A Study of Outsourcing in the Manufacturing Sector

For many companies that are interested in reducing costs on labor and overall production, outsourcing has been the main option that has proved significant. In the manufacturing industry, outsourcing is normally carried out for part or an entire product. Basically, people seek third-party producers because of cheap labor and overall low production costs. In this proposal, outsourcing in the manufacturing sector together with the resultant benefits have been covered. At the same time, the research is aimed at understanding the risks and challenges associated with local, national, and international outsourcing with an objective of determining the possible solutions. The research is also keen to analyze how differentiation of products can be achieved through outsourcing. The topic of outsourcing is covered under theoretical background, make or buy decision, and supplier selection factor.

Keywords: outsourcing, manufacturing, contract manufacturer, risks

Introduction

Generally, outsourcing entails the moving of production process from within the company to an outside manufacturer. Normally, the outsourced company deals with production of either parts or an entire products (McCarthy & Anagnostou, 2004). In the manufacturing sector, outsourcing has proved very essential delivery of component parts necessary for assembling finished goods such as electronics, motor vehicles, and other machinery (Minondo & Rubert, 2006). Basically, outsourcing is beneficial to companies in that it reduces operational costs, and enhances flexibility and focus in manufacturing (Heshmati, 2003). Additionally, engaging contract manufacturers helps in fueling innovation, supporting increased demand, and contributes to overall production efficiency. Since production of different parts can be done simultaneously using outsourcing, the time spent to complete a given item is shortened leading to timely delivery. An example of outsourcing is where Apple Company has engaged oversea companies especially in China such as Foxconn for the production of the iPhones, iPads and other related products (Stewart, 2014).

Despite the benefits associated with outsourcing, there are various risks involved in the entire process. This is because the contract manufacturers are usually stationed far away from the manufacturing company thereby making coordination difficult (Minondo & Rubert, 2006). Moreover, there are problems to do with the management which may pose a challenge to the success of the whole process. Therefore, this project intends to explore the process of outsourcing in manufacturing to identify the risks and challenges involved along with the possible solutions (Ten Raa & Wolff, 2001). Literally, the project outcome and recommendations will be significant for the manufacturing companies in realizing the hidden problems in outsourcing and hands will allow the management to plan appropriately so as to increase benefits and reduce unseen losses.

In the implementation of outsourcing in manufacturing sector, a total of six risks can be cited out which the company should look out for. Firstly, the original manufacturing company will lose control of part of the process Regardless of the established governance model (Merino & Rodríguez, 2007). Normally, their contracted manufacturer will seek to dictate part of the production independent from the instructions of the main manufacturing. This happens in order to achieve certain cost benefits during the production process. Secondly, the manufacturer will rely on the contracted manufacturer to produce the desired quality as per the design (Bardhan et al, 2006). As such, there is risk on the part of quality of the components produced because of separate producers. Normally, the problem with quality May surface sometime in the future leading to inconveniences on the part of consumers. Third, there is a challenge in terms of flexibility whereby the contract manufacturer may not be able to adjust its facilities to suit certain specifications of particular customers (Harland et al, 2005). Fourth, there are foreign constraints in outsourcing such as cultural differences, currency valuation, and contract enforceability (Merino & Rodríguez, 2007). Fifth, the company risks the component of knowledge for the production of the outsourced parts and may land into future problems if it desires to bring back the services into the company. Lastly, there may be additional costs when the manufacturer desires to outsource a new service or to perform modification for existing services through contracted manufacturer (Ten Raa & Wolff, 2001).

To mitigate these risks the original manufacturing company should conduct a proper analysis of the entire production process and implement protective measures against losses (Aron et al, 2005). Firstly, the management should identify hidden costs and plan on how they are to be covered to avoid overall project failure (Harland et al, 2005). Examples of hidden costs include data gathering, preparation and issuance of request for information, requesting quotations, evaluating proposals, and professional fees. Secondly, the manufacturer should perform a review to identify which components are suitable for outsourcing in order to meet the organization’s objectives (Dhar & Balakrishnan, 2006). Thisis to be performed so as to maintain control of sensitive parts in the production process. Additionally it is important to consider evaluating different service providers so as to select the best, faster, cheaper, and more competent manufacturer (Logan, 2000). Moreover, there should be constant communication among the employees as well as within the management of the different companies to ensure that the process continues as designed and that the goals are effectively realized (Dhar & Balakrishnan, 2006). Most importantly, the original manufacturing company should establish a strong governance model which regulates on quality and time.

