Outsourcing: The Merits and Limitations

The following three objectives guided the present study:

• To review the merits and limitations of outsourcing to the manufacturers
• Analyze the quality control measures employed to safeguard conformity to manufacturing standards
• Investigation of the risk management approaches in outsourcing

The present study was limited to 20 managers working at Mimas engineering – a manufacturing multinational with headquarters in Turkey. The company was selected because it had diversified its operations to the Russian Commonwealth and the MENA region. The empirical data indicated that outsourcing had both its merits and limitations. On the one hand, it facilitated cost management in line with the transactional cost economics and enabled the company to focus on essential competencies. On the other hand, it diminished the development of inimitable internal resources and competitive advantage in tandem with the resource-based view. The risk of non-conformity to the quality standards or delivery schedule can be addressed through the development of robust selection criteria. In brief, the study offered new insights and made a novel contribution to outsourcing research.

Background Information

The research purposed to review the benefits and limitations, quality control and management of risks associated with outsourcing. The empirical investigation was limited to Mimas Engineering and Construction – a company with operations in marine construction, fabrication and contracting of oil and gas companies. The firm also manufactures pipes, fuel vaults and components, scaffoldings for heavy industry enterprises such as refineries, mining enterprises and power plants (Mimas, 2018). The company was selected because it has operations in multiple localities across North Africa, Middle East and the Russian Commonwealth. The company outsources manufacturing operations to sub-contracted companies. Therefore, the outsourcing operations at Mimas are representative of the Turkish manufacturing sector.

The research was limited to the manufacturing sector because it is the leading contributor to GDP growth. In 2013, the manufacturing sector contributed about $6 trillion to the US GDP (University of Pennsylvania, 2016). Moreover, the industry employed about 14.6 million persons in 2017 (Statista, 2018b). Another study claimed that the industry directly or indirectly supported up to 21 million employees (Statista, 2018b). Similarly, the manufacturing industry in the UK was the third largest contributor to the national GDP, with a total contribution of about £140 billion. The industry also created jobs for 2.6 million British residents (Department for Business Innovation and Skills, 2010); it is anticipated that the contribution of the manufacturing sector could be higher at the moment given the values were based on a 2010 study. The manufacturing industry is one of the main pillars of the global economy. Therefore, changes in outsourcing and reshoring would have a domino effect on employment rates and the GDP.

Beyond offshoring and outsourcing, new trends had emerged in the market such as servitisation of operations (Department for Business Innovation and Skills, 2010). In addition, the growth in disposable incomes, changes in demographics, technology (biotechnology and nanotechnology), and increased ecological consciousness has influenced manufacturing trends in the past (PwC, 2009). The researcher posits that environmentally conscious manufacturers might not be motivated to outsource from China and India given the two nations were leading in environmental pollution. Besides, new industries and niche markets might emerge from global manufacturing dynamics.

Global Outsourcing

Even though manufacturing outsourcing has gained prominence from the 1800s (Gonzales et al., 2008), ancient civilisations such as the Romans had outsourced tax-collection. In the latter years, the Americans had outsourced the manufacturing of the wagon components to the United Kingdom (Scotland in specific) (Hirschheim & Dibbern, 2009). On the other hand, the manufacturers in Scotland sourced the wagon materials from India. In the 20th century, automobile manufacturers in the US preferred to outsource the manufacturing of selected components to OEMs based in the UK – a factor which contributed to the phenomenal growth of the auto-manufacturing sector (PwC, 2009). Therefore, outsourcing is not a new phenomenon – it has traditionally constituted an integral aspect of business operations (Gonzales et al., 2008).

The practice has been catalysed by inequalities in resource distribution (Giertl, Potkany, & Gejdos, 2015; Gonzales et al., 2008). For example, China has a surplus supply of human and technology resources. On the other hand, western nations have a competitive advantage in R&D and proprietary technology (Bailey & De Propris, 2014). In addition to the resource advantage, outsourcing has been augmented by cross-boundary infrastructure such as the railroads, shipping routes and telecommunications (Gonzales et al., 2008). Beyond infrastructure, global geopolitics mediated outsourcing. For example, after WWII, the US president outlined the economic blueprint of the nation and the world by extension through the “New Deal” (Palley, 2008). Moreover, the formation of the EU and the unification of Germany enhanced global collaboration.

According to Starosta (2010), globalisation and capitalist development have been the primary catalysts for outsourcing due to the integration of production processes. The motivation to review outsourcing in manufacturing is premised on global trends, competition, specialisation, economies of scale, the concentration of labour in East Asia, and the rising cost of production in the west (Giertl et al., 2015). The outsourcing and offshoring processes had facilitated the development of a global network for manufacturers (original equipment manufacturers – OEMs). The scaling up of outsourcing had also expanded the scope for companies whose area of operation was previously limited by the national borders.

