13-2c Outsourcing and Insourcing

Another disadvantage of global procurement is that the profits that the company could earn by producing the goods and services in-house may now go to the suppliers. This could affect the profitability of the buying company. Similarly, perhaps the company could produce the goods and services more efficiently than the supplier and, hence, at a lower cost.

Buying may also tip the balance of power in favor of suppliers. When IBM’s PC Division first decided to buy microprocessors from Intel and operating systems from Microsoft, IBM had the negotiation advantage. By choosing Intel’s microprocessors and Microsoft’s operating system, IBM made these products the industry standard. Consequently, as more software and peripherals were developed for the Intel-Microsoft standard, it became increasingly difficult for PC manufacturers, including IBM, to seek alternative sources of supply for microprocessors and operating systems.3

Buying from suppliers could unintentionally lead to suppliers becoming competitors. This is the case of SAP and Oracle. Several decades ago SAP, the largest provider of enterprise resource planning software in the world, was buying 80 percent of its databases from Oracle. When Oracle realized how profitable SAP’s business was, Oracle created its own brand of enterprise resource planning software, to become a direct competitor of SAP. After Oracle’s expansion, SAP has only purchased 20 percent of its databases from Oracle.

Procuring goods and services from suppliers can also carry the risk of suppliers providing those same goods and services to the competition. This is the case for IBM with regard to its suppliers Intel and Microsoft. Intel and Microsoft are now selling their products to Dell and Hewlett-Packard, which were IBM’s competitors in the PC business until 2005, when Lenovo acquired IBM’s PC Division.

In Chapter 11, the text discussed outsourcing and offshoring from the Global Human Resource Management perspective. In this section, the text will revisit outsourcing and offshoring from the global procurement perspective.

When a firm has been “making” goods and services in-house, and then decides to “buy” these goods and services from suppliers, it is said that the firm has outsourced these goods and services. As in the case of the business functions procurement, production, logistics, and R&D, outsourcing can be domestic or global.

Domestic outsourcing means that the firm doing the outsourcing and the supplier that will provide the outsourced good or service are located in the same country. Global outsourcing means the firm and the supplier are located in different countries. Moreover, in some business circles, global outsourcing is also called offshoring. In general, outsourcing is a term that can be used to describe almost any corporate activity that is managed by an outside vendor, from the running of the company’s cafeteria to the provision of courier services.4

Consequently, the type of outsourcing considered in this chapter should be understood as “operations outsourcing”; however, for brevity it will simply be called outsourcing.

Outsourcing can have strategic implications for business organizations. The Sony Corporation, for example, has recently been affected by outsourcing. When Sony Chief Executive Howard Stringer announced that he was considering drastic cost-cutting steps for Sony’s core electronics division, outsourcing topped his to-do list. This shift marked a minor victory for Stringer. After more than three years leading the company, Stringer finally has appeared to be breaking the company’s addiction to manufacturing (“make”). To show that he is serious, the Welsh-born American CEO has said he will close five or six of Sony’s 57 global plants and reduce the company’s budget for factories and chip-making equipment by one-third over the next fiscal year. “We have to move very, very quickly and control our costs,” Stringer told journalists in Tokyo. He appears to have made up his mind about outsourcing one specific product: television sets. What will Stringer’s outsourcing strategy look like? That has not been determined, but experts predict that Sony will continue to make the

outsourcing

when a firm has been making goods and services in-house, and then decides to buy these goods and services from suppliers

domestic outsourcing

when the firm doing the outsourcing and the supplier that will provide the outsourced goods and services are located in the same country

global outsourcing

when the firm doing the outsourcing and the supplier that will provide the outsourced goods and services are located in different countries; also called offshoring

