CHAPTER 3: THE OUTSOURCING CONCEPT 3.1 INTRODUCTION 3.1.1 Background and methodology of the chapter As has been discussed in some detail in Chapters 1 and 2, the business environment
has undergone major changes, particularly in the last six decades, and companies
are under significant pressure to maintain and increase their profitability as well as
customer service and market share in a global economy. Managers are therefore
searching for any edge that can provide them with success. Outsourcing is one more
approach that can lead to greater competitiveness. (Weston, 1996; as quoted by
Embleton & Wright, 1998). Also in Chapter 1, the following paraphrase by Greaver
(1999) was provided which supports this view and points to the need for
organisations to think strategically about how they are going to deal with these many
changes and increasing pressures: He asserts that organisations are questioning
whether the traditional paradigm of owning factors of production is the best to achieve
competitive advantage, but that the outsourcing concept of moving activities out of
the organisation to where the experts and their resources exist as opposed to owning
all of the resources, is in opposition to most tradition and experience. Furthermore,
although when successful outsourcing can be a powerful tool for achieving
competitive advantage, when unsuccessful, it can lead to sub-optimal performance,
lack of morale, and lost business opportunities. Many problems result from
outsourcing, due to companies searching for short cuts to deal with pressures or
weaknesses, and failing to consider the long-term implications of outsourcing. In
order to ensure success, therefore, outsourcing must be a strategic decision and a
well-planned and executed initiative. This is never more so than, for example, in the
outsourcing of logistics activities.
This chapter of the thesis therefore seeks to investigate the important issues and
problem areas associated with the concept and practice of outsourcing. Chapter 3
will thus cover outsourcing as a generic concept, providing a further introduction to
the rest of the thesis which will consider logistics outsourcing trends and issues with
Chapter 3 - 3
particular focus on the manufacturing sector in South Africa, general logistics
outsourcing trends in the US, as well as the problems experienced with regard to
outsourcing initiatives.
In summary, the preceding chapter of this thesis outlined the competitive pressures
and profitability challenges facing businesses in modern times. It discussed the
resultant need for management to implement innovative strategies, with which to
advance their company’s competitive advantage and profitability, and the role and
importance of logistics and logistics management therein. The chapter discussed
various important underlying concepts and definitions particularly with regard to
logistics and supply chain management. This chapter of the thesis expands upon
these discussions, concepts and definitions and introduces further concepts and
definitions relevant to the topic of outsourcing, building a basis for the introduction to
logistics outsourcing which follows in Chapter 4. The information in this chapter
therefore focuses on the background to, and trends and issues in, outsourcing.
The methodology or work procedure followed for this chapter included investigating
relevant and available information regarding the subject of outsourcing, and defining
and discussing terms and concepts important in the study of the outsourcing concept.
This methodology has provided an outline of outsourcing practice in general. The
sources of information for this chapter included available literature mainly in the form
of academic textbooks, articles and other formal and non-formal publications.
Chapter 3 - 4
3.1.2 Outsourcing defined The following discussions with respect to the concept of outsourcing have been
compiled from a number of sources for the purposes of this thesis, providing mainly a
background to the subject material that will follow in the rest of the chapters and
contributing to the main focus of the thesis.
As has already been mentioned, Greaver (1999) asserts that outsourcing is of a
strategic nature and that the decision-making process of a company should take this
into account. This will be discussed in more detail in further sections of the thesis.
He goes on to define outsourcing as the act of transferring some of a company’s
recurring internal activities and decision rights to outside providers, as set forth in
a contract. Because the activities are recurring and a contract is used, outsourcing
goes beyond the use of consultants. As a matter of practice, not only are the
activities transferred, but the factors of production and decision rights often are,
too. He also defines factors of production as the resources that make activities occur
and include people, facilities, equipment, technology, and other assets; and decision
rights as the responsibilities for making decisions over certain elements of the
activities transferred. Bendor-Samuel (2000) concurs and insists that the key to the
definition of outsourcing is the concept of transfer of control, i.e. outsourcing thus
takes place when an organisation transfers the ownership of a business process to a
provider. It is the transfer of ownership that defines outsourcing and often
makes it such a challenging, painful process.
Similarly Fan (2000) states that outsourcing is a contractual agreement between the
user and one or more providers to provide services or processes that the user is
currently providing internally. He states that the fundamental difference between
outsourcing and any other purchasing agreement being that the user contracts-out a
part of their existing internal activity. Lankford and Parsa (1999) define outsourcing
as the procurement of products or services from sources that are external to the
organisation; while Gavin and Matherly (1997) define outsourcing more from an
operational auditing perspective, as utilising external providers to satisfy any of a
company’s capital requirements i.e. material, labour, or plant and equipment. Such a
Chapter 3 - 5
broad definition encompasses every resource acquisition decision. Furthermore,
global outsourcing can be defined as a management strategy by which an
organisation delegates major, non-core functions to specialised and efficient
service providers. Global outsourcing represents a significant shift in the way
organisations manage and staff their business support activities. (Elmuti &
Kathawala, 2000).
Embleton and Wright (1998) combine various definitions to explain outsourcing in
answer to their question as to what outsourcing comprises.
They state that outsourcing includes the following:
• having an outside provider supply a service that you usually perform in-house
• transferring of routine and repetitive tasks to an outside source
• paying other companies to perform all or part of the work
However, it is important to note that the defining of outsourcing should also make
provision for the problem of timing the move from in-house to external sourcing as
well as for differentiation between contracting-out, joint-venturing, strategic
partnering, and outsourcing. Outsourcing is not a synonym for contracting-out, i.e. it
is not merely the assignment of work to an outside provider on a job-by-job basis for
an agreed fee, but entails a long-term relationship between provider and user through
a contractual arrangement including shared resources, information, risks, and
benefits, and enabling the continuance of those activities which are critical to the well-
being of the company, but do not fall within the company’s own core competencies;
where core competencies are capabilities that are or may be crucial to the future
competitiveness of the company or processes that are not core to the business but
are essential to its operation. (Bendor-Samuel, 2000). The subtle distinctions
underlying the definitions of outsourcing and contracting are the reason for much of
the complexity that plagues outsourcing, and the challenges and value that
outsourcing can deliver also lie within this subtle definition. Therefore while
contracting is the purchasing of goods or services to facilitate a process that the
user owns, if the provider owns the process then the user is probably outsourcing.
What also sets outsourcing apart from sub-contracting and joint-venturing is the
Chapter 3 - 6
fact that internal activities are being transferred out, which may not necessarily be the
case with sub-contracting and joint-venturing. (Greaver, 1999).
Detailed definitions of outsourcing therefore need to include or imply the following key
elements:
• Deciding to obtain selected, recurring, non-core goods and services previously
provided internally, from outside the company
• Finding outside providers and new ways to secure the delivery of raw materials,
goods, components and services, by
• Utilising the knowledge, experience, creativity and facilities or capabilities of new
providers not used previously, thus
• Handing over or transferring the planning, management and operation of certain
functions to an independent third party, and
• Using formalised agreements/contracts and payment.
The decision-making process that management must undergo when considering
outsourcing thus hinges on a make-or-buy or in-source-out-source philosophy and in
the current business environment it is possible to outsource virtually any aspect of the
business. (Embleton & Wright, 1998). In today’s knowledge and service-based
economy, therefore, there are innumerable opportunities for well-run companies to
undertake strategic outsourcing (Zhu, Hsu & Lillie, 2001). These developments,
outsourced functions, reasons for undertaking outsourcing and outsourcing options
will be discussed in more detail in the following section.
Chapter 3 - 7
3.1.3 The development of the outsourcing concept
Recorded outsourcing practice appears to date back to 18th century England;
however it was the 1960s that saw the rise of specialised companies that promoted
their identities as being able to take on and run processes for other organisations.
(Bendor-Samuel, 2000). Over the years, as organisations became more complex,
their resources also became increasingly specialised and directed towards specific
elements of their operations such as project design, engineering, manufacturing,
human resources, information technology, sales, and logistics. This specialisation
encouraged the outsourcing of non-core activities, challenging management to re-
evaluate the desirability of traditional vertical integration and the meeting of all
organisational needs with in-house support. (Boyson, Corsi, Dresner & Harrington,
1999).
By the 1970s there was also an increasing recognition that many large and diverse
corporations were under-performing, showing disappointing rates of return. Formed
in the post-war period, when managers were encouraged to conglomerate,
horizontally integrate or vertically integrate, these corporations had aimed to achieve
economies of scale within their own organisations, to exercise greater market power,
to increase security through an increased production range, and to gain greater
control over raw materials sources or distribution channels by means of vertical,
forward and backward integration.
In the 1980s this under-performance became even more pronounced with the onset
of global recession, and a consensus emerged which suggested that corporate
strategies should go into reverse and that companies should focus on fewer core
activities. (Lonsdale & Cox, 2000). Since then outsourcing has been in continuous
use in numerous industry sectors, particularly as it received impetus in the latter half
of the 1980s and 1990s in the emerging service sector. (Kakabadse & Kakabadse,
2000). The rise in awareness in the ranks of senior management that such a tool as
outsourcing exists and is appropriate for more than the most menial tasks however
mainly occurred only during the 1990s. (Bendor-Samuel, 2000). Now it is estimated
that every Fortune 500 company will consider outsourcing during the first decade of
Chapter 3 - 8
the 21st century and that 20% of them will enter into a contract by 2010, if they have
not already done so. (Lankford & Parsa, 1999).
In the current environment of competitive and financial pressures and of right-sizing
of companies there is therefore a renewed focus on core business activities.
Companies no longer assume that all organisational activities and services can, and
must, be provided and managed internally. Furthermore, competitive advantage is
increasingly critical and, as has also already been alluded to, may be gained by
outsourcing, where products or services are provided more efficiently and effectively
by outside providers. Outsourcing has therefore become a key strategic tool in
today’s competitive business environment and there is increasing acceptance of the
need for leadership and management capability to structure and manage co-operative relationships crucial to the effective working of outsourcing arrangements.
Greaver (1999) also provides the following useful and insightful history of the
outsourcing concept, stating that outsourcing is a term invented by the information
systems trade press in the late 1980s. It was coined to describe the growing trend
whereby large companies transfer their information systems to outside providers.
The transferring of services to outside providers however can be traced back to at
least World War II when systems facilities management services were provided to the
US government. For decades it has also been common practice for:
• Farmers to hire groups of migrant workers to supplement the existing employee
corps at harvest time
• Construction companies to subcontract elements of subsystem construction
(electrical and plumbing, for example)
• Governments to contract for the production of military equipment with contractors
who are strategically partnered, and for those contractors to subcontract the
components.
Furthermore, Greaver (1999) points out that, for many years, manufacturers in the
automobile industry made component parts that were unique and supported their
product differentiation; however as these components became commodities, the auto
Chapter 3 - 9
manufacturers outsourced the components to providers, a practice that also
expanded to subassemblies. In recent years, many other functions in all industries
have been actively outsourced, including the following: payroll; pension
administration; information systems and technology; telecommunications; document
processing facilities and services; inventory stocking and distribution; facilities
management and maintenance; food services; janitorial services and management
services.
Outsourcing of entire processes however has not been prevalent. Nevertheless,
processes such as facilities maintenance, and inbound and outbound logistics are
more frequently being outsourced nowadays. Carriers in particular are aggressively
marketing their logistics services and are assuming responsibility for many internal
logistics processes.
Greaver (1999) goes on to further discern between the activity levels at which
outsourcing can occur, i.e. at an individual, functional or process level. Outsourcing
of individual activities, for example, involves moving specific positions out of the
organisation. This could be the management position of a poorly performing function,
or technical positions that are difficult to fill when employee turnover occurs.
Organisations have typically been structured on a functional cost centre basis, with
each function having specialised knowledge and responsibilities while processes are
related to how the product or services actually flow through the organisation. When
similar activities are linked to create an output for the user’s benefit, this is a process.
The outsourcing of functions as opposed to processes will also be touched on at a
later stage in this chapter.