The cumulative effect was the accumulation of manufacturing in nations with low labour costs such as China. However, high tech research and development and product design remained in western countries due to the concentration of capital and knowledge resources (Bailey & De Propris, 2014). The need to safeguard proprietary technologies also reinforced the latter approach. Therefore, optimisation of the operational costs was the key driver for outsourcing. For example, IT firms in the US recorded a $121 million decline in operational expenses following the implementation of outsourcing (Han & Mithas, 2014). The cost decline was partly attributed to resource reallocation and greater operational efficiency.

The sustainability of cost optimisation has been compromised following the emergence of disruptive outsourcing (Deloitte, 2018a). Besides, global outsourcing in manufacturing has its limitations especially given the size of the value chains. According to Statista, the value of outsourced commodities was 89 billion in 2017 (Statista, 2018a). The periodical growth in global outsourcing is depicted in Figure 1. According to the figure, manufacturing outsourcing grew substantially between 2000 and 2012. However, a marginal decline in revenue has been reported since 2012.

The decline has been partly occasioned by the prospects of relocating facilities to the home nations of the multinational companies – a phenomenon referred to as manufacturing reshoring (Bailey & De Propris, 2014). The demand to relocate services has recently gained prominence in Anglo-Saxon countries such as the UK and the US following the inflation of the labour expenses in China (Bailey & De Propris, 2014). The motivation to relocate services to the parent company home location has been mediated by the adverse effect on the local labour markets (Palley, 2008). On the one hand, outsourcing has resulted in widespread unemployment given that jobs have been transferred from the west to the east. Therefore, even though the process has favourably contributed to the division of labour, it has negatively impacted job security in western countries. On the other hand, the successful implementation of reshoring has been constrained by structural bottlenecks, market forces (minimum wages and exchange rates) access to finance and human resource skills. The current exchange rates are an issue of concern due to the appreciation of the GBP and higher wage costs in the UK relative to China (Bailey & De Propris, 2014). The objectives and research questions are listed below.

Figure 1 Global outsourcing revenue (2000 to 2017) (Statista, 2018a)

Objectives

1. To review the merits and limitations of outsourcing to the manufacturers

2. To analyse the quality control measures employed to safeguard conformity to manufacturing standards

3. To investigate risk management approaches in outsourcing.

Questions

1. What are the merits and limitations of outsourcing in the manufacturing sector?

2. What measures have been put in place to safeguard the quality of products manufactured overseas?

3. Which measures have been implemented to manage outsourcing risks?

Statement of the Problem

The traditional outsourcing structure has recently proven unsustainable following the emergence of disruptive outsourcing (Deloitte, 2018a). Besides, multinational manufacturers in developed economies are contemplating reshoring due to the diminished competitiveness of offshore and outsourced manufacturing. The rising cost of production in China coupled with the overconcentration of manufacturing in East Asia has necessitated companies to explore alternatives. In addition to the decline in the cost advantage, companies have to contend with quality concerns. For example, companies in North American were obliged to recall pet foods which were manufactured through product outsourcing schemes (Kong, 2012). A similar scandal was also reported in China after pet foods were found to contain melamine and lead paint (Williamson, 2008). Therefore, the enforcement of the contractual outsourcing terms remains a challenge. The quality inconsistencies increase the risk of outsourcing operations. Even though existing literature had established a robust link between outsourcing and product quality inconsistencies, recent studies had not comprehensively addressed the merits, limitations, quality and risk mitigation measures; the present study was undertaken to solve the above challenges.

Justification

The focus on outsourcing in manufacturing was validated by the present uncertainties in the global economy and outsourcing (operational risks and quality standards). On the one hand, the surge in manufacturing costs in offshore locations had necessitated companies to reconsider offshoring and outsourcing. The observations are reinforced by national industry statistics (Department for Business Innovation and Skills, 2010). UK manufacturers are uncertain about future outsourcing owing to the uncertain working environment in the emerging nations. For example, bureaucracy and corruption in Asian countries such as India and China had impacted offshore manufacturing operations (Department for Business Innovation and Skills, 2010). Besides, the implementation of contractual terms concerning intellectual property was a challenge; therefore, competitors might utilise proprietary technologies developed by western countries without compensation. On the other hand, the appreciation of the local currency, higher local waged made reshoring capital intensive. Therefore, the investigation of best practices employed by Mimas would help diminish the impact of uncertainties.

