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Outsourcing: Issues and Opportunities for Supply Management

Author(s):

Lisa M. Ellram, Ph.D., C.P.M., CPA
Lisa M. Ellram, Ph.D., C.P.M., CPA, Associate Professor of Supply Chain Management, Arizona State University, Tempe, AZ 85287-4706 602/965-2998
Arnold Maltz, Ph.D.
Arnold Maltz, Ph.D., Associate Professor of Logistics and Marketing, New Mexico State University, Las Cruces, NM 88003-0001 505/646-7510.

82nd Annual International Conference Proceedings - 1997 

Introduction. "Outsourcing has become one of the most widely talked about and implemented tools for organizational change in the 1990s" (Fortune, Oct 28, 1996). Many factors have contributed to this phenomenon - globalization, the desire to reduce the workforce/decrease the fixed asset base, down-sizing, and the growing availability of outsource service providers. What is really happening, and how does this affect supply management? Bases on a recent Center for Advanced Purchasing Studies focus study: "Outsourcing: Implications for supply management," this paper will explore:

  • why outsourcing is occurring
  • what is being outsourced
  • how supply management can contribute
  • a summary of the potential treats and opportunities presented by outsourcing.

The Why Of Outsourcing. Most top managers cite strategic reasons for increasing outsourcing. Companies are choosing to develop internal competencies which the competition cannot match. But enhancing capabilities such as advanced product design or flexible manufacturing requires financial and managerial resources. Successful outsourcing is designed to free up resources to be applied to the company's core competencies.

Companies also outsource to reduce costs. The outside firm may enjoy lower wage rates. As a specialist, the outsource supplier may be more efficient and can apply lessons learned from its other customers. The outside firm probably uses customized software, whose cost is spread over several different customers. Finally, the outside firm is focused only on a specific task or process - MRO purchasing, janitorial services, etc. Such focus usually leads to better processes and more efficient execution.

Some aspects of supply management are increasingly seen as candidates for outsourcing. Companies may find that supply management's effort is mostly concerned with non-strategic and MRO items. A distributor or other third party can often do these routine acquisitions faster and cheaper. JIT and quick response programs necessitate electronic linkages to suppliers. Rather than develop and support such links, the manufacturer may turn over supply planning and purchase order generation to a third party.

On the other hand, supply management has skills which are critical to successful outsourcing. Effective supply managers have experience in contract negotiation and monitoring, supplier relationship development, and requirements specification. Supply management may lead the company's outsourcing efforts, if top management sees the supply function as a source of important competencies.

What Is Being Outsourced. As part of the CAPS Outsourcing Study, over 120 supply managers reported their firms' outsourcing level relative to 13 purchasing activities. Table 1 shows the 3 most outsourced and the 3 least outsourced activities for MRO purchases, while Table 2 shows the same information for strategic purchases. The column headed "Mean" represents an average of the degrees of outsourcing, which varied from 1="None" to 5="Extensive."

Table 1 - MRO - Degree of Outsourcing
Percentage Indicating -

  Mean
  • None
Slight
Moderate
Substantial
Extensive


(=1)
(=2)
(=3)
(=4)
(=5)
Monitor inventory
2.4
37.2
19.0
22.3
14.0
7.4
Place order
2.2
42.5
15.8
23.3
15.0
3.3
Put away
2.1
45.0
23.3
15.0
11.7
5.0
Inspection
1.8
53.8
19.3
19.3
5.0
2.5
Contract negotiation
1.8
56.7
19.2
15.8
5.0
3.3
Payment for product
1.8
60.8
13.3
16.7
7.5
1.7

Table 2 - Strategic Item - Degree of Outsourcing
- Percentage Indicating -

  Mean
None
Slight
Moderate
Substantial
Extensive


(=1)
(=2)
(=3)
(=4)
(=5)
Monitor inventory
1.6
70.8
12.5
5.8
6.7
4.2
Place order
1.6
70.8
12.5
5.8
7.5
3.3
Inspection
1.6
72.1
10.7
6.6
8.2
2.5
Put away
1.5
78.7
5.7
5.7
7.4
2.5
Contract negotiation
1.5
80.3
5.7
5.7
4.1
4.1
Payment for product
1.4
81.1
6.6
4.1
3.3
4.9

Comparing the two tables, it is clear that MRO-related activities are more likely to be outsourced than purchasing activities for strategic items. In fact, for strategic items there is no statistically significant difference in outsourcing levels among the various activities.

For MRO items, the inventory monitoring function is most likely to be outsourced, and the difference between inventory monitoring and inspection, negotiation, or payment is statistically significant at the 95% confidence level. Order placement outsourcing is also statistically higher than product payment outsourcing.

Additional analysis was performed based on combining outsourcing levels across activities. Firms with annual revenue over $5 billion report more outsourcing of MRO activities vs. companies with revenues of less than $5 billion.

