In the competitive environment of the global market, companies have found it less pricey to purchase many commodities than to produce them internally. As international commerce becomes easier and the barriers to global trading fall, the use of outsourcing continues to rise. In 1995, companies outsourced more than $75 billion in goods and services, with major corporations leading the way. General Motors, for instance, is purchasing over $10 billion a year in components from external sources, and BellSouth is outsourcing $60 million in goods and services.
In fact, about 90 percent of major corporations are now outsourcing. (Bernard, A. B. and Jensen, J. B. 2003) Downsizing, which refers to reducing the number of employees to further cut operating expenses, is fueling the increased use of outsourcing. AT&T and IBM each reduced their staffs by more than 40,000 over a recent three-year period. With fewer employees to hold greater workloads, the need to outsource is further increased. Indications are that the use of outsourcing will continue to increase.
Globally, the outsourcing market is probable to exceed $120 billion by the year 2010. (Bernard, A. B. and Jensen, J. B. 2003) Numerous companies, however, have not reduced costs to the extent that they hoped when they first turned to outsourcing. As an effect, the anticipated increase to profit levels has not been realized. A recent study has shown that, although gains in productivity of up to 40 percent had been projected by corporations, improvement in various cases has been less than 10 percent.
This is because the decisions to outsource are being based primarily on lower direct costs. Not enough deliberation is being given to the source’s performance in other criteria that can cause indirect costs to increase. Although goods and services might be provided by external sources at lower prices, their performance in the criteria of quality, delivery, customer service, and product advancements might be weak. Poor performance by sources in any or all of these criterions will result in the company incurring indirect costs that will more than counteract the reduced direct costs.
By applying the concept of the Strategic Business Unit, or SBU, to each source of key corporate functions, and viewing each as a Strategic Business Source, the overall performance of internal and external sources can be simply determined and compared. With the overall performance measured for the many available sources of corporate functions, the decision to select the optimal source can be easily made. Under the SBU concept, related product lines are organized into separate profit centers.
With this organizational approach, the company’s ability to produce profitable product lines is better. This is because, within the focused SBU structure, all five of the performance criteria that fuel competitiveness are more easily monitored and improved. By similarly viewing the sources for goods and services as Strategic Business Sources, and evaluating their overall performance in all of the important criteria beyond just costs, the most favorable source (whether an internal department or an external supplier) can be easily selected.
However, if a company chooses to outsource the manufacturing of a part used in its products based solely on an external supplier’s price being lower than internal production costs. The supplier’s performance in other criterion can result in the true cost being greater. For example, if the supplier of the outsourced parts delivers poor-quality products, the outsourcing company will incur expense by either having to rework the items to correct the troubles or delay production until the supplier offers acceptable replacement parts.
Also, if the supplier delivers the parts late, the company may have to setback completion and delivery of the end products to the customer base, impacting cash flow and sales revenues. In addition to the financial impact, the company’s customers will be disgruntled because of the delays in receiving the products they purchased. If the external supplier is not preceding the manufacturing processes used to produce the parts, production methods in use could become outdated and not competitive.
Furthermore, if the supplier provides the company with poor customer service (for example, not being receptive to the company’s request for scheduling information needed to support its internal operations), again delivery of its products to the customers could be delayed. For these reasons, sourcing decisions require to be made considering the overall performance of each available source, whether an internal department or an external supplier, in all five performance criterion that determine the company’s competitiveness: quality, delivery, customer service, and product advancements, as well as cost.