Outsourcing decisions in eight Swedish manufacturing and engineering companies Anna Fredriksson1 and Lars Medbo2 1.
Chalmers tekniska högskola, Department of Logistics and Transportation 412 96 Göteborg 031-772 13 46
[email protected]
2. Chalmers tekniska högskola, Department of Logistics and Transportation 412 96 Göteborg 031-772 13 47
[email protected]
Abstract Focus in this article is to discuss and present how Swedish manufacturing and engineering companies work with and handle outsourcing and sourcing decisions from a logistic perspective. Eight interviews are summarized to give a picture of how companies work with and what considerations and concerns they have about outsourcing and sourcing decisions. All the companies have either outsourced production or transferred suppliers to low cost countries. There is a pressure from the owners to source more to low cost countries and this creates conflicts within some of the companies. The paper shows several areas which there are questions and concerns around and a need to become better in appreciate the consequences and costs of outsourcing and sourcing decisions. This research is financed by VINNOVA (the program “Innovativa logisticsystem och godstransporter”) and is a joint project between Chalmers University of Technology and IVF Industrial Research and Development Corporation.
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1. Introduction Most companies in the Swedish industry today are influenced by the globalization of manufacturing and trade. Out of reasons of increased competition or shifting in markets are several companies under pressure to outsource at least parts of their production or source their purchasing to low cost countries (LCC). The following definition of ‘outsourcing’ will be used in this paper: “outsourcing is when a company hires a supplier to perform an activity that was earlier performed by the company” and with ’sourcing’ we include supplier transfers from western countries to low cost countries. The discussion regarding these questions arises in a time when there is more and more focus on flexibility and ability to deliver. The cost focus that has driven the development in this area until now is complemented with a focus on the income side. After a long period of creating stabile and well managed supply chains there will be a shift towards active reconfiguration of supply chains and supply networks. The cost of not being able to live up to undertakings will be more and more distinguishing between companies. To be able to combine outsourcing or LCC supply and ability to deliver will be the big challenge for logistic managers from now on. (Bengtsson et al. 2005) The logistic departments of today rarely have models for describing the consequences of outsourcing or sourcing to different geographical places and they show a big interest in improving the management of opportunities and risks coming with globalization. To make it possible for Swedish companies to make outsourcing and sourcing decisions in a prepared way it is necessary for them to analyze the pros and cons with the alternatives in a comprehensive view. To be able to form a strategy and a model for decision support within this area there is a need to describe how companies work and handle logistic consequences when outsourcing today. Influences on the outsourcing or sourcing decision have been widely discussed the last couple of years, both in public debate, in industry as well as in research. Typically are outsourcing and sourcing decisions based on short term perspectives to achieve cost reduction (Tayles and Drury, 2001). Lowson (2003) demonstrates a number of disadvantages if focusing on low cost in sourcing decisions in the state of hidden costs (i.e. delays, administrative and quality costs) and inflexibility costs. However, lately strategic considerations have become more important (Tayles and Drury, 2001). In spite of this, companies tend to take outsourcing decisions individually, based on the activities
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performed by the company at a given time (Freytag and Kirk 2003). They argue that the capacity of the focal company can be understood in its interaction with its context and the market and supply side can unambiguously be tied together. Contrary other studies report on successful use of strategic sourcing models, e.g. regarding long-term capital allocation (Tayles and Drury, 2001). Christopher and Towill (2001) argue that even if cost and price is important is it many markets availability that is order winner in the supply chain. Fine and Whitney (1996) stress the importance of competence; companies have not all the necessary knowledge to manufacture everything in-house. Outsourcing is a strategic choice not only related to the product competencies, but also to manufacturing process competencies, business process competencies and dynamic instabilities. It is argued that most important, are the skills that support the choice of which skills to retain. Many researchers have attended the relationship between product development and production. Bengtsson et al. (2005) argue that there is a strong dependence between these areas. If a certain product is outsourced, then will also the product design have to be transferred later on. Especially if the need of flexibility is high can outsourcing give problems due to longer geographical, time and organizational distances between product development, production and customers. The automotive industry is a good example