With respect to users of outsourcing services by industry sector, the biggest are the
retail, wholesale and manufacturing sectors, while the lowest use of outsourcing is in
the mining and public utility sectors. This information supports the fact that managers
in more competitive industries are forced to investigate all avenues to maintain profit
margins. Mining and public utilities traditionally have been protected and, thus, have
not been large users of outsourcing. Deregulation and international competition may
change this in the future. (Embleton & Wright, 1998). As a matter of fact, reforms in
Chapter 3 - 10
the public sector through a combination of privatisation and contracting-out in local
government in the 1980s, spreading to central government in the 1990s, had an
important influence on the outsourcing trend in the United Kingdom (UK). The effect
of these public sector reforms and outsourcing was two-fold: Firstly, it reinforced the
idea that third party contractors could provide goods and services more efficiently and
effectively than internal departments. Secondly, it contributed to the development of
supply markets for services that were increasingly being outsourced by both public
and private sector organisations. The 1980s thus saw a change in direction, both in
terms of the dominant way of thinking about business strategy, and in terms of what
strategies businesses were pursuing. The idea of core was dominant, consultants
were growing in influence and encouraging companies to follow this line, and
managers were re-evaluating the idea that they needed to be vertically integrated
and self-sufficient. (Lonsdale & Cox, 2000).
In summary, the growth of outsourcing has resulted from an economic climate
characterised by fierce competition, and emphasis on cost savings and increased
profit. At the same time, the technology of the late 1990s provided a new window of
opportunity for the provision and the purchase of outsourcing services. (Embleton &
Wright, 1998).
Therefore, as has also been alluded to in preceding discussions, increased levels of
outsourcing can be attributed to fundamental changes in the competitive market
environment facing companies today, most notably rapid technological change;
greater emphasis on core corporate competencies; globalisation; and therefore
increased risk and search for flexibility. Furthermore, while cost saving is usually the
primary motive behind outsourcing initiatives, there is more to outsourcing than just
cost savings, for example improvement of services, the ability to focus on core
business, and the ability to access outside expertise.
It is therefore important to investigate the many and varied needs and purposes for
companies deciding to outsource thus contributing to the growth of this practice.
According to Greaver (1999) it is critical is that a company understands its reasons
for considering outsourcing and the benefits it seeks.
Chapter 3 - 11
Although literature suggests that the reason for outsourcing has changed from
primarily cost disciplines to strategic re-positioning, core competence enhancement,
greater service integration and/or higher value creation, the US auto industry, for
example, provides compelling evidence that outsourcing is primarily driven by cost
reduction efforts through scale economies and strategic sourcing. (Kakabadse &
Kakabadse, 2000). Economies of scale happen when the marginal cost is less than
the unit cost and for a provider that already has the particular process in place, it
costs less to produce another unit. (Begg, Fischer & Dornbusch, 1984). The Boston
Consulting Group (1991); as quoted by Kakabadse and Kakabadse (2000), studied
more than 100 key companies with extensive outsourcing practices and concluded
that most Western companies outsource primarily to save on overhead or induce
short-term cost savings. Indirect overhead cost activities, which represent non-core
competencies, are thus increasingly being outsourced. However, outsourcing is a
trade-off between lower production costs, provided the provider possesses lower cost
technology and benefits from economies of scale, and higher monitoring costs.
During the 1990s, global competitive pressures forced large companies to adopt
greater market discipline, for example by divesting of peripheral or supplementary
businesses in order to focus upon their core business and, thus increasingly
outsourcing their requirements for components and business services. This search
for greater discipline and efficiency, in turn, has led to increased specialisation, and
as such, outsourcing is seen to be a manifestation of these trends. Cost-savings and
the freedom to focus upon core business thus still tend to be the major reasons for
outsourcing. This vertical de-integration also makes sense in industries that have
global sources of supply where instead of owning their providers companies negotiate
with several outside providers for their various requirements. However, global
competition is also spurring companies to reduce their number of providers and to
demand higher levels of service and quality from those they keep. Although
traditionally relying on many providers to ensure uninterrupted supplies and low
prices, Western companies are now following the lead of Japanese companies, for
example who have far fewer providers and closer, long-term relationships with
those few. (David, 1995).
Chapter 3 - 12
Outsourcing is also a way in which companies seek to solve problems created by
business reorganisation such as restructuring, a key trend in companies today, which
usually means doing more with a smaller staff. Companies need to be more cost
effective and contribute more value. Outsourcing is one way to accomplish these
goals. (Spee, 1996; as quoted by Embleton & Wright, 1998).
There are therefore various reasons why companies outsource and benefits sought,
and essentially, companies should consider outsourcing when it is believed that
certain support activities, functions or processes can be completed faster, cheaper, or
better by an outside organisation. Tasks that are not core competencies of the
organisation are thus candidates for being contracted out, however, any skill or
knowledge that allows a company to serve its customer base better, that deals
directly with the product or service provided by the company, is one that must remain
in-house. (Lankford & Parsa, 1999).
In summary, the key aspects of the modern business environment, as highlighted by
Greaver (1999) that impact on the development of and trend towards outsourcing as
an important restructuring tool and strategic option are:
• Large organisational size is not necessarily a competitive advantage
• Small, agile niche competitors can change industries and cost structures overnight
• Competitive pressures are more severe in a global economy
• Product cycle and service cycle times have reduced dramatically, and time-based
competition demands quicker response
• Investors and analysts demand a focused management that delivers
• Bottom-line performance, growth, and size are not predictors of future profits
• Significant operating and financial performance improvements are critical to
success and long-term survival
• Supplies of technical specialists are reasonably plentiful and employing them
internally is unnecessary
• Cutting edge technology and knowledge are competitive weapons but expensive
to acquire and success can be elusive when implemented internally
• Shareholders expect companies to consistently deliver economic value putting
pressure on management to search for tools that help meet the challenges
Chapter 3 - 13
Historically, outsourcing was used when organisations could not perform, perhaps
due to incompetence, lack of capacity, financial pressures, or technological failure.
Now outsourcing is being used to restructure organisations that are successful as
they recognise that management’s undivided attention on building core competencies
and serving user needs is critical. Anything that distracts from this focus should be
considered for outsourcing. As has been mentioned previously, there is even a trend
particularly in larger organisations to outsource entire processes by means of
strategic relationships and the transfer of significant decision rights, to outside
providers with large operations providing sophisticated value-added services.
Rapidly changing technical functions that require substantial systems investment,
support, and expertise are thus increasingly being outsourced. Organisations are
reluctant to invest in and maintain cutting-edge technology and technical specialists
internally, when they know that similar assets exist outside the company, developed
without any investment and risk being required of them. (Greaver, 1999).
These trends and developments are certainly also becoming increasingly applicable
to logistics and this will be discussed in greater detail in Chapter 4.
3.1.4 Conclusion
As can be seen from the preceding discussions, outsourcing is an important concept
and trend and increasingly so considering the current environment within which
companies find themselves, with increasing pressure from users in terms of
competitive prices and service, and from shareholders in terms of profitability, return
on investment and shareholder value. Outsourcing provides managers with a
strategic tool to meet the increasing challenges, improving company performance, by,
for example, concentrating on core competencies, being more cost effective and
expanding levels of customer service. Outsourcing is thus an increasingly important
trend and development in the business world and is growing in terms of its strategic
relevance to companies. Similarly with the increased focus on logistics and its
contribution to a company, the idea of outsourcing logistics activities, in an attempt to
cut costs and improve service, is increasingly receiving consideration. However, the
Chapter 3 - 14
decision to outsource is not an easy one and must receive the attention of top
management and due consideration of its strategic nature, particularly if the true
benefits of outsourcing are to be achieved and at the same time the many potential
problems avoided. The following sections will thus discuss outsourcing as a strategic
consideration where-after its potential benefits, problems, and implementation will be
touched on.
Chapter 3 - 15
3.2 OUTSOURCING AS A STRATEGIC CONSIDERATION 3.2.1 Introduction
(i) Strategic trends and outsourcing
As has been discussed in the preceding section companies are increasingly
considering outsourcing as a strategic option and important restructuring tool. These
companies are operating in increasingly difficult environments with major change
impacting on their operations and strategies. Embleton and Wright (1998) in
discussing the strategic nature of outsourcing, emphasise that companies have in
particular been impacted by:
• Information technology – computers and the ability to produce products have
dramatically changed the structure of work, type of work and who does it.
• Communication – communication technology has accelerated the pace of change
where events in one part of the world now have implications everywhere and work
can be undertaken anywhere. The economic influence of increased global
communication cannot be over-emphasised.
• Organisational change – organisational structures are changing, with re-
engineering, organisational change and JIT manufacturing being examples of
processes that are transforming the way business is conducted.
• Cost cutting – cost reduction has become a primary focus of successful
companies.
They go on to point out that the renewed focus on outsourcing is driven by all of
these trends, particularly as they have led to enormous competitive forces and thus a
period of aggressive organisational change throughout the world. Unfortunately,
however, as has also been alluded to previously, in many companies understanding
these trends and concepts stops at the process of cost cutting. Management is under
pressure by shareholders to cut costs, and view a company’s sole purpose to be the
maximising of total shareholder return and profit. This emphasis on cost cutting leads
to an interest in outsourcing and the opportunities it presents to do so. The
Chapter 3 - 16
increased emphasis on outsourcing is thus a natural progression of today’s
competitive environment characterised by cost reduction and the reshaping of
organisations. Benefits of outsourcing such as cost reduction, and outsourcing and re-engineering will also be discussed in further detail in Sections 3.3.2 and 3.2.3
respectively.
Companies that successfully implement innovative strategies, to better manage their
company and its requirements, are better equipped to increase their competitive
advantage and corporate profitability and to become market leaders in this
challenging environment in which they find themselves. However with the
implementation of an outsourcing strategy, there are also great risks and possible
pitfalls. This will also be discussed in further detail in a later section. Outsourcing is
thus a strategic decision, requiring proactive, professional decision-making.
(Greaver, 1999).
(ii) Decision-making
However, before the strategic nature of the outsourcing concept and the importance
of the related decision-making can be discussed in greater detail, certain relevant and
important management concepts must be clarified including decision-making,
policies, goals, objectives, missions and strategies.
With regard to decisions and decision-making, Kroon (1998) asserts the following:
Decision-making can be seen as the most important of the additional management
functions, i.e. additional to the four basic management functions of planning,
organising, activating and controlling, because it can mean the difference between
profit and loss, and even between the success and failure of a business. Because
decision-making deals with the present and the future and with probabilities and
uncertainties, the decision-maker should carefully weigh up the consequences of
each alternative before making a decision. Decision-making can thus be defined as
the process whereby alternative solutions to a problem are purposefully considered
and the best alternative is chosen after considering the consequences and
advantages and disadvantages of each alternative. (Kroon, 1998).
Chapter 3 - 17
(iii) Company policy and goals
Key to decision-making are therefore policies which have as their aim the facilitation
of decision-making in the company hierarchy, to ensure that there is unity of action
and agreement in decision-making, thus promoting co-ordination and integration.
Top management must formulate business policies that can serve as guidelines for
the functional policies of the lower levels of management. During the planning
process management must ensure that all plans thus formulated are in line with the
policies of the business. A policy can thus be defined as a general guideline for
management when making decisions and sets the limits within which such decisions
must be made when similar situations occur repeatedly. (Kroon, 1998). In the same
vein David (1995) states that policies provide a basis for management control, allow
coordination across organisational units, and reduce the amount of time managers
spend making decisions. He broadly defines policy as specific guidelines, methods,
procedures, rules, forms and administrative practices established to support and
encourage work toward stated goals. Goals (in the long-term) and objectives (in the
short-term) are the end results that the business strives for and must be spelt out as
such. (Kroon, 1998). Policies are also instruments for strategy implementation.
(David, 1995).
(iv) Company strategy
A company’s strategy forms a comprehensive plan stating how it will achieve its
goals and objectives and primary business. It maximises competitive advantage and minimises competitive disadvantage. (Wheelen & Hunger, 1995). Also
important to note is that a company’s mission must clearly define an organisation’s
primary business but therefore also limit the scope of its activities in terms of the
products or services offered, the technology used, and the market served. It might
even restrict opportunities for growth (Wheelen & Hunger, 1995) and thus also limit
what may be considered a company’s core competencies. This is particularly
relevant when it comes to decision-making, for example, regarding outsourcing. The
mission thus impacts the strategy because the strategy is the comprehensive plan
Chapter 3 - 18
stating how the mission will be achieved. Strategies are thus about how the company
intends to succeed in the long run, while strategic management is therefore the
continual long-term planning process of top management whereby it may realise its
aims and objectives within a changing environment by way of the formulation and
implementation of a suitable plan of action.
The strategic plan thus covers a period of five or more years. Lambert, Stock and
Ellram (1998) define strategy as a plan, method, or series of manoeuvres or
stratagems for obtaining a specific goal or result also a set of dynamic, integrated
decisions that absolutely must be made in order to position the business in its
complex environment. Thus, strategy represents the overall actions or approach to
be taken to achieve the company’s goals and objectives. Strategic management can
thus be defined as a long-term planning process by top management, in particular, in
order to identify and implement plans of action so as to keep abreast of a rapidly
changing environment and the demands of the modern world of industry. (De Bruyn
& Kruger, 1998)
(v) Strategic planning
Figure 3.1 illustrates the relationship between the important concepts of strategic
management, strategic planning, and strategy.
