Strategic Outsourcing Definition
Outsourcing is the transfer of control of a process or product to a supplier. An example of a manufacturing process is plating of a part. Plating is difficult and messy and is often treated as a process "orphan" in a plant. In these cases companies haven't invested the time and money into plating process improvements. Outside suppliers who focus on this business and have better equipment and technology, as an automated plating line, will outperform the process with better control, quality, and cost.
Companies outsource parts or components that are not one of their critical core processes for economic gain or better quality. An electronics manufacturer may choose to outsource its sheet metal work for control panels. Or an off-road equipment manufacturer may outsource a sub-assembly, such as a cab for a tractor.
At the strategic level, outsourcing allows not only the transfer of control to an outsider, but also the method of manufacture using a different technology or process. In strategic outsourcing a company may transfer an entire product, a product line, or an entire plant for strategic value.
The
benefits generally are lower costs, higher quality, and shorter lead
times. The term "lean manufacturing" is
coined to represent half the human effort in the company, half the
manufacturing space, half the investment in tools, and half the
engineering hours to develop a new product in half the time.
The Good, the Bad, and the Ugly
Global sourcing has been a trend over the past 20-30 years as companies seek to drive down costs: sourcing outside of a company's traditional market. Over time, companies have learned that suppliers outside the home market can often offer superior technology or low labor cost in products. The vast majority of companies turning to global sources are primarily because their domestic suppliers are no longer providing "world class" cost and/or technology. Looking at trends in trade, there is a possibility that India may be increasingly placed as a resource for offshore outsourcing in its relationship with the US and the entire world. A more detailed breakdown of “professional and business services” reveals that the number of services industries with declining employment has grown at an increasingly rapid pace in recent years. The Good: Advantages of Outsourcing But there have been advantages reported by companies other than reductions in just direct labor cost: How have these companies been able to accomplish these successes? No one said it was easy. Key to the success in global sourcing is in commodity segmentation to identify the best targets for "global sourcing”. A company that sources globally to import back to its home market needs to determine if products can be shipped economically. This often means looking to developing countries for components with labor cost advantages in simple process technologies. In developing global sources of supply, there are other considerations that are just as critical as product cost: Consider the following: These complexities in a lengthy supply chain can produce costs that are implicit and not taken into consideration during the initial outsourcing analysis. Most outsourcing analyses look at “total landed cost”, i.e. the “door-to-door” cost of procuring the product or component including all transportation and logistics costs, but leave out the implicit costs such as exchange rate variances, cash tied up in “floating inventory” on the high seas, expediting efforts, engineering changes, travel, loss of a customer order because of late deliveries, or deliveries of wrong or defective products, parts, and components. We visited the top operations officer of a mid-west manufacturer and importer of drawer slides used in office furniture. He had performed a lengthy analysis of his total landed cost of the same product he was buying from China for extended capacity. When all door-to-door costs were tabulated with implicit costs, he determined that he could actually manufacture the drawer slides more cheaply than he was buying them. The Bad: Hidden Costs But the extent of costs can be much greater than these, when events don’t progress as they should, and they never do. So what are some of these hidden costs that can surprise you after the “horse is out of the barn?” We decided to identify these costs with one of our clients who had sourced electrical and electronic components from China. One Chinese supplier was providing electrical wire harnesses to the mid-west assembly plant. Although the supplier was certified, we calculated there were 4500 defective harnesses supplied during a three month period. When we confronted purchasing about the high level of defective materials supplied, they simply stated that the company received credits from the supplier for every wire harness that was returned. What they didn’t consider, was the cost of the labor and processing for faulty products that occurred starting at the receiving dock, extending through the production process, out to the customer and back to the plant: Please see our Outsourcing Success Story:
Supply Chain Management: Outsourcing for Fast Results The Ugly: Risks That Materialize The biggest single issue in strategic outsourcing is the giving up of control of the process or product. The risks are (1) degrading of quality, (2) delayed deliveries, (3) starving production, (4) theft of proprietary design or process, and (5) inadvertent creation of a competitor. Common Buyer Mistakes: Pragmatic Applications For starters a company should never engage in strategic outsourcing because it is in vogue, or the "fad of the month." Obviously, a careful analysis of current economics and the opportunities that present themselves will determine whether or not it is sensible. Please see our white paper:
Supply Chain Agility: Inducing World Class Performance in the 21st Centry Caveats © 2007 Rockford Consulting Group, Ltd. All Rights Reserved Author
Richard
G. Ligus is President of Rockford Consulting Group, Ltd., located in
Rockford, IL., with over 30 years experience in manufacturing,
procurement, transportation and distribution. He specializes in
developing and implementing manufacturing, distribution, and supply chain strategies. Rich is an author
and a speaker, and has developed seminars with the American Management
Association. He is certified by both the Institute of Management
Consultants and the The National Bureau of Certified Consultants. Rich
has a bachelor of science degree in mechanical engineering from the New
Jersey Institute of Technology, and a master of business administration
degree from Rutgers University. He is a member of CASA/SME, and has
been listed in Jane's Who's Who in Aviation and Aerospace. He has been
a speaker at IMTS, USCTI, APFA, NEPMA, MCAA, Hand Tools Institute,
CASA/SME, and others. He has appeared several times on WREX-TV,
Mid-Morning Magazine. Rockford Consulting Group applies concepts and technologies as the situation
warrants, that will result in the ultimate benefit to our clients. We treat strategies, technologies, and methodologies as tools in a
toolchest, and use them when they offer practical solutions and achievable results. We believe that each client situation is unique, with its own unique set of solutions. Please see our
Supply Chain Management consulting services (Click here) Why Us? Rockford Consulting Group can provide long-term assistance to many companies in
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The value of U.S. exports of legal work, computer programming, telecommunications, banking, engineering, management consulting, and other private services, according to the U.S. Department of Commerce, jumped to $131.01 billion in 2003, up $8.42 billion from 2002. Imports of services - a category that encompasses U.S. outsourcing of call centers and data entry - hit $77.38 billion for the year, up $7.94 billion from 2002. Measuring imports against exports, the United States posted a $53.64 billion surplus in 2003 in trade in private services with the rest of the world.
