Strategic Importance of Outsourcing in U.S. Manufacturing Company

Strategic Importance of Outsourcing in U.S. Manufacturing Company

An increase in market competitions, decision to lower production costs and shortened time to market are the driving forces that make a large number of manufacturing companies adopting the outsourcing policy. Outsourcing is the management policy of allowing the third party external providers to take up the activities of non-core activities of an organization to make firms focusing on the core businesses. In the contemporary global business environment, firms are required to produce the innovative products, and developing a new strategy to increase profitability, outsourcing has become a new business technique that firms employ to remain competitive. Thus, outsourcing helps manufacturing companies to lower costs and remain competitive in the fiercely competitive business environment. However, there is an ongoing debate that outsourcing decision can be detrimental to organization business advantage.

The objective of the essay is to explore the benefits and shortcomings of outsourcing for the manufacturing companies.

Benefits and Shortcomings of Outsourcing for Manufacturing Companies

The goal to lower the costs of production is one of the major factors that makes the U.S. manufacturing companies to adopt the policy of outsourcing. Typically, outsourcing assists the manufacturing companies in reducing costs and competing in the global competitive environment. The outsourcing makes firms focusing on core activities because the core functions give them a clear leadership position and deliver greater value to customers at lower costs. Dabhilkar et al. argue that outsourcing high volume of materials to suppliers assist firms to lower the fixed costs because the higher capacity utilization of the machinery and plant space will be reduced. (146). Moreover, the outsourcing decision assists the manufacturing companies to lower the variable costs when entrusting higher volume of materials to a third party. When firms design the same type of materials for different customers, it leads to cheaper costs of sourcing materials. For example, "engineering/design capability for outsourced parts can lead to lower variable costs." (Dabhilkar et al. 146). When a firm outsources a design of large volume of the materials to a third party company, they will be able to reduce the variable costs by enjoying the economies of scale from outsourcing. For example, a company that outsources its operations to low-wage countries will enjoy a reduction in the variable costs.

The outsourcing can also assist firms to gain power over suppliers. Porter argues that pressures from suppliers can make firms increase product prices and lower the quality of the final products. (1). When there are few suppliers in the industry, their bargaining of power will be high compared to the availability of a large number of suppliers forcing the power of suppliers to be relative low. However, when firms have established good relationships with the third party materials providers and have developed expertise in negotiating with suppliers, they will develop capabilities to exert power over suppliers. As being pointed out by Dabhilkar et al., the "purchasing capability for outsourced parts can lead to lower variable costs by using buying power to get pre-specified components for several customers at lower cost." (146).

Additionally, manufacturing companies will be able to improve the supplier's relationships because firms-supplier interaction will improve the likelihood of leveraging operating capabilities. For example, firms and suppliers will be able to share the production systems, and plan, and develop a common framework for cost reduction. The strategy will assist in improving delivery performances and product pricing. Outsourcing also assists firms to be more focus on product differentiation to assist in producing superior products. A long time strategic collaboration with the third party company helps firms "to create distinct competence in the market." ( Dabhilkar et al. 147).

Despite the benefits that firms can derive from outsourcing, the decision to outsource can be risky. Rob uses the theory of transaction economics to explain the shortcomings of firms' decision to outsource. According to the transaction costs economics, a firm and third party provider are required to draw a contract agreement to finalize the outsourcing business. During the course of negotiation, one party may possess more information about the contract than other party leading to information asymmetry. The concept of information asymmetry in economics refers a situation where one party in the contract negotiation has more information than the other party. If the third party provider has more information than the firms, the issues lead to uncertainty in demand, moral hazard, asset specificity, and opportunist behaviors. For example, when a vendor possesses more information that the buyer, they will mandate the buyer to entrust specific assets or high-value assets at their disposal. When a firm transfers a high valued asset to the vendor when signing the outsourcing contract, the whole issue becomes risky, which always happens in the outsourcing that involves technical skills.

In the contemporary manufacturing environment, increasing number of manufacturing companies are outsourcing the IT functions to the third party providers. The goal of the IT outsourcing is to use the best competent IT professionals to develop best products. However, the issue of asset specificity can occur during the outsourcing contract where the vendors instruct the firms to transfer their IT assets at their disposal in order to perform their functions effectively. In this circumstances, the contract deal can become risky, instead of firms deriving benefits from outsourcing, they may incur a loss in the end. An outsourcing contract that involves transferring the IT assets to the vendor can lead to the security vulnerabilities. Moreover, poor outsourcing contract agreement can lead to an operational problem, and threats to information confidentiality. It is critical to realize that absence of data integrity can jeopardize organizational efficiency, and inability to make sound and effective business decisions. A loss of competency is another shortcoming of outsourcing. When firms entrust part of their business activities to service providers, they lose competency in that line of business because they rely entirely on the vendors to deliver the services. Sometimes, some vendors may be unreliable making firms lose their business reputation, and incur financial loss.