Chapter 3 - 19
Figure 3.1 Strategic management, strategic planning and strategy
Source: De Bruyn & Kruger, 1998.
Management’s planning, and strategy development and implementation should be
guided by the company mission. Therefore with respect to logistics, for example, the
mission of logistics management can be identified as the need to plan and co-
ordinate all those activities necessary to achieve desired levels of delivered service
and quality at lowest possible cost (Christopher, 1998), while all the time considering
the scope of logistics which spans the organisation, from the management of raw
materials through to the delivery of the final product. Logistics strategic planning
can thus be defined as a unified, comprehensive, and integrated planning process to
achieve competitive advantage through increased value and customer service,
which results in superior customer satisfaction (where we want to be), by anticipating
future demand for logistics services and managing the resources of the entire supply
chain (how to get there). (Stock & Lambert, 2001). This planning is done within the
context of the overall corporate goals and plan. This definition thus comprises
three major elements i.e. (i) the long-term goals (customer satisfaction, competitive
advantage, supply chain management); (ii) the means to achieving these goals (value, customer service); and (iii) the process for achieving these goals (anticipate,
manage, relate to company’s goals). (Stock & Lambert, 2001).
Strategic management/strategic thinking
Strategic planning
Comprehensive master plan: How the organisation plans to fulfil its goals and objectives
Strategy
Chapter 3 - 20
The different characteristics of planning types, i.e. operational, tactical and strategic,
are also important and have an important impact of the planning being undertaken
and the decisions being made. These characteristics are reflected in Table 3.1
below.
Table 3.1 Characteristics of planning types Type of plan Time frame Focus Level of detail Level of integration Operational Day to day ≤
1 year Efficiency Heavy financial
orientation Functional
Tactical ≥ 1 to 5 years Event Somewhat financially oriented
Integrated-functional
Strategic 5 to 10 years or more
Competition, resources, stakeholders
Few financials, more goal oriented
Integrated-corporate and supply chain
Source: Lambert, Stock & Ellram, 1998.
A strategic plan therefore considers key issues such as the company’s mission,
stakeholders, basic business, core competencies, resources, and so on and therefore
options such as outsourcing, its viability and its impact on the company, long-term.
(vi) Outsourcing and company mission and strategy
Outsourcing can be described as a change in business philosophy where in future big
companies and institutions will not necessarily be the ones that employ a great many
people. They will be the ones with substantial revenues and substantial results
however, achieved in a large part due to them doing only work that is focused on their
missions; work directly related to their results; and work that is recognised, valued
and rewarded appropriately. The rest they will contract out. With increasing
customer service and economic pressures, companies are thus concentrating
increasingly on what they do best, i.e. their core competencies, and outsourcing has
become an effective vehicle for helping to achieve these changing business goals. It
is therefore vision, function, and economics that drive the need for outsourcing.
(Harkins, 1996; as quoted by Lankford & Parsa, 1999).
Chapter 3 - 21
As has been outlined in the preceding sections, outsourcing can provide companies
with reduced costs, expanded services and expertise. It allows companies to refocus
their resources on their core business. However, for outsourcing to be successful the
decision needs to be an informed one and the management of the outsourcing relationships thereafter is critical. Furthermore, as had been alluded to previously,
the risks associated with the outsourcing decisions must be analysed carefully, in
terms of the length of contractual time commitments as well as the potential loss of
financial and operational knowledge and flexibility. It is also important to note that
once a process, for example, has been outsourced, with the accompanying
investments, the outsourcing provider will have made on behalf of the user’s process,
it is very difficult to return the process to an in-house operation, if for no other reason
than the fact that the user will have to replace the process expertise. (Bendor-
Samuel, 2000). The outsourcing of selected organisational activities must therefore
become an integral part of corporate strategy (Lankford & Parsa, 1999), and as with
any strategic opportunity, outsourcing should be considered in a systematic and
analytical fashion (Gavin & Matherly, 1997).
3.2.2 Strategic outsourcing Increasingly, companies are focusing on strategy and committing to integrating
resources across all operational levels to achieve their identified objectives.
However, to implement strategic initiatives, top management must have a complete understanding of their company. Gavin and Matherly (1997) state that a
complete knowledge of an organisation includes understanding fundamental aspects
such as how core business processes are conducted. They go on to point out that
individuals at the top of organisations do not have as complete a knowledge of their
organisations as is generally assumed, particularly with respect to the level and
extent of their basic understanding of core business operating activities. It is
this basic understanding which must be grasped, along with the associated costs,
before an outsourcing decision can be made.
(i) Core competencies
Chapter 3 - 22
Strategists are no longer concentrating only on market share or vertical integration as
the keys to strategic planning, but are identifying those few core service activities where the company has, or can develop, a continuing strategic edge. They seek to
develop these competencies in greater depth than anyone else in the world,
eliminating, minimising, or outsourcing activities where the company cannot be pre-
eminent, unless those activities are essential to support or protect the chosen areas
of strategic focus. (Quinn, 1992; as quoted by Wheelen & Hunger, 1995). Therefore,
the key to outsourcing is to purchase from outside only those activities that are not
essential to the company’s distinctive competence. Otherwise, the company may
give up the very core technologies and/or capabilities that made it successful in the
first place. In deciding on functional strategy therefore, the strategic manager must,
according to Wheelen and Hunger (1995):
• Identify the company’s or business unit’s core competencies
• Ensure that the competencies are continually being strengthened
• Manage the competencies in such a way that best preserves the competitive
advantage they create.
An outsourcing decision thus depends on the fraction of total value added by the
activity under consideration and by the amount of competitive advantage in that
activity for the company or business unit. Only when the fraction of total value is
small and the competitive advantage in the activity is low, should a company or
business unit outsource. (Bendor-Samuel, 2000).
The importance of a company coming to terms with its core competencies and competitive advantage has also been alluded to in many of the preceding
discussions, particularly with reference to the danger of a company misunderstanding
its core competencies and capabilities that are crucial to future competitiveness, thus
mistakenly transferring key activities, factors of production and/or knowledge that
would provide the foundation for future core competencies, opportunities for
competitive advantage and profit. It has been pointed out that outsourcing is ideal,
for example, for certain support functions, i.e. non-core competencies of the
organisation that can be executed faster, cheaper, or better by an outside
Chapter 3 - 23
organisation, but that any competency that enables the company to serve its
customer base better, and that deals directly with its offering, should remain in-house.
According to Bendor-Samuel (2000), the nature of what is core, however, is
dependent on several factors which vary for each organisation and change over time.
Core processes are tied to the way in which a company generates shareholder value.
They are a factor of an organisation’s competitive situation and are the true tools it
uses to differentiate itself from its competitors. As such, core processes will change
over time when competition and new technologies bring change to the value chain
and companies evolve to maximise their value under the new conditions.
Nevertheless, the distinction of what is core is crucial as those processes are the soul
of a company and cannot be for sale at any price. Not understanding this fact can
lead to disaster for a company. Due to the competition and challenges facing
companies in the modern business environment, no company can master all its
processes all of the time. This forces companies to choose which processes should
receive executive focus and resources. A company that has defined its core
processes can therefore use this knowledge to further its profitability and maximise its
return to investors. The ongoing process of defining what is core to a company
should drive outsourcing decision-making. Nevertheless, it may also happen that a
company outsources a process that might otherwise be considered core, but does so
because it lacks economies of scale in that process and knows it competes on some
other element.
Core business and non-core processes and related dependencies, as well as areas
lacking in economies of scale, must thus be identified in order to highlight outsourcing
opportunities.
(ii) Involvement of top management
Outsourcing however cannot be looked at as the answer to a situation where more
unknowns exist than can be dealt with. Outsourcing is not intended to be a vehicle
used to escape from internal fact finding and analysis. Top and middle management
Chapter 3 - 24
must be committed to understanding their own business from top to bottom, from
strategic, tactical, and operational perspectives.
With respect to this strategic, tactical, and operational approach to outsourcing,
Greaver (1999) also quotes research undertaken in the US in 1997 whereby the 50%
of the Chief Executive Officers (CEOs) that responded considered their approach to
outsourcing as strategic, 47% as tactical, and 3% as both. In a similar study, in the
same year, 89% of senior-level executives in large companies across the US that
responded agreed that outsourcing was a strategic tool. In 1999, Lankford and Parsa
stated that the outsourcing of selected organisational activities is an integral part of corporate strategy and that for outsourcing to be successful the decision needs to
be an informed one. However, they go on to assert that senior managers sometimes prefer to entrust outside companies with critical tasks as they often find
that outside companies are more cost-effective. While middle managers often claim
that they can appoint someone to do it cheaper, top management look at things
differently and while they know that outsourcing will be more expensive, they also
expect that the job will be done on time and in a predictable fashion, and should this
not be the case, they can procure someone else without the difficulties of hiring and
firing employees.
However, research in the UK that has explored the extent to which outsourcing
decisions are forming part of the business strategy of a company, has suggested that
they have yet to gravitate to the top of the organisations in all but a few cases. This
could mean that the largest percentage of outsourced activities are peripheral and do
not warrant board level attention, or that few outsourcing proposals of any nature are
being considered at board level. With regard to company policy on outsourcing
therefore the indication was that outsourcing was not a fully integrated part of the
business planning process of the companies, and that generally these decisions were
not conducted at group board level to consider their overall effect on the business.
Outsourcing decisions were by and large conducted at divisional or business unit
level to consider their effect on the division or business unit. In addition, the
companies’ emphasis was on outsourcing business functions as opposed to
processes. (Fan, 2000)
Chapter 3 - 25
Lankford and Parsa (1999) quote the study, New Directions in Finance: Strategic
Outsourcing which was based on interviews with 50 global organisations plus a
survey of 303 senior executives throughout North America and Europe, and which
showed a clear trend toward the use of outsourcing as a competitive tool, rather than
just a simple means of cost control. Especially relevant is the outsourcing of key business processes and financial functions.
(iii) Activities suitable for outsourcing
Outsourcing of traditional corporate tasks has also become very popular, and doing
so can be cost-effective, provided the right tasks are contracted out. Consultants
say that companies should consider outsourcing when it is believed that certain
support functions can be completed faster, cheaper, or better by an outside
organisation. Tasks that are not core competencies of the organisation such as
human resources, payroll and benefits, information services, even food services in
the cafeteria, are appropriate for contracting out. Such aspects were also touched on
in Section 3.1.3. On the other hand, and as was also mentioned previously, any skill
or knowledge that allows the company to serve their customer base better, that deals
directly with the product or service that the company is trying to provide, is one that
must remain in-house. Support functions serve the company’s employees better, and
these tasks can thus be transferred to a group that treats the employees like
customers. Therefore, historically, third party participation in a company’s business
has generally focused on the manufacture of parts and components and the provision
of auxiliary services such as legal and travel services. A more recent phenomenon,
however, which affirms the strategic nature of the outsourcing decision, involves third
party participation in the management of the information systems function. Since
information is a principal resource in most businesses today, the consequences of external control of a company’s information system must be considered carefully.
The formulation and management of the service contracts with information
service providers are therefore critical issues. (Behara, et al. 1995; as quoted by
Lankford & Parsa, 1999). Organisations need systems and processes in place to
identify and monitor the evolving dynamics of all resource requirements and how they
Chapter 3 - 26
can be most effectively and efficiently acquired. (Gavin & Matherly, 1997). These
are of necessity, strategic considerations.
(iv) Strategic alignment and options
According to Greaver (1999), the outsourcing initiative becomes strategic when it is
aligned with the organisation’s long-term strategies, when the typical outsourcing
benefits will emerge over several years, and when the results, either positive or
negative, will be significant to the organisation. The concept of strategic outsourcing
thus takes outsourcing to a higher level by asking fundamental questions about
outsourcing’s relevance to the organisation and its vision of the future, and its current
and future: core competencies; structure; costs; performance and competitive
advantages.
Nevertheless, according to Gavin and Matherly (1997), who also acknowledge the
strategic nature of outsourcing, outsourcing decisions can cover a short or a long period of time, although they go on to say that the more interesting outsourcing
decisions deal with long-term arrangements because of the risks and consequences
associated with the contractual commitment.
