What Is the Right Outsourcing Strategy for Your Process? Essay Example

This results in the loss of valuable knowledge and capabilities. Two important theories in outsourcing are transaction cost economics (ETC) and the resource's view (ORB) of the firm. Transaction cost economics explains when it is beneficial for an organization to manage an economic exchange internally within its hierarchies or externally through markets, while markets involve shorter-term contractual relationships between independent buyers and suppliers.

According to transaction cost economics, companies opt for outsourcing to reduce production and transaction costs as the buyer's needs are non-specific, allowing economies of scale in the supply market.

The text discusses production costs, which are the direct costs related to producing a product or service, encompassing labor and infrastructure expenses. It also addresses transaction costs, which include costs associated with supplier selection, price negotiations, contract writing, performance monitoring, and the risk of opportunistic behavior from suppliers. The risk of opportunism rises when investments specific to a particular relationship are required. ETC suggests that organizations should adopt hierarchical governance or a governance structure that relies on less specialized investments to minimize the potential for opportunism.

The resource-based view theory is another important theory used to make decisions about outsourcing. This theory sees the firm as a bundle of assets and resources that, when used in unique ways, can create a competitive advantage (Peter, 1993; Barney, 1991). The resource-based view focuses on how a company's capabilities develop and impact its competitive position and performance. Proponents of this view argue that differences in performance and the sustainability of competitive advantage can be explained by the heterogeneity of an organization's knowledge-based resources and capabilities (Tech et al., 1997). Therefore, the decision to outsource is influenced by

an organization's ability to invest in developing and sustaining a superior performance position in certain capabilities compared to competitors. If an organization lacks the necessary internal resources or capabilities, it may choose to outsource certain processes. By doing so, organizations can access complementary capabilities from external providers where they cannot gain any advantage by performing these processes internally.

When making outsourcing decisions, organizations have to deal with two important issues: (1) the search for competitive advantage and (2) the most efficient governance structure. Practitioners are increasingly faced with constraints on resources, so they must assess their capabilities across different business areas. This implies that they have to prioritize resource allocation in key business areas where they have strengths and outsource less critical areas.

The increasing specialization in various product and service markets allows for more outsourcing opportunities. Specialist suppliers are catering to demand by offering a wider range of capabilities in critical business areas. Organizations view outsourcing as a way to improve performance in different aspects of their operations. Specialist suppliers are expected to achieve cost efficiencies while adding more value. However, the potential for improved performance must be weighed against the possibility of opportunistic behavior in the supply market.

When organizations assess the possibility of opportunistic behavior, they must consider several factors. These factors encompass the extent of specific investments made with the supplier, challenges in measuring performance, and the use of contractual safeguards to address uncertainties and changes in requirements. Comprehending these factors enables organizations to adopt a relationship strategy that reduces risks associated with outsourcing while leveraging their suppliers' specialized capabilities.

The literature presents various frameworks for outsourcing that provide guidelines and

recommendations for making outsourcing decisions. Initially, these frameworks primarily focused on outsourcing in manufacturing and the classic make-or-buy decision. Quantitative models were used to evaluate this decision (Scullion, 1956; Higgins, 1955). Transaction cost economics has had a significant impact on outsourcing frameworks proposed in the literature (Pining and Clobbering, 1999; Magenta and Bryon, 1999).

Proponents of approaches influenced by the transaction cost perspective argue that the optimal sourcing option is chosen based on minimizing transaction costs. Pining and Salesman's (1999) framework explores how organizations assess potential transaction costs that arise in outsourcing and how and when these costs can be reduced.

The predominance of cost considerations in the outsourcing decision has been challenged by some, who argue that little attention has been given to how this decision impacts the overall business strategy of the organization (Baden-Fuller et al., 2000). As a result, several frameworks proposed in the literature have focused on the strategic implications of outsourcing (Roy and Auber, 2002; Innings and Were, 2000; Quinn, 1999; Eventuates, 1992). Many of these approaches to outsourcing have incorporated principles from the resource-based view.