While the outsourcing contract agreements may have some loopholes, business organizations are still using the outsourcing business strategy to lower the costs and gain competitive market advantages. The decision to focus on the core competencies are the major factor that makes firms sticking to outsourcing business. Nicholas and Gerhard point out that the benefits of outsourcing outweigh the shortcomings. For example, many SMEs (small and medium enterprises) are facing challenges to control costs, thus, they need to adopt the current business model to remain in business. Moreover, SMEs lack the capacity to address the market demand such as developing a new innovative product. The only option available for them is to seek for the external assistance.

The major factor that makes firms considering outsourcing is to develop the RBV (resource-based view). Typically, many SMEs do not have facilities to carry out an R&D (research and development) to develop an innovative product. Thus, they need to outsource the R&D division to develop innovative products that will assist them achieving competitive market advantages. Outsourcing R&D division can be beneficial for SMEs since they do not possess the competencies and other resources to carry out the R&D functions. A major benefit from outsourcing the R&D is that firms will be able to develop innovative new products that command market acceptability. Typically, the R&D is an integral part of manufacturing business. The R&D consists of a range of activities that helps in generating knowledge and new technologies. The R&D not only assists in improving the existing products and technologies, the R&D helps firms achieve competencies in the production of goods. Since R& D. is expensive to design, outsourcing the R&D can assist firms to overcome a large investment of the R&D. Apart from helping firms to increase profitability, outsourcing R&D will help firms to achieve a distinct differentiation through innovation. The concept of innovation is a process where firms develop distinct products that have not being developed or introduced in the market. Companies such as Boeing, General Electric, IBM, Phillips, Proctor & Gamble, and Microsoft are moving their R&D from in-house and entrust it to third party providers. For example, Boeing has outsourced 90% of their R&D to the external service provider and retain only 10%. A change in the business philosophy has to yield positive benefits for firms. Dyer and Hatch claim that Toyota has been able to record 14% output and more than 50% few defects by outsourcing part of their business activities.

"Toyota is not alone. More and more, companies are recognizing the competitive advantage that springs from the manner in which they work with their partners. Even powerful Microsoft Corp. has to rely on companies around the world to localize and translate its products in markets as diverse as those of China, Chile and the Czech Republic".( Dyer, Hatch, 57).

Discussion and Conclusion

The outcome of the essay reveals that firms' decision to outsource part of their business process cannot be reversed because the financial benefits companies derive from outsourcing are more than its shortcoming. Many firms are outsourcing their manufacturing process to low-wage countries such as China and Mexico Apart from tapping cheap labor costs from China, firms are also able to have access to cheap materials. Let us be realistic, a complete manufacturing of the product in the United States is very expensive, and if all firms decide to remain in the United States, they may face challenges in securing markets for their products globally amidst of stiff competitions from Chinese products. It is essential to realize that the U.S. markets are not the only market that manufacturing companies sell their products, they also sell outside the United States. Thus, if the U.S. firms decide not to outsource part of their business processes to cut costs, they will face challenges in selling their products outside the United States. This essay argues that outsourcing is more beneficial than its shortcoming. Apart from assisting firms to increase profitability, outsourcing increase standard of living of the global population.

The essay provides the following recommendations to assist manufacturing companies in deriving more benefits from outsourcing contracts. First, a firm intending to enter into the outsourcing agreement should seek the services of a professional consultant who will advise them on the outsourcing strategy before signing the final contract. Moreover, firms should seek for the services of professional contract negotiators to derive major benefits from the contract agreements.

Works Cited

Dyer, Jeffrey H; Hatch, Nile W. Using supplier networks to learn faster. MIT Sloan Management Review, vol 45, issue 3, pp 57 -- 63

Nicholas O'Regan, and Gerhard Kling, Technology outsourcing in manufacturing small- and medium-sized firms: another competitive resource? R&D Management, vol 41, Iss; 1, 2011 pp. 92-105.

Porter, E. Michael, "The Five Competitive Forces that Shape Strategy," Harvard Business Review, 2008, p.86-104.

Rob Dekkers, "Impact of strategic decision-making for outsourcing on managing to manufacture," International Journal of Operations & Production Management, Vol. 31 Iss: 9, 2001 pp.935-965

Dabhilkar, Mandar, Lars Bengtsson, Robin v. Haartman, and Par Ahlstrom. " Collaboration or Supplier selection? Determining factors of the performance improvement when outsourcing manufacturing." Journal of Purchasing & Supply Management, vol. 15, 2009, pp. 143-53.