Originality and Contribution to Existing Knowledge

The present research is the first to review the merits, limitations, quality and risk measures implemented in the management of risk using Mimas Engineering and Construction Company as a case study. The observations made from the survey would help manufacturers to streamline outsourcing operations based on empirical evidence. Moreover, the elucidation of the risk management measures is critical given that leading multinationals were planning to reshore operations due to the diminished competitiveness of Chinese manufacturing. Finally, the information derived from the surveys and interviews would enable manufacturers to streamline outsourcing operations in line with empirical evidence derived from the Turkish manufacturing sector.

Definition of Terms

Outsourcing: The term is composed of two distinct terms namely “out” and “source”. The latter refers to the origins of the manufacturing supplies while the former term denotes the location or boundaries of the firm. The combination of the two terms represents changes in the sources of supply (Palley, 2008). Therefore, the parent firm cedes manufacturing monopoly to another company which can produce and deliver the commodities within the specified duration and at a lower cost compared to internal production (Giertl et al., 2015). In particular, outsourcing is guided by the Marxian law of value (Starosta, 2010). Therefore, outsourcing becomes obsolete when there is no creation of new value.

Offshore Outsourcing: The term denotes the transfer of activities which were previously undertaken in a parent company to another country (offshore) and ceding production responsibilities to another party (such as the OEMs) (Palley, 2008). The widespread prevalence of offshore outsourcing might trigger economic instability through the disruption of the labour market. For example, Palley (2008) estimated that the US economy was losing an estimated 30,000 jobs during the peak of the offshore operations and close to 900,000 jobs were lost by 2005.

Conclusion

The case for the present research and the theoretical framework were outlined in this chapter. The selection of the research theme was justified based on the global challenges in the outsourcing of manufacturing operations. Quality, cost and operational risks were the primary concerns. Additional concerns include the fragmentation of the supply chains and the loss of competitiveness (Slepniov, Brazinskas, & Wæhrens, 2013). Despite the risks, outsourcing had enhanced manufacturing efficiency by reducing the costs of production and facilitating specialisation in manufacturing. A comprehensive review of the risks, types and strategies employed in outsourcing are highlighted in the primary literature review in the next chapter.

Chapter Two: Literature Review

An appraisal of existing knowledge relevant to outsourcing was presented in the current section. The literature review was confined to the following themes, merits and limitations of outsourcing, outsourcing strategies, risk management, and the measures employed to guarantee successful outsourcing.

Outsourced Operations among Manufacturers in the EU

A survey by Ernest and Young noted that outsourcing in the EU varied depending on the nation and the industry. The data depicted in Figure 2 illustrates that Finland was leading in outsourcing at 19 per cent; it was closely followed by Spain and the United Kingdom at 17 per cent (Ernest and Young, 2013). Besides, automotive and cosmetic manufacturers had a higher probability of outsourcing operations compared to IT and clean technology enterprises (Ernest and Young, 2013). The data depicted in Figure 3 illustrates that 42 per cent of manufacturing in the automotive sector was outsourced followed by 35 and 31 per cent in the telecommunications and consumer products industry. The IT, oil and gas industries had the least levels of outsourcing (Ernest and Young, 2013).

Figure 2 Percentage of outsourced and in-house operations in selected EU states (Ernest and Young, 2013)

Figure 3 Outsourced operations per industry in Europe (Ernest and Young, 2013)

Outsourcing in Turkey

The outsourcing strategies employed in Turkey are similar to other nations in the EU. For example, Turkey’s BPO has been in existence since the early 1990s, and the sector has recorded phenomenal growth – surpassing 20 per cent in 2010. In 2014, the industry was worth about 1.2 billion Euros, and it had employed about 80,000 Turks (Oxford Business Group, 2015). The statistics indicate that Turkey has strategically positioned itself as one of the leading providers of BPO services. Beyond BPO services, the nation has invested in logistics outsourcing (Agaran, Ulengin, Onsel, & Aktas, 2011). However, a survey conducted in 2017 established that there was a lack of synergy and cooperation between third-party logistics and the parent companies. The lack of synergy has impacted the growth of the logistics sector considering that companies cannot manage in-house logistics (Agaran et al., 2011). The outcomes reported by Agaran et al. (2011) were based on a population of 17 companies operating in Turkey. Despite the limitations, outsourcing in Turkey was preferred by large companies compared to small firms due to the economies of scale and cost management.

