EFFICIENT EXECUTION

Outsourcing. Companies reconfigure their supply chains by letting in-house activities be performed by external organizations. Outsourcing can provide greater flexibility to companies involved in rapidly evolving technologies, fashion industry or when dealing with complex systems. It also spreads the development risk across a number of suppliers; overcomes the limitations of the firm’s own innovative capabilities by tapping into the innovative capabilities of small enterprises; and allows the firm to leverage internal technical capabilities. Many companies try to improve their return on capital employed by shedding their asset base, integrating the supply chain and reinventing themselves as product designers and service and innovative solution providers. The dramatic increase in the market-to-book ratios of companies is testimony to this diminishing importance of maintaining a large tangible asset base.

Factors such as global access to and diminishing interaction costs with suppliers and improved technology, provide companies with a wide range of options to configure their value chains. This may enable them to shift some operational activities and the accompanying responsibilities to external parties, realize cost savings and reduce their capital requirements. The following criteria can be used to evaluate the soundness of outsourcing decisions: the potential competitive advantage when considering transaction costs; the potential strategic vulnerability; and appropriate controls while maintaining the necessary flexibility. In situations where a low level of control is sufficient, off-the shelf purchasing is the appropriate approach and internal production is necessary when a high level of strategic control is called for. Special contract arrangements will give a moderate level of control. However, in the first instance, a company is interested in improving its efficiency and providing superior value and outsourcing may be merely one of several approaches to achieve this. It should first improve the productivity of its existing assets, integrate its supply chain and maximize its operational efficiency.

The usefulness of outsourcing for overall improvement depends on whether it is achieved through the release or sale of assets, a spin-off or initial public offering, or though an alliance or joint venture. Outsourcing also has its downside and research points out the negative impacts and dangers that companies may incur by externalizing certain activities in an indiscriminate way. Companies may loose their unique, distinguishing skills and processes and could have problems with managing suppliers that may have an impact on downstream customers. Original equipment manufacturers may embed such a balance of power in their favor that suppliers are substantially disadvantaged and as a result may not be able to deliver the required quality and service on a sustainable basis. Crucial experience may shift to suppliers and enhance their power position. If outsourcing is not well planned and used only to save on short-term costs, the firm may end up with a vast number of subcontractors that are difficult and costly to manage. In addition, the firm may lose control, and experience an erosion of its core competencies. Outsourcing offers potential benefits, but also challenges and risks such as the specific dangers of loss of critical and cross-functional skills, and loss of control over a supplier.

Although outsourcing may be a faster route to short-term competitive advantage, it does not contribute to embedding the necessary skills for long-term leadership. In addition, extensive outsourcing to the same group of suppliers results in more standardized purchased input items that provide individual companies with less opportunity to differentiate themselves. It also lowers entry barriers, as new entrants need fewer propriety capabilities to compete in an assembler role. Existing players in the industry may lose crucial capabilities to suppliers and control over certain activities. The firm has to identify those activities related to its core competencies that are crucial to generate competitive advantage and unique value for customers. A recommendable strategic performance criterion is the consideration whether ownership of an asset has any strategic importance. The firm may consider, for outsourcing, those activities for which it has no compelling strategic need or the necessary capabilities. Depending on the potential for competitive advantage and the extent of strategic vulnerability, each activity can be classified in terms of the level of control that the company has to exercise over it.

outsourcing is not attractive if competitive advantage is obtained by doing an activity better internally; at lower cost; more timely or with some unique capability
internal transaction costs to support an internal activity, such as R&D, personnel development, infrastructure investment, and management costs
the danger of vulnerability from market failure due to the presence of powerful suppliers; a lack of available information about the marketplace or individual suppliers; high costs to monitor progress on the suppliers’ premises
appropriate supplier controls in accordance with the trade-off between the need for control and flexibility.

The firm should favor outsourcing when it offers dramatic cost savings, a unique location, technology or skill, greater capacity that helps to stabilize the production volume, the possibility of accessing and benefiting from shared expertise.

Partnering. The definition of the value chain relies on the contribution of partners in order to find the right configuration and ownership of internal and external activities. Partnering is a well-accepted principle of strategy and outsourcing as discussed above is a common form of partnering. With the advent of the Internet it has lead to the belief that partnering is a sure way of improving industry economics, but when it involves complementary products, companies may lose their unique differentiation and invite more intense rivalry.

Deconstruction. In order to develop competitiveness companies have to maximize effectiveness and efficiency. To find the right ownership of each of the value-adding activities the whole business has to be disaggregated into its component parts and then rebuilt again. According to Evans and Wurster, this process of deconstruction is the "dismantling and reformulation of traditional business structures" and it occurs because of the "separation of the economics of information from the economics of things".