Outsourcing decisions can also encompass one or more capital requirements, i.e.
material, labour, or plant and equipment. The number of capital requirements
affected by an outsourcing decision is a function of the specific type of product or
service outsourced and whether the area is currently operated in-house or is a new
venture. Once an area has been identified as a candidate for outsourcing, the total
internal cost of providing it should be compared with the price charged by outside
providers for a similar product or service. From a quantitative perspective therefore,
the decision to outsource would be appropriate when the price offered by the outside
provider is less than the total internal cost of providing the same product or service.
Determining internal cost however is a difficult task. Total internal cost consists of
two key elements, i.e. primary costs and secondary costs. Primary costs are those
costs that can be specifically traced to the targeted outsource area. Examples
include material, labour, and overhead costs arising from providing the product or
Chapter 3 - 27
service. Secondary costs occur when an area consumes the output of other activities
of the company. For instance, manufacturing operations rely on the company’s
engineering department. A portion of the cost of maintaining in-house engineers
should be treated as a secondary cost of manufacturing. Therefore, the total internal
cost of the manufacturing operation includes the primary costs of material, labour,
and overhead costs (for example, depreciation on machinery, indirect material, and
indirect labour costs) along with any relevant secondary costs, such as engineering
and other supporting activities.
Generally, operating flexibility becomes more constrained as the outsourcing contract
period lengthens; when more than one element of capital is required; when core
business processes are involved; when the risk of the company recovering from an
inappropriate outsourcing decision is larger; and when the knowledge acquisition and
analytical skills related to the outsourcing decision are beyond those possessed by
executives within the organisation. As the number of these business variables
related to a specific outsource decision increase, the likelihood of successfully
negotiating the transition to, operating within, and monitoring an outsourcing decision
becomes more difficult.
It is, however, also important to consider, when performing an outsourcing analysis,
that outsourcing does not imply an all, or nothing, undertaking for a department,
function, activity, or process. Examples of limited outsourcing arrangements
include both partial and collaborative relationships, according to Gavin and Matherly
(1997), and in the past, partial and collaborative outsourcing efforts have taken
several forms of acquisition and/or sharing arrangements, with examples including
• Durable goods (plant and equipment) acquisition/sharing
• Product components acquisition/sharing
Chapter 3 - 28
They go on to state that collaborative outsourcing relationships are often structured
as joint ventures and partnerships, and that these endeavours have been effective in
the past and will continue to be so in the future because of the flexibility, risk, and
knowledge sharing which they afford. However, limited outsourcing decisions or
partial relationships are generally more analytical than emotional in nature, primarily
because few people are impacted on by the decision process or its outcome.
Irrespective of the type of outsourcing relationship that exists, companies must
understand them and their impact upon the company, thus developing negotiation
and relationship management strategies for each. Outsourcing relationships will be
discussed in greater detail in a following section.
3.2.3 Outsourcing and strategic restructuring
According to Elmuti and Kathawala (2000), outsourcing is nothing less than the
wholesale restructuring of the corporation around core competencies and outside
relationships. An introduction to outsourcing definitions and the concept of core
competencies was provided in preceding sections, however this link between
outsourcing and restructuring requires further discussion.
Outsourcing works best when it is an outgrowth of re-engineering (Lankford & Parsa,
1999) and re-engineering is an effective way to implement a turnaround strategy such
as that of outsourcing. Re-engineering is also a new and effective approach to
strategy implementation aimed at improving operations. Re-engineering is thus
the search for a new way of organising the various elements of work in an
organisation. It is the radical redesign of business processes to achieve major gains
in cost, service or time. (Wheelen & Hunger, 1995). Accordingly it involves the
following:
• Fundamental rethinking of the way work is done
• Structural reorganisation; breaking hierarchies into cross-functional work teams
• New information and measurement systems
• New value systems with greater emphasis on customers
Chapter 3 - 29
Lankford and Parsa (1999) quote Gamble (1995) and add the following with regard to
re-engineering principles:
• It reassesses whole processes with the aim that they be reconceived and rebuilt.
• It is bold, rational and efficiency seeking.
• It does not protect jobs in any function, operation, or department.
• It sets out to build better systems, whatever the consequences.
• It is resisted by tradition and entrenched self-interest.
• It is not a naturally popular process.
Re-engineering thus strives to break away from the rules and procedures that have
developed and become ingrained in an organisation over the years and that block
change. These obstacles may be a combination of polices, rules and procedures that
have never been seriously questioned since they were established years earlier and
may no longer be relevant.
However, while many companies have had success with re-engineering, re-
engineering is almost always accompanied by a significant amount of pain and
between 50% and 70% of re-engineering efforts fail to achieve their goals.
(Stewart, 1993; as quoted by Wheelen & Hunger, 1995). Such change is therefore
possible only through innovation that encompasses the envisioning of new work
strategies, the actual process design activity, and the implementation of the change in
all its complex technological, human, and organisational dimensions. (Lankford &
Parsa, 1999). Thus re-engineering initiatives such as outsourcing must not neglect
necessary aspects of the process such as those of change management and training in order to be successful.
In summary, when re-engineering looks at who is best suited to performing a
particular task, who can do the task with the greatest efficiency and the highest
quality, and then determines that it is not the in-house staff, outsourcing is likely to
result. When competitive pressures get strong, truly re-engineered companies will
rise to the top because they have built the vital processes that work best. (Gamble,
Chapter 3 - 30
1995; as quoted by Lankford & Parsa, 1999). However while outsourcing can often
help control costs, simplify operations, and keep a company focused on its core
competencies, it will not be successful unless properly implemented. (Kelley, 1995;
as quoted by Lankford & Parsa, 1999). In line therefore with the principles of re-
engineering, the decision to outsource should address the critical role of information
and processes in organisations, including the role that systems play. If an entire
function is to be outsourced, sufficient provision should be made in the outsourcing
contract to deal with current and future requirements of the organisation. Special
attention should be given to the potential need for innovative solutions to be provided
by the outsourcer, and to the timing of these actions. (Lankford & Parsa, 1999). It is
therefore important in the outsourcing decision-making process to determine whether
outsourcing is in fact the correct strategy to follow in the circumstances.
Decision-making with respect to outsourcing will be discussed in further detail in the
following section, and detail in addition to that is provided in Annexure A to this thesis.
3.2.4 Outsourcing decision-making As alluded to in the preceding introductory discussions, identifying the core
competencies of the company as well as the activities, functions and/or processes
that present the opportunity for outsourcing is critical to the outsourcing decision. It is
also crucial that this is undertaken with the involvement of top management as with
the identification of all possible unknowns or variables in the outsourcing process and
the overall effect on the business, its employees and so on. Costs must be
analysed and the various outsourcing options and relationship types considered.
Lankford and Parsa (1999) concur with these aspects and recommend that
management should determine the company’s core competencies and primary
sources of revenue as this will identify the functions and processes that will not be outsourced, and the opportunities for functions and processes that can be
outsourced. However, the company must know and evaluate the costs of the
potentially outsourced activity and be realistic with regard to the reductions in costs
and realisation of other objectives that outsourcing can achieve. A company must be
cautious when approaching the outsourcing decision and implementation process, for
Chapter 3 - 31
example with respect to choosing an outsourcing partner, if this initiative is to be a
success. Outsourcing is not an automatic solution. The parties must be flexible,
constantly seeking ways in which to improve operations and the outsourcing
initiative, in conjunction with the outsourcing partner, as part of the ongoing management and monitoring of the outsource relationship and agreement.
A number of issues are thus involved in the decision to outsource an organisation’s
requirements and resources. Key items that must be analysed are scale economy,
outsourcer expertise, short- and long-term financial advantage from the sale of
resources, inability to manage the function, strategic realignment, and a need to focus
on the core business. Additional issues that are typically involved and need to be
considered in the context of a specific company’s situation include the following:
• Impact on company competitiveness
• Identifying services to be outsourced
• The number of providers to be used
• Ability to return to in-house operations if required
• Provider reliability
• Provider service quality
• Co-ordinating with the provider and evaluating performance
• Flexibility in the products and services offered by the provider
• Providing the latest/advanced technology and expertise
These are key elements in the successful implementation of an outsourcing strategy
or agreement and will also be discussed in further detail in Sections 3.2.5 and 3.3.
Also important to note in the outsourcing decision, and as has been mentioned
previously, is an understanding of outsourcing at the individual, functional and
process activity levels. (Greaver, 1999).
Each organisation determines its own processes and it is important that they
understand not only these but also how the various functions in the company add
value to the processes, before an outsourcing decision can be made. The following
Chapter 3 - 32
table, for example, shows six generic value chain processes (refer also to Figure 2.1
in Chapter 2 of this thesis). It also shows a few of the typical functions in a
manufacturing company. The Xs represent points in each process where the
functions add value to the process. For the sake of clarity and consistency, most
references to outsourcing in this thesis deal with activities as opposed to functions
and processes. This is due to the fact that activities are the basic components of
company functions and processes.
Table 3.2 Processes and functions
Functions: Processes:
Purchasing Receiving Accounts payable
Inventory control
Inventory distribution
Inbound logistics X X X X Operations X X Procurement X X X Technology dev. X X X X X HR management X X X X X Infrastructure X
Source: Greaver, 1999.
It can however be dangerous to focus too narrowly on a single, isolated process
when making an outsourcing decision. Such decisions should only be made after the
following questions have been answered:
• What will be the net gain or loss in efficiency and cost-effectiveness if
outsourcing?
• What will be the net gain or loss in performance quality if outsourcing?
• What will be the net effect on the strength, versatility and resourcefulness of the
department if some of its duties are outsourced?
• What dependence on a third party will be created by outsourcing, and how
vulnerable would the organisation be if that third party became unable to perform
as expected?
In summary therefore, with the increasing complexity of the business environment,
and the demands made on the company, its management and activities and
Chapter 3 - 33
processes, there is an increasing trend, world-wide, for companies, especially
manufacturers, to focus on their core competencies and outsource much of their
other company functions to companies with expertise in their non-core areas.
Following the strategic perspective that core activities should remain in-house while
non-core activities could be outsourced, Kakabadse and Kakabadse (2000) assert
however that where core competencies are essentially a bundle of corporate skills
that cut across traditional functions such as logistics, outsourcing decisions should be
driven by:
• The nature of the sourcing contracts
• The contractual and informal relationships between user and provider
• The use of market opportunities for competitive advantage and
• The successful management of outsourcing relationships and contracts
The importance of these outsourcing relationships and the various types thereof will
thus be discussed in the following section.
Chapter 3 - 34
3.2.5 Types of outsourcing relationship
As was outlined in Section 3.2.2(iv), outsourcing agreements can include limited
outsourcing, for example, partial and collaborative relationships which can take
several forms with respect to acquisition and sharing arrangements. Collaborative
outsourcing relationships are often structured as joint ventures and partnerships,
characterised by flexibility, risk and knowledge-sharing. Limited outsourcing
decisions or partial relationships are generally more analytical than emotional in
nature, primarily because few people are impacted on by the decision process or its
outcome. (Gavin & Matherly, 1997). Outsourcing contracts can also be all-inclusive,
modular (focusing on specific operations), or turnkey (specific jobs). While turnkey
contracts historically have represented the typical arrangement between outsourcing
companies and the service providers, the modular and all-inclusive approaches
characterise today’s outsourcing relationships. Furthermore, in identifying potential
service providers, the company’s in-house function might well be considered as a
possible alternative. Internal audits indicate that a function that rationalises its
operations can generally outbid the service providers. (Lankford & Parsa, 1999).
However, as was mentioned previously, leading-edge companies in particular are
considering outsourcing and leveraging their assets by forming strategic alliances
with service providers to help them achieve, for example, preferred-provider status
with key customers. Therefore, although many agreements remain transaction-based
sub-contracting, the relationships involved in outsourcing implementation are
becoming a matter of increasing strategic importance. (Greaver, 1999).
From a global outsourcing point of view, Elmuti and Kathawala (2000) assert that the
trend is for outsourcing relationships to function more and more as partnerships as
opposed to subcontracting and joint venturing. Outsourcing is not subcontracting and
rather involves the transferring out of internal activities to an external provider as has
been pointed out in the earlier sections of this chapter. Outsourcing providers are
therefore taking increasing responsibility in areas that have traditionally remained in-
house, such as corporate strategy, information management, business investment,
Chapter 3 - 35
and internal quality initiatives, and the trend is therefore toward closer business
relationships.
