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Outsourcing–InsourcingCan vendors make moneyfrom the new relationshipopportunities?
Per Jenster, Henrik Stener Pedersen,Patricia Plackett and David Hussey
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Outsourcing–Insourcing
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Outsourcing–InsourcingCan vendors make moneyfrom the new relationshipopportunities?
Per Jenster, Henrik Stener Pedersen,Patricia Plackett and David Hussey
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Copyright C© 2005 John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester,West Sussex PO19 8SQ, England
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Library of Congress Cataloguing-in-Publication Data
Outsourcing–insourcing : can vendors make money from the new relationshipopportunities? / Per Jenster, Henrik Stener Pedersen, Patricia Plackett and David Hussey.
p. cm.Includes index.ISBN 0-470-84490-6 (alk. paper)1. Contracting out. 2. Industrial procurement. I. Jenster, Per V.
HD2365.O9435 2005658 .7′23—dc22 2004025691
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
ISBN 0-470-84490-6 (hb)
Typeset in 11/16pt Garamond by TechBooks, New Delhi, IndiaPrinted and bound in Great Britain by Antony Rowe Ltd, Chippenham, WiltshireThis book is printed on acid-free paper responsibly manufactured from sustainable forestryin which at least two trees are planted for each one used for paper production.
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http://www.wiley.com
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Contents
Preface ix
Introduction xiii
1 Understanding the opportunities 1
Introduction 1
What is outsourcing? 1
The origins of outsourcing 2
Trends and pressures 6
Influential concepts 10
Outsourcing today 15
Traditional activities 16
Peripheral activities 18
Critical activities and processes 20
Strategic and problem-solving activities 22
Summary 24
References 24
2 Moving to supplying total solutions 27
Introduction 27
Management issues for outsourced activities 27
Traditional activities 28
Peripheral activities 29
Critical activities and processes 31
Case study: The 1999 crisis at the UK Passport Agency 32
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vi Contents
Strategic and problem-solving activities 43
Case study: The European Chewing Gum Company
(identity disguised) 44
Summary 46
Reference 46
3 Retooling marketing and the sales force 47
Introduction 47
The search for a better way to trap mice 47
Market segmentation variables 51
Segmentation approaches 53
Criteria for initial screening 55
Evaluating potential segments 56
Defining the market 58
Timing, niche markets and global considerations 59
Sales force management in a changed environment 61
Sales force development for supplying total solutions 62
Building sales force capabilities 63
Summary 65
References 66
4 Managing buyer/supplier relationships 69
Introduction 69
The challenges for suppliers 69
Case study: Timex Dundee (after Martin and
Dowling, 1995) 72
Case study: IBM Denmark 77
Supplier Challenge 1 – The need for additional
competencies 79
Supplier Challenge 2 – Managing the entry phase 82
Supplier Challenge 3 – Running the contract 90
Case study: Driver and Vehicle Licensing Agency
(DVLA), UK 92
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Contents vii
The challenges for buyers 97
Buyer Challenge 1 – The pre-bid phase 99
Buyer Challenge 2 – Identifying the key suppliers 100
Buyer Challenge 3 – Awarding the contract 101
Buyer Challenge 4 – Running the contract 102
Summary 102
References 103
5 Pricing solutions and managing risks 105
Introduction 105
The value of strategic pricing 105
Fundamental pricing concepts 106
Pricing the bundle of goods and services 109
Pricing when distributors are involved 111
Price administration 111
Understanding the risks to suppliers and buyers 115
Mechanisms for bridging uncertainties 117
Summary 118
References 119
6 ‘Transitioning’ human resources 121
Introduction 121
Setting the scene 121
The fundamentals 124
Strategies for employee transfer 126
Pitfalls and critical factors 130
Summary 132
References 133
7 Structuring ‘next generation’ IT solutions 135
Introduction 135
The changing role of IT departments 135
The real problem with IT investments 136
What ROI? 138
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viii Contents
IT: Overadministrated and undermanaged 140
The IT paradox 142
The ‘next generation’ approach to IT 145
Summary 149
References 150
8 Achieving quality in outsourcing 153
Introduction 153
Understanding the role of quality management 153
Defining quality for integrated products and services 157
Challenges: Leadership and strategy 160
Challenges: Processes 162
Challenges: People 163
Factors conditioning quality management 163
Summary 166
References 167
9 Getting a good slice of a larger pie 169
Introduction 169
The outsourcing pie 169
How good are we at making larger pies? 171
How sellers can make the pie larger 175
How buyers can make the pie larger 176
In the final analysis 178
The Claimpower story 178
Summary 181
References 181
Index 183
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Preface
Outsourcing started to become fashionable in the late 1980s. How-
ever, it very much came of age in the 1990s, and certainly became a
normal part of corporate life by the turn of the century. It is built on
three long-established principles – corporate focus on core compe-
tencies, ‘make or buy’ make or buy cost analysis and the preferred
supplier concepts of total quality management. And now global out-
sourcing is on everyone’s mind.