As we noted above, supply management is well-equipped to lead outsourcing efforts. Therefore, it may be of interest to show what functional areas are likely candidates for outsourcing. A relatively new organization, the Outsourcing Institute, has surveyed major manufacturers on this issue. They found that such functions as the mail room, freight bill audit, payroll processing, direct mail, and facilities maintenance are presently often contracted out. All of these functions are non-strategic and involve either relatively low skill levels or highly specialized knowledge. Candidates for future outsourcing include office supply inventory management, fleet management, training, reservations and sales operations, and facilities management/maintenance. Again, these are functions which are non-strategic and not particularly good preparation for career success in a manufacturing organization.

How Supply Management Can Contribute. Outsourcing is essentially purchasing services and/or goods from the outside that were formerly performed/produced internally. As such, many of the analytical, negotiation and human relations skills needed to be successful in supplier selection, evaluation and management are the same skills as that required to be successful in evaluation, selection and management of an outsourced provider! There is no functional area in the organization with a more compatible skill set. The supply management function can use its skills to support outsourcing effects by:

  • Providing a comprehensive, competitive process
  • Identifying opportunities for outsourcing
  • Aiding in selection of sources
  • Identifying potential relationship issues
  • Developing and negotiating the contract
  • Ongoing monitoring and management of the relationship.

These are all areas of unique expertise that the supply management group can contribute to the outsourcing process in general. Yet in many organizations, purchasing is not playing a key role as a contributor/participant in outsourcing decision making.

Based on the case study analysis performed as part of the CAPS study, we found that there is a pattern of successful outsourcing participation among supply management organizations. Some key issues include:

  • Supply management must have the right skill sets to deliver on their promises
  • Supply management must be willing to "sell" themselves, their skills, the benefits of working through purchasing on outsourcing
  • Supply management should have some successful experience in outsourcing decision making, perhaps through outsourcing some of their own activities
  • Top management support is essential to purchasing's successful participation
  • Supply management should contribute to the outsourcing decision-making process as a member of a cross-functional team
  • Supply management should support the outsourcing process via ongoing monitoring/evaluation of the third-party relationship.

Many organizations fail to recognize that outsourcing is not an end in itself, but one possible outcome of performing a rigorous, professional sourcing analysis. It should be part of a larger, strategic plan for continuous improvement. Thus, supply management should not get involved in outsourcing analysis only after a decision to outsource has been made, but should be involved in the identification and analysis of alternatives to maximize the value it adds to the process.

There are various approaches to supply management's involvement in the outsourcing process. There is not necessarily one correct approach. The best approach will vary according to the situation and the corporate culture. While some supply management organizations may try to get control of outsourcing and bring it under supply management, others will be successful if they act as members of a cross-functional team, contributing a structured buying process to the outsourcing analysis. Still others may co-locate supply managers within functions to ensure day-to-day involvement and participation. The most important issue is that outsourcing is analytically assessed using a good commercial buying process.

At Glaxo Wellcome plc, the North American Supply Management group has the perspective that they are the purchasing steward for the company. As such, they educate/lead others who are doing the buying to use a competitive, commercial method. This is a good approach for firms with limited sourcing resources. Glaxo Wellcome PLC follows this approach, with representatives from Supply Management acting almost as "purchasing process consultants" to teams that handle nontraditional buys. Nynex also does this to some extent, in that it uses a team approach to sourcing, getting internal customer involvement as well as involvement of other functional areas. But Nynex does not "release" the responsibility to the customers to perform buys without using the sourcing area.

Summary/Conclusions. The trend toward outsourcing today seems clear. There is no telling how long it will last, or how far it will go. Participation in the outsourcing process represents an important opportunity for the supply management function to increase its strategic role and contribution.

Many people within the supply management function believe that purchasing cannot be outsourced. Based on our study, supply management personnel view their own performance as clearly superior to that of suppliers on all activities related to strategic purchases. However, this is supply management's perception of itself, rather than the perception of others within the firm. Supply management must take care that it does not hold itself in such high esteem that it misses opportunities for outsourcing on strategic items that could benefit the organization. It must also take care that it does not miss such opportunities that come to the attention of top management. This would make the supply management function look uninformed or self-preserving, and potentially hurt its status in the organization.

Supply management personnel are willing to acknowledge that suppliers can perform better than they can when it comes to all aspects of staying in touch with the market for nonstrategic items. Nonstrategic items are also more frequently outsourced than strategic items. This shows a willingness on the part of supply managers to recognize areas that are not a strong suit. This ability to see viable opportunities for outsourcing may help prevent supply managers from being blind-sided on opportunities for outsourcing strategic items.

"Sales" is now an important aspect of supply management. It is up to the supply management group to create and "sell" its value internally. There are people outside of supply management within most organizations who view themselves as "buyers." Supply management needs to ensure that it is continually improving the acquisition process and acquisition results in actuality as well as in the perceptions of top management. Otherwise, the various non-purchasing "buyers" in the organization will not support a centralized supply management function, and it may be outsourced. Top management wants to see the supply management job carried out in the most efficient and effective way possible. If users can perform as well as or better than professional supply managers, there is no reason to believe that most of the supply management department will not (and should not) be outsourced.

REFERENCES

  1. Ellram, Lisa M., and Arnold Maltz, Outsourcing: Implications for Supply Management, Tempe, AZ: Center for Advanced Purchasing Studies, 1996.
  2. Fortune, Special Advertising Section on Outsourcing, October 28, 1996.

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