OUTSOURCING AND INSOURCING IN AN INTERNATIONAL CONTEXT

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OUTSOURCING AND INSOURCING IN AN INTERNATIONAL CONTEXT MARC J. SCHNIEDERJANS ASHLYN M. SCHNIEDERJANS DARA G. SCHNIEDERJANS

First published 2005 by M.E. Sharpe Published 2015 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN 711 Third Avenue, New York, NY 10017, USA Routledge is an imprint of the Taylor & Francis Group, an informa business Copyright 2005 Taylor & Francis. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Notices No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use of operation of any methods, products, instructions or ideas contained in the material herein. Practitioners and researchers must always rely on their own experience and knowledge in evaluating and using any information, methods, compounds, or experiments described herein. In using such information or methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility. Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data Schniederjans, Marc J. Outsourcing and insourcing in an international context / Marc J. Schniederjans, Ashlyn M. Schniederjans, Dara G. Schniederjans. p. cm. Includes bibliographical references and index. ISBN 0-7656-1585-1 (hardcover: alk. paper); ISBN 0-7656-1586-X (pbk.: alk paper) 1. Contracting out--management. I. Schniederjans, Ashlyn M. II. Schniederjans, Dara G. III. Title. HD2365.S36 2005 658.4'058--dc22 2005010488 ISBN 13: 9780765615862 (pbk) ISBN 13: 9780765615855 (hbk)

Brief Contents List of Tables and Figures Preface xv xix Part 1. Introduction to Outsourcing-Insourcing in an International Context 1. Introduction to Outsourcing-Insourcing 3 2. Advantages and Disadvantages of Outsourcing-Insourcing 21 3. Outsourcing-Insourcing Strategy and International Risk Factors 36 4. Planning International Outsourcing-Insourcing 49 Part 2. Methodologies for Different Types of Outsourcing-Insourcing Decisions 5. International Outsourcing-Insourcing Metrics-Based Methodologies 75 6. Financial Methodologies for the Initial Outsourcing-Insourcing Decision 98 7. Methodologies for Selecting Outsourcing-Insourcing Partners 125 8. Methodologies for Allocating Business Activities Between Outsourcers and Insourcers 150 Epilogue: There Are Wrong Ways and Right Ways to Outsource-Insource in an International Context 182 Index 203 v

Detailed Contents List of Tables and Figures xv Preface xix Part 1. Introduction to Outsourcing-Insourcing in an International Context Chapter 1. Introduction to Outsourcing-Insourcing 3 What is Outsourcing-Insourcing? 3 What is Outsourcing-Insourcing in an International Context? 5 Types of Outsourcing-Insourcing 6 Why Use Outsourcing? 9 Strategic Planning of Core Competencies 9 The Economics of Outsourcing 10 Outsourcing Trends 12 Risk in the Outsourcing-Insourcing Process 14 How This Book Is Organized 17 Summary 18 Review Terms 18 Discussion Questions 19 Concept Questions 19 References 19 Chapter 2. Advantages and Disadvantages of Outsourcing-Insourcing 21 Introduction 21 Outsourcing as an Industry 21 Information Technology (IT) Outsourcing Industry 22 Human Resources (HR) Outsourcint Industry 22 vii

v i i i D E TA I L E D C O N T E N T S Industry Recognition and Support 23 What Are the Advantages of Outsourcing (or Disadvantage of Insourcing)? 24 Linking an International Context with Outsourcing Advantages 27 What Are the Disadvantages of Outsourcing (or Advantages of Insourcing)? 27 Linking an International Context with Outsourcing Disadvantages 30 Risk and Outsourcing Advantages and Disadvantages 31 Summary 33 Review Terms 33 Discussion Questions 33 Concept Questions 33 References 34 Chapter 3. Outsourcing-Insourcing Strategy and International Risk Factors 36 Introduction 36 The Relationship of International Business with Outsourcing-Insourcing 36 Organization Planning and International Business 36 Relationship of Organizational Strategic Planning and Outsourcing-Insourcing 38 Relationship of Outsourcing-Insourcing with International Business 40 Outsourcing-Insourcing Strategy and International Risk Factors 40 Risk Factors in an International Context 41 Case Studies on the Complication of Risk Factors 43 Summary 46 Review Terms 46 Discussion Questions 46 Concept Questions 47 References 47 Chapter 4. Planning International Outsourcing-Insourcing 49 Introduction 49 Strategic Planning Steps in Outsourcing-Insourcing 50 Internal Organizational Analysis 51