Research Questions

Generally, outsourcing adds value in the supply chain of manufacturing companies because it leads to speedy and cheaper means of production. In effect, the finished goods can be availed to final consumers at affordable prices. Moreover, outsourcing creates a section for improving innovation since the outdoor contract manufacturers come new ideas for the purposes of better service delivery. Therefore, the quality of outsourced products is likely to increase over time as the original producers continue to engage third party suppliers. However, most literature on outsourcing, either local or international have not fully exhausted the negative impacts of outsourcing on the mother company and on the consumers. Consequently, this research is focused on the research question: what are some of the risks faced during outsourcing? Secondly, what are the possible solutions to the identified problems and risks?

Aims and objectives

The aim of the current project is to analyze the concept of outsourcing in manufacturing environment. The objectives include determining the advantages and disadvantages involved in the processes of outsourcing, the risks involved, and how vulnerable the arrangement can become. Additionally, at the end of the research, recommendations shall be generated regarding the best methods of risk management in local, national and international outsourcing.

Methodology

The research will utilize qualitative approach to address the aims and objectives. A qualitative research is a scientific study model which seeks to answer questions by obtaining the perspectives of the selected sample populations (Amaratunga et al, 2002). It is a type of research which is effective in receiving specific information on behavior, opinions and cultural contents from an individual’s view (Merriam, 2015), (Lewis, 2015). In other words, qualitative research can be defined as a market research method which is aimed on getting data using opened-ended communication. Basically, qualitative research is about what people think and why they think so (Schram & Thomas, 2006). Therefore, the method allows for in-depth probing of respondents by the interviewer in an attempt to understand the respective motivations and feelings (Bryman & Burgess, 2002). Usually, the design of qualitative research methods in such that they help in revealing the perception and behavior of the target audience with reference to the specific topic of study (Hsieh & Shannon, 2005). The types of qualitative research methods include; in-depth interview, focus groups, ethnographic research, and content analysis.

Qualitative research methods will be utilized in this study principally because the outcome is usually descriptive and the data obtained can be used to draw inferences easily (Maxwell, 2012). Additionally, the method is appropriate in this study because it allows openness which encourages people to expand the responses thus providing a wider view than the initial intention (Tetnowski & Damico, 2001). Moreover, qualitative research method eliminates pre-judgments in data collection since there is an explanation for every response made (Savin-Baden & Major, 2013). The current study will utilize qualitative research model to get the details about outsourcing in manufacturing industry. The research design will seek draw informed decisions from respective respondents regarding the use of outsourcing and the various risks involved as well as the solutions that are in place for the purpose of mitigation.

Literature Review

The section is to contain a discussion of past research works on outsourcing in manufacturing companies and the encountered challenges. In particular, the theoretical foundation of outsourcing will be considered and the various aspects of outsourcing decisions will be critically discussed.

Theoretical Background

The three main theories behind outsourcing include resource-based view, transaction cost economic, and agency (Barney, 1991). In particular, resource based view theory argues that an organization is regarded to be a collection of productive inputs. Basically, the view assumes that businesses gain the desired competitive advantage through internal resources (Das & Teng, 2000). The theory provides answer on the performance of firms in a given industry vary over time. Since resources are immobile and farms have competitive advantage locally, it is prudent to go for outsourcing in case the company wants to exploit the outside market (Acedo et al, 2006). On the other hand, transaction cost economic theory answers the questions: why do firms exist? What firms should make? What effective strategy for profit maximization? (David, & Han, 2004). The main argument of the theory is that farmers should consider both transaction and production costs in outsourcing process (Williamson, 1979). The transaction costs include research, negotiation, monitoring, and service enforcement between suppliers and buyers (Williamson, 1981). Meanwhile, agency theory regards organizations as networks of contracts between stakeholders and agents (Ross, 1973). One of the problems in agency relationship is when the desired goals cannot be effectively supervised by their stakeholder. The second problem arises due to fear of risk sharing where different opinions and attitudes exist between the agent and stakeholder (Zsidisin & Ellram, 2003). The existence of the agency problems lead to additional costs known as agency costs which are projected to reduce over time as the two parties get along (Eisenhardt, 1989).

