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  1. 1. OUTSOURCINGUsing FMEATo AssessOutsourcing Riskby Cliff Welborn normal and healthy part of the evolution in theO utsourcing has become a growing trend among many U.S. companies.1 Two com- U.S. workforce.2 Lower costs are often the dri- mon examples of the practice are out- ving factor, and there have been many successsourcing IT jobs to India and outsourcing product stories of companies that enter this global supplymanufacturing to China. Some say the practice is a chain and realize significant cost savings.3, 4 However, outsourcing does not guarantee business success. There is risk involved and notIn 50 Words all sides benefit from such arrangements.5 Or Less The advantages of outsourcing should be care- fully weighed against risk and must go beyond• Outsourcing has become common for many U.S. evaluating just price. So much more goes into judging the business impact of an outsourcing businesses, but assessing the risk involved in decision. Without a systematic analysis technique such arrangements hasn’t. to assess risk, much can go wrong: unexpected cost, extended lead times, poor quality or other• A modified version of failure mode effects negative performance variables. analysis (FMEA) is one way businesses can Risk Assessment Basics evaluate the risk of outsourcing options. Indeed, risk associated with outsourcing can offset the often more publicized benefits.6• Risk priority numbers can be calculated to rate Sometimes the risk doesn’t pay off. Some U.S. companies have joined the outsourcing trend any potential failures. only to be disappointed in the overall net effect QUALITY PROGRESS I AUGUST 2007 I 17
  2. 2. OUTSOURCING on business operations and eventually returned FIGURE 1 FMEA Process Steps jobs back to the United States.7, 8 Analyzing the risk associated with a supply chain Identify risk categories. and outsourcing is a relatively new subject, and little research has been done.9 But one thing is certain: Identify potential risks. Documenting and analyzing risk is an essential ele- Rate the opportunity, probability, ment to continued learning and process improve- and severity for each risk. ment.10 It is critical to have an easily understood method to identify and manage risk.11 Calculate the risk priority Failure mode effects analysis (FMEA) is tool number (RPN) for each risk. used to collect information related to risk manage- ment decisions.12 There are documented procedures Analyze risks by RPN to complete an FMEA and examples of its applica- using a Pareto distribution. tion in various industries.13 A modified version of the tool can be used to help evaluate the risk of Develop actions to mitigate outsourcing options. risks with high RPN. FMEA is a well documented, proven technique Reassess risks with commonly used to evaluate the risk for failures in another cycle of failure mode product and process designs.14 Every potential fail- effect analysis (FMEA). ure studied is evaluated in terms of likelihood and severity. A higher FMEA score indicates greater risk. Common variables used to quantify risk are fre- quantity of parts associated with the defect, ability quency of an activity associated with the defect, to detect the defect, probability of defect and sever- ity of defect. Other industry specific FMEAs use other variables to quantify risk. Rating scales of 1-5 and TABLE 1 Outsourcing Risk Assessment 1-10 are often used to quantify each variable. The 1-10 scale Risk priority allows more precision in esti-Risk Opportunity Probability Severity number mates and typically createsCost more separation in scoresUnforeseen vendor selection cost 2 4 2 16 between risks. However, the 1-5Unforeseen transition cost 2 4 2 16 scale makes it easier for a teamUnforeseen management cost 4 4 3 48 to agree on rating values.Lead Time A risk priority number (RPN)Delay in production start-up 2 4 4 32 is calculated for each potential failure. A common RPN is theDelay in manufacturing process 5 3 2 30 product of:Delay in transportation of goods 4 2 2 16Quality Probability of failure XMinor cosmetic/finishing defect 5 4 1 20 detectability of failure X severityMajor cosmetic/finishing defect 5 2 2 20 of failure.Component will not fit with mating The steps to complete a 5 2 4 40parts—requiring rework FMEA process are illustrated inStructural defect—function failure 5 1 5 25 Figure 1.18 I AUGUST 2007 I www.asq.org