Current literature concerning manufacturing outsourcing in Turkey does not provide company-specific information regarding the state of outsourcing in firms such as Citmas and Cebid among other competitors in the pipe and fuel vaults market. Therefore, it was not possible to determine the emerging trends in manufacturing outsourcing.

Factors Influencing Outsourcing: Types of Outsourcing

Outsourcing is grouped into the manufacturer, IT, professional, near-shoring, multisourcing, reshoring, knowledge process outsourcing, offshore outsourcing, project, business process outsourcing (BPO), process-specific outsourcing. The merits and limitations of the different types of outsourcing are reviewed below. In particular, IT outsourcing is limited to voice and data, data centres, maintenance and application development (Delloite, 2013). In contrast, BPO outsourcing encompasses aspects such as human resource management, back office and finances (Delloite, 2013). The main elements of knowledge process outsourcing are discussed in the following section.

Knowledge Process Outsourcing (KPO)

In contrast to other forms of outsourcing, knowledge process outsourcing focuses on the provision of high-value services. KPO builds upon the benefits derived from the outsourcing of IT services to companies with technical expertise (S. M. Mudambi & Tallman, 2010). The implementation of KPO requires skilled professionals such as lawyers, engineers, doctors, MBA, and doctorate holders (IBEF, 2008). The professionals are recruited to undertake legal services, insurance analytics, engineering design, data mining, brand management, testing, research, pharmaceuticals, biotechnology, market research and intellectual property design; it is evident that no single company has the capacity to invest each of the above-listed activities (S. M. Mudambi & Tallman, 2010). The latter statement is reinforced by the fact that each activity requires significant investments in human resources. Therefore, the implementation of such activities is more expensive compared to other less-knowledge intensive forms of outsourcing. The cost is also higher given the human resources have to be trained about the emerging patterns in the industry. The higher cost has contributed to the low adoption of KPO compared to BPO and other forms of outsourcing. However, less saturation of the service providers has enhanced the profit margins in the KPO sector (IBEF, 2008). The difference between BPO and KPO in the insurance, consulting, pharmaceuticals and healthcare, telecommunications, and banking is depicted in Table 1. In brief, it is evident that KPO is a value-adding process.

Table 1 Difference between BPO and KPO operations

Industry

KPO

BPO

Consulting

Research and synthesis of the findings

Back office support

Banking

Research and financial analytics

Settlement of claims

Healthcare and pharmaceuticals

Portfolio analytics, intellectual property and patent designs

Customer support and contact centre

Telecommunications

Strategy, research and analytics

Consumer support

Source: IBEF (2008)

Even though previous research has confirmed the contribution of KPO in value addition, there are concerns about the long-term merits of the approach (Mudambi & Tallman, 2010). The suitability of the approach is dependent on the perceived value addition, quality, proprietary knowledge and internal capabilities within the firm. Therefore, if it is possible for the company to derive higher strategic competitive advantage from internal operations, it is advisable for the company to manage knowledge processes internally.

Nearshoring

The term denotes the transfer of business operations to a location which is close to the parent company’s base of operations (Slepniov et al., 2013). In most cases, nearshoring operations are undertaken in countries with comparable time zones; for example, manufacturers in the US might shift their operations to Canada or Mexico (Delloite, 2013). Manufacturers operating in the UK stated that closeness to the consumer was only second to cost and the quality of the human resources (PwC, 2009). Such considerations also informed Japanese companies’ intentions to invest in the UK OEM sector. For example, Nissan had established a manufacturing facility at Sunderland (PwC, 2009). Even though the UK was geographically distant from Japan, it was close to a critical segment of the population – consumers of Japanese vehicles. Therefore, nearshoring is defined by multiple short-term and long-term considerations.

Leading motor vehicle manufacturers such as Toyota, Ford, and Volkswagen and have selected Turkey as the preferred destination for manufacturing operations due to geographic proximity and the availability of affordable labour (Karabag, Tuncay-Celikel, & Berggren, 2011; Toyota, 2018). Apart from the geographical proximity, labour costs also determine the location of the nearshoring operations. For example, Mexico is a viable alternative compared to Canada for US manufacturers due to the availability of cheap and skilled labour. Nonetheless, Slepniov et al. (2013) argued that cost was not the most critical factor in nearshoring compared to the operational risks and the distance dilemma. The observation is reinforced by empirical evidence which indicates that companies have to balance between the desired location and the preferred cost savings.