D E TA I L E D C O N T E N T S i x External Environmental Analysis 52 Choice of O-I Strategy for Non-Core Competencies 54 Tactical Planning Steps in Outsourcing-Insourcing 54 Establish Goals and Draft Outsourcing Agreement Specifi cations 55 Indentify and Select Outsource Provider 56 Negotiate Measures of Outsourcing Performance and Goals 61 Operational Planning Steps in Outsourcing-Insourcing 63 Monitor and Control Current Outsourcing Program 63 Evaluate Outsourcer and Provide Feedback 66 An International Context Risk Rejoiner 66 Case Study on Avoiding Risk in International Outsourcing 67 Summary 69 Review Terms 70 Discussion Questions 70 Concept Questions 70 References 70 Part 2. Methodologies for Different Types of Outsourcing-Insourcing Decisions Chapter 5. International Outsourcing-Insourcing Metrics-Based Methodologies 75 Introduction 75 Executive and Board of Director Polling 75 Rating/Scoring Metrics and Multi-Criteria Scoring Methods 77 Metric Accuracy and the Delphi Method 80 External Benchmarking and Gap Analysis 81 External Benchmarking Procedure 82 Gap Analysis 84 Measuring International O-I Risks 86 Economic Risk Factor Assessment 87 Politics Risk Factor Assessment 90 Culture Risk Factor Assessment 90 Demographic Risk Factor Assessment 90

x D E TA I L E D C O N T E N T S Summary 93 Review Terms 93 Discussion Questions 93 Concept Questions 93 Methodology Problems 94 References 96 Chapter 6. Financial Methodologies for the Initial Outsourcing-Insourcing Decision 98 Introduction 98 Present Value Analysis 99 Net Present Value 100 Break-Even Analysis 102 Return on Investment 104 Internal Rate of Return 105 Accounting Rate of Return 106 Payback Period 107 Cost/Benefit Analysis 108 An International Context Risk Rejoinder 114 Alternative Unit Break-Even/Risk Methodology 116 Summary 119 Review Terms 120 Discussion Questions 120 Concept Questions 120 Methodology Problems 120 References 123 Chapter 7. Methodologies for Selecting Outsourcing- Insourcing Partners 125 Introduction 125 Preliminary Selection Considerations and Risk Factors 127 Screen Out Providers That Do Not Satisfy the Primary Objectives in the RFI 127 Screen Out Providers That Do Not Qualify 127 Screen Out Higher Risk Providers 129

D E TA I L E D C O N T E N T S x i Benchmarking and O-I Partner Selection Decisions 129 Benchmarking as an Ex Ante Selection Method 129 Benchmarking as an Ex Post Selection Method 131 Decision Theory Methods for Partner Selection Decisions 132 Decision Theory Model Elements 134 Types of Decision Environments 134 Decision Theory Model Formulation Procedure 135 Decision Making Under Risk 136 Decision Making Under Uncertainty 138 Geographic Distance Selection Methodologies 142 The Centroid Method 142 Summary 144 Review Terms 145 Discussion Questions 146 Concept Questions 146 Methodology Problems 146 References 148 Chapter 8. Methodologies for Allocating Business Activities Between Outsourcers and Insourcers 150 Introduction 150 Game Theory Methodology for O-I Proportional Allocation Decisions 152 Game Theory Model Elements 153 Game Theory Model Formulation Procedure 154 Computer-Based Solutions for Game Theory Problems 155 Linear Programming for O-I Proportional Allocation Decisions 157 LP Model Elements 158 Linear Programming Model Formulation Procedure 160 Computer-Based Solutions for Linear Programming Problems 167 Extending the LP Solution with Duality and Sensitivity Analysis 170 Linear Programming Model Assumptions/Limitations 173 Summary 175 Review Terms 175