While professional and business services in the US continue to grow, the pace of growth has slowed, suggesting that professional and business services are maturing as an industry. Looking at the relationship between outsourcing market maturity and off-shore outsourcing, service trade statistics reveal that the trade value of “professional, scientific and technical services” exports still outstrips that of imports, but increase rates suggest that imports are growing faster than exports. Affiliated transactions account for a growing share in the case of both imports and exports.
Outsourcing originally started with assembly, and progressed to manufactured components. Today it has crossed over into the office, with information technology comprising the lion’s share of what is being outsourced today. 
The impact on U.S. jobs has been devastating. From 1987 to 1997, the offshore sourcing for the high-tech manufacturing sector increased by 45-50%. Total manufacturing offshore sourcing increased by 35-40%. The jobs lost in the U.S. to China alone over a six-month period amounted to nearly 35,000. Total jobs lost to China, Mexico, and other Asian and Latin American countries comprised nearly 75,000 in the same period. Most of the jobs were lost in the electrical/electronic, chemical, apparel and household goods sectors.
Today, offshoring has expanded dramatically to include information technology, administration, and distribution/logistics. Fifty-five percent of Information technology jobs are outsourced, as are 47% of administration jobs. 
Driving the rush to offshore sourcing is the relative low cost of labor. This is nothing new. In the 1970’s the trend was to “head south” in search of cheap labor. So companies packed up their assets and moved to the southern U.S. regions where the business climate was favorable, and non-union labor could be hired much more cheaply than in the North. Then came Mexico, followed by Japan and Taiwan. Today the key sources for manufactured and assembled products are in Mexico, China, and India. The future sources will be where the lower cost of direct labor exists: Asia-Pacific, Viet Nam, Turkey, Caribbean countries, and Africa.
So, if the rush to sourcing offshore has been increasing in volume and expanding in breadth to other industries, then what are the benefits that are being realized? We know that cost direct labor is lower in offshore companies, but what other benefits accompany the reduction in direct labor cost?
A survey of 33 multi-national companies by Watson Wyatt revealed that 65% of those surveyed have lowered production costs. Another 61% surveyed claimed that operational efficiency was improved.
One major consulting firm claims that offshoring can produce a 15-20% cost advantage. By looking at the differences in the cost of direct labor in the table below, this becomes more apparent:
Differences in Hourly Cost of Labor:
Lost time in receiving, material handling, assembly, inspection, shipping, transportation, field inspection, process a return goods authorization, receiving, material handling, disassembly, inspection, repair, reassembly, and shipping. When we calculated the post-production costs for the defective harnesses, it amounted to 16%. The net result was, they saved 12% on Total Landed Costs, but lost 16% on Post-Production Costs of defective materials, for a net loss of 4% overall. So the hidden costs can be deceptive and need to be included in the total cost analysis of offshoring.
Typical add-on hidden costs can surprise the best of us, amounting to as much as 40% of the cost out of the supplier’s door, depending on circumstances. Shipping and logistics typically adds 17%. The following are costs quite often overlooked because the tendency is to assess “Total Landed Costs” instead of overall total costs:
A company is not present at a supplier from day-to-day, hour-by-hour and can't possibly monitor production activities as it would in its own facility. Given that a company is unlikely to farm out manufacture of a component to a shoddy producer, a quality producer can undergo changes with its ownership, management or workforce, and a gradual degrading of quality can take place if not effectively monitored.
Once a supplier has control of a component, it may compete for production time with other customers. The customer with the greatest sales volume to a producer will likely get the most attention. This can cause delays in delivery to other customers.
Production stoppages at a supplier facility due to catastrophic events, or neglectful attention to customer orders with smaller volume can starve production for those customers.
Another high risk in strategic outsourcing is that a company may effectively transfer control of a proprietary design or process that, if not controlled, may find its way into the hands of a competitor.
One of the highest risks associated with strategic outsourcing is that by trusting the production of a core product to a supplier, a company may inadvertently create a new competitor.
Other risks are:
Please see our Supply Chain Management success story:
Supply Chain Logistics: Redesigning the Supply Chain for Velocity
When outsourcing, a company should be looking for economic or technical advantages that a supplier can provide. Keep in mind that when going to the outside for services, or product lines, you are adding that company's gross margin to the cost of producing. A company just as inefficient as your own won't produce any gains.
Ensure that the scope, boundaries, and performance levels are well defined when engaging in negotiations. This will avoid some of the pitfalls described above. In addition this will avoid a supplier providing something that was not agreed upon and then charging a premium for it, or the supplier not providing something the buyer assumed it would be getting for the price it is paying.
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