There are numerous benefits of outsourcing various activities within the value chain. Some American firms have decided to focus on their core competencies of product development and marketing and outsourcing their production and logistics. The high volume contract manufacturers and logistics providers can make better use of assets by leveraging resources across multiple customers and can meet time to cost objectives. Other firms have experienced a growing competition, where the speed of new product introduction has been critical. Using contract manufacturers and logistics providers with worldwide operations enables rapid global ramp-up and helps to reduce the time-to-market, allowing the firm to reap larger profits after product introduction. The supplier invests in the facilities and equipment reducing the risk for the firm doing the outsourcing. In industries such as heavy metal or chemical, avoiding US environmental regulations by off-shoring manufacturing may result in significant savings in both cost and management attention Some companies benefit from more relaxed regulations dealing with the environment. Outsourcing/offshoring offers firms protection from market fluctuations and an opportunity for higher returns on assets. Overall, it is clear that many outsourcing organizations can produce at 30-40% lower costs and also realize several additional benefits.

Not all efforts, however, have been successful. Ford, for example, has developed a global network of parts suppliers but is now bringing some engineering functions back in-house. Dell moved much of its technical support call centers to India but, after several complaints from corporate customers about support for their newer products, they brought some of the call center work back to the US. To better understand potential problems with off shoring/outsourcing, consider the impact on the entire value-chain -- from pre-sales to R&D to conversion to logistics to post-sales services.

Assessing the impact on the value chain

To assess the impact of off shoring and outsourcing, take a detailed look at the benefits, costs and risks of activities at each stage of the value chain. Figure 1 shows some of the many costs and risks that companies overlook.

Figure 1

Pre-sales

Many firms have outsourced pre-sales activities in order to provide 24 hour, 7 days a week coverage for customer support. In developing countries these jobs can have lower turnover than in the U.S. The result: More experienced customer representatives. For example, Hewlett-Packard's customers may place orders from any part of the world. The transactional customers typically are familiar with the product they need and do not require a deeply knowledgeable salesperson. For these customers H-P provides order-taking operators that are available 24 hours a day/7 days a week. Providing this service using a U.S. workforce would be prohibitively expensive. But H-P outsources the task to call centers across the world.

Such outsourcing does incur risks though. HP found that some customers prefer to work with a specific sales agent. HP worried that this discomfort could alter the buying intentions of certain customers. HP's response to this concern was to build a Customer Relationship Management system that enables any sales person to have access to the most recent information about the customer. The system also enforces a discipline on each salesperson to more fully document the customer interaction. This customer information can be useful in identifying customer needs and in developing new products and services. HP also found they should require the vendor to whom they outsourced activities to establish a disaster recovery plan that would account for a variety of disaster scenarios. One vendor, in Halifax, was shut down because of a snowstorm. The disaster plan was to route the incoming calls to a neighboring city but, the same snowstorm had closed that town as well. This vendor needed to redevelop its recovery plan to accommodate similar problems in the future.

R&D

Many firms pursued outsourcing relationships in order to improve the speed and quality of R&D activities. By having a global development network, a firm can broaden its technical skills and development capacity in order to shorten the time for product development. In addition, firms are able to be closer to their global customers and modify their products to meet region specific tastes and needs. For example, Coca-Cola's "globalization" efforts focus on modifying flavors so that the global Coca cola brand is more attractive to local customers. McDonalds have adopted a similar philosophy. McDonalds burgers in India, for example, are made without beef. Toyota cars in the US are adapted to the size of the typical American driver.

But outsourcing R&D can lead to significant costs. Time-to-market is a key metric of successful R&D operations. But, if the function or part of it is outsourced, several factors work against a rapid time to market:
Communication between geographically dispersed R&D centers can be difficult. Because of time zone differences phone calls have to be scheduled at a compatible time. This may require having people communicate across fourteen time zones. E-mail may also be unsatisfactory. An e-mail sent in the afternoon from one country may arrive at the other center late at night. The result a one-day delay between communications. This can be particularly costly when engineering change orders or changes in the project scope are involved. These exchanges may require substantial interaction. And, companies have been known to have people meet physically when the change is complex.