Initially much of outsourcing was at the easily definable end of the
spectrum – such as having a supplier make a component previously
manufactured in-house, taking over management of the company
cafeteria, or using a fleet of rented trucks for services previously
carried out internally. Such activities remain a part of the outsourc-
ing spectrum today, but the big opportunities for suppliers lie at the
other end of the spectrum where suppliers become strategic part-
ners of the organization for a specific, but not always easy-to-define,
slate of activities that might, for example, add product improve-
ment and development to the supply of a subassembly for which
not even the components were previously bought outside the firm.
It is not uncommon now for entire departments such as accounting
and R&D to be fully outsourced.
Questions of relevance for outsourcing activities at the strategic
partnering end of the spectrum include the following:
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x Preface
� What form of relationship or strategic alliance should be estab-
lished between the buyer of outsourced services and the seller
of those services?� What are the scope, scale and importance of the outsourced
activities?� What pricing strategy should be used and what risk-sharing is
involved?� What are the changes to organizations that lead to decisions to
seek more service outsourcing?
The literature on outsourcing has grown rapidly, and there is an
increasing number of books on this subject. Much of the work on
outsourcing has taken the perspective of the buying organization,
and the specific strategic and operational difficulties that buyers
face. However, there are at least two organizations in every out-
sourcing decision: What, for the buying organization, is a strategic
decision involving benefits, risks and organizational change, is for
the selling organization a strategic opportunity, which has a related,
but different, series of benefits, risks and organizational implica-
tions. Unlike the majority of publications on outsourcing this book
takes the perspective of the seller of outsourcing services spe-
cifically in terms of outsourcing strategy and implementation. In
so doing, this book fills a gap in the business studies literature.
Today, one can hardly open a newspaper or switch on the tele-
vision before the topic of global outsourcing appears; however, the
issues are more concerned with the international trade aspects of
outsourcing. It is less the business aspects and more the outsourc-
ing of jobs that raises eyebrows. The themes of this book are less
concerned about this ‘flavour of the month’, as the concerns about
vanishing jobs to overseas vendors have been around for centuries.
What this book does focus on are the firm-specific business aspects
of outsourcing and the complexities being imposed as firms engage
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Preface xi
in new business areas focusing on delivering complex business
solutions.
The foundation of this book is three years of research activity at
Copenhagen Business School, funded by the school and the Danish
Industrial Mortgage Foundation, as well as the Confederation of
Danish Industry. The research project included the participation
of 12 companies that provided active participation and funding for
the research. The firms and their industries are listed below:
� Diversey-Lever cleaning system� Berendsen Textil A/S textile management� Berendsen PMC A/S compression technology� Bossard Group fasteners� NEG-Mikron A/S windmills� PostDanmark transport systems� BP/Mobile/Exxon lubricants� Quest International flavour systems� IBM Danmark information technologies� Sjællandske Kraftværker utility management� Oxford Research business research services� Canon office equipment
Most of the participating companies are international, if not global,
players in their respective industries. One area of focus was the tran-
sition from the provision of a narrowly defined product and service
portfolio to a dramatic shift in scale to more complex solutions. The
combination of research on the companies studied as well as case
studies and the study of participant contributions has provided a
much fuller picture of outsourcing from the supplier side.
The research project was organized around a number of PhD
studies, clinical studies of specific companies and issues, surveys,
literature reviews, research colloquiums, management workshops
and a large international conference. The contributing researchers,
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xii Preface
apart from the authors of this book, included Mikael Lynnerup,
Michael Ahern, Kim Møller, Mogens Bjerre, Jens Geersbro, Trine
Erdal, Carlos Cordon (IMD professor) and Tom Vollmann (IMD pro-
fessor) – we thank them all for their valuable contribution.
For managers at various levels in organizations who are already
involved in outsourcing, or who see the need to become involved
in supplying value-added outsourcing products and services, this
book offers a range of practical management insights. We feel that
the book is particularly valuable for those who currently offer out-
sourcing services but who have not as yet moved to the strategic
partnering end of the outsourcing spectrum. For participants in
MBA programmes and in executive management courses this book
offers comprehensive coverage of a topic of increasing relevance in
this era of ever-increasing economic globalization.
Finally, we would like to make a special tribute to David Hussey, a
close friend and colleague and a significant contributor to business
literature over many years, who died in January 2003.
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Introduction
If you are competing with the rest of the world, you had better
focus on what you are good at.
