Lecture 6: Outsourcing and Risk Management

Definition and Characteristics of Outsourcing

• Outsourcing is the decision and subsequent transfer process of activities from a company to an external supplier.
• Key characteristics of outsourcing include:
  • Activities initially performed in-house are transferred to an external party.
  • Assets, knowledge, and sometimes people are transferred to the external party.
  • An extended relationship between parties is involved over a longer period.
  • The buyer is exposed to both cost and risk profiles.

Forms of Outsourcing

• Offshoring: Commissioning work to a provider in a low-cost country.
• Nearshoring: Outsourcing activities to nearby low-cost countries.
• Onshoring: Outsourcing activities to providers in the same country.
• Turnkey outsourcing: The external provider takes responsibility for executing the entire function.
• Partial outsourcing: Only a part of an integrated function is outsourced.

Rationale for Outsourcing

• Tactical reasons:
  • Reduce control costs and operating costs.
  • Free up internal resources.
  • Improve performance.
• Strategic reasons:
  • Improve company focus.
  • Gain access to world-class supplier capabilities.
  • Get access to resources not available internally.
  • Improve customer satisfaction.
  • Increase flexibility.
  • Share risk.

The Outsourcing Process

• Three phases:
  1. Strategic phase (Why, what, who?)
  2. Transition phase (How?)
  3. Operational phase (How to control?)
• Four-phase model:
  1. Market search and preliminary assessment.
  2. Detailed audit and supplier selection.
  3. Contract negotiation and execution.
  4. Supplier report card and post-contract review.

Risk Assessment

• Technical risks:
  • Maintaining crucial knowledge in the company.
  • Ensuring the supplier applies leading-edge technology.
  • Ensuring supplier staff capability.
• Commercial risks:
  • Uncertainty in price and costs (mitigated using incentives and penalties).
• Contractual risks:
  • Difficulty in mentioning all terms and conditions in a contract.
• Performance risks:
  • Supplier capacity and flexibility to meet fluctuating requirements.
  • Buyer capacity and flexibility to trace and track supplier operational processes.

Critical Success Factors

• Understanding company goals and objectives.
• A strategic vision and plan.
• Selecting the right vendor.
• A properly structured contract.
• Open communication with individual groups involved.
• Ongoing management of the relationship.
• Senior executives' support and involvement.
• Careful attention to personnel issues.