Therefore, outsourcing options come in many forms, and these relationships are
characterised in terms of several different elements (Eckert, Handfield, Rinehart &
Zaversnik, 1999):
• The degree of trust between the parties
• The level of interaction between the parties
• The commitment of the parties to the relationship
Trust is a concept that is critical to the foundation of provider-user relationships. On
a personal level, trust can be assessed by the interpretation of the level of character
of the other party. On an organisational level, trust addresses the capability of the
provider to meet the needs of the outsourcing company through the relationship, and
vice versa. Success in a provider-user relationship is also based on how frequently
the individuals interact concerning business activities. The personal level interaction
includes the amount of face-to-face interaction as well as the amount and type of
information exchanged. At the organisational level, the success of the relationship is
assessed through the amount of business that the parties conduct. In many cases,
large providers or outsourcing companies are viewed as adding greater value to a
relationship than smaller organisations. The added value can cause more frequent
communication between the parties and result in greater volumes transacted.
Provider-user relationships are also influenced by the level of commitment by the
parties. Commitment involves the perception of dependence of one party on the
other, and the amount of investment that they make in the relationship with respect to
time and resources. (Eckert, et al. 1999). These elements or variables are discussed
in more detail, with respect to different relationship types, in Annexure A to the thesis.
Provider-user relationships can therefore range from basic transactions to highly complex relationships between providers and users that are differentiated by the
levels of trust, interaction frequency, and commitment to the relationship. Partial
outsourcing relationships for example non-strategic transactions, and administered,
Chapter 3 - 36
contractual and speciality contract relationships, have a smaller impact on the
companies involved, while partnerships and joint ventures provide greater flexibility
also involving greater risk and knowledge sharing. Strategic alliances further enable
the parties involved to leverage their assets. A strategic alliance is thus characterised
by mutual investment and benefit, high levels of co-operation, trust, and
communication. A more strategic alliance and speciality type relationship would
therefore, for example, be more appropriate for the outsourcing of activities such as
those involved in the logistics function, where trust is key as is interaction frequency
and commitment, and investment and joint co-operation.
In this regard, Bendor-Samuel (2000) asserts that participants in an outsourcing
relationship are in fact allies not partners. He states that partners imply joint
ownership and a permanent relationship, whether good or bad, while allies on the
other hand act together for the benefit of each other in many spheres and instances
where their common interests match. Therefore their relationship, while
longstanding, is not permanent, and where their interests do not match, they are not
allied. It is however important to note that it is possible for an outsourcing relationship
to never progress beyond the exchange of money for services, while others expand
into ever-increasing areas of value creation. Not every relationship can therefore be
made into such an alliance, but where the participants take on the characteristics of
allies, they have a potentially enormous amount of value they otherwise would not
have been able to obtain. Outsourcing should thus be built on a foundation of such
an alliance.
Kakabadse and Kakabadse (2000) assert that a fundamental paradigm shift is
underway from strictly provider-user relationships to an emerging array of partner
based relationships and new outsourcing arrangements and organisational forms.
They state that the emergence of partnership or alliance arrangements as
alternatives to the formerly more popular transaction-based contracts, usually shorter
and more tightly defined, indicates a shift to closer interactions between client and
provider. While partnership arrangements vary considerably in their operations, from
flexibly defined, formal contacts, to loose strategic initiatives, they also encompass
the provision of shared risk and benefits. As was also alluded to in the previous
section, the type of relationship between provider and user depends on:
Chapter 3 - 37
• The nature of the purchase capabilities required
• The nature of the product/service exchange and the related technology
• The competitive conditions in the upstream markets and
• The capabilities of the providers available to meet the user’s needs
Furthermore, the quality of the relationship will also depend on aspects such as the
quality of information sharing. (Bensaou, 1999; as quoted by Kakabadse &
Kakabadse, 2000). The strategic partner provider, for example, will want to approach
the relationship as if it were a part owner of the business, aiming to perform not only
the services requested, but also to participate in strategic planning meetings and
share in the strategic decisions. Greaver (1999) states that such a company will want
to enlist whatever resources are necessary to deliver those services, and will prefer a
pricing model in which it is rewarded for outsourcing results, for example, pay-for-
performance, gain-sharing, or value-based fees. This type of provider is generally a
better fit for functional or process outsourcing and for areas that are closer to core
competencies, because of their generally more strategic impact at these levels. The
number of providers able to operate as a strategic partner is also more limited.
(Greaver, 1999). However the top tier of outsourcing companies also cannot be
leaders in all areas and hence outsourcing companies need to contract with two
and/or a network of providers who are expected to co-operate in order to deliver a
seamless service on behalf of their clients. (Kakabadse & Kakabadse, 2000).
Further useful examples of outsourcing agreements and relationships are therefore
also found specifically with respect to outsourcing in the field of information
technology (IT). Outsourcing partners in this field need to create an infrastructure of
technology, and strategic and operational skill to ensure the required service
provision. The integration of partners in this respect can be more important that the
technology itself. More information regarding IT outsourcing agreements and
relationships can also be found in Annexure A to this thesis. Suffice to say, at this
stage, that the parallels between IT outsourcing and logistics are significant in terms
of the expertise involved; high levels of capital required; rapidly changing technology;
Chapter 3 - 38
and key impact on company business and competitiveness; and therefore the need
for longer, more committed relationships.
Another emerging aspect of outsourcing relationships is the realisation that a single
provider does not possess world-class capabilities in all aspects of business, and
companies are increasingly embarking on selective outsourcing to multiple providers.
A multiple provider model can be structured so that one provider acts as the prime
contractor, while at other times all providers hold equal status. Often the central
player serves as broker/co-ordinator. (Kakabadse & Kakabadse, 2000). The network
of partners itself is seen as a sequence of value-adding activities in a value chain.
(Porter 1985; as quoted by Kakabadse & Kakabadse, 2000). Therefore while some
companies will only have one outsourcing partner or provider, many fall into the
category of two to five different service providers used, and still others six or more.
A further important trend in the move by companies toward focusing on their core
businesses is the decision whether to divest of non-core processes through an
outsourcing strategy or to create a provider company that that will handle all the
divested processes for the parent company as well as for other companies.
(Bendor-Samuel, 2000). In effect, therefore, companies develop world-class
competencies in supplementary or non-core activities that they then turn into
separate organisations with the intention of making them profitable even though
unrelated to the parent company’s traditional line of business. Thus, as an alterative
to externalising sourcing, such companies induce competitive market pressures
internally in order to transform supporting cost based activities into separately
managed profit centres.
Today, as companies are increasingly recognising the strategic nature and value of
outsourcing, they are increasingly realising the value of strong, close relationships
with a few high quality providers. Nevertheless, there is no single successful management approach that can be applied, and although the terms partnership and
alliance are most frequently applied to provider-user relationships, there are often
misunderstandings regarding the key factors associated with the expected benefits of
partnerships and alliances and other associated terms used to describe such
Chapter 3 - 39
relationships. It is therefore important to identify the specific forms or types of
relationship that exist between providers and users, and the different attributes that
characterise these relationships. (Eckert, et al. 1999).
Therefore, based on the preceding discussions about the different types of
relationship available in outsourcing practice, the following categorisations and
distinctions can be made and will be used in the rest of this thesis with respect to
outsourcing relationships:
• With respect to limited or less formal outsourcing or subcontracting: Transaction-
by-transaction based agreements are distinguished from formal contracts of at
least one year in length, while
• With respect to partnerships: These are differentiated with reference to those with
benefit and risk sharing for an agreed period; those with sharing of facilities and/or
human resources; and those with formal sharing of information.
While strategic alliances and partnerships are formed for many reasons, partners
have various, if not sometimes hidden, often different and possibly conflicting
objectives. Nevertheless alliance problems and failures, which can be overcome, as
will be explained in later sections, are often blamed on ignorance and a lack of
collaborative experience. (Lei & Slocum, 1992; as quoted by Kakabadse &
Kakabadse, 2000). Many companies thus also prefer to go for a less strategic
approach to outsourcing relationships whereby the provider merely delivers the
requested services with a performance that at least meets the specifications. They
will use an operational, tactical or transactional approach, paying close attention to
activity and performance and their role will be well defined. However, as was
discussed in previous sections, outsourcing is increasingly recognised as a strategic
tool and, accordingly, it would appear that many CEOs are of the opinion that the
strategic partner option is most desirable.
It is also important that the outsourcing company understand the type of provider or
outsourcing relationship that it will be most comfortable with, for example transaction-
based versus strategic, as this will affect aspects such as the types of providers that
are asked to respond to the request for proposals (RFP) and how the scope is
Chapter 3 - 40
described in the RFP. Traditionally, much of this process was governed by the
bidding process and market forces, today however companies must be diligent when
entering new provider relationships. (Greaver, 1999). Important guidelines in this
regard can be found in Annexure A to this thesis.
Finally, once the relationship has been entered into it must also be managed and
monitored on an ongoing basis. Irrespective of the type of relationship, and due to
the strategic nature of the outsource decision and the relationships involved, the
management of these relationships is key. Companies, once having outsourced
certain functions or processes, may be tempted to overlook that aspect of their
business. However the ongoing management thereof and the ongoing relationship
with the service provider are crucial. This does not imply interfering with the
operations of the provider but infers a monitoring and quality control role.
In summary therefore, due to the increasing recognition of the strategic nature and
value of outsourcing, companies are increasingly realising the value of strong, close
relationships with a few high quality providers. The relationship should thus be
nurtured if all involved are to receive maximum benefit. Outsourcing undertaken
properly is a partnership that benefits both organisations involved.
3.2.6 Conclusion In the preceding sections some guidelines have been given with respect to the
outsourcing decision-making process such as determining the company’s core
competencies, looking for outsourcing opportunities, and evaluating costs. In their
decision-making, companies are also advised to be cautious and flexible, to make
sure that outsourcing is the appropriate strategy for the situation, and to make sure
that the relationship is carefully and continuously monitored, should the decision be
made to undertake outsourcing. The impacts of outsourcing on the company; its part
in the company’s strategic direction and structure; functions and/or processes
suitable for outsourcing; as well as the availability and characteristics of providers and
the services they offer or may offer; as well as the types of outsourcing relationship
available and appropriate, and the management thereof, must all be systematically
Chapter 3 - 41
and thoroughly considered and analysed before decisions can be made regarding the
viability of outsourcing in a specific situation. Once this has been done however, and
the decision to outsource has been taken, several key steps must be followed to
ensure successful implementation of the outsourcing initiative. The diligence of the
companies involved, in following the necessary steps, is critical to avoiding the typical
pitfalls of outsourcing and ensuring that as far as is possible the many potential
benefits of outsourcing are achieved. These various benefits and pitfalls or problems
with respect to outsourcing, and the necessary steps for successful implementation
thereof, will be discussed in Section 3.3.
3.3 OUTSOURCING IMPLEMENTATION 3.3.1 Introduction In a study quoted by Fan (2000), where in most cases it was a peripheral support
activity being outsourced with cost reduction as the primary driver, outsourcing
decisions were taken early in the process without active involvement of the in-house
provider, and there were problems in provider selection and management. This
research identified the pre-outsourcing decision process and post-outsourcing management as the two key areas that give cause for concern. It was also found
that while few companies regretted outsourcing, most had not met their expectations,
mediocre outcomes were frequent and real failure too common. Respondents to
another study stated that the most frequent problems encountered in their
outsourcing experience were cost, selection of the contractor, choosing which
functions or processes to outsource and monitoring the contractor or provider’s
performance.
As was mentioned in the previous paragraph, cutting costs is often seen as a major
reason for outsourcing. However, this can lead to disappointment as outsourcing
does not necessarily save money. (Lankford & Parsa, 1999). Furthermore, the
pursuit of outsourcing as a solution to a weakness in a company function, for
example, can easily fail. (Gavin & Matherly, 1997). Bendor-Samuel (2000) concurs.
He states that outsourcing holds great potential for those who learn how to apply its
Chapter 3 - 42
principles effectively. Conversely there are deep pitfalls for those who attempt to use
this powerful tool without first learning the important principles related to it.
Apart from unrealistic cost-cutting expectations, frequent problems are also
experienced in other areas which according to Gavin and Matherly (1997) impact on
the company, the targeted function, and the prospective provider(s). For example,
there is often a decrease in employee loyalty or a loss of internal expertise, while
incompatibility of operating styles between the company and the provider is also often
experienced and this is generally discovered only after the contract has been signed
and a working relationship has been under way for a short period of time.
Furthermore, there is often a lack of thorough analysis of the factors that gave rise to
the outsource decision.
According to Lankford and Parsa (1999) therefore, a better reason to outsource than
cost-cutting, is the specialised knowledge that the provider can supply. However
apart from this and the reduced-costs-increased-profit reasons for outsourcing, there
exist many other factors and reasons that lead companies to consider and indeed to
undertake, outsourcing. These reasons for, and thus benefits inherent in, outsourcing
are detailed in Section in 3.3.2.