Turnover -- a fact-of-life in most organizations -- complicates the communication issue. A newly hired marketing director can interpret the market data and trends differently and require significant changes to the design. Newly hired engineers may want to make changes to the product architecture. Information needs to be stored and companies have invested significantly in knowledge databases. But, despite that investment, significant re-scoping would require the different parties to meet.

Testing needs to be conducted at several locations. When components are designed at one location, they need to be tested at that point. But, they also need to be tested at the location where it will be matched with another component. When a product has been completely designed prototypes need to be made and tested with consumers in specific markets. If the manufacture is being outsourced to another plant, a certification sample needs to be manufactured and tested before mass production can begin.

Intellectual property issues are also significant. A serious concern is the theft of intellectual property. China is known to have few laws protecting intellectual property. There have been instances when the company that was manufacturing an item under subcontract established another factory to make an identical product and sell it under their own brand. India does have laws, but enforcement is weak. Pharmaceuticals as a product have no protection in India. However, processes are protected. So, an Indian company can clone a pharmaceutical product as long as the process used to make it is different.Conversion and logistics

Outsourcing/offshoring makes the supply chain longer. Longer supply chains means increased transit times, greater uncertainty along the supply chain and less accurate forecasting of market demands. Coping with the increased uncertainty requires companies to invest in more inventory resulting in higher carrying costs and increasing the risk of obsolescence. Keeping these costs in line requires an investment in expensive supply chain management systems.

Longer supply chains make it more difficult for supplier and manufacturer to stay in touch. Suppliers can help the manufacturer integrate new technology into products and to develop strategies for reducing complexity of product and minimizing inventory. Theresa Metty, chief procurement officer at Motorola sees the vital link in the electronics supply chain as the link between component supplier and the OEM, not the contract manufacturer. "Contract manufacturers are not in the business of nurturing relationships between the component supplier and the OEM". Motorola maintains the relationship with their suppliers and is the buyer of record for parts it buys from suppliers for use in Motorola equipment manufactured by contract manufacturers.

About The Process Management Institute The Process Management Institute works with leading companies to explore the latest trends in process management and the implications for Global 2000 companies. Topics currently being examined include the strategic issues around global sourcing, process governance and network relationships, and management of knowledge-intensive processes. Learn more. Logistics, the sourcing, manufacturing, and moving product to market is often a nightmare for US companies. Global logistics is significantly more complex. An Ingersoll-Rand study of global logistics costs found that up to 25% of the total cost of a commodity bought internationally to be duties, taxes, freight, and miscellaneous fees. Not included in this estimate is the cost of not having the product available when the customer wants it or the cost of inventory to ensure availability.

Rick Moranian, President of Asia/Middle East for APL Logistics identifies four critical areas worth investigating when evaluating the total cost of off-shoring: network, people, information technology, and regulatory and compliance. Problems in any of these areas may delay getting product to market and increase cost. The difficulty in managing each of these areas in unfamiliar geographies leads many companies to use 3PL's for their global logistics needs.

Global logistics systems can cut costs significantly. Baan reports that its typical customer sees inventory reductions of 50% and transportation costs reduced by 30% while on-time delivery is close to 100%. But, when links in the chain are in developing nations, the technology may not be current. So, disparate technologies must be integrated. For example, scan data from retail to manufacturer and RFID tracking of product from manufacturer to market may not be available. Plan to collect this data by other means or to estimate it.

Another complication: The physical infrastructure may not be robust enough to support the movement of large quantities of data through a fully integrated supply chain. Plan for power blackouts (emergency backup power supplies), dropped Internet connections (dedicated lines), equipment breakdowns (redundant equipment and a disciplined preventive maintenance program).

Post-sales services

Companies with significant post-sales service commitments need to evaluate their operations to ensure that they are providing optimal levels of support while at the same time gaining the benefits of customer loyalty and business growth. Outsourcing post-sales service can help to improve a company's ability to provide adequate service by providing cost-effective 24x7 availability and flexibility capacity to manage peaks in demand and changing customer locations.

However, without proper control over the post-sales service, firms can negatively impact the customer experience and their long term retention. Post sales services, whether in the form of support centers, spare part or equipment repair/replacement, or returns, provide an opportunity to gain important information about customer needs and product issues. When the service is outsourced, many companies fail to capture this valuable customer data and never provide feedback for future product development efforts. It is critical that the companies' systems are integrated to allow for easy transmission of customer and product information.