Focusing on what you are good at in companies today means a care-
ful assessment of core competencies within a broader industrial
context and strategically outsourcing many other activities. Com-
panies are being transformed from highly integrated organizations
producing and delivering goods and services themselves to much
more specialized enterprises that contract out to the marketplace for
many goods and services. As a consequence, successful outsourcing
has become a key to competitiveness. Because the new relationship
opportunities for profitable business outsourcing are global in na-
ture, cross-cultural management issues are increasingly a factor that
adds to the complexity of the task.
In this book we examine the key issues of relevance to successful
outsourcing. Our focus is on profitable business strategies. A diverse
range of examples is used to illustrate the key features of outsourcing
success and failure.
Overview of key issues in this book
Each chapter addresses a specific aspect that is required for suc-
cessfully managing the supply of outsourcing services taking buyer
perspectives into account:
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xiv Introduction
1. Understanding the opportunities: Understanding what is driv-
ing customers. The changes taking place in purchasing organ-
izations. The supplier view of the impact of what is happening.
The spectrum of outsourcing arrangements that is possible.
2. Moving to supplying a total solution: Strategic and organ-
izational implications. The issues that have to be considered.
Lessons learned from companies that have managed the tran-
sition to total solution provision.
3. Retooling marketing and the sales force: Market segment iden-
tification. New ways of market segmentation (e.g., by customer
strategy). Mining the segment. Positioning the offer. Selling so-
lutions. Different requirements of the sales force. Managing and
motivating the sales force. Changing competency requirements.
4. Managing buyer/supplier relationships: Organizational
changes in both parties. Cultural shifts. Communication issues.
Information sharing.
5. Pricing solutions and managing risks: Pricing strategies for
solutions. Understanding the risks to both suppliers and buyers
and creating appropriate pricing. Avoiding risks.
6. ‘Transitioning’ human resources: Implications for employees.
Where competencies change. Training, recruitment, reward and
retention issues. Temporary employees.
7. Structuring ‘next generation’ IT solutions: Aligning systems
with the customers. Ensuring that systems give the strategic and
control information needed for the new arrangements. Where
information may add value.
8. Achieving quality in outsourcing: Meeting quality require-
ments. Cooperating with customers and other vendors. Philos-
ophy of continual improvement.
9. Getting a good slice of a larger pie: Working with buyers
to make the overall pie larger. Getting a larger slice of the
pie from seller and buyer perspectives. Enhancing outsourcing
profitability.
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1Understanding theopportunities
Introduction
Outsourcing – that is, the process of shifting tasks and services pre-
viously performed in-house to outside vendors – is hardly a new
idea in management. But the volume, extent and character of out-
sourcing have been changing rapidly. The challenges are not merely
simple ‘make or buy’ decisions, but also responses to what some
have declared as the new round of globalization in which not only
typical manufacturing jobs are being sent offshore, but also upscale
tasks, such as research projects, technical service support functions,
engineering and even financial analysis, are being placed in so-called
developing countries. In this chapter we look at the historical devel-
opment of outsourcing and current trends. We also introduce our
classification system for four key types of outsourcing activities. The
decision drivers for each are presented both from the perspective
of the seller of the outsourced solution and from the perspective of
the buyer of the solution.
What is outsourcing?
Outsourcing is now high on the list of the things that many savants
believe well-run organizations must consider, so that it is now as
much a management fad as a reasoned decision, offering important
augmentation to the current organizational design, or even giving
rise to new enterprise designs. It can offer great opportunities to
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2 Understanding the opportunities
both the buyer and supplier when used wisely. However, when it
becomes a mantra, used without thought, it can do great damage to
both parties.
According to the Wall Street Journal, Indian labour in banking
costs about one-tenth as much as comparable banking personnel
in Europe and the U.S. However, employing someone in back
office processing in India is only about 50% less expensive once
other costs are factored in. Wages in India are also rising rapidly
each year, a factor that could make the savings short-lived.1
What is outsourcing? One definition is the market procurement
of formerly in-house produced goods and services from legally
independent supplier firms (Semlinger, 1991). Like all definitions,
it gives the scope of the topic but conceals the infinite variety of
outsourcing possibilities. It makes it clear that there are two parties
to an outsourcing arrangement, but is really a definition from the
buyer viewpoint. The supplier may have decisions to make that are
as tough as any faced by the organization taking a decision to out-
source. In fact, outsourcing can be an opportunity for both parties,
but it may also do damage to one or both of the parties. We hope that
we can show in this book some of the pitfalls and the principles on
which good outsourcing decisions should be taken, and also look
at the issue from the viewpoint of both parties.