Ruohonen (2008) observed that the success of the nearshoring operations in Eastern Europe was party augmented by the geographic advantage. For example, companies in Eastern Europe were able to outsource manufacturing to India. Alternatively, Western European nations consider Eastern Europe as the preferred nearshoring destination due to the cost advantage (Slepniov et al., 2013). In other cases, nearshoring was part of the operations strategy or the global dispersion of operations. In general, the US has outperformed the EU in nearshoring given that conservative capitalism principles primarily guide companies. For example, European manufacturers have been primarily concerned about the impact of outsourcing on the labour market given that about 13.7 million Europeans are employed in the service sectors (Bobirca, 2007).

Reshoring

As noted in the introductions section, reshoring is the process of transferring operations back to the home country. Leading multinationals such as Walmart (a US multinational) has committed to invest $50 billion in reshoring (Ellram, 2013). The trend was not limited to Walmart, other companies have promised to return manufacturing operations to the US, especially since the election of Donald Trump. Carrier Company had pledged to reshore operations back to the US (University of Pennsylvania, 2016). Based on the above patterns it can be deduced that political considerations influenced reshoring.

 Reports from the UK indicate that manufacturers were also reshoring their operations. In particular, about one-seventh of UK firms were planning to reshore or near shore due to cost and quality concerns (Department for Business Innovation and Skills, 2010). Therefore, the perceived cost advantages were not the absolute determinants. Nonetheless, from an empirical perspective, the sustainability of reshoring is an issue of debate given that it was partly reinforced by political considerations, especially in the US (University of Pennsylvania, 2016). Besides, industry experts suggest that the reshoring of manufacturing could be capital intensive (University of Pennsylvania, 2016). The reversal of traditional trends in outsourcing seems to indicate that the transition to low-cost manufacturing locations did not contribute to the most optimal supply chain configurations.

The reverse trends in reshoring have been informed by political and economic instability in countries with low wages such as India and China. Recent data suggests that the two countries would experience macroeconomic instability and uncertainty (OECD, 2018). In particular, a recent publication on Bloomberg indicated that the sluggish growth of the Chinese economy would diminish industrial production and introduce multiple uncertainties to the global economy (Bloomberg, 2018). The core aspects of outsourcing are discussed below.

Outsourcing

According to PwC (2009), outsourcing was dependent on the vehicle component as illustrated in Figure 4. In particular, the automotive manufacturers outsourced the manufacturing of electrical components, interiors, powertrain and the chassis. However, the body structure of the vehicles was manufactured in-house. The trends had remained consistent between 2002 and 2015, except for electrical components. Nonetheless, outsourcing is non-ideal if the demand for agility is high and shorter lead times are required, or when the manufactured parts are fragile.

Figure 4 Historical trends in the outsourcing of automotive trends (PwC, 2009)

BPO

BPO outsourcing is a common phenomenon globally. According to the Global Service Location Index, the US, India, Philippines, and Poland are leading in BPO services as illustrated in Figure 5. In particular, BPO encompasses sales, HR, procurement, analytics, finance, and consumer service (Delloite, 2013). According to recent research, BPO decisions are informed by multiple considerations such as the location-specific elements, process-level constraints, and geographical proximity (Gerbl, McIvor, Loane, & Humphreys, 2015). Out of the four factors, it can be deduced that location attractiveness is the core determinant based on proximity and availability of the factors of production.

Figure 5 Distribution of BPO based on the type of jobs (AT Kearney, 2018)

Mitigation of Risks Associated with Outsources

The main risks associated with outsourcing include a mismatch in expectations, inconsistencies in cultural practices between the home country and the new location, communication barriers, insufficient experience, non-conformity to industry standards, poor, quality delays, damages, and the management of threat perceptions (Delloite, 2013; El Mokrini, et al., 2016; Zhu, 2016). Industry experts such as Deloitte have developed certain best practices which reduce the adverse effects of outsourcing (Delloite, 2013). In particular, it is recommended that companies should create a robust governance system before initiating outsourcing and must acquire extensive knowledge about the preferred destination country for manufacturing operations. Besides, the company should have sufficient financial resources to counter any legal or commercial risks. The offshore activities should also be closely aligned with the manufacturer’s vision, mission and niche market (Delloite, 2013). Enterprises which are contemplating the transition should first establish the cost benefits before initiating the transfer of operations to other countries.

Offshore Outsourcing

Offshore outsourcing is characterised by the subcontracting of selected in-house operations to another entity to undertake manufacturing on behalf of the parent company (Gylling et al., 2015). In most cases, the foreign entity tasked with the production is either an offshore supplier or affiliate. Therefore, the offshoring process is structured to favour large companies with international linkages. In addition, the size of the firm predicts the capital resources available to absorb the external shocks. The latter claim was validated by Criscuolo & Leaver (2008).