Originally Published MDDI March 2004
Guide to Outsourcing
Many companies seem eager to outsource, but is outsourcing always the right choice for your company?
Outsourcing seems to be every company's favorite way to grow, cut costs, or respond to market changes. It seems anything today can be contracted: sales, marketing, payroll, manufacturing, logistics, and even new product development. While outsourcing does have advantages, are there times when something should not be outsourced? How do companies know when they should farm out a tough operation or work through it themselves?
Simply put, companies outsource operations when it will lower total operational costs. Typically, three benefits are cited: quicker implementation, fewer idle resources, and cost reduction. Often these benefits are real. Sometimes, though, they are illusory and, in reality, outsourcing costs the organization more.
The Mistakes of Quick Implementation
When there is a need for speed, an outsourced solution may be implemented more quickly than one using internal resources. This reduces the need for highly skilled or experienced hires who command premium salaries. By outsourcing the operation, a company rents specialized talent, cutting out the learning curve associated with a new or improved operation. A commonly uttered sentence in these organizations is, “We need to complete this quickly.” For these companies, time is more valuable than saving money, since competition drives the decision-making process.
A recent sales trend, customer relationship management (CRM), provides a good example. Technologically, it is nothing more than sophisticated contact management software. By enabling feedback from customers to be communicated to the rest of the organization, it improves marketing, sales, manufacturing, and new product development. Instead of deploying a manual system based on forms and procedures, a company can contract with a firm to supply them with the software, hardware, and training. This enables the organization to focus on properly applying CRM to their business, rather than wrestling with the implementation details.
Sometimes, however, the need for speed blinds an organization. For some problems, the outsourced solution can take just as long, or longer, to implement than an in-house one. If proprietary knowledge is required to achieve the goals, then outsourcing will save no time, even in the best of circumstances. Both in-house and external help will need time to absorb and digest the new information. Furthermore, because the in-house staff is already familiar with current operations, they will probably be able to apply the information more quickly. If the outsource provider quits, the company will have to develop and educate a new outside supplier all over again.
Alternatively, internal resources tend to stay with a company longer, and their knowledge is more easily dispersed throughout an organization. For example, most sales forces would be a bad operation to outsource. Customer lists, value proposition, and intangible client relationships are all critical proprietary resources that are indispensable. If the supplier were to leave, the company could go out of business as it scrambles to learn how to sell to its current customers.
Another type of problem arises when the contracting operation is less capable than the hiring operation. Additional time must then be spent to both raise the contractor's performance and implement the transition. Such situations can occur when the company's standards are higher than the rest of the industry, or the vendor is unable or unwilling to comply. For example, 21 CFR Part 11, or electronic records and signatures, is now partially implemented in the medical device industry. While some companies depend on FDA enforcement discretion to stay in operation, others have defined strong programs of compliance.
For the latter type of company that is highly compliant, outsourcing can pose a dilemma. Either the company must find an equally compliant supplier, or work with a less-compliant one to raise its customer-specific processes into compliance. With higher standards, fewer suppliers will be able to comply or be interested in complying. For those that do qualify, this compliance will undoubtedly translate into a higher price, which could negate any cost advantage of outsourcing. In-house resources are clearly better in situations where there is a single, high compliance standard.
Temporary Needs or Permanent Challenges?
Outsourcing can help when occasional needs do not warrant a permanent solution. Expensive equipment or software may be required to perform an annual project, but remain idle the rest of the time. For example, new primary packaging for a medical device requires material testing for such metrics as impact, hardness, tensile strength, leak, and vibration. Instead of buying the equipment for this presumably infrequent project, a company may seek outside laboratories that offer the tests at a fraction of the cost of the equipment. Furthermore, the company will save money because in-house software and hardware would draw some resources for maintenance, calibration, and validation.