In summary, there are many potential advantages in outsourcing and the reasons for
frequent failure in outsourcing are often related to the outsourcing decision-making
and implementation processes. Organisations often do not realise their outsourcing
objectives due in part to unrealistic expectations, but more likely because of the
outsourcing process itself. (Fan, 2000). The following sections will therefore discuss
not only the many potential benefits and problems associated with the practice of
outsourcing but will also outline important principles and steps in the implementation
of an outsourcing initiative, that will help to ensure that these benefits are maximised
and the problems minimised.
Chapter 3 - 43
3.3.2 The reasons for and benefits of outsourcing
As has been discussed on numerous occasions in this thesis, companies are under
tremendous pressure to cut costs, and improve customer service and company
profitability. Generally companies are seeking to expand their markets as well as to
focus on their core competencies and improve their competitive advantage,
outsourcing non-core areas for some or all of these preceding reasons, including lack
of internal expertise and capability.
The obvious advantages of outsourcing thus include reducing costs and capital
requirements; acquiring economies of scale and increasing profitability while at the
same time increasing customer service; expanding services and expertise; accessing
technical expertise to keep up with world-wide technological trends while eliminating
learning curves that are too steep and/or too frequent; simplifying industrial relations
by securing flexible staffing, improving employee productivity and morale, managing
time more efficiently, and minimising excessive downtime; and finally controlling
quality and acquiring a more positive corporate image. Although companies usually
outsource to save money, when asked two or three years into a contract about the
benefits of outsourcing, companies have suggested that it is the opportunity to
concentrate on core business, the predictability of services, and the ability to manage
a cost stream with less variables. (Lankford & Parsa, 1999).
However, these apparent advantages should not be seen as a blind invitation to
pursue what some might consider a managerial fad. (Gavin & Matherly, 1997).
Appropriate analytical techniques should be employed along with sound professional
judgment to arrive at an outsourcing decision, as was touched on in the preceding
sections.
Greaver (1999) asserts that it is critical that a company understand its reasons for
considering outsourcing and the benefits it seeks thereby, in order to make an
informed outsourcing decision. He lists a variety of outsourcing benefits which he
also refers to as outsourcing reasons. These are categorised as organisational,
Chapter 3 - 44
improvement, financial, revenue, cost, and employee driven reasons, the detail of
which can be found in Annexure A to this thesis.
Strategically, financially and operationally, outsourcing also holds the potential for
many improvements and other possibilities for a company (Greaver, 1999; Stock &
Lambert, 2001):
• Strategically, outsourcing allows management to focus on its core competencies
and reduces the consumption of valuable time. It increases customer services
levels due to focused and specialised production.
• Financially, outsourcing reduces capital requirements, which means that capital
can be applied for production purposes and increases in profitability. Outsourcing
can also reduce costs due to economies of scale. A third party provider can, for
example, invest in expensive computer programmes as they will use this on all
their contracts. They can also negotiate bulk discounts on certain equipment.
• Operationally, outsourcing largely simplifies industrial relations by contracting out
all excess labour. Strikes and labour disputes become the problem of the third
party and not the producer. It is also more possible to keep up to date with world-
wide technological trends as a third party with leading technology can be
contracted, resulting in maximum customer service with minimal costs. The
introduction of a new company in terms of certain existing functions, can also
bring in innovative ideas, concepts and mindsets.
According to Lankford and Parsa (1999) another reason why companies outsource a
support function is because they admit to having little control over their existing in-
house support departments, and they see a legally enforceable contract with an
external supplier as a way of controlling costs and improving the quality of the service
they get. Kleeman (1994) adds that outsourcing enables a company to better adjust
to work fluctuations, and Fan (2000) that it enables a company to overcome capacity
and entry barriers such as capital equipment and technology. Embleton and Wright
(1998) state that on average, companies are realising a 9% cost saving and a 15%
increase in capacity and quality through outsourcing, and they provide a useful list of
Chapter 3 - 45
advantages of outsourcing, the detail of which can be found in Annexure A to this
thesis.
Adding a specifically global perspective, Elmuti and Kathawala (2000) assert that the
top reasons why global outsourcing projects are undertaken are:- cost reduction;
quality improvement; increased exposure to world wide technology; delivery and
reliability improvements; access to materials only available overseas; establishing a
presence in a foreign market; use of resources that are not available internally;
reducing the overall amount of specialised skills and knowledge needed for
operations; making capital funds available for more profitable operations; and
combating the introduction of competition to domestic supply. These suggest that
global outsourcing is undertaken for purposes that have a large impact on an
organisation’s bottom-line, however strategy, competitive advantage, and competitor
actions may also often be the rationale. Elmuti and Kathawala (2000) go on to state
that several authors (Casale, 1996; Jennings, 1996; Jones, 1997; Ramarapu,
Parzinger & Lado, 1997; Kleppes & Jones, 1999; Bender, 1999) agree that the
primary goals of outsourcing efforts are performance, cost-savings, productivity, cycle
time, customer service, market share, and quality.
Zhu, et al. (2001) summarise many of the preceding discussions by stating that to use
outsourcing strategically to increase the organisational flexibility and the speed of an
organisation to react to the changes in the business environment would be the most
valuable for top managers in the new economy. They add that outsourcing can be
used to enhance the connectivity throughout the value chain; be more efficient in the
use of capital; produce value-added service and consumption; and to manage risk.
Kakabadse and Kakabadse (2000) however assert that perhaps the greatest
advantage of outsourcing is the full utilisation of external providers’ investments,
innovations, specialised professional capabilities, that otherwise would have been
prohibitively expensive for one organisation to replicate. If the client uses multiple
best-in-class providers, each provider can contribute greater depth and sophisticated
knowledge in specialised areas and thus offer higher quality inputs than any
individual provider or client could. (Quinn & Hilmer, 1994; as quoted by Kakabadse &
Kakabadse, 2000).
Chapter 3 - 46
In his list of reasons why businesses most often choose to outsource some of their
processes, Bendor-Samuel (2000) adds the reduction of cycle time, and the
stabilisation of an unstable situation. Outsourcing is important for gaining efficiency in
operations, minimising costs and keeping to a strategy of staying lean, flexible and
responsive. He also states that outsourcing of functions is important for career
development opportunities, as well as maintaining high levels of expertise.
Finally, with respect to areas such as logistics and information technology, for
example, the following outline is provided: Companies find that if they can identify
and focus on their core processes and functions, and allow other companies which
are expert in a process to perform the non-core processes or aspects of the business,
they begin to thrive. By outsourcing non-core functions, the user can tap into more
competence, energy and ideas. The provider can perform the tasks more efficiently
as it has more specialists considering that particular element of the business and the
provider can be tapped for creativity, new ideas and investments. (Bendor-Samuel,
2000).
There are therefore many different reasons which may lead to a company deciding to
outsource one or many of its functions, activities or processes. The following table
attempts to summarise these.
Chapter 3 - 47
Table 3.3 Reasons to outsource and the benefits sought Reasons to outsource: Companies decide to outsource because of:
Benefits of outsourcing: Outsourcing offers the following benefits/advantages i.e. improvements in the following areas:
Pressure to cut costs
Reduced and controlled costs; savings; profits and shareholder value; cashflow; changing variable costs to fixed; hidden costs; capital requirements; accountability; discipline and efficiency; economies of scale; investment in assets; re-engineering and transformation in the company
Pressure to improve customer service
Enhancement and focus on core competencies; expertise and service; quality and effectiveness; delivery and reliability; accountability; profit and shareholder value; value creation; competitive advantage; flexibility to meet demands; downtime
Market expansion Resources freed to focus on core competencies; accessibility to and competitive advantage in markets; specialisation and focused production; corporate image and credibility; profit and shareholder value; injection of cash; sales and production capacity; downtime; capacity; processes; systems; networks; global sources of supply and demand; entry barriers in terms of capital and technical requirements overcome
Lack of internal expertise/capability
Focus on core competencies and competitive advantage; expertise; capability; innovative ideas; re-evaluation of business processes; skill/technology/equipment availability; independent advice; quality of products and service; technological performance and competence; company performance
Human resource considerations
Management control; discipline; efficiency; fewer functional areas to be managed; less steep learning curves; increased focus on core competencies; quality and effectiveness; control of quality/risk/costs; time management and use of time; career paths and opportunities; commitment and energy; productivity and morale; less excess labour; IR and HR aspects simplified; less strikes and labour dispute problems; flexibility in staffing to meeting changing demand/work fluctuation; existing skills can be exploited commercially
Sources: Compiled for this thesis: 2003.
Many companies have reasons, however, why they decide not to outsource certain
activities, functions or processes, such as their following perceptions:
• That the company’s control, particularly with respect to the activity to be
outsourced, would be diminished by outsourcing
• That service commitments by the company to its customers would not be met
should a particular activity be outsourced
• That costs would not be reduced by outsourcing and therefore this motivation for
outsourcing does not hold true for them
Chapter 3 - 48
• That the company has adequate expertise to perform the particular activities in-
house and thus there is no need for outsourcing
• That the particular activity, function or process being considered for outsourcing is
too important to outsource
• That outsourcing is too complex to be considered and thus that the possibility for
success is too slight
In summary, as can be seen from the preceding discussions, one of the main reasons
for outsourcing is the pressure to reduce costs. In fact, according to Lankford and
Parsa (1999), most outsourcing contracts target a minimum 15% cost savings,
sometimes between 20 and 25%. However they go on to point out that to attain such
goals, it is essential to have multi-year agreements so that the economies of scale
and cost-cutting measures can take effect. They quote Manion, Burkett and Wiffen
(1993) in this regard with respect to the US where such deals are multi-million dollar
contracts signed for five years or more with performance clauses built in. Such
agreements and arrangements are critical to avoid the problems and pitfalls that can
characterise an outsourcing initiative. These potential problems and pitfalls, together
with the perceptions of many companies as outlined in the preceding paragraph,
often lead companies not to outsource or to become disillusioned with their current
outsourcing arrangements.
Some of these problems and pitfalls will be discussed in Section 3.3.3.
3.3.3 Problems and pitfalls associated with outsourcing
As with any process, there is a negative side to outsourcing. However many of the
disadvantages of outsourcing, are the flipside of the advantages or benefits, and may
arise mainly due to poor outsourcing decisions and management. Embleton and
Wright (1998) provide a useful list in this regard which can be found in Annexure A to
the thesis as can the main risks of outsourcing as identified by Lonsdale and Cox
(2000).
Chapter 3 - 49
Lankford and Parsa (1999) add that determining core competencies, which is key
to the outsourcing decision, can be difficult, and a mistaken decision, very costly.
They go on to point out that despite the sound financial appeal, outsourcing is also a
subject that is still fraught with emotional overtones. The fear of losing control, for
example, is a major emotional stumbling block to outsourcing. Companies are also
averse to the idea of provider dependency.
According to Greaver (1999), outsourcing problems can generally be divided into
people, process, technology and other problem areas. People problems can have
many causes, from the loss of key people to poor performance, to people not getting
along well together. Process problems generally result from how the operations are
set up; how decision rights, responsibilities, and authorities are distributed; and how
the activities are defined. Technology problems generally relate to the acquisition,
implementation, and maintenance of equipment or systems. These problems can
have their root causes in either party, and addressing the problems is a shared
responsibility.
As was also introduced in the previous section, companies have various reasons why
they choose not to outsource. Greaver (1999) asserts that these are excuses; that
companies avoid outsourcing by saying that it needs more study; they are too busy to
study it presently; it is a good idea but the timing is wrong; they require several pilot
projects to be successful first to prove that it works; customers will be unhappy; there
are too many hidden costs to outsourcing; and that they could never terminate
employees who would not transfer to the provider. He goes on to categorise the
excuses that companies have not to outsource, as excuses of uncertainty; loss of
control; conflict; financial; employee unhappiness, the detail of which can also be
found in Annexure A.
Employee unhappiness, for example, is a significant problem with regard to
outsourcing. The concept brings fear to labour unions and bureaucrats alike and thus
is a source of considerable risk as the cultural and psychological barriers work
against its acceptance. (Cardinali, 2001). Most employees do not understand what
outsourcing means, and they view the process as synonymous with losing their jobs.
(Ransom, 1996; as quoted by Embleton & Wright, 1998). With attitudes like this, it is
Chapter 3 - 50
obvious that management’s job is not complete once the outsourcing contract is
signed. In addition to ensuring that external processes run smoothly, management
must address the issue of staff reduction and corporate structure. Failure to do so
may well negate the value of the whole exercise. Furthermore, where management
is bent on staff reductions and prejudges outsourcing as a way to keep essential
functions operating while deep staff cuts are carried out, then mistakes are likely.