Make or Buy Decision

Generally, outsourcing involves making decision on whether to buy the service or to perform the task within the company. It is the responsibility of the management to determine whether the factors of production are favorable for outsourcing or in house building in order to maximize profits (Fill & Visser, 2000). Make or buy decisions are anchored upon three major pillars namely, business strategy, risks and economic factors. These factors should be put into consideration in weighing the significance of involving a contract manufacturer or sticking to the internal available resources to produce the desired item (McIvor & Humphreys, 2000). According to Fine & Whitney (2002), business strategy should be considered in regard to the competitive environment touching on required skills, technologies and the process of making the service or product delivery. Most importantly, it is proper to take into account the possible changes in the environment in relation to the selected business strategy (Tayles & Drury, 2001). When a service is sensitive and forms a core operation of a given company then it is desirable to choose in-house production as opposed to outsourcing. On the other hand, outsourcing is a good choice when an organization is seeking to reduce costs, supervise fewer workers, eliminate capital burden comma leverage external expertise, gain access to new technological networks, and phase out unnecessary management paperwork (O’Brien, 2014).

 At the same time, Van de Water & Van Peet (2006) asserts that make or buy decision depends on the intensity of risks involved in the outsourcing program. Such risks may include holdup risks, supply market risks, transport risks and intellectual property protection. Outsourcing it’ll be the best decision if hold up risks aloha or if there is sufficient management via broader business relationship contract (McIvor & Humphreys, 2000). If services are foreign-sourced, the risks involved are political stability as well as exchange rate volatility which are linked to supply market risks (Ruffo et al, 2007). In this case, outsourcing decision should be made if there are low switching costs or the existence of alternative supply markets easy accessibility. Meanwhile, the associated transport risks are to do with lead times and supply disruptions (O’Brien, 2014). Therefore, making by decision should only be when the disruption of the supply chain has negligible impact on the consumers. Finally, outsourcing should be done where there are no involvement of intellectual property so as not to breach the terms and conditions of innovations which are provided in trademarks, patents and copyrights (Leiblein et al, 2002). As such, there should be a close examination and evolution of all the risks that are involved for these will determine the future success of the outsourcing process in the manufacturing industries. In case the risks are too high the company may decide to provide the services personally so as not to lose market trust and the expected revenue.

Apart from business strategies and risks involved, the decision on whether to make or buy depends on the existing economic factors. These factors include operating performance such as skill, utilization, reliability, quality, efficiency, cost factors, and level of skills and expertise (Ehie, 2001). Additionally, companies should consider the capital requirements as well as financial returns when services and goods are outsourced or built in-house (Ellram & Billington, 2001), (Ellram et al, 2008). Therefore, outsourcing is better if suppliers operates at lower costs than the company and provides better quality goods and services. At the same time, a manufacturer may opt for outsourcing if there are major new investments which are to be made regarding the products offered. Moreover, buy decision can be appropriate where suppliers have lower Return on investment (ROI) targets compared to the original manufacturer (Ehie, 2001). Furthermore, the manufacturer should settle on sourcing if in-house production is characterized by insufficient skills or expensive expertise. For instance, Apple Company considered the Chinese firms for most of its production since the desired skills was not readily available in the U.S. In the United States, it could take up to nine months to find experienced employees while it took only fifteen days in China (Stewart, 2014). Overall, a proper consideration of the pillars of make or buy decisions will help manufactures in making informed decisions which leads to higher returns on production.