In the US engine manufacturer, Cummins Engine, Eventuates (1992) explains the strategy used to determine whether processes should be outsourced. This approach involves integrating product differentiation, analyzing component families, and considering manufacturing capabilities. The core competence approach, derived from the ORB, has had a significant impact on distinguishing between in-house and outsourced processes.

According to Quinn (1999), successful outsourcing for an organization means focusing on core competencies where it can excel while outsourcing non-critical processes or those where the company lacks a distinctive capability. While valuable, many of the discussed frameworks on outsourcing

are limited in their predictive power as they are derived from a single theoretical standpoint.

Cox's relational competence framework (Cox, 1996) is a prevalent approach in the literature for considering ETC and the ORB in outsourcing decision making. However, this conceptual approach lacks sufficient integration of each theoretical standpoint to fully explain the intricacies of outsourcing. While it connects capabilities and asset specificity to outsourcing, it does not offer explicit recommendations on how to incorporate the principles associated with the ORB into the analysis.

The existing frameworks discussed in the text do not have a structured approach to outsourcing. This is a significant limitation in the current literature because evidence suggests that outsourcing in practice takes into account both capabilities and transaction costs. Various factors, such as asset specificity and the threat of opportunism, are also considered in outsourcing practice.

The case studies in this article involve micro directors, senior managers, and managers from various business functions. These studies not only demonstrate the practical implications of the outsourcing framework but also highlight the presence of ETC and ORB considerations in real-world scenarios. These findings emphasize the importance of considering both theoretical perspectives to fully comprehend outsourcing decisions. Lastly, this article presents management implications in the final section.

The paper emphasizes the importance of considering multiple factors when implementing an outsourcing strategy, such as the organization's capability in the process, the contribution to competitive advantage, and the potential for opportunism. By analyzing these dimensions, suitable sourcing strategies can be determined. Figure 1 visually represents the relationship between these dimensions and corresponding sourcing strategies.

The importance of considering loneliness in outsourcing levels is now a subject of

research. This article presents a framework that combines ETC and the ORB, and analyzes case studies of outsourcing strategies in real industry situations. The development of this framework was based on a research project that aimed to understand how theoretical and practical factors affect outsourcing in organizations that heavily rely on it. The goal was to create a practical approach that can be used in both service and manufacturing settings.

The work is grounded in a case study approach, beginning with a literature analysis of ETC and ORB in outsourcing decision-making. This was followed by exploratory research using practitioner interviews and analysis of documentary evidence, aimed at understanding how organizations approached outsourcing. Additionally, this research phase assessed the presence of ETC and ORB variables in outsourcing decision-making. This led to the creation of an initial outsourcing methodology, informed by both theory and practice.

The initial methodology was first implemented by conducting workshops with various organizations, leading to further improvements. The outsourcing methodology was then refined through in-depth case study analysis with multiple organizations, following the recommendations of Eisenhower (1989) for this type of research. The following section offers an overview of the outsourcing methodology, while the subsequent section explains the implications of each sourcing strategy.

This section demonstrates the implications of sourcing strategies through real case studies of companies included in the research. These case studies showcase successful outsourcing strategies from the companies and confirm the proposed outsourcing strategies in the framework. The case studies were based on interviews with personnel involved in every stage of the outsourcing process within the companies, including the relative capability position in the process. A key aspect of competitive

strategy is comprehending why one firm differs from another.

Certain firms have an advantage over others due to their ability to conduct organizational processes better than their competitors. This advantage is sustainable when it is difficult for competitors to replicate the performance within a reasonable timeframe or cost (Barney, 1991). Considering whether an organization performs certain processes better than competitors and suppliers is crucial in evaluating the suitability of outsourcing.

Hence, this analysis does not consider the differences between the sourcing organization and potential external providers of the processes in question. Instead, it helps the organization determine if outsourcing certain processes would harm its competitive position. It is also crucial to assess if the organization can maintain a sustainable competitive advantage by internally executing a critical process consistently.

If the organization can perform a specific process exceptionally well, it should continue to do so internally. In order to choose the best sourcing option for critical processes, it is important to analyze the sustainability of superior performance. This understanding will greatly impact the organization's competitive position. Identifying the source of the advantage will help determine the challenges in replicating or surpassing superior performance levels in that process.