where a strategic ambition to reduce the end producers assembly operations through modularization and close relations between product development and production resulted in sharp competence areas in product development and production for the first and often second tier suppliers (Jurgens, 2004). Liberalization in global trade, structural changes and rapid technology development has further reinforced the consequential outsourcing. The aim in this paper is to describe what questions Swedish manufacturing and engineering companies work with and include in outsourcing and sourcing decisions today. Also which areas they feel most concern about and give most attention to when making outsourcing and sourcing decisions. Focus in this article is to discuss and present how Swedish manufacturing and engineering companies work with and handle outsourcing and sourcing decisions from a logistic perspective. The paper is made up of interviews with eight Swedish manufacturing and engineering companies. The interviews have been semi structured and carried out during half a day at the companies’ major Swedish production units and the interviewees have either been from the logistics, purchasing or production departments and the interviewees work with questions regarding outsourcing and sourcing on a regular basis. The interviews have 143
been conducted with 1-2 persons per company and the answers represent the interviewees’ view of the questions. In this paper follows first descriptions of the companies outsourcing and sourcing related activities which end up in a summarizing discussion.
2. Company descriptions This section presents the empirical data from the interviews. Table 1 show a summary of the characteristics of the companies and their settings and will be followed by the company descriptions. The companies have been selected because of their concern about these questions and their interest in participating in research. In table 1 indicates “Origin” the ownership of the company and if it is part of a group of companies or not. “Number of product variants” display if the company has a large number of products or variants and is introduced to indicate how flexible the production needs to be compared to changes and “Production volume variation” shows if the company produces different volumes at different times and indicates how flexible the company needs to be regarding production volume. “Demand controlled production” shows how much of the production that is produced directly against customer order.
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Table 1: Characteristics of the companies. The indicators “Small, Medium and Large” compare the eight companies to each other and are not an absolute measure. Company
Origin
Customers
Number of product variants
Production volume variation
Demand controlled production
Key competitive factor
A
European global group
Component
Medium
Medium
Medium
Price and functionality
B
Swedish global group
End user
Medium
Small
Small
Quality and functionality
C
Swedish
Component
Small
Large
Small
Quality and functionality
D
American global group
End user
Large
Large
Medium
Quality and functionality
E
Swedish global group
End user
Small
Large
Small
Quality and time to market
F
American global group
End user
Large
Medium
Large
Price and functionality
G
American global group
Component
Medium
Medium
Medium
Quality and price
H
Scandinavian group
Component
Medium
Large
Large
Price and quality
Company A The products of company A have relatively long life cycles and the production is customer oriented with short delivery times and hard competition on the market. A uses double sourcing and works continuously to reduce the number of suppliers. A has worked with allocation to LCC for a relatively long time and to get started they did have a percentage goal for LCC supply. The outsourcing projects are run by a project leader from the purchasing department and they calculate a total cost of the product. The main incentives to outsource are lower costs and accessing new markets, though A points out the problems with being too early into a market. To be able to compete on the Asian markets you have to offer products to local prizes and especially in China costs outrun production technology and this influence the quality. A has several areas which they feel uneasy about when making sourcing decisions: competence of the supplier, if
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tests are completed under industrial forms, quality of product, quality of materials and standards, communication and financial stability of the supplier. Also, what are the consequences for the rest of the production? The trickiest part to predict is the cost and time of moving and restart, in most cases these are underestimated and better estimations have resulted in less outsourcing. A uses a trading company to bring the products back because they have the possibility to combine and fill containers up. Company B The production of company B is controlled by warehouse levels and the products consist of many models with small series and large industrial customers. It is important for B to construct the products in modules which make it easier to separate production steps from each other and this also allows B to be more flexible when sourcing. At the moment B is trying to find synergies between the different production sites within the company group. The majority of B suppliers are today found in Sweden but they are looking for LCC alternatives to be able to reduce costs. It