The employment of highly technical specialists is another reason to outsource. Although their services are needed sparingly, companies often hire them permanently to ensure their continual availability. Scientists and engineers may fall into this category. A scientist might be hired for a single phase or period of a project. After the project is over, such an employee can consume valuable resources conducting irrelevant studies and writing unread white papers. In this situation, outsourcing is an attractive alternative. For example, if a company wants to improve its quality systems to meet a specific customer's requirements, a quality consultant is a more effective use of resources than hiring a full-time six sigma expert. Once the project is over, the consultant's contract is terminated, while the hired expert remains. He or she will want to move on to the next customer's product and try to improve it, despite the fact there may be no business reason to do so.
Sometimes, though, an organization needs ongoing help but hires a contractor rather than an employee. This happens when organizations incorrectly anticipate the amount of change the product might need in the future. While it is impossible to predict exactly how a product will change, it is reasonable to assume that customer requests, market changes, or business needs might drive product changes. Incorrectly anticipating that such changes may occur can cause an organization to outsource continuously in order to accommodate the changes as they appear over a product's life. Perhaps a new device that was unique and profitable lost appeal when copycat devices emerged, or a customer asks that a device be sent packaged and sterilized instead of bulk shipped. If an organization is not prepared to accommodate such changes, hiring a contractor is not always the best option.
When the company changes the product, it will have to go through design controls and require engineering, quality, and marketing support as well as overall project management. While it may be tempting to outsource, realistically, this product will have to be changed again. While each project appears to be a one-time event, the product actually requires regular support to keep it updated and profitable.
Validation is another example of an activity that appears transient but in reality is ongoing. Is it really likely that all of the equipment, software, and processes will only have small, like-for-like changes? No, it is not likely. Even if an entire operation freezes its configuration, the suppliers will still make changes to their processes, and eventually one will be made that will affect the finished product. Thus, validation may be better handled by a permanent employee.
One Size Fits All
Perhaps the most compelling reason for companies to outsource is that lower costs can be achieved outside the organization, through economies of scale. Particularly for capital-intensive operations, a supplier can dedicate equipment and personnel to a single process, achieving enormous gains in productivity.
A company that wants to begin selling a sterilized product will need to evaluate—and possibly upgrade—its packaging processes, add quality systems to document and assure sterilization requirements, and develop manufacturing personnel to work with sterile products. Outsourcing this moves all of the work to the supplier. Since the supplier is spreading these quality systems and knowledge over multiple clients, the cost to each client is usually lower than that of an in-house operation.
But while large, specialized operations appear to have good economies of scale, they can be too rigid or inflexible for a specific company's requirements. The outsourcing companies achieve their lower costs by standardizing and specializing. This often means that the customer must learn to conform to the supplier's requirements, and not vice versa.
For example, Web-based software solutions are becoming the vogue as the costs of hardware, upgrades, and technical support can be moved onto the supplier. If a company outsources its inventory management, it may not be sufficiently configurable to accommodate a medical device. If the system does not have the ability for quality assurance (QA) to place a product on hold, search release dates in case of a recall, or automatically remove an expired product from inventory, the buyer will have to develop systems to augment the outsourced solution. So in this case, outsourcing reduces the cost of an information system, but QA costs increase to accommodate the system's shortcomings. Since the QA system will be manually developed, the total costs will likely be greater after the transition.
Furthermore, as the economically efficient organizations change their operations to continuously reduce costs, the buyers must change their practices to accommodate them. A contract packager, for example, could eliminate a package size to better utilize resources, or perhaps change from radio frequency sealing to heat sealing. Regardless, these changes will be transmitted upstream to the product development team. Instead of spending resources to develop new and innovative products, contracting organizations will have to spend money to keep doing business with their suppliers.
Of course, the customer could go shopping for a new supplier, but that would take time and effort. Organizations that have realized the cost savings of an outside vendor are highly unlikely to move the operations back in-house for both practical as well as political reasons.
While outsourcing helps companies to grow quickly and lower costs, there are times when it is the wrong solution. In situations involving proprietary knowledge or highly technical or customized operations, the outsourced solution may not only be more expensive, but a complete disaster if it turns out to be intransigent or incompetent. Since both of these are not realized until after the transition takes place, it is important to be wary when outsourcing any operation.
Jeffrey Stephens is president of Ixian Consulting Inc. (Jefferson, GA), a management consulting organization.
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