The evaluation of the process's impact on competitive advantage is the focus of this stage.

Determining the Quadrant One

The most suitable option is when the relative capability allows for replicating and improving upon the superior performance of competitors/suppliers in the process. Additionally, if achieving superior performance in the process has a significant impact on competitive advantage and there is a high potential for opportunism associated with outsourcing, it is also recommended.

Quadrant Two

The most suitable

situation for sourcing a process from an external organization is when the sourcing organization has a substantial competitive advantage that is hard to replicate, the process contributes significantly to competitive advantage, and there is a high potential for opportunism in outsourcing the process.

Outsourcing is most suitable in situations where competitors/suppliers have a superior performance position that cannot be replicated, when the process is expected to become less significant for gaining a competitive advantage in the future, and when there is the potential to manage opportunism through an appropriate relationship strategy.

Critical to Competitive Advantage Invest to Perform Intern Ally

In cases where it is not possible to sustain a superior performance position in the process and the process is likely to diminish in importance in the future, adopting an appropriate relationship strategy can manage the potential for opportunism. This is particularly important when the contribution to competitive advantage is not critical.

Quadrant Three

The position of competitors/suppliers in the process impacts performance. However, the process itself does not act as a source of competitive advantage.

The potential for opportunism can be managed by adopting an appropriate relationship strategy. This strategy is most applicable when the sourcing organization has a performance advantage over competitors/suppliers in a certain process. The process itself does not contribute to the organization's competitive advantage. In this scenario, a possible strategy is to collaborate with a supplier or spin-off the process as a separate business.
On the other hand, if the sourcing organization has a significant performance advantage that is difficult to replicate and the process is not a source of competitive advantage, outsourcing is not possible

due to the lack of capable suppliers and spin-off is not feasible.
Figure 1 illustrates the different sourcing strategies based on relative capability and opportunism potential.
It is important to note that when a process contributes to competitive advantage and the organization possesses a distinctive capability in that process, it should remain internal and receive strategic attention to maintain its position.

Processes that are crucial for gaining a competitive edge greatly influence an organization's ability to outperform competitors by either achieving lower costs or implementing higher levels of differentiation. As a result, excelling in these processes enables an organization to consistently offer lower prices and/or distinguish its product or service in the eyes of customers. Conversely, processes that are not essential for gaining competitive advantage have minimal impact on an organization's ability to outperform competitors.

While it is important to perform these processes well, any improvements in performance are unlikely to give a competitive advantage because customers do not see them as key factors in their purchasing decisions. This stage involves evaluating the possibility of opportunism when outsourcing a business process. There are several indicators of potential opportunism in outsourcing situations. Investments in physical or human assets dedicated to a specific relationship will create switching costs for the organization doing the sourcing.

The problem of opportunism is worsened when there are only a few capable suppliers in the supply market. This makes the sourcing organization more vulnerable to opportunistic behavior during contract negotiations and renewals. The uncertainty in the business environment and the sourcing organization's requirements may make it impossible to create comprehensive contracts, leading to frequent amendments and renegotiations. Additionally, complex interdependencies

between business processes can further increase the potential for opportunism.

Increasing the need for coordination, joint problem solving, and mutual adjustment, high levels of interdependencies between processes - whether internal or with outsourced processes - were found (Van deer Vega et al., 1998). The ease of transferring the process to the supplier is influenced by the degree to which it can be codified. Processes with a higher proportion of explicit knowledge are more codified and can be transferred to a supplier more readily compared to those with a higher proportion of tacit knowledge (Aaron and Sings, 2005).

Difficulties in measuring the contribution and performance of suppliers can cause problems in the relationship. The sourcing organization must allocate additional resources to monitor performance. Furthermore, differences in interpreting performance can also pose challenges. For example, without established effective performance measures for outsourced processes, it becomes challenging to evaluate if the supplier has improved upon how the process was handled internally.