The outcome might be a lean, mean internal staff or a dispirited, anorexic one.
(Gamble, 1995; as quoted by Lankford & Parsa, 1999).
Similarly, according to Embleton and Wright (1998), outsourcing has an obvious
effect on company morale. They state that the downsizing that results from
outsourcing therefore does not always achieve the desired objectives, and go on to
quote Anfuso (1996) that between 1989 and 1994, operating profits increased in only
51% of companies reporting workforce reductions while in 20% of cases, profits
declined; and there is further research to suggest that fewer than half of the
downsized companies achieve a reduction in overall expenditures, and less than one
quarter show increased productivity. Furthermore, businesses with a high morale
factor have a competitive edge over other businesses where morale is an intangible
feeling transmitted from each employee to every other employee and to the customer,
making the customer respond with repeat orders. (Noer, 1996; as quoted by
Embleton & Wright, 1998). These statements show the importance of morale to the success of an organisation.
Management must thus step in and rebuild trust among the workers, and jobs may
need to be reevaluated and expanded or changed to fit the new organisation.
(Malhorta, 1997; as quoted by Elmuti and Kathawala, 2000).
Elmuti and Kathawala (2000) also state, with respect to problems in global
outsourcing, that this usually reduces a company’s control over how certain services
are delivered, which in turn may raise the company’s liability exposures. Companies
that outsource should continue to monitor the contractor’s activities and establish
constant communication (Guterl, 1996; as quoted by Elmuti & Kathawala, 2000).
Another significant problem with global outsourcing, as with any outsourcing as has
already been mentioned, comes from the workers themselves as they fear loss of
Chapter 3 - 51
jobs which can also lead to a decline in the morale and performance of the remaining
employees. Furthermore, operations managers who embark on a re-evaluation and
comparison of internal operations with foreign options must be aware of the risks
involved in dealing with companies that operate in different legal and cultural
environments. Problems can arise regarding confidentiality, security, and time
schedules (Ramarapu, et al., 1997, as quoted by Elmuti & Kathawala, 2000).
Even companies that have successfully implemented outsourcing strategies, identify
problem areas. These include the following, according to Elmuti and Kathawala
(2000), and are outlined in more detail in Annexure A to this thesis:
• Fear of change and of job loss
• Poor choice of sourcing partners
• Inadequate training and skills for outsourcing
• Lack of understanding of the goals of outsourcing
• Unclear expectations of outsourcing
• Lack of comprehensive plans
• Lack of support (top management and infrastructure).
In summary, problem areas generally include inadequate control systems over how
certain services are delivered, which in turn may raise the company’s liability
exposures; hidden costs and risks; inadequate, or lack of, high level management
support; poor organisational communication; cross functional political problems;
unclear expectations; uncertainties associated with the stability of the service
companies; issues of confidentiality, security, time schedules, lack of flexibility;
keeping contracts short; and other priorities taking precedence. Service level
commitments, and cost, time and effort reductions, are often not realised; technology
capabilities are not delivered; control over the outsourced function is diminished; a
lack of strategic management skills, continuous ongoing improvement in service, and
consultative knowledge-based skills is encountered; and there are often cost creep or
price increases and misunderstandings or disagreements with the provider after the
relationships has started.
Chapter 3 - 52
As pointed out by Greaver (1999), even in the best of outsourcing situations,
problems arise. New innovative management strategy can produce expected
problems. Furthermore, it is important to investigate whether such problems and
mediocre outcomes of outsourcing implementation, are due to inherent flaws in the
concept, or whether they are the result of poor management practice. (Lonsdale &
Cox, 2000). Ensuring the success of an outsourcing project thus includes the
management of potential problems, and the more planning that is undertaken around
the risk factors before implementation, the higher the probability of success.
(Crowley, 1999; as quoted by Elmuti & Kathawala, 2000). In addition, developing a
comprehensive plan outlining detailed expectations, requirements, and expected
benefits may be the key to successful outsourcing. Careful attention should be paid
to developing a comprehensive plan that outlines detailed objectives, expectations,
requirements and expected benefits of the project and management support for the
project before the company begins implementation. Furthermore, management must
focus on alleviating the fear that is generally associated with change and job loss.
It is crucial that companies considering and indeed implementing outsourcing
initiatives be fully aware of these various problems and pitfalls associated with
outsourcing in order that they may gain additional insight into what should be done to
ensure the success of the outsourcing project and be aware of areas that require
further investigation. These aspects also receive further attention in the sections of
this chapter dealing with outsourcing as a strategic consideration and implementation.
3.3.4 Steps to successful outsourcing
As has been discussed in the previous sections, outsourcing holds many advantages
for a company that is successful in its implementation; however many problems can
also be experienced. In order to avoid as many of the problems as possible, certain
steps must be taken such as undertaking a thorough business analysis; correctly
identifying the core competencies of the company; having a clear understanding of
what the organisation wants to achieve by outsourcing; developing comprehensive plans to ensure that outsourcing provides enhanced business performance; choosing
the correct outsourcing providers and treating them as partners; ensuring
communication and honesty throughout the outsourcing process; and providing
Chapter 3 - 53
adequate training and skills to facilitate the inevitable changes resulting from the
process. There must also be complete support of the process by top management with the commitment of the necessary company infrastructure.
Embleton and Wright (1998) concur with the importance of making the right decisions
with respect to outsourcing and identify the following keys to successful outsourcing:
• Strategic analysis and planning
• Selecting the providers
• Managing the relationship
(i) Strategic analysis and planning
The key to determining the viability of outsourcing lies in an analysis of the
organisation. According to Embleton and Wright (1998), this entails the following:
• Determine candidate functions for outsourcing
• Determine the cost of providing the service
• Determine the quality level of service
• Determine the impact on corporate culture
• Quantify the outsourcing goals
• Look at both the long- and short-term
Lankford and Parsa (2000) point out that investigating of the benefits of outsourcing
is a lengthy but important evaluation process as outsourcing is a major event that a
company would want to avoid repeating. Companies must take a long-term view of
the move to outsourcing. The company must understand its vision, core competencies, structure, transformation tools, value chain and strategies.
(Greaver, 1999). There are certain functions that a head office can best sustain and
in downsizing without due care for such functions, companies risk dismantling the
very foundations of their success. (Stephenson & Russell, 1995; as quoted by
Embleton & Wright, 1998). The significance of this risk and the importance of
determining the company’s core competencies have also been discussed in previous
sections. The company must therefore, in their strategic analysis, determine which
Chapter 3 - 54
areas are not core and will provide the company with the best return on investment if
outsourced. A function that is outsourced should be routine and well-delineated. It is
also important for it to be measured and managed at arms length; provided by
established providers; and offered in a competitive environment.
The importance of management understanding the nature of their business and
determining their core competencies, as well as analysing current costs and
performance and exploring the strategic implications, are also key to the outsourcing
decision-making process which has already been discussed in some detail.
Therefore, only when the strategic analysis is complete and the decision to outsource
made, can the important steps in the outsourcing implementation process be taken.
Greaver (1999) thus also identifies the following steps to successful outsourcing:
• Exploring strategic implications
• Analysing costs/performance
• Planning initiatives; then only
o Selecting providers
o Negotiating terms
o Transitioning resources, and
o Managing relationships.
These steps must be modified to fit each specific company and outsourcing situation,
but must always be thorough. Furthermore, while some of these steps take place in a
chronological order some are also interrelated and run parallel. This is due to the
fact that there is constant learning and new information, testing, and adjustment to
the outsourcing project as it progresses. However it is important to constantly keep in
mind the purpose of the outsourcing initiative or project, namely the reasons that the
company identified in its strategic analysis regarding the option of outsourcing.
As with any significant new initiative, planning activities, including project management issues, are important. Greaver (1999) asserts that this must include:
Chapter 3 - 55
• Assessing the risks
• Announcing the initiative
• Forming the project team
• Engaging advisers where necessary
• Training the team
• Acquiring other resources
• Managing resources, information and project
• Setting objectives
Cross-functional teams should be formed to study, plan and implement outsourcing
initiatives, and to assess the risks and resources, information, and management skills
needed to mitigate those risks. Team objectives, deliverables and timetables should
be set and management support achieved. Furthermore, as the outsourcing
providers are experts in their fields as well as in negotiating contracts, companies
may involve outside advisers to assist in the implementation process, including:
• Outsource consultants helping the team work effectively in the shortest time
• Lawyers experienced in negotiating and drawing up outsourcing contracts
• Accountants to analyse costs using tools such as activity-based costing
• Other specialists, depending on the situation
Furthermore, how the organisation announces the outsourcing initiative to its
employees must also be planned and well executed.
Since employees inevitably learn of the initiative as soon as it is decided, it is better to
make an announcement that outsourcing will be explored, otherwise employees will
generally assume the worst without having the facts, and morale will be negatively
impacted. Employees must also be kept informed about the initiative’s progress.
(Greaver, 1999). This aspect is also dealt with in more detail in Annexure A to the
thesis.
Chapter 3 - 56
(ii) Selecting the providers and negotiating terms
In the strategic analysis, the company must also have developed a clear
understanding and quantification of the type and the level of service currently being
provided in-house, and that desired in the future, in order for the RFP to be compiled,
the tender document issued, and the provider selected. The RFP must describe the
outsourcing requirements in detail. This document provides general information
about the purchasing organisation and the scope and the objectives of outsourcing.
The company may even decide to conduct a request for information (RFI) prior to the
RFP, circulating the RFI to a selected pool of potential providers, determine the level
of interest, capabilities, corporate culture and strategy among these providers.
It is also important to define goals explicitly. Without measurable goals, it will be
impossible to quantify current results, or to define the level of service required in the
future. The outsourcing company must break down its planned outsourcing initiative
in terms of the actual services required. Therefore establishing the scope of work by
means of an adequate RFP, determining the desired and measurable SLA, and
developing a thorough contractual agreement, all contribute to the success of an
outsourcing initiative.
In this regard, Bendor-Samuel (2000) states that few users take the time to
adequately define what it is they are buying. What usually happens is that the
procurement process focuses on obtaining what is perceived as a good price, leaving
the definition of the scope of the services for the provider to establish after the user
has retained the provider. In these cases the provider determines, during the course
of the agreement, what its scope of work is. A more prudent approach is for the user
to establish the scope of the services before circulating an RFP or approaching a
provider. This process should be started by defining what contributions are required
of the provider. When assessing value, the user must understand what is valuable to
them, for example low costs; however beyond that companies vary widely when
defining value. Scope thus describes the boundaries of the process so that both
parties can see clearly where one’s responsibility ends and the other begins.
Chapter 3 - 57
For example, in logistics, one might choose to break apart the transportation from the
warehousing, and the inbound logistics from the outbound logistics. It is important
not to take short-cuts with the definition process. The significant effort required is
difficult and expensive, but the discipline of breaking up the service into its constituent
parts is worth the effort. Furthermore, it is also extremely helpful for those individuals
who have to administer the relationship as it provides a clear and easy way to
administrate the process boundary, enabling both parties to determine what services
are in and out of scope. The different components are also usually cost drivers that
are influenced by different business issues and change at a different pace. In every
outsourcing relationship, which should be preceded by a thorough RFP process,
users and providers must specify exactly what services are being purchased.
Often the user has unwritten expectations of the provider to make additional
contributions to the user’s business goals. Sometimes the user expects continuous
improvement where none is explicitly defined or measured. Just as often, a user
expects that a provider will leverage its capabilities in other areas to assist the user in
its struggle to compete. If these benefits are anticipated, they should be defined and
measured. When such aspirations defy definition and objective metrics, they are
unlikely to occur or are unrealistic expectations. Users must realise that it is unfair for
providers to have to agree on a price until they understand what they will be providing
and how it will be measured.
The RFP, negotiation and contractual phases of outsourcing implementation are therefore critical to the success of an outsourcing initiative.
Agreeing on a fair price is therefore usually the focus of the RFP and negotiation
processes. The most common trap that a user can fall into is to negotiate a price
before it has adequately defined the services and agreed with the provider about the
degrees of accountability that the provider will undertake in supplying those services.
The parties must make sure that the services and metrics are defined and agreed
upon before price negotiations take place. Before embarking on an expensive RFP
process, both users and providers need to bear in mind that in a free market, price is
a function of competition and negotiating prowess. Furthermore, for a user who
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wants a competitive market price, it is imperative that there still be competition when
price is negotiated at the end of the RFP process. (Greaver, 1999; Bendor-Samuel,
2000).
