This is topic one of a short open course on outsourcing this first session covers the basic ground of the rationale and history of outsourcing. It is accompanied by a guide and course notes on the www.1stoutsource.com website.

1. Slide: 1
Slide 1
Defining Outsourcing Topic 2
In this Topic we will understand
 Some of the key economic issues in the make or buy decision to
outsource.
 Some of the key risk issues in managing the selection of outsource
processes.
 The process of identification of services and products that can be
sourced from the market

2. Slide: 2
Slide 2
Recap: the outsourcing decision is basically a
make or buy choice
Reasons to buy
 Cost efficiencies
 Technology uncertainty
 Non core process (or
declining)
 Access to expertise
Reasons to make
 Core competency
 Competitive edge
 Asset specificity high
 Critical process
 Dependent on core or
critical process
 Risk
 Difficult to measure

3. Slide: 3
Slide 3
Outsourcing is about setting the Boundary of the
Organisation
In House
Service
Offshore
Outsource
Internal Governance Vendor
Organisationalboundary
In source
External
Division
Back source Market
Governance

4. Slide: 4
Slide 4
The make or buy decision driven by cost of doing
something externally or internally
 Transaction cost economics
– (offers an) Explanation of the boundary choice
 Model
– Hierarchical decomposition (form of governance)
– Asset specificity
– Externality
 Behavioural assumptions
– Bounded rationality
– Opportunism
 Point of departure from classical economics
– Economic agents under classical model act to maximise profit
– Economic agents from a TC perspective act to minimise cost

5. Slide: 5
Slide 5
Boundary where the costs internally and the costs
of the market just balance
 Costs are all aspects of
the control and
monitoring of the
performance of the
activity
 Make
– Training
– Management Time
– Direct cost
– Facilities
– Payroll etc.
 Buy
– Negotiating
– Monitoring
– Writing agreements
Accounting
Distribution
Customer Service
Information Systems
Manufacturing
$
$
$
Purchasing
Quality Assurance
Research & Development
Warehouse
Sales
Board of Directors
Shipping
Organisation
Boundary

6. Slide: 6
Slide 6
These core aspects define the boundary
Hierarchical
Decom-
position
Asset
Specificity
Externality
Frequency
Uncertainty
or risk Specific
investments
Quality
compliance
IPR
Confidential
ity
Measurement
risk
Organisation
Structure
Bounded
Rationality Opportunism
Agents act
to serve own
interests
Agents a
rationale but in
a limited way
can’t do
everything!

7. Slide: 7
Slide 7
Basic principles of market sourcing
 Market is favoured if relative demand client is less that of the market
– Vendors can aggregate all the clients demands
– Offering wider scale…
… and wider scope
– Can specialise in the delivered service (competence)
 The advantage of the market dissipates if the service becomes (too)
specific to the client
– The more specific a service is the less a vendor is able to ‘pool’ demand

8. Slide: 8
Slide 8
Specialisation and learning drive specificity
 Specificity arises when specialisation of an asset means it cannot be
used outside the context of the service.
– Vendor cannot realise scale effects as will need services to be generic
and spread across several clients
– Can reduce room for cost reduction (so left with just labour cost
arbitrage)
– This process inhibits switching of the client and locks the supplier in
 The process of service delivery acts to increase specificity
– knowledge transfer and …
…Learning by doing locks out competition

9. Slide: 9
Slide 9
Summary
 Value of market sourcing reduces as human and physical assets
become more specialised
 Specialism leads to single use
– Which is less transferable to other clients
– Can drive re-integration as economies of scale cannot be realised (and
client can do just as well)

10. Slide: 10
Slide 10
Reflection
 Research has shown that clients prefer to
have service that is customised to their
needs.
 What is the consequence of this for the
outsource deal?
 How might a vendor respond to this?

11. Slide: 11
Slide 11
Evidence from the field
 Large outsource deals typically tailored (100% according to
Deloittes survey)
 Corollary
– Vendors find it difficult to standardise services
– As need to tailor a solution increases the ability to deliver savings
decreases
‘if a project needs customising, it should not be the subject to outsourcing’
(Deloittes (2005) survey quote)

12. Slide: 12
Slide 12
The High Level Make or Buy Choice
Project type services
(legal, consulting)
Specific investments
needed that makes
transfer to other
clients difficult
Joint governance or
partner models to
manage complex
services
Commodity type
Services (desktop,
payroll, transport)
Mixed ‘basket’ of
services - selective
sourcing may be
favoured
Unified
management
(highly embedded
services)
OccasionalFrequent
Generic Mixed Highly Specific
ServiceFrequency
Need to sustain relationship
Service Characteristics

13. Slide: 13
Slide 13
The High Level Make or Buy Choice
Project type services
Specific investment
transfer difficult
Joint governance
Partner models
Joint ventures
Commodity type
Services (desktop,
payroll, transport)
Selective sourcing
may be favourable
Unified
management
(highly embedded
services)
OccasionalFrequent
Generic Mixed Highly Specific
ServiceFrequency
Need to sustain relationship
Service Characteristics
Marketsourcing
NormalcontractingRules
StandardSLA
Relational contracting
continuous interaction and
evaluation of value created
Independent oversight
extends formal contracting
Demands
integrated
approach
supplier/buyer

14. Slide: 14
Slide 14
Reflection
 Suggest what circumstances might lead to
insourcing?
 Review the advantages and disadvantages of
Outsourcing

15. Slide: 15
Slide 15
Just some of the problems with outsourcing
relationships
 Breakdown of relationships
 Failure to meet service levels
 Constant contractual wrangles
 Unforeseen charges
 Poor contracting
 Losing control
 Selecting the wrong vendor
 Overlooking hidden cost
 No exit strategy
 Forgetting about personnel issues

16. Slide: 16
Slide 16
“...there's the unmeasurable aspect of what happens when a company
is no longer a culture but an amalgamation of outsourcing partners.
They may add great efficiency into the business, but they generally
add nothing to the long-term vision. As most companies that have
been around awhile are aware, great ideas don't always come from
the people at the top. Outsourcing can eliminate an entire interaction
layer that is impossible to measure with objective tools. Cultures are
inextricably linked to innovation and quality, and the less there is of
the former the more the latter two will suffer in the long term.”
What about outsourcing everything?

17. Slide: 17
Slide 17
We will review in future topics why these problems
occur and hopefully how we might tackle them!
Management Preparation
NegotiationTransition
Scoping
Relationship
Formation
Relationship
Maturity
Relationship
Engagement
The Outsource
Lifecycle
Definition
Interpretation
Renegotiation
Terminate
Selection
Reconnaissance