To handle opportunism, companies can utilize different strategies. One approach is to keep the process in-house when there is a high chance of opportunism. In certain instances, it might not be viable to create a contract that effectively deals with potential opportunistic behavior. However, in many cases, an appropriate contracting arrangement can be implemented to address this issue.

When outsourcing with minimal investment in assets and predictable requirements, a short-term contract can be used. On the other hand, if the sourcing organization has specific needs and uncertainty exists regarding the transaction, a relational contracting arrangement is better suited. Relational contracting goes beyond a formal contract and incorporates social mechanisms that encourage flexibility, information sharing, and collaborative problem

solving.

Finally, a possible approach for sourcing strategy is to simplify the process by restructuring it into several generic processes that can be offered by multiple suppliers. This will decrease uncertainty in the transaction. It's also possible that these outsourced standard processes have some similarities to short-term market contracts. Another strategy to reduce opportunism is to transfer the process to a supplier with whom the sourcing organization already has a relational contracting arrangement.

Outsourcing a process can be a strategic decision to improve the relationship with an important supplier. R. Micro aims to outperform its rivals by delivering exceptional results. There are different scenarios where this option is favored, for instance, when processes are in their initial development phase and have room for growth. In such situations, investing in this field might be the optimal solution.

The analysis of the process may indicate that the difference in performance lies in an aspect like quality or productivity, which can be improved through an initiative. Conducting a benchmarking exercise can help determine necessary actions to enhance performance. Outsourcing this process to a supplier may lead to opportunistic behavior, which in turn, may compel the sourcing organization to improve and keep it internal.

Exhibit 1 demonstrates a retail bank's decision to enhance a process rather than outsourcing it, primarily due to potential opportunism in the service provider market. This case centers on a retail bank facing significant growth in mortgages, overwhelming their internal systems. To address this, the bank explored the possibility of outsourcing this area. This involved evaluating their existing mortgage systems and the capabilities of external service providers.

The investigation found that the bank had

insufficiently invested in appropriate technology and was coping with the increased workload by hiring more staff and imposing excessive overtime. Examination of the service provider market uncovered several providers with lower costs and the ability to deliver larger levels of service than the bank could internally, mainly by achieving greater economies of scale and investing more in technology.

An in-depth analysis and benchmarking study of one service provider showed that it could bring new products to market within six weeks, which was significantly faster than the bank's internal timeline. At first, this service provider seemed like the perfect choice for outsourcing. However, further analysis of the bank's internal mortgage processes revealed complex interdependencies, such as cumbersome reporting structures and duplications, that would hinder the transfer of these processes to the selected service provider.

The current structures were problematic for establishing clear acquirement and linkages with other internal processes, which would have increased the potential for opportunism in an outsourcing relationship. Additionally, the bank was concerned about its lower volume of business compared to other clients of this service provider, which may have impacted service levels. As a result, senior management initiated a business improvement initiative.

The process of redesigning the mortgage processing structure internally included two distinct steps. First, mortgages were separated into sales/sanctioning and processing processes. Second, current work roles were re-defined, and key reference indicators were created. These indicators include the sourcing strategies Quadrant one, which involves critical processes that are better handled by competitors or suppliers rather than internally within the sourcing organization.

When considering how to improve performance in the sourcing process, the organization should explore various strategies. One option

is to invest internally by allocating resources to address any performance issues. The decision to choose this option will depend on the extent of the performance disparity. If the disparity is not significant, resources can be invested to handle the process internally.

Furthermore, the sourcing organization may need to consider this option due to the high potential for opportunism caused by a shortage of capable suppliers. However, the sourcing organization should make sure that it can replicate and maintain productivity rates, quality of work, turnaround times, and levels of cross-sales achieved. Additionally, by re-designing the mortgages area into sales/sanctioning and processing, the bank would be able to outsource the processing element in the future.

If an organization lacks capabilities compared to competitors, it can be challenging to justify investing considerable resources in order to catch up or exceed external capabilities. This is particularly true if replicating a superior performance position is both difficult and costly for the organization. For example, consider an automaker that has traditionally designed and produced engines in-house for all of its models.