x i i D E TA I L E D C O N T E N T S Discussion Questions 176 Concept Questions 176 Methodology Problems 176 References 180 Epilogue: There are Wrong Ways and Rights Ways to Outsource-Insource in an International Context 182 Introduction 182 The Wrong Way to O-I 183 Avoid Outsourcing Critical or Non-Core Business Activities That Could Become Core Business Activities in the Future 183 Avoid Outsourcing Critical Information and Relying on Trust 184 Avoid Outsourcing Just to Make the Accounting Books Look Good 185 Avoid Outsourcing Just to Handle or Deal with Labor Problems 186 Avoid Outsourcing Just to Mitigate Risks 186 Avoid Outsourcing Business Activities That Are Easily Copied by Outsourcing Firms 187 Avoid International Outsourcing Risks in Foreign Countries Where You Will Be at a Disadvantage for Reasons of Politics, Culture, Economics, or Demographics 188 Possible Consequences of Wrong Way O-I 188 Outsourcing Industry at Risk 188 Evolution of Industries 190 Loss of Outsourcing Industry 191 The Right Way to O-I 191 Seek to Use O-I as an Organizational Transformation Process, to Learn New Ideas, Train Personnel, and Implement New Technologies/Processes 192 Seek to Use O-I as a Means to Further International and Global Business 193 Seek to Use Outsourcing to Augment Existing Business Activities 193 Possible Consequences of Right Way O-I 194 What Needs to be Done? 194 Government Regulation 194 Industry Ethics Program 197

D E TA I L E D C O N T E N T S x i i i Review Terms 199 Discussion Questions 199 Concept Questions 199 References 199 Index 203

List of Tables and Figures Figures 1.1 Balancing Outsourcing and Insourcing Benefits and Costs 4 1.2 Evolution of Business Organizations and Outsourcing 6 1.3 Strategic Planning and Core Competencies 10 1.4 Transaction Cost Theory and Outsourcing 11 1.5 Agency Theory and Outsourcing 11 1.6 U.S. Outsourcing Market for Information Services for Select Years 13 1.7 Conceptual Steps in a Typical Outsourcing Process 14 2.1 Da Rold Transfer-of-Risk Model in Outsourcing 31 3.1 Organization Planning Stages 37 3.2 Steps in the Strategic Planning Stage Leading to the International Business Strategy Decision 38 3.3 Steps in the Strategic Planning Stage Leading to the O-I Strategy Decision 39 3.4 Risk Factors in International O-I 41 3.5 Example of O-I Risk Factors Creating an Interactive Chain Effect 44 4.1 Strategic, Tactical, and Operational Planning Steps in International O-I 50 4.2 Overview of Outsource Provider Selection Steps 52 4.3 Three-Dimensional Rating/Scoring Table for Outsource Provider Selection 60 5.1 Application of This Chapter s O-I Metric-Based Methodologies in International O-I Planning 76 5.2 Gap Chart of Outsource Provider Monitoring Example 86 5.3 Example of Interactive Chain Effect for O-I Risk Factors 92 6.1 Application of This Chapter s Methodologies in International O-I Planning 99 6.2 Decision Rules for Unit Break-Even Model 118 7.1 Application of This Chapter s Methodologies in International O-I Planning 126 7.2 Grid Map of Existing Markets with Coordinates for Centroid Method Problem 144 7.3 Centroid Method Solution for Outsource Provider Selection Problem 144 8.1 Application of This Chapter s Methodologies in International O-I Planning 151 8.2 Computer Solution for GT O-I Proportion Decision Model 156 8.3 Computer Solution for GT O-I Strategy Selection Model 157 8.4 Computer Solution for LP O-I Proportion Decision Help Desk Problem 168 xv