is important for B to find their suppliers in a relative geographical closeness of Sweden to be able to visit them on a regular basis. B has the experience that different cultures and communication problems have a negative influence on the start up time. The reasons to outsource are to set capacity and space free and to reduce costs. Insecurities when making outsourcing decisions are considered to be: will the supplier be able to keep the offered prices and still produce at the expected quality, competence of the supplier, capacity of the supplier, price stability and influence on flexibility. Company C The life cycles of company C products are long and there is a variation in demand. C has a strategy that includes staying and growing in the geographical region of were they are located today and find suppliers of critical products in the same region who are suitable for long term cooperation. C is dependent on tools that are large investments and have to be renewed when changing suppliers. It is important for C to have the development geographically close to the production. The incentives for outsourcing are quality problems, machine problems and competence of the supplier and reasons not to outsource are to keep control, retain the competence in house, degree of financial coverage and customer needs. C finds it tough to determine what should be in house and what is more profitable to outsource, i.e., how the limited internal resources should be used. What consequences does outsourcing bring to the rest of the company? 146
C has several supply areas which they feel insecurity about when making sourcing decisions: price stability, supplier competence, financial status and stability of the supplier, market position of the supplier, ability to collaborate, manufacturing methods, security of deliveries and self development potential. Company D The production of company D is customer oriented with highly shifting demand. D uses single sourcing and develops close cooperation with the suppliers. D has a goal to increase the percentage of LCC supply. The outsourcing and sourcing projects have a project leader from the purchasing department and also includes the production and logistic departments. They work with landed cost of the product (Landed cost according to Bardi et al. (2005) includes the cost of the product at the source plus the cost to transport the product to its destination, i.e. the place and time of consumption). There are conflicts of interest within D regarding how an outsourcing project should be judged. D has several areas concerning the suppliers which they feel insecurity about when making sourcing decisions: security of deliveries, quality, production process, competence, delivery times, time for start up and legal liabilities of the supplier. One issue for D is how to handle the variation in demand when having long leadtimes. Also how profitable it is to serve Europe from Asia? One of the hardest things with a supplier far away is that it takes more time and more effort to handle interaction and quality issues and it makes difficult to be as flexible as the customers wish. Company E It is important for company E to be quick in the response to changes and this puts high demands on the flexibility of the production. To avoid dependency on only one supplier uses E double sourcing. E has a goal to increase the percentage of LCC supply. The purchasing department is measured on behalf of price cuts and this has caused a conflict of interest within E because the consequences for the production of a supply change have not been taken into account. E has a purchasing council including the departments of purchasing, production, development and market and when outsourcing also including the management and they work with landed cost of the product. To be able to handle the supply from countries far away has E hired a third part logistic company to do this. A concern within E is how the low costs influence lead times, precision of deliveries and control, E has the experience when making business with LCC that everything takes much more time and this affects the flexibility and the cost of tied up capital. The cost of wages in the products is 147
small compared to the cost of transports and to estimate the relationship between these is a problem in outsourcing decisions. There are different quality levels in different countries and this concerns E and also if the suppliers will be able to handle full production. They also point out the problems of currency risks, capacity, price stability, cultural differences, communication problems and different value of agreements. Company F The manufacturing of company F is based on customer demand and main markets are Europe and USA. F has a planned process for outsourcing and sourcing decisions. In the process one of the main objectives is to work with landed cost to make the most profitable decision regarding the whole organization even though it could possibly mean increased costs for one department. Outsourcing and sourcing decisions are made in regular meetings held every month. Participating in these meetings are all departments that could be influenced of the decision and the project leaders comes from the purchasing department. F has a percentage goal of how much of the supply that should come from LCC and the incentive behind an outsourcing or sourcing decision is to cut costs. The purchasers like the suppliers to compete against each other and this creates problems for the production that only can handle