  3. 3. Outsourcing options can be FIGURE 2 Example of Pareto Distribution of Risks in Outsourcingevaluated in much the samemanner as product and pro- 50cess defects. Risks are evaluat-ed in terms of opportunity, 40probability and severity, andcan be grouped into intuitive Risk priority number 30categories. The opportunity score for arisk is the frequency at which 20that activity happens. Usingthe 1-5 scale, an activity that is 10a one-time event or seldomtakes place has an opportunity 0score of 1. If the activity is a ts rts p s ct ct ct s st st es od tu os co co fe fe fecommon occurrence, the op- pa oc go ar de de de tc n n g st pr io o en of in al ic ic itiportunity score is 5. The prob- ct n g at ur et et em n ns tio rin le tio m sm sm ct tra se uc ag tuability score is the expected ru rta fit co co od ac or an St en t po no or or nd pr uf m selikelihood that the risk will ns aj in an ve ill en n re M M tra yi w m fo se enactually happen. la nt n Un n re se De yi yi ne fo re la la The severity score indicates po Un De fo De m Un Cothe level of impact if the riskmaterializes. A risk with a low Riskseverity score causes a mini-mal impact on operationswhen it happens, while a riskwith a high severity score creates a significant instance, when RadioShack builds a new store orimpact to operations. The impact might be in terms remodels an existing one, RSSF consolidates theof cost, lead time, loss of intellectual property, required construction materials from various ven-quality to the customer or other relevant cate- dors into one shipment. This procurement configu-gories. ration reduces complexity and shipping costs for The RPN for a risk is calculated as the product of: RadioShack. The supply of major store display fixtures is typ- Opportunity score X probability score ically awarded on a yearly contract basis. Through X severity score. a request for proposal (RFP) process, vendors sub- mit bids to supply a fixture for a calendar year. Once the RPN is calculated for each risk, the Historically, RSSF used domestic manufacturers torisks are analyzed using a Pareto distribution. supply all major furniture and fixtures, includingActions are then taken to mitigate risks, and the items such as wall systems, gondolas and shelvesprocess can be performed again to evaluate resid- to display products.ual risk. Recently, RadioShack changed its fixture design direction from primarily wood based products toRadioShack Example metal based fixtures. When this design change was RadioShack Store Fixtures (RSSF), a division of implemented, potential vendors in Asia were con-RadioShack Corp., procures and distributes furni- sidered in the RFP process. Initial estimates indi-ture and fixtures to RadioShack retail store loca- cated that Asian vendors offered a significant costtions. RSSF serves as a consolidation warehouse for savings compared with domestic vendors, espe-items purchased from many different vendors. For cially those vendors that provided metal fixtures. QUALITY PROGRESS I AUGUST 2007 I 19
  4. 4. OUTSOURCING RadioShack decided to award the business to an Ratings and Scores Asian manufacturer. In the third step, the team evaluated each risk Although the quoted purchase price from the using the 1-5 rating system and the variables of selected vendor was significantly lower than other opportunity, probability and severity. The 1-5 rat- domestic or offshore vendors, there was a concern ing was determined by consensus following group about the risk of entering into a long-term relation- discussion. Although this rating technique might not represent the utmost in analytical accuracy, it is a quick, easy and commonly used technique that provides a quantitative measurement to a qualita- tive concept. Outsourcing options can be For example, the risk of a delay in the manufac- turing process was given an opportunity score of evaluated in much the same 5. Since manufacturing is a recurring activity, the chance of a delay at this stage is recurring. The manner as product and opportunity score of 5 indicates that there were many instances when this risk could materialize. process defects. Risks are The probability score for a delay in manufactur- ing process risk is 3. This is the team’s evaluation evaluated in terms of of the chance that there would actually be a delay in manufacturing. This evaluation was also based opportunity, probability on the team’s understanding of the vendor’s man- ufacturing capabilities and performance history. and severity, and can be The final variable scored was severity. A delay in manufacturing was evaluated to have a severity grouped into intuitive score of 2. The score indicates the overall impact to RadioShack if the delay materializes. The score also categories. suggests that the impact would not be greatly sig- nificant to the overall performance of the company. As described in Figure 1, the fourth step in the FMEA development was to calculate the RPN value ship with a relatively unknown vendor not based in for each risk. This was a simple multiplication of: the United States. The outsourcing risk assessment procedure illustrated in Table 1 was used to evalu- Opportunity score X probability score ate the risks of this relationship. A cross functional X severity score. team consisting of representatives from design, global sourcing, operations and quality assurance In the fifth step of the FMEA development, the was established to perform the FMEA. The out- risks were sorted in descending order based on their sourcing risk assessment chart in Table 1 was used RPN score and graphed as a Pareto distribution, as to collect the relevant FMEA data. shown in Figure 