Suppliers are able to provide a level of responsiveness through new technologies that undermine the need for the vertically integrated organization and achieve economies of scale. This translates into benefits for the buyer. A network of suppliers provides the organization with the ability to adjust the scale and scope of its production capability (upward or downward), at a lower cost, to changing demand conditions and at a rapid rate.
This creates greater flexibility than is the case for the vertically integrated organization.
The benefits of outsourcing any service, identified via surveys a few years ago (1998) conducted by the Outsourcing Institute of the top 10 reasons why organizations buy outsourcing services for their operations, fall into the following areas:
● Reduction and control of operating costs.
● Improvement in organizational focus.
● Gain of access to world-class capabilities.
● Free internal resources for other purposes.
● Resources are not available internally.
● Accelerated re-engineering benefits.
● Function difficult to manage/out of control.
● Capital funds made available.
● Shared risks.
● Cash infusion.
We have referred to the organizations that use and supply ITO
services as separate entities. In terms of legal setup, corporate governance, responsibility to shareholders, corporate structure and the like, these organizations are indeed separate. When two organizations engage in an ITO exercise, however, the processes that link both participants make them more logically appear as a single entity. This concept can be confusing as the boundaries that define each organization are now blurred.
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Outsourcing models
There already exist numerous outsourcing models. Additional models are constantly being formulated as the requirements of 25
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each ITO agreement differ. The need to create new models to describe each flavour and variation is nevertheless important as it serves to highlight also the variations in effort, measurement of risk and treatment of the outcomes. Transformational outsourcing, for example, provides for a set of partners who have a considerable stake in the game, and often that means sharing both risk and reward. To make the transformation work, the commercial agreement must fund the necessary investment at the best possible cost of capital and simultaneously motivate the outsourcing partners’ commitment by aligning goals. This is quite different from the outsourcing of the commoditized IT function.
Evans and Wurster (2000) describe the new economics of information where information can be replicated at almost zero cost (in contrast to the economics of items that incur manufacturing costs). The evolving technological capabilities for sharing and using information are transforming business definitions, industry definitions and competitive advantage where information is the glue that holds the value chains and supply chains together.
This observation impacts on the way organizations are structured. Informational value chains become separate from physical value chains, releasing tremendous economic value. When the trade-off between richness and reach is no longer tenable, traditional structures and relationships throughout the business world begin to deconstruct (as new level of richness and reach are attainable). Processes that used to work within an organization and between organizations, as well as between organizations and their customers, are being transformed.
There are observable changes as organizations deconstruct. The same authors, Evans and Wurster, talk about deconstruction that occurs as organizations dismantle and re-form traditional business structures. Competitive advantage is de-averaged as competition escalates. Information businesses take on new value.
New opportunities arise for physical businesses. Wholesalers, retailers and distributors are disintermediated. Navigators emerge and incumbents are challenged. The organized supply of competency-based services and products, however, has matured as an industry over the past two decades. Information is becoming increasingly accessible across time and space. People, and more importantly our collective knowledge, are becoming increasingly interlinked via high-speed networks, databases and active data collection devices. Individual, group and organizational relationships have drastically changed. In this environment, however, the stage is set for optimal use of outsourcing services given the ability to seamlessly share information.
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Common Terms and Concepts Used in Outsourcing Very often suppliers of ‘outsourcing’ services have access to a very limited amount of information, just sufficient to complete the work at hand. For example, incomplete personnel data are shared, just sufficient to complete regular payroll for payroll outsourcing. If information on recruitment, personnel evaluation, staffing, strategy and planning were available, the supplier can more proactively plan for changes in resourcing, provision of supplies, staffing for its own delivery and investments in infrastructure.
Outsourcing types
Outsourcing has been used in a variety of ways, those which involve combinations of partnership agreements and duration, payment structures, and service as well as product content. Some of the characteristics of the outsourcing genre are discussed here.
The adjectives that describe outsourcing activity are as varied as the combinations of outsourcing models that are present. Some common types of outsourcing models include total outsourcing (with sole supplier), multiple-supplier sourcing (or with prime contractor and partners), joint venture/strategic alliance sourcing and insourcing. It is logical also to assume that there is prolific variation on the themes given the differences in each organization’s situation. Alternative structures include matrix-type models, based on the interrelationships of core competencies and organization activities, to assist managers with outsourcing decisions. The effort to reduce costs and exploit new channels of distribution like the Internet reveal new organizational forms.
Cost-savings and freedom to focus upon core business, however, are still major reasons for outsourcing.
Literature suggests the buyer sourcing choices between carrying out activities in-house, or under ‘hierarchical governance’, and outsourcing them and placing them under market governance through cost–benefit reasoning, is determined by the relative costs of production and transactions. Economic analysis of the provision of outsourcing services is limited. It does not, for example, account for the organization’s management capability to structure and manage co-operative relationships crucial to the effective working of outsourcing arrangements. Further, it does not take into account the effectiveness (as opposed to the cost) of acquiring the necessary information. This supports the assumption that a closely integrated network of organizations will perform better. Learning through alliances can complement endogenous learning to create new competencies.
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The extent to which such strategies are successful is not always clear; for instance it was found that there is no direct effect of strategic technology alliances on economic performance in general. However, it was established that in high-tech industries research-oriented strategic technology alliances are associated with higher economic performance. It is often also suggested that complementarity is a major driver of partnering behaviour (Hagedoorn, 1993). This suggests that a strategy aimed at creating a rather broad set of alliances that are complementary to the already existing capabilities could have a more positive effect on organizational performance than the formation of alliances that parallel existing capabilities.
The concept was for basic (more routine) operations to be performed on behalf of the organization to the extent that they could be carried out by machines or computers. Some have envis-aged scenarios where mass-produced or ‘off-the-shelf’ products would eliminate the need for services, whether in-house or externally sourced.
Complete/Selective outsourcing
Theoretically, the whole organization can be outsourced. The rationale for total outsourcing is to enable the client to concentrate on its core business activities, thus leaving the supplier to manage core business functions more efficiently. Total ITO, as opposed to selective outsourcing, is generally thought to have begun in 1989, when Kodak outsourced its entire IT function to IBM and a few smaller suppliers. In the early 1990s approximately twenty major corporations followed suit, but the general view in the business world was that this total ITO exercise was a mistake.
On the other hand, there are some who argue against complete outsourcing. Fowler is an advocate of the case against complete outsourcing (Fowler, 1997). He argues that there is a significant proportion of personnel work that is central to the culture and strategic objectives of the organization that can be undertaken effectively only by the organization itself. Hence, personnel should be retained, at least in part, as an integral part of the business. Further, the occurrence of situations such as industrial disputes may be quite unpredictable; these issues require immediate action. It is all but impossible to specify such tasks precisely enough to contract them out, or to find an external provider that can guarantee the instant and informed response they require.
Selective outsourcing involves outsourcing portions of the process, rather than the process in its entirety. The strategy of 28
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Common Terms and Concepts Used in Outsourcing selective outsourcing where discrete services or functions are sourced to a group of best-of-breed service providers is seen as an appealing alternative to large-scale, single-supplier arrangements, which are frequently characterized by excessive fees, unrealized cost-savings, ill-defined contractual terms and service levels, and inflexibility in response to changing business requirements. This is a strategy to mitigate certain of the risks that were inherent in the ‘deal’. Half-measures, however, would prevent the buyer from achieving best practice and introduce further risks.