x v i L I S T O F TA B L E S A N D F I G U R E S 8.5 Computer Solution for Integer LP O-I Proportion Decision Phone Service Problem 169 8.6 Computer Solution for Zero-One LP O-I Provider Selection Problem 170 8.7 Computer Solution with Duality and Sensitivity Analysis for LP O-I Proportion Decision Help Desk Problem Model 171 E.1 A Negative Interactive Chain-Effect Resulting from Distrust 190 E.2 Creating a Growth-Interactive Chain-Effect Resulting from Positive Experience 195 Tables 1.1 Types of Cooperative Agreements Serving as a Basis for Outsourcing 7 1.2 Common Types of Outsourcing 8 1.3 Possible Risks in the Conceptual Outsourcing Process 15 1.4 Outsourcing Risk Categories and Examples 16 2.1 Outsourcing Advantages: Cost Savings and Gaining Outside Expertise 24 2.2 Outsourcing Advantage: Improve Service 25 2.3 Outsourcing Advantages: Focus on Core Competencies, Gain Outside Technology, and Other Advantages 26 2.4 Advantages of Outsourcing in an International Context 28 2.5 Reasons Why Organizations Internationalize 28 2.6 Disadvantages of Outsourcing 29 2.7 Outsourcing Risks That Will Lead to Business Failure 32 3.1 International Business Factors to Be Considered in the External Environmental Analysis 38 3.2 Examples of the Relationship Between International Business and O-I Issues 40 4.1 An Example of Rating International Risk Factors by Country 53 4.2 Common Features in Outsourcing Agreements 57 4.3 An Example of Rating Tactical Provider Selection Criteria Risk Factors by Country 59 4.4 International Risk Factor Evaluation for Country Selection in Client Firm Example 61 4.5 Guiding Principles for Content in Negotiating Outsource Agreements 62 4.6 Selected Questions Reflecting Distrust in the Client Firm Example 68 5.1 Examples of O-I Survey Polling Questions 77 5.2 MCSM Table for Unweighted Outsource Provider Selection Problem 78 5.3 MCSM Table for Weighted Outsource Provider Selection Problem 79 5.4 Computation for the Weighted MCSM Outsource Provider Selection Problem 80 5.5 Steps in Using the Delphi Method to Reach Consensus on Parameters 82 5.6 Benchmarking Measures for O-I 83 5.7 Operational Management Questions Used in the Construction of a Gap Chart to Measure Outsource Provider Performance 85 5.8 Typical Rating/Scoring Questions for Tabular Model Risk Assessment 88 5.9 Economic Risk Factor Categories 89 5.10 Politics Risk Factor Categories 90 5.11 Culture Risk Factor Categories 91

L I S T O F TA B L E S A N D F I G U R E S x v i i 5.12 Demographic Risk Factor Categories 92 6.1 Data for NPV Problem with Unequal Investment Lives 102 6.2 Costs and Benefits of an O-I Strategy 103 6.3 Annual Net Income for Sample Problem 107 6.4 Annual Book Value of Assets for Sample Problem 107 6.5 Cost and Cash Data for Payback Period Sample Problem 108 6.6 Payback Period Computations for Sample Problem 109 6.7 Potential Costs of an O-I Project 110 6.8 Potential Benefits of an O-I Project 110 6.9 Costs and Benefits of Outsource Provider A 112 6.10 Costs and Benefits of Outsource Provider B 112 6.11 Benefit/Cost Ratios for Outsource Sample Problem 113 6.12 Payback Period Data for Outsourcing Sample Problem 114 6.13 Payback Period Risk Adjustment Computations for Sample Problem 116 6.14 Suggested Adjustments to Financial Parameters for International Risk 117 7.1 Categories of Outsource Provider Selection Criteria 127 7.2 Risk Factors to Consider in the Outsource Selection Process 128 7.3 International Risk Factors to Consider in the Outsource Selection Process 130 7.4 Sources of Benchmarking Standards 131 7.5 Sources of Business Process Benchmarks for the Telecommunications Industry 132 7.6 Some Measures of Outsource Provider Performance to Be Used in Benchmarking 133 7.7 Generalized Statement of the DT Model 134 7.8 DT Formulation of the Outsource Provider Selection Model 136 7.9 Expected Value Solution for the Outsource Provider Selection Problem 137 7.10 Best Payoffs for Each State of Nature in the Outsource Provider Selection Problem 138 7.11 Opportunity Loss Table for Outsource Provider Selection Problem 138 7.12 Expected Opportunity Loss Values for Outsource Provider Selection Problem 139 7.13 Laplace Solution for Outsource Provider Selection Problem 139 7.14 Maximax Solution for Outsource Provider Selection Problem 140 7.15 Maximin Solution for Outsource Provider Selection Problem 140 7.16 Max and Min Payoffs for Use with Hurwicz s Method 141 7.17 Hurwicz Solution for Outsource Provider Selection Problem 142 7.18 Minimax Solution for Outsource Provider Selection Problem 142 7.19 Methodologies Useful in Considering Distance Criteria in Outsource Provider Selection 143 8.1 Generalized Statement of the GT Model 153 8.2 GT Formulation of the O-I Proportion Decision Model 154 8.3 GT Model of the O-I Strategy Selection Problem 155 8.4 Risk Factors for International O-I Zero-One LP Provider Selection Problem 164 8.5 Methodologies Useful in Selecting O-I Provider Proportions 174 E.1 Ethical Principles and Related Outsourcing Linkages 198