(iii) Transitioning resources and managing the relationship
Another step that is very important to the success of outsourcing implementation and
which must take place not only at this stage, i.e. before provider selection, but also
during the remainder of the implementation process, and in particular with regard to
the transitioning of resources, is communicating with and preparing staff members for
the change. Communication, change management and training are thus also key
to success, as was also touched on with regard to outsourcing and strategic
restructuring within the company. As outsourcing can be a key component of the re-
engineering process within a company, it has many human resource and structural
implications which must be managed carefully if the implementation of an outsourcing
strategy is to be successful.
The transitioning of resources, change management and the human element of the
outsourcing implementation process is also outlined in more detail in Annexure A to
this thesis.
3.3.5 Selecting and contracting with providers
It is critical that the company spends the necessary time and effort selecting and
contracting with the correct provider. The outsourcing company must determine the
provider profile; conduct a RFI, RFP, and site visits; and negotiate a mutually beneficial agreement.
Typically, outsourcing is a long-term relationship, which requires the provider and the
user to work closely together. Often, additional services are required and should the
agreement be terminated, the organisation will require the provider’s co-operation
Chapter 3 - 59
until the outsourced service is settled elsewhere. Also there are many costs
associated with changing an outsourcing provider. It is therefore worthwhile spending
the time and money choosing the right provider the first time and negotiating and
contracting effectively with them.
In addition therefore to the outsourcing steps discussed in Section 3.3.4, a company
should, according to Greaver (1999), undertake the following with respect to potential
providers:
• Conduct visits to the provider’s sites
• Check references on the provider
• Negotiate terms and the contract
• Develop exit provisions
• Develop guidelines to resolve issues or disputes
• Develop SLAs
(i) Selecting the right provider
With provider selection, the focus is on acquiring a dependable and reliable service,
without increasing the cost that is currently incurred conducting that activity in-house.
Where the activity that is being outsourced plays a particularly important role in the
company, such as in the case of logistics, it is most important that the company seek
and select a provider with whom they can partner to complement their own business.
The company must therefore establish the criteria that are most important to them in
a provider and although some will be quantifiable and others intangible, there must
be a checklist of important items to ensure that the best provider is selected.
Examples of such provider selection criteria can be found in Annexure A to the thesis.
The responses to the RFI and RFP, and the site visit are also important in order to
ensure that a potential provider will comply with these criteria that are important to the
outsourcing company. The focus is on people, cultural fit and corporate processes.
Chapter 3 - 60
The outsourcing company must also establish whether the provider has a good track
record of service commitment and this should be examined from multiple
perspectives. The user should also ascertain how their account will be managed.
Account management is effectively service in action and is a critical dimension of
the outsourcing relationship. It is also useful to identify the provider’s existing
customers and their levels of satisfaction with the service provided. Finally, the user
must establish the quality of the provider’s infrastructure and human resources.
(Manring, 2001).
Most importantly, and implicit in each of the preceding steps or criteria is the aspect
of service level. It is essential that SLAs be discussed with the provider and that
these cover customer service standards. This is also critical with regard to managing
the outsource relationship and measurement of provider performance.
Every aspect should be negotiated and contracted to avoid misunderstandings and
disagreements between the parties at a later stage.
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(ii) Negotiating and contracting
As has also already been outlined, outsourcing is a contractual agreement between
the user and the provider for services that the user is currently providing internally.
(Fan, 2000). The provider agreement is thus the contract that is negotiated and
signed by both the outsourcing user and the outsourcing provider. (Zhu, et al. 2001).
It is important to negotiate a mutually beneficial deal. Both management teams must
have an agreement with which they are comfortable. The specific needs of the
organisation therefore should be matched with the provider’s capabilities during
negotiations so as to develop a contract around a shared vision.
Lankford and Parsa (1999) state, in this regard, that a cross-functional team with
members from a variety of decision-making levels is required to assess the
company’s needs. Such a team is also required to manage the contract after its
execution. Outsourcers should also have the financial and technological incentive to
help the company migrate to technology that is suitable to the organisation.
Providers that have a good understanding and an interest in the outsourcing
company’s business will be better positioned to help define mutually beneficial goals.
The purchasing function should also be involved in the negotiations and contract
development when outsourced services are purchased. This procedure will have a
positive impact on the quality and value the organisation receives because of the
purchasing function’s expertise in procurement issues and service contracts.
Corporate risk management, legal, and strategic planning groups should also be
involved. This will also ensure that the strategic impact of the outsourcing contract is
adequately evaluated.
Furthermore, as is the case in all other procurement, users of outsourced services
should not be willing to accept the standard contract offered by most providers.
Lankford and Parsa (1999) provide some guidelines in this regard, which can be
found in Annexure A to the thesis.
Chapter 3 - 62
Outsourcing activities are contract-intensive in nature (Deckelman, 1998; as quoted
by Zhu, et al. 2001) and a successful outsourcing process therefore must include a
good contract. However good contracts are only possible when both parties know
exactly what they are trying to accomplish. The agreement should therefore be
clearly understood by both parties and prior to signing they should have the entire
agreement reviewed by legal advisors with adequate experience in contract
preparation and execution. The provider agreement should also clearly identify items
such as the services to be provided by the provider; the specification of the user’s
compensation to the provider; terms of payment; an exit/escape clause for each
party; and methods for making changes to the agreement and for settling disputes.
Additional items to consider include the impact of taxes; record retention
requirements; audit agreements; warranties; guarantees; assignment potential; and
subcontracting. Depending on the agreement it may also be appropriate to include
items such as licensing agreements; patent rights; disaster recovery; protection of
computer assets; publicity; and unusual circumstances. (Zhu, et al. 2001).
Significant time and energy are thus required by all involved in order to create
successful outsourcing contracts and relationships. For an outsourcing initiative to be
successful there must be an agreement that is solid and flexible. The best-planned
initiatives will eventually fail if care is not taken to ensure a fair and equitable
relationship. An important basis therefore, for example with respect to logistics
excellence through outsourcing, is in the formation of close partnerships between a
company and other participants in the supply chain, to the point of including them in
the early planning stages of new ventures. Agreements need to be drawn up in a
way that will reward all partners, by means for example of co-operative incentives.
Also key to successful outsourcing contracts is the management thereof.
(iii) Managing the outsourcing contract
Embleton and Wright (1998) assert that the necessary time and effort must also be
spent on negotiating and establishing the outsourcing contract, with respect to
management structures and systems for monitoring and evaluating the
Chapter 3 - 63
relationship. They state that regardless of how the activity is handled in-house,
outsourcing must be managed differently, often requiring new management skills.
As has already been outlined, the outsourcing company must identify and stipulate
the required service level in order to measure the service provider accordingly, and
management must monitor and evaluate adherence to the outsourcing contract.
In research quoted by Fan (2000), interviewees were asked how their outsourced
activities were measured. The scope of measurement varied greatly with a distinct
correlation between the size of the organisation and the sophistication of the
measurements employed. In general the smaller companies were measuring
absolutes such as on-time delivery, levels of rework, i.e. quality control, and lead-
time, and not esoteric service metrics such as relationships, provider flexibility or
added value solutions. Furthermore, there was no end-user feedback incorporated
into the process. With respect to setting of improvement targets and benchmarking only half of the organisations interviewed were setting any form of
improvement targets for the provider and only one company was conducting
benchmarking exercises on an ongoing basis. This has important implications, i.e.
the absence of any improvement targets could result one party recouping all the
surplus value that both parties generate, potential savings not being realised, and the
competitiveness of the outsourcing venture gradually diminishing in relation to the
market.
Fan (2000) thus recommends, with respect to post-outsourcing provider performance
management, that this should include regular formal business review meetings that
should cover a business overview by both parties; a performance review of the
preceding period and discussion of any corrective actions needed; as well as new
targets for the following period. The objective should be to continuously review and
re-set targets in an effort to sustain competitive advantage. Some kind of reward-
based approach may also be appropriate to encourage optimum provider
performance. An open co-operative relationship should be encouraged.
Benchmarking should also be performed on a regular basis and should involve the re-
tendering of the outsourced activity to other providers. The provider must be aware
that they are being regularly assessed against the best performance in their sector as
Chapter 3 - 64
this will help to sustain long-term competitive advantage. Provider performance
should also be assessed on both technical and functional quality. Technical quality
includes maintaining the required response time, minimising system downtime,
providing error-free service, and utilising leading edge technology. Functional quality,
in essence, is the quality of customer service. (Lankford & Parsa, 1999).
From a human resources point of view, attempting to get the support of employees
for performance measurement can also be very difficult. It is important to ensure they
understand the need for and potential benefits of measurement systems; however
there is a strong risk that such measurement will be seen as a critical approach to
existing performance. (Powell ed. 2002). The human aspect of outsourcing and the
management thereof, has also been touched on previously.
In summary, outsourcing can provide many benefits for a company. However, for
outsourcing to be successful, the decision needs to be an informed one and the
implementation needs to be thorough. Detailed and meaningful information in the
hands of competent management can help avoid a costly step, one that is not easily
reversed.
Successful outsourcing also depends on planning and process. The most critical
ingredients for successful outsourcing in this regard are: the strategic analysis and
plan; provider agreement and relationship; impact on human resources;
communication plan; the outsourcing timeline; the outsourcing transition plan and
checklist; and the post-outsourcing review. (Zhu, et al. 2001). Ultimately, for
outsourcing in any form to be successful, quick response times to strategic
opportunities and threats are essential, and effective management of the outsourcing
relationships is an organisational imperative. (Lankford & Parsa, 1999).
3.3.6 Conclusion
Outsourcing has not proved to be the panacea that many hoped it would be, however
it can provide tangible and varied business benefits to those that implement it
properly. (Lonsdale & Cox, 2000). The many potential benefits and problems related
to outsourcing initiatives highlight the strategic nature of the outsourcing decision.
Chapter 3 - 65
Outsourcing is a business tool and like all tools, must be used properly to achieve the
desired results. These desired results and potential benefits as well as the potential
failure and pitfalls of outsourcing have been outlined in some detail. The advantages
in outsourcing can be operational, strategic, or both. Operational advantages usually
provide for short-term trouble avoidance, while strategic advantages offer long-term
contributions in maximising opportunities. (Lankford & Parsa, 1999). Managers that
define the process as a one-dimensional strategy will thus be doomed to failure.
Outsourcing must be part of an overall corporate strategy and management must
ensure that all employees are aware of the overall situation. Successful
implementation requires a tailored solution, and entails analysis, investigation,
planning and sophisticated human resource and company management. (Embleton
& Wright, 1998).
3.4 CONCLUSION
Outsourcing is increasingly being recognised as a strategic tool to reduce costs, gain
competitive advantage and increase customer service and profitability. By using a
well-managed outsourcing agreement, a company can gain in markets that would
otherwise be uneconomical. Outsourcing can contribute short and long-term benefits;
however the long-term should always be the driving force. Outsourcing can also be
fraught with problems, and is usually a sensitive issue for employees. It is thus key
that the strategic nature, potential benefits and problems of outsourcing are identified
and understood, and that considerable time and effort are spent on ensuring
successful outsourcing implementation. This must include identifying, for example,
the various types and most appropriate outsourcing arrangements available. The
outsourcing initiative must also have the necessary involvement and support of top
management as well as all other managers that may impact or be impacted by the
outsourcing decision. Valuable input is made into the outsourcing decision-making
and implementation processes, if the right people are included in the outsourcing
team. This team must approach the outsourcing initiative as a project and manage it
accordingly.
Chapter 3 - 66
It is also critical that the necessary time and effort be spent on the outsourcing
process, analysing the current costs and performance of the in-house activity and
exploring the strategic implications of outsourcing that activity. With respect to
selecting the correct service provider, the company must compile selection criteria
and a RFP; visit the sites and check references of potential providers; and establish
what will be expected of the provider. Significant time and effort must also be spent
on negotiating and contracting the provider agreement; transitioning the resources;
and managing the relationship.
Logistics outsourcing is also a key trend. With this chapter as a background to the
outsourcing concept, highlighting the importance and complexity thereof, Chapter 4
will discuss the concept of logistics outsourcing in more detail.
Chapter 3 - 67
SOURCES OF REFERENCE
CHAPTER 3: THE OUTSOURCING CONCEPT
• Begg, D; Fisher, M & Dornbusch, R 1984: Economics, British Edition.
Maidenhead: McGraw-Hill Book Company (UK) Limited.
• Bendor-Samuel, P 2000: Turning Lead into Gold: The Demystification of