offshoring

when a firm and the supplier are located in different countries

ultra-thin, high-end televisions in-house. Small and midsize sets, however, may be produced by one or more manufacturers in Taiwan or Hong Kong. (In June 2013, Stringer retired as Chairman of the Board of Sony.)5 Outsourcing is a practice that has rapidly grown in recent years. According to one estimate, in the 1940s only 20 percent of a typical American manufacturing company’s value-added in production and operations came from outside sources; 50 years later the proportion had tripled to 60 percent. In the automobile industry, firms with the biggest profit per car, such as Toyota, Honda, and Chrysler, were also the biggest outsourcers, sourcing around 70 percent to various suppliers during the 1990s. Those car companies that outsourced the least (e.g., General Motors, which outsourced only 30 percent of its valueadded operations) were the least profitable.6 The nature of outsourcing contracts has changed over time as well. What began as a straightforward arm’s-length agreement between a buyer and a supplier has become structured more like a partnership agreement. Any increase in the client’s volume of business is reflected in the outsourcer’s scale of charges, and both parties in some way also share the risks and rewards of the outsourced activity. Some firms have taken A Sony monitor. Its founders, Akio Morita and Masaru Ibuka, derived the Sony name the idea of outsourcing to such an extreme that from sonus, the Latin word for sound, and from the English slang word “sonny.” they have left themselves with little to do. An American company named Vizio, Inc. produces LCD television sets, and only has 85 employees, but its sales are in the billions of dollars. Vizio uses modules to assemble its own brand of televisions and because the major components of televisions are now readily available as commodities, Vizio can design the television, buy the components, hire a contract manufacturer, and market the televisions with very little cost.7 Similarly, the sports gear company Nike can be characterized as owning and making little beyond concepts and designs.8 Companies like Nike, which focus only on product design and outsource all other production process functions are called hollow corporations. When a firm has been buying goods and services from suppliers and then decides to “make” these goods and services in-house, it is said that the firm has insourced these goods hollow corporation a company that only completes product design and outsources all other production and services. Similar to its outsourcing counterpart, businesses can use insourcing for strategic purposes. For example, after two years of delays caused by outsourced suppliers, Boeing plans to do more in-house work on its new 787 Dreamliner. Plagued by repeated problems with some suppliers, Boeing has been forced to delay the delivery of its 787 by process functions several months. In addition, Boeing is now reconsidering its global outsourcing model that, according to experts, has been responsible for most of these delays. Boeing engineers report that in order to solve several design and production crises, they have frequently sent employees to visit with suppliers, and Boeing’s top executives are now relying less upon their outside suppliers as a result. If this change takes place, the impact on suppliers would be huge, since they account for approximately 70 percent of the 787 in cost—a far larger share than Boeing has outsourced on earlier planes. Outsourcing the majority of the work on the new 787 has been part of a strategy to share financial risk, to contain costs, and to

Reuters/Kim Kyung Hoon

insourcing

when the firm has been buying goods and services from suppliers, and then decides to make these goods and services in-house

Evolution1/Dreamstime.com

The Boeing 787 Dreamliner, whose development and production has involved a large-scale collaboration with numerous suppliers around the globe.

ECONOMIC PERSPECTIVES Outsourcing Production of Televisions

Although demand continues to increase for flat panel liquid-crystal display televisions, major manufacturers of televisions, such as Sony, Toshiba, and LG Electronics, must reduce their manufacturing costs due to sharp price declines. As a result, these companies are relocating production from South Korea, Japan, and Mexico to contractors such as Taiwan’s Hon Hai Precision Industry Co., Ltd. and Hong Kong’s TPV Technology Limited. “Rapidly declining profit margins have forced television makers to outsource a certain percentage of their production to companies such as Hon Hai,” said Santosh Kumar, an analyst at Californiabased consulting firm Frost & Sullivan.

J.P. Morgan predicts that the LCD television outsourcing market will more than double in revenue over the next several years. As an example of the outsourcing trend among the major television manufacturers, Sony plans to increase its percentage of television manufacturing outsourcing to more than 50 percent in its current fiscal year, from 20 percent in the past fiscal year. This will include transferring its plants in Tijuana, Mexico, and Nitra, Slovakia, to Hon Hai, said George Boyd, a spokesman at the company.

QUESTIONS:

1) What are some of the advantages for Sony,

Toshiba, and LG Electronics to move outsourcing television manufacturing from South Korea,

Japan, and Mexico to plants in China and Taiwan? 2) Under which conditions do you think Sony,

Toshiba, and LG Electronics may decide to insource from plants in China and Taiwan, the manufacturing of televisions to companies in

South Korea, Japan, and Mexico? 3) Television makers are being forced to outsource some of their production because: a) television prices increased; b) the television market increased; c) their profit margins decreased; d) their profit margins increased. 4) J.P. Morgan predicts that the LCD television outsourcing market will: a) more than double in revenue over the next several years; b) decrease by 50 percent; c) decrease by 40 percent; d) decrease by 20 percent. 5) Sony plans to increase its percentage of television manufacturing outsourcing to: a) more than 30 percent; b) more than 40 percent; c) more than 50 percent; d) more than 60 percent.

Source: Lorraine Luk, “China Takes Leading Role in TVs,” Wall Street Journal, June 10, 2010.