable business strategy
4Definitions and concepts Characteristics of outsourcing:in-house performed activities are transferred to a third partyAssets, knowledge and sometimes employees are send to the external partyExtended and long term relationshipBuyers from both parties experience new costs and risk profiles
5Forms of outsourcing services Labor outsourcingMixed outsourcingComplete outsourcingContractor provides…Some employeesSome or all of the following:EmployeesMaterialsProcess and SystemsTechnology and EquipmentFacilitiesManagement/SupervisionHost firm provides…Program managementChandrashekar, 2000
6Definitions en concepts Offshoring: Offshoring relates to the commissioning of work to a provider in a low cost country. In many cases offshoring is concerned with outsourcing of (IT) services.Partial outsourcing: only a part of an integrated function is outsourced. The coordination of the function and activities still lies with the client (the buyer). Here a major problem is of course how to demarcate the responsibility between the parties involved.Turnkey outsourcing: applies when the responsibility for the execution of the entire function (or activities) lies with the external provider. This includes not only the execution of the activities, but also the coordination of these activities.
7Definitions en concepts Two different types of outsourcing:Turnkey (integral) outsourcing: responsibility for the execution and the coordination of the entire function (or activities) lies with the external supplier.Partial outsourcing: Only a part of an integrated function is outsourced. The coordination of the function still lies with the outsourcer.
8Partial versus turnkey outsourcing AdvantagesDisadvantagesTurnkey outsourcingBuyer has minimal responsibility for outsourced processesBuyer doesn’t need to have experience with similar projectsThe project generally goes smooth for the buyerThe buyer has limited influence on the determination of the price and little insight in cost structure of providerBuyer has limited influence on the staff, technology and materials used and their qualityLarge dependence of buyer on provider resulting in high commercial, technical and performance risksPartial outsourcingThe buyer has more influence on prices, rates and costsThe buyer has more influence on the staff, technology and materials used and their qualitySpecific advantages can result in cost reductionsBuyer is required to have knowledge of the separate parts of the outsourced function/ activitiesThe buyer is required to have the organizational capabilities to coordinate and integrate the outsourced function / activitiesCommunication and coordination problems between parties involved can be a cause of delay and disappointment
9Rationales for outsourcing Strategic reasons for outsourcingImprove company focusGain access to world class capabilitiesGet access to resources that are not available internallyAccelerate reengineering benefitsImprove customer satisfactionIncrease flexibilitySharing risksTactical reasons for outsourcingReduce control costs and operating costsFree up internal resourcesReceive an important cash infusionImprove performanceAbility to manage functions that are out of controlAll these reasons underlie one overall objective: to improve the overall performance of the outsourcing firm
10Rationales for outsourcing Maintain / invest (opportunistically)Competencies are not strategicbut provide important advantages;keep in-house as long theseadvantages are (integrally) realIn-house / investCompetencies are strategic andworld-class;focus on investments in technologyand people; maximize scale andstay on leading edgeHighLevel of competitivenessrelative to suppliersOutsourceCompetencies haveno competitive advantageCollaborate / maintain controlCompetencies are strategic butinsufficient to compete effectively;explore alternatives such aspartnership, alliance, joint-venture,licensing, etc.LowLow(non-core)High(core)Strategic importance of competenceSavelkoul, 2008
11Advantages and disadvantages of outsourcing Freeing up of cash: investments can be concentrated on core activitiesIncreased dependence on suppliersOptimal usage of knowledge, equipment and experience of third partyContinuous follow-up and monitoring of the supplier relationship necessaryIncreased flexibility: fluctuations in the workload can more easily be absorbedRisks of communication and organizational problems during the transfer of activities to a third partyOutsourcing leads to easier and more focused primary processes in the organizationRisks of leakage of confidential informationInput through an independent party’s point of view which reduces the risks of introvert short-sightedness in the organizationPerformance incentives and penaltiesRisk of losing essential strategic knowledge
12Success of outsourcing Lyons (2001): 76% of outsourcers rate their outsourcing as good or extremely good.Gartner (2003): Satisfaction with the business benefits from outsourcing contracts fell from 86 percent in 2001 to 50 percent in 2002 among executives in Europe.Monczka e.a (2005) reported that 9 to 31 percent of the companies reported that outsourcing initiatives were falling short of their expectations and goals.