The quality of post-sales service also has a large impact on customer satisfaction and loyalty. Consider a semiconductor chip foundry as the customer of an equipment supplier. Typically foundries lose $100,000 per hour when equipment fails, according to Forrester Research. A delay in service or part availability can disrupt their production and depending upon the structure of the service contract, the equipment supplier may incur huge penalties associated with the equipment downtime. Similarly, a personal user of a computer may rely on the customer help line for resolving equipment problems. When service is poor, it may impact that customer's choice of computers in the future but is also likely to influence his friends and family that will likely hear about the bad experience.

Post-sales service that involves the delivery or return of physical goods can also present a problem for many companies. When repairs or returns are outsourced, poor inventory tracking systems often lead to poor visibility of inventory and/or inventory obsolescence. Many companies outsource repairs to service technician who works from the trucks of their cars and maintain inventories known as "truck stock" so that they have immediate access when problems arise. However, this stocking systems can lead to issues of parts obsolescence as 60 percent of spare parts sit idle in the technicians truck (Forrester research: Unleashing the Aftermarket's Hidden Value, September 2002). Similarly, many companies consider only the costs associated with the return transaction when they outsource the return process. By ignoring time-based metrics, such as the time to return the product to the regular distribution/inventory system, high costs of inventory and obsolescence can be overlooked.

Other implementation issues

While there can be significant benefits from outsourcing/offshoring, including the achievement of time-to-market and time-to-cost objectives, many firms fail to account for all of the costs associated with outsourcing decisions. Tom Gary of Bearing Point notes that many of his clients "spend more money for the first couple of years" than expected. First, there is often significant time and capital investments that are required to develop the information technology infrastructure that allows multiple firms to integrate their systems. One large computer manufacturer spent four years and millions of dollars implementing a system that helped them realize the expected savings. Second, when a contractor has been selected for outsourcing, it is critical to provide training to that organization. In addition, your organization incurs fees associated with layoffs and retraining of the on-shore management teams that manage the outsourcing relationship.

An extended global supply chain requires the American manager to work with many different cultures. These are most visible as differences in communication methods, sense of urgency and work schedules. When Nortel outsourced their manufacturing to Mexico, they realized that their sense of urgency was higher than that of the Mexican plant managers. They established standards for communication, i.e., return phone calls within 12 hours, and improved the methods of communication, i.e. cell phones and beepers, so that the response time to issues was at an acceptable level.

Extending the supply chain geographically can be part of a long-term strategy to enter a new market. In that case it is important to maintain quality to support the brand image. In India a test of Coca-Cola revealed the presence of pesticides. Though this report was later discredited, the impact on the brand and sales of Coca-Cola was significant.

Increasingly companies are being held accountable for their practices both within their firm and within their outsourcing partners. Issues such as child labor violations, layoffs in the home country, and environmental/economic impact on the community can lead to bad press and a negative impact on your brand equity. Nike and Reebok have to continually monitor their offshore manufacturers to ensure they are not violating US child labor laws.

Offshoring/outsourcing can provide enormous benefits to a firm's performance, but it is not simple to execute. A small software start-up with Indian owners tried to outsource to India on two occasions. They failed both times and eventually hired local software engineers. Many large companies have adopted a learning approach ¨C try a little, learn from the experience, try a little more. But the potential of significant benefits are driving companies to outsource larger operations and at a faster pace. Venture funds are looking at small companies with special expertise and/or an established market that could benefit from outsourcing. In addition to manufacturers, service providers are shifting their back office operations abroad. Financial services, health care, lawyers see very clearly the benefits of a 30 to 60% reduction in costs.

With mounting market pressures on costs a gradual learning approach is difficult to implement. What is needed is a thorough assessment of the benefits, risks, costs and implementation challenges using the value chain framework we have outlined. Jumping on the outsourcing/offshoring bandwagon without careful analysis can lead to poor customer service, higher than anticipated costs, or product introduction delays. Poorly implemented, offshoring/outsourcing can significantly damage a firm's reputation. When handled properly, the benefits can be enormous and continuous as business expands.