Supplier Selection Factor

Generally, supplier selection is crucial if an outsourcing program is to fail or succeed since they are entrusted with the production of an entire parts or parts of a given item or service which adds up to the overall image of the original manufacturing company (Wadhwa & Ravindran, 2007). Therefore, suppliers should be properly selected in order to avoid uncertainties of failure, delay or substandard outcomes. The selection factors can be broadly categorized into operating capability and relationship strategy (Ho et al, 2010). According to Stevenson & Hojati, (2007), operating capabilities include volume, purchasing skill, manufacturing design, and wage structure. Normally a supplier dealing with high volumes of outsourced parts operates at lower fixed costs compared to a low-volume supplier. As such, manufacturers should consider contract suppliers who have experience in dealing with large volumes of production from different customers (Aissaoui et al, 2007). Additionally, suppliers should be at a position to adopt effectively with changes in volume from different clients. Also, high volumes leads to lower variable costs for the supplier resulting into overall lower costs judge on the jobs received. Consequently, a high-volume supplier will be operating at lower costs while providing high-quality products and services within shorter lead time (Wadhwa & Ravindran, 2007). Such a supplier is a preferable choice for an outsourcing manufacturer who is seeking to reduce production time, improve quality and enhance innovation. Meanwhile, the supplier should be one who is capable of designing the outsourced parts so as to reduce variable costs. By designing the parts repeatedly over time, contract manufacturers may discover a much cheaper and better design for the component to the benefit of the customers. Most importantly, designs helps in standardizing the entire manufacturing process while providing possibilities of continuous improvement (Yang & Chen, 2006). For instance, Nissan Techno Vietnam is a third party part manufacturer contracted by Japanese companies to build automobile-related parts because it has CAD design software for automobile data such as design and layout (Jin, 2007). Furthermore, when selecting a third-party supplier, the focal manufacturer should consider the purchasing capability for the parts outsourced because this leads to lower variable costs (Bhutta & Huq, 2002). As a result, the supplier will be at a position of acquiring the specified part components and delivering to the clients at relatively reduced prices. In effect, original manufacturing companies will operate at much lower production costs compared to if they could have made the components within their own factories. Similarly, it is crucial to consider picking supplier from low-wage countries because this leads to much lower variable costs compared to low-wage nations (Bhutta & Huq, 2002).

The second factor of supplier relationship strategy entails the collaboration method utilized by the supplier for the customers. Basically, there should be effective supplier-buyer interaction necessary in leveraging supplier operating capabilities (Dabhilkar et al, 2009). There are 4 collaboration strategies between the supplier and outsourcing company. Firstly, there is sharing of production systems and plans strategy which is described as operational collaboration. The strategy enables the outsourcing company to receive benefits such as improved delivery performance and pricing since it reduces asset-specific type of investment (Kannan & Tan, 2002). The other three relationship strategies include cost reduction through common work, production process adaptation, and early new product development involvement by supplier (Oly Ndubisi et al, 2005). These last three strategies are concerned with the obtaining of differentiation in production so that the final outcome becomes more superior in functionality compared to original products. Overall, the collaboration strategies which link the supplier and the manufacturing company helps in developing a competitive advantage by creating a unique market competence (Oly Ndubisi et al, 2005). Therefore, the outsourcing company must consider the appropriate supplier relationship strategy which is in line with the company’s own market strategy. Other than relationship strategy, the manufacturing firm should consider the characteristics of the parts to be outsourced (Aksoy & Öztürk, 2011). Some parts are complicated and require high technological expertise to finish while others require the general knowledge to complete. Additionally, some parts have great influence on customers’ perspectives regarding the image of the manufacturing company. Consequently, the management should select the most reputable company for buying decision so as to maintain production standards and satisfy the customers (Ting & Cho, 2008). Due to the desire to get the best out of outsourcing, the original manufacturing company will be tasked with choosing the right contract supplier whether local, national or international provided that the required features are met (Dabhilkar et al, 2009).

Scope of Study

The study will focus mainly on outsourcing activities in organizations. Although the concept of outsourcing can be adopted at any stage of production, this paper will narrow down to the buy decision at the manufacturing level. As such, there will be a comprehensive description of outsourcing for part construction industries for marine, mining, and refineries. The participants in the survey will be derived from the manufacturing sector mainly in the managerial level. This is because they have prior experience with outsourcing and will be instrumental in understanding the dynamics of the concept. Regarding time factor, there are 25 days set aside for proposal and 3 months for the completion of the entire dissertation. Consequently, there is time constraint for the entire research work. As a result, the study will utilize descriptive and critical analysis approaches instead of experimental work to derive meaningful information from data collected.

Although outsourcing activities of a number of companies have been considered by other researchers in their literature, none has been fully open as to the inner management operations. Therefore, this study will go a step further in covering the confidential parts involved in outsourcing such as the effect on the balance sheet. The data collection procedure will concentrate in seeking to understand the risks involved in local, national, and international outsourcing in manufacturing industry. Both the outsourcing companies and the contract manufactures will be involved in the research so as to have a broad view of the third party constructor.

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