2 (p. 19). This representation of the The first step of the FMEA development process risks was used to prioritize risk mitigation efforts. was to identify risk categories. Through group dis- In this example, the risk with the highest RPN cussion, the general categories were established as score was “unforeseen management costs.” It had a cost, lead time and quality. RPN of 48. “Unforeseen management costs” repre- In the second step of the FMEA development, sented the risk associated with incurring additional the team brainstormed and generated a detailed cost to conduct business with a vendor from anoth- list of potential risks. The detailed risks were er country. The management team was concerned grouped under the risk categories established in about the communication barrier and its ability to step one. efficiently convey business transactions.20 I AUGUST 2007 I www.asq.org
  5. 5. The risk with the next highest RPN was “com- REFERENCESponent will not fit with mating parts—requiring 1. J.K. Liker and T.Y. Choi, “Building Deep Supplierrework.” Its RPN was 40. The new vendor would Relationships,” Harvard Business Review, Vol. 82, No. 12,be producing many different fixture components pp. 104-113.that would have to connect to components made 2. T.J. Rodgers, “The Truth About Outsourcing,” IEEEby other vendors. There was a concern that com- Design and Test of Computers, Vol. 22, No. 1, pp. 12-13.ponents from two different vendors would have 3. H.L. Lee, “The Triple A Supply Chain,” Harvard Bus-dimensional discrepancies resulting in a poor fit. iness Review, Vol. 82, No. 10, pp. 102-112. 4. R.E. Slone, “Leading a Supply Chain Turnaround,” Har- With this quantified risk assessment, RSSF’s vard Business Review, Vol. 82, No. 10, pp. 114-121.management team implemented mitigation 5. P.J. Singh, A. Smith and A.S. Sohal, “Strategic Supplyefforts. A small product/process development Chain Management Issues in the Automotive Industry: Anteam was established to ensure smooth opera- Australian Perspective,” International Journal of Productiontions with the new vendor. This three-person Research, Vol. 43, No. 16, pp. 3,375-3,399.team made several trips to the vendor’s location 6. Mohammed H.A. Tafti, “Risk Factors Associated within Asia. Focus was on the development of a sys- Offshore IT Outsourcing,” Industrial Management & Datatem to manage business transactions, such as Systems, Vol. 105, No. 5, 2005, pp. 549-560.communication of orders, schedules, payments, 7. Lee, “The Triple A Supply Chain,” Harvard Businessreturns and repairs. Review, see reference 3. Additionally, the representatives from RSSF 8. Brad Stone, “Should I Stay or Should I Go?” Newsweek,and the new vendor met to establish clear product April 19, 2004, pp. 52-53.specifications. Samples from RadioShack’s exist- 9. Roshan R. Pai, Venkata R. Kallepalli, Reggie J. Caudill and MengChu Zhou, “Methods Toward Supply Chain Risking product stock were sent to the new vendor to Analysis,” Proceedings of the IEEE International Conference onverify fit conformity. In some cases, the mating Systems, Man and Cybernetics, Vol. 5, 2003, pp. 4,560-4,565.parts that were not to be produced by the vendor 10. John A. Walewski, Edward G. Gibson and Vines F.were sent to ensure proper fit. Prototypes were Ellworth, “Improving International Capital Project Riskproduced and sent to RSSF’s warehouse for thor- Analysis and Management,” Proceedings of Project Manage-ough evaluation before the vendor was allowed to ment Institute Research Conference, July 2002.begin production. 11. Thomas A. Carbone and Donald D. Tippett, “Project These proactive risk mitigation efforts resulted Risk Management Using the Project Risk FMEA,” Engineer-in a smooth supply chain relationship. Without ing Management Journal, Vol. 16, No. 4, pp. 28-35.the FMEA based outsourcing risk assessment 12. Anand Pillay and Jin Wang, “Modified Failure Modetool, unforeseen problems might have impacted and Effects Analysis Using Approximate Reasoning,” Reli-the overall success of the global outsourcing ability Engineering & System Safety, Vol. 79, No. 1, pp. 69-85. 13. D.H. Stamatis, Failure Mode Effect Analysis—FMEAefforts. From Theory to Execution, ASQ Quality Press, 1995.Future of the Analysis Tool 14. G.Q. Huang, J. Shi and K.L. Mak, “Failure Mode Effect Analysis Over the WWW,” International Journal of Advanced Decision makers considering outsourcing Manufacturing Technology, Vol. 16, 2000, pp. 603-608.options should use the FMEA based outsourcingrisk assessment technique. The technique is easilyimplemented and understood. CLIFF WELBORN is an assistant Further research should be undertaken to veri- professor at Middle Tennessee Statefy the risk assessment results with actual short- University in Murfreesboro. He earnedcomings and failures of various outsourcing a doctorate in industrial engineeringoptions. This can be done through a comprehen- from the University of Texas atsive study of companies undertaking outsourcing Arlington.programs. QUALITY PROGRESS I AUGUST 2007 I 21