The origins of outsourcing
Because outsourcing has gained much in popularity, it is tempting
to think of it as new. Certainly it has changed shape and may have a
different form today, but the concept is centuries old. It is another
form of what economists call specialization, which has been defined
1 Wall Street Journal, 29 March, 2004.
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The origins of outsourcing 3
as concentrating activity in those lines of production in which
the individual or firm has some natural or acquired advantage
(Pearce, 1983).
Imagine a primitive village of several thousand years BC in which
every family made its own pots, spears and arrows, and hunted
and gathered its own food. Since some people were naturally more
skilled at certain of these tasks than others, they began to concen-
trate on their core competencies (to borrow a phrase from Prahalad
and Hamel, 1990), such as weapon making, and to outsource the
other things that they used to do, such as hunting. They bartered
their knives, spears and arrows for the things they no longer pro-
duced. Later money became the medium of exchange, but the prin-
ciples of modern outsourcing can be said to have had their roots in
the recognition that there were economic benefits in specialization.
Hamel and Prahalad (1994, p. 219) state that a core competence
is a bundle of skills and technologies that enables a company to
provide a particular benefit to customers. Although the technology
of making flint-headed weapons is basic, the skill level is high. (Try
making some, if you do not believe us.) Flints have to be found,
selected, knapped, and the resultant blades and heads fixed to a
haft or shaft, which also required skill to make. The benefits of
specialization were in the increased quantity and quality of all the
needs of the village that could be gained if people concentrated on
doing the tasks for which they were most skilled.
But there was another benefit. The ‘learning curve effect’ meant
that the amount of time needed to produce a product would have
diminished as more experience was gained. This effect meant that
more thinking time could be freed up with the result that ideas
could be developed for improving the product and the processes
by which it was made.
Put another way, there was an opportunity cost when every family
tried to be self-sufficient in all respects. As long as people had to
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4 Understanding the opportunities
spend a disproportionate amount of time on the things they were
not good at, they could not spend that time on tasks for which they
had comparative advantages. So, without specialization the overall
output and quality of what was produced would have been lower,
as would the rate of innovation. Although our primitive prehistoric
villagers would not have understood terms like core competencies,
outsourcing, productivity increases, opportunity cost, or learning
curves, the benefits were real and it is these that lie at the heart of
many of the modern arguments in favour of outsourcing. However,
our basic example shows something that is often overlooked today:
there have to be benefits for suppliers as well as for buyers.
Modern organizations are nurtured by another outgrowth from
the specialization roots – division of labour – which means that
the modern organization consists of individuals who have different
skills, attributes and competencies, and who are hired to fulfil a
specific task or role. Few organizations of the last century or so have
attempted to do everything themselves. There were always some
products and services that came from outside suppliers and were
never made in-house, and the boundaries between the two were
flexible. The main manifestation of outsourcing until the early 1980s
was the ‘make or buy’ decision. The focus of this activity was mainly
on cost reduction, and the main writing about this topic that we have
seen is in books on accounting. This quote from Anthony and Reece
(1978, p. 672) is typical of what has appeared in accounting books
before and since 1978:
Make or buy. Make or buy decisions are among the most com-
mon type of alternative choice problems. At any given time, an
organisation performs certain activities with its own resources,
and it pays outside firms to perform certain other activities. It
constantly seeks to improve the balance between the two types
of activities by asking: should we contract with some outside
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The origins of outsourcing 5
party to perform some function that we are now performing
ourselves? Or should we perform some activity that we now
pay someone else to do?
Although in practice both opportunity cost and strategic implica-
tions were usually taken into account in the final decision, up un-
til the early 1980s most ‘make or buy’ decisions were cost-driven.
Although some services had been outsourced by this time, more
frequently outsourcing decisions applied to components. There
were already well-established specialist organizations providing in-
house catering and security services, so the concept of suppliers
whose main mission was to perform this type of work existed long
before the outsourcing of services became more common. At least
one modern book (e.g., Nohria, 1998, p. 276) appears stuck with the
erroneous idea that outsourcing is a ‘make or buy’ decision about
components and not about services:
Outsourcing. The purchase of parts from outside suppliers.
Many American small appliance manufacturers use a great deal
of outsourcing. The various parts and subassemblies for, say, a
toaster or a blender are manufactured by a number of different
companies, the so-called manufacturer does only the assembly
and selling. When a company is heavily outsourced it is referred
to as ‘hollow.’ Outsourcing is usually a good idea if the outsource
can provide the parts or components at lower cost or higher
quality. Outsourcing is an economic decision.
Starting in the 1980s services became a target for outsourcing.
One stimulus to this change in the UK, which overflowed into other
countries, was the move to privatize many of the organizations in
the public sector. An early manifestation of this trend was the re-
quirement for local authorities to market test many of the activi-
ties that they ran by having the current departments doing the job