This is the strategic use of resources to perform activities traditionally handled by international staff and their resources. An alternative definition is the buying in of components, sub – assemblers finished products and service from outside suppliers rather than supplying them internally. It is strategy by which an org outstand.
The term “outsourcing” probably refers to buying materials or components from suppliers instead of making then in-house. It also refers to buying materials or components that were previously made in-house. In recent years, the trend has been moving toward outsourcing combined with the creation of supply chain relationships, although traditionally firms preferred the make option by
using backward and forward vertical integration. Backward vertical integration refers to acquiring upstream suppliers, whereas forward vertical integration refers to acquiring downstream customers. For example, an end-product manufacturer acquiring a supplier’s operations that supplied component parts is an example of backward integration. Acquiring a distributor or other outbound logistic providers would be an example of forward integration.
Whether to make or buy materials or components is a strategic decision that can impact an organization’s competitive position. It is obvious that most organizations buy their MRO and office suppliers rather than make the items themselves. Similarly, seafood restaurants usually buy their fresh seafood from fish market. However, the decision on whether to make or buy technically
advanced engineering parts tat impact the firm’s competitive position is a complicated one. Traditionally, cost has been the major driver when making sourcing decisions. However, organizations today focus more on the strategic impact of the sourcing decision on the firm’s competitive advantage.
Generally, organizations outsourcing noncore activities while focusing on core competencies. Finally, the make-or-buy decision is not an exclusive either-or option. Firms can always choose to make some components or services in-house and buy the rest from suppliers.
Reasons for buying or Outsourcing
Organizations buy or outsource materials, components, and/or services from suppliers for many reasons.
1. Cost advantage: For many firms, cost is an important reason for buying or outsourcing, especially for supplies and components that are nonvital to the organization’s operations and competitive advantage. This is usually true for standardized or generic supplies and materials for which suppliers may have the advantage of economies of scale because they supply the same items to multiple users. In most outsourcing cases, the quantity needed is to small that it does not justify the investment in capital equipment to make the item. Some foreign suppliers may also offer cost advantage because of lower labour and/or materials costs.
2. Insufficient capacity: A firm may be running at or near capacity, making it unable to produce the components in-house. This can happen when demand grows faster than anticipated or when expansion strategies fail to meet demand. The firm buys parts or components to free up capacity in the short term to focus on vital operations. Firms may even subcontract vital components and/or operations under very strict terms and conditions in order to meet demand. When managed properly, subcontracting, instead of buying, is a more effective means to expand short –term capacity because the buying firm can exert better control over the
manufacturing process and other requirements of the component parts or end products.
3. Lack of expertise: The firm may not have the necessary technology and expertise to manufacture the item. Maintaining long term technological and economical viability for noncore activities may be affecting the firm’s ability to focus on core competencies. Suppliers may hold the patent to the process or product in question, thus precluding the make option, or the firm may not be able to meet environmental and safety standards to manufacture the item.
4. Quality: Purchased components may be superior in quality because suppliers have better technology, process, skilled labor and the advantage of economies of scale. Suppliers may be investing more in research and development. Suppliers’ superior quality may help firms stay on top of product and process technology, especially in high-technology industries with rapid
innovation and short product life cycles. An organization also makes its own materials, components, service and/or equipment in-house for many reasons.
Let us briefly review these reasons;
1. Protect proprietary technology: A major reason for the make option is to protect proprietary technology. A firm may have developed an equipment, product, or process that needs to be protected for the sake of competitive advantage. Firms may choose not to reveal the technology by asking suppliers to make it, even if it is patent. An advantage of not revealing the technology is to be able to surprise competitors and bring new products to market ahead of competition, allowing the firm to charge a price premium.
2. No competent supplier: If the component does not exist, or suppliers do not have the
technology or capability to produce it, the firm may have no choice but to make an item inhouse, at least for the short term. The firm may use suppliers development strategies to work with a new or existing supplier to produce the component in the future as a long-term strategy.
3. Better quality control: If the firm is capable, the make option allows for the most direct control over the design, manufacturing process, labour and other inputs to ensure that high quality components are built. The firm may be so experienced and efficient in manufacturing the component that suppliers are unable to meet its exact specifications and requirements. On the other hand, suppliers may have better technology and processes to produce better quality components. Thus, the sourcing option ensuring a higher quality level is a debatable question and must be investigated thoroughly.
4. Use existing idle capacity: A short term solution for a firm with excess idle capacity is to use the excess capacity to make some of its components. This strategy is valuable for firms that produces seasonal products. It avoids laying off skilled workers and, when business picks up, the capacity is readily available to meet the demand.
5. Control of lead-time, transpiration, and warehousing cost: The make option provides easier control of lead time and logistical costs since management controls all phases of the design, manufacturing and delivery process. Although raw materials may have to be transported, finished goods can be produced near the point of use, for instance, to minimize holding cost. Outsourcing can be described as the transfer of activities, that were previously conducted in-house, to a third party. Ellram and Billington (2001) see outsourcing primarily as the transfer of the production of goods or service that had been performed internally to an external party.
Outsourcing means that the company divests itself of the resources to fill a particular activity to another company to focus more effectively on its own competence. The difference with subcontracting is the divestment of assets, infrastructure, people and
competencies.
Types of outsourcing
There are two different types of outsourcing namely :
- turnkey integral and
- Partial outsourcing.
Turnkey outsourcing applies when the responsibility for the execution of the entire function (or activities) lies with the external supplier. This includes not only the execution of the activities but also the coordination of these activities. Partial outsourcing refers to the case in which only a part of an integrated function is outsourced.