Preface Outsourcing, which includes the decision of insourcing, is not just a popular phenomenon, but is viewed as one of the most important management strategies of our time. Indeed, there have been calls in the literature to elevate the process of outsourcing-insourcing to the status of a new management function that can replace entire purchasing, information systems, operations, marketing, finance, and accounting departments. This is particularly important to business operations the world over because of the international nature of outsourcing. Considering that half of the outsourcing-insourcing decisions meet with failure, making the right decision may be the difference between long-term success or failure for a firm. The need to make the right outsourcing-insourcing decision has never been greater than it is now. As the outsourcing industry grows by double digits every year, students seeking jobs increasingly need to know about this new industry. Even more urgent, practitioners in industry, regardless of position, need to be educated on issues, concepts, philosophies, procedures, methodologies, and practices of outsourcing. The purpose of this textbook is to provide current concepts and methodologies that can help individuals understand and use outsourcing strategies. The book is designed for an upperlevel undergraduate course or a graduate course in business. It can also be useful to professionals in any field of business or engineering that is affected by outsourcing issues. This would include practitioners at the board of director or CEO level down through an organization s structure to frontline supervisors who are interested in and make outsourcing decisions. Other faculty, trainers, and graduate students will also find this textbook useful. The book assumes a reader has had exposure to business terminology that undergraduate students are normally exposed to in business or industrial management degree programs. Throughout this textbook, important terms are italicized and are usually followed by a definition. The location of the definitions can be found in the index at the end of the book. The contents of this book are organized into two parts. In Part 1, Introduction to Outsourcing-Insourcing in an International Context, four chapters are presented that help to overview the concepts and strategies defining outsourcing-insourcing in an international context. In Part 2, Methodologies for Different Types of Outsourcing-Insourcing Decisions, four chapters are focused on methodological techniques for implementing outsourcinginsourcing decisions. The authors wish to thank all the people who have helped completing this textbook. One of the major sources of outsourcing information on which we relied is FSO Magazine. We thank the many contributors to that online publication, whose work in the outsourcing industry is greatly appreciated by all. We also thank the editorial xix

x x P R E FA C E staff at M.E. Sharpe for their professionalism and responsiveness. It was a joy to work with them. Finally, we wish to thank Jill Schniederjans, wife and mother, who spend countless hours editing drafts. She has made a significant contribution to this textbook. While many people have had a hand in the preparation of this book, its accuracy and completeness are the responsibility of the authors. For all the errors this book may contain we apologize in advance. Marc J. Schniederjans Ashlyn M. Schniederjans Dara G. Schniederjans

Part 1 Introduction to Outsourcing-Insourcing in an International Context