13The outsourcing process Three phases:Strategic phase (why, what, who?)Transition phase (how?)Operational phase (how to control?)Figure 8.4Strategic phaseTransition phaseOperational phaseCompetenceanalysisAssessment& approvalContractnegotiationProject execution& transferManagingrelationshipContractterminationAdapted from Momme, 2002
14Strategic phase Motives for outsourcing Focus on core competencesFocus on cost efficiency/ effectivenessFocus on serviceWhich activities or functions are outsourcedTransaction cost approachCore competence approachQualifications of the supplierTechnical and managerial qualities to achieve demanded level of performance
15Continuous improvement opportunities Four phase modelIdentification and assessmentPhase 1Market searchPreliminary assessmentPotential supplier listMarketbenchmarkPerformance managementAudit and approvalPhase 4Supplier report cardPost contract reviewContinuous improvementSupplier validationPhase 2Detailed auditConfidentiality agreementApproved supplier listCustomer focusPhase 3Contract negotiationOrder issueKick-off meetingExecutionContinuous improvement opportunitiesProject executionAdapted from Momme, 2002
16The Transition phase Contract negotiation Contract forms a legal basis for relationshipContracts depends on characteristics of outsourced activityThe contract type has a great impact on the success of the joint operationProject execution and transferOutsourcing transition can be very complexThe transfer should be conducted using project management principlesTest phase before going ‘life’
17Different outsourcing contracts Lump sum turnkeyContract is based upon a fixed price (per period) for executing the project or a certain activityReimbursable turnkeyThe provider is compensated for all costs that he incurs for executing the project or a certain activitySemi lump sum turnkeyPart of the work is compensated on a fixed price basis; the other part is compensated on a reimbursable basisLump sum fixed priceThe supplier agrees to complete the work against a fixed price based upon a predefined, detailed scope of work. Everything that is not included in the scope of work is settled between parties on an ad-hoc basisCost reimbursableThe supplier agrees to complete the work on open book, open cost basis based upon a general scope of work. There is no sharing of savingsGuaranteed maximum contractThe same as a cost reimbursable contract, only the outsourcer pays to a certain agreed maximum. The extra costs are for the supplierShare the savings / loss (target price contract)The services are paid for on a reimbursable basis. When the contract costs are higher or lower than the original budget (target price), the difference is shared between parties on a pre-agreed basisUnit rateRates are agreed for regular, routine activities, the size of which cannot be anticipated. Rates are defined per m2 of paint, meter of cable to be installed, etc. Payments are made based upon actual use.
18Transition phaseThe type of contract is just one of many issues to be discussed. Other ‘ingredients’ in an outsourcing agreement are:The scope of the serviceTerms of agreementRates, fees, incentivesTermination planConflict resolutionCommunicationManagement and controlOther (warranty, confidentiality etc.)
19The operational phaseIt is in the operational phase that the outsourcing will deliver its expected resultsSuccessful outsourcing depends heavily on close cooperation with the supplierMcQuiston (2000) identifies six core values as being critical to a successful outsourcing relationshipCore valuesSupporting factorsShared goals and objectivesMutual dependenceOpen lines for communicationConcern for the other’s profitabilityMutual commitment to customer satisfactionTrustDeveloping a personal relationshipHaving professional respectInvestment of effort by top managementCommitment to continuous improvementMcQuiston (2000)
20Risk assessmentIn cases where trust and interpersonal relationships are not present, parties try to arrange for dealing with these risks and uncertainties by detailed outsourcing contractsThese contracts are associated with the following kinds of risks:Technical risks: related to the extent to which the supplier is able to provide the desired functionality and performanceCommercial risk: related to the uncertainty with regard to the price we will pay and the costs that we will incur when having outsourced our activities to the supplierContractual risks: e.g. does the contract in sufficient detail describe the performance that is expected from the supplier?Performance risks: related to the chance that the supplier is not capable of doing the job he was hired for.Trust and partnership are more important to solve the problem.
21Critical success factors of outsourcing Understanding company goals and objectivesA strategic vision and planSelecting the right vendorA properly structured contractOpen communication with the individual groups involvedOngoing management of the relationshipSenior executive support and involvementCareful attention to personnel issuesThe way the company is strategically positioned vis-à-vis its supplier. Can it still exert some control over its supplier, or not?
22ConclusionsOutsourcing has become very popular as a business strategy in many industries around the world.The new strategy involves the decision to move an activity, that was conducted in house, to an outside provider.A careful outsourcing process is crucial for its success.The outsourcing strategy should be in line with the overall corporate strategy.