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1. STRATEGIC MANAGEMENT » STRATEGIC OUTSOURCING
The opposite of integration (a firm’s growth, in number of businesses) is
outsourcing value-creation activities to subcontractors. In recent years there has been
a clear move among many enterprises to outsource non-core or non-strategic
activities. Any function can be outsourced, if it is not critical to a firm’s success (is not
one of its distinctive competencies).
Outsourcing begins with a identification
of a firm’s distinctive competencies—these will continue to be performed within the
company. All other activities are then reviewed to see whether they can be performed
more effectively and efficiently by independent suppliers. If they can, these activities
are outsourced to those suppliers. The relationships between the company and those
suppliers are then often structured as long-term contractual relationships.
The term virtual corporation has been coined to describe companies that have
pursued extensive strategic outsourcing.
Advantages of Strategic Outsourcing
There are several advantages of strategic outsourcing.

2. 1. First, by outsourcing a non-core activity to a supplier who is more efficient at
performing that particular activity, the company may reduce its own cost structure,
enhancing its cost leadership strategy. Suppliers may be more efficient due to
economies of scale or learning effects and low-cost location.
2. By outsourcing a non-core value-creation activity to a supplier that has a
distinctive competency in that particular activity, the company may be able to
better differentiate its final product.
3. A third advantage of strategic outsourcing is that it allows the company to remove
distractions, focusing more resources on strengthening its distinctive
competencies.
Risks of Strategic Outsourcing
There are also some risks associated with strategic outsourcing.
1. There is a risk of holdup, or becoming too dependent on an outsourced activity.
This risk can be reduced by outsourcing from several companies at once, using a
parallel sourcing policy. Another way to manage this risk is simply to signal to the
subcontractors the company’s willingness to choose a different provider when the
contract is up for renewal.
2. A further drawback of outsourcing is the potential for loss of control of scheduling.
This problem is intensified by a long supply chain, unpredictable demand, and
outsourcing to a number of competing companies, rather than just one.
3. Another concern is the potential for a loss of important competitive information.
This risk can be managed by ensuring good communication between the
subcontractor and the company.
Case Study on Failed Strategic Outsourcing: Cisco’s $2 Billion Blunder
Cisco, the largest supplier of Internet hardware such as routers and switches,
performs R&D, marketing, and supply chain management within the organization, and
outsources all other functions, including manufacturing. Cisco claimed that the firm

3. benefited by not investing in capital-intensive manufacturing facilities and by not
maintaining any inventory. The supply chain was a four-level pyramid, with Cisco at
the peak and hundreds of suppliers of commodity inputs at the base. But when
demand started to fall in 2001, Cisco found that its system couldn’t adapt quickly
enough, and the company had to write off $2.2 billion in unusable inventory. This
occurred because customers overbooked in the high-demand periods, and then at
each level of the pyramid, buyers overbooked, magnifying the extent of the problem.
Cisco’s outsourcing system distanced the company from its suppliers, with a
disastrous loss of communication capability. Since the write down, Cisco has
implemented a web site for industry-wide supply chain management that allows firms
at all stages of the supply chain to stay in touch with the true level of demand