supply from one location and has to make parallel competitors cooperate. F has several areas which it feels are insecure when making sourcing decisions: quality levels, environmental aspects, lead-times and the time aspect; there is a long time period between decision and full scale production. Company G The production of company G has small seasonal variations and customers growing in size and importance with main markets in Europe and US. G uses single sourcing with close cooperation and long term agreements with the suppliers, the agreements includes clauses of continuous cost reductions from suppliers. They have a goal to increase the percentage of LCC supply. The incentive behind an outsourcing decision is to cut costs, get access to new markets and investments, since there is a policy within G were it is hard to get new investments accepted. Most of the sourcing decisions are made in the design process and the project leader for outsourcing projects come from the purchasing department but also the quality, construction and production departments are taking part in the project and they work with landed cost. G says that it requires high volumes to use suppliers in LCC. Also it likes to outsource geographically close to the main production site to keep control 148
which is hard with geographically long supply chains. However, the global company that G is part of facilitates outsourcing through giving access to common plants in low cost countries. There is a conflict of interests within G between the local plant controllers and the company group controllers over outsourcing because the base for distribution of costs changes when outsourcing and this affects the local cost coverage. G has realized that there is several start up costs that are hard to estimate when outsourcing. The insecurities when outsourcing or sourcing to LCC are: price, quality, what materials and standards that are used, capacity, the competence of the suppliers and if the tests are really performed under full production circumstances. Company H For company H it is important to have a close link between development and production and to look at the total cost of the product. For H there is a big difference between a traditional contractor and outsourcing and it is hard and important to asses the relations between products, production process and flow. When outsourcing is it also important to know where in the life cycle the product is and where in the life cycle the company is. It takes a lot more work to outsource a young product than an old, already established one and the only reason to outsource an old product is to reduce costs, according to H. H says that high volume established products with an acceptance of long lead-times and with few changes are suitable for sourcing to LCC in Asia, this because problems have a tendency to increase with distance. It is vital that the involved companies in an outsourcing understand the importance of information transparency. An outsourcing decision should be taken at a management level in the organization; otherwise there is a risk for sub optimization. It is also critical that they are willing to work as a team. Insecurities that come with outsourcing are: development without the users, travel expenses, political stability, price stability, competence, lead-times and the risk for misuse of intellectual properties.
3. Discussion and conclusions Based on the interviews, the company descriptions are summarized in this section to create an outline of how the companies work with outsourcing and sourcing decisions.
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3.1. Experiences and strategies Ten different areas are used to describe the companies’ current experience and strategies with outsourcing and sourcing. “Outsource” and “Supplier transfer to LCC” indicates whether the companies has outsourced or is presently outsourcing part of their production or if they have transferred their suppliers from western countries to LCC. “Supplier evaluations” and “Organized process” shows if the companies use regular supplier evaluations and if they have an organized process for outsourcing. “LCC purchasing % goal” displays which of the companies have a percentage goal on how much of the supply that should originate from LCC. The interviews have shown that these goals are usually a part of the budget and are an owner requirement. “Conflict of interest within company” follows from that different department have different goals and these can with regard, to outsourcing and sourcing be contrary to each other and this creates conflicts of interest within the companies. “Sourcing strategy” intends to show whether the companies have a pronounced strategy of how to select suppliers or outsource their production. The three final areas show three ways of reasoning around outsourcing and supplier transfers that some of the companies emphasize. “Outsource to LCC only at large volumes” argues to be able to make a profitable outsourcing to LCC you need large volumes of the product. “Development close to production” is a topic that the participating companies have brought up and it points on the need to have the production geographically close to the development. “Landed/total cost” is when the companies use a calculation model that tries to include all possible costs when outsourcing and bring them together in a landed or total cost that can be compared with the present cost.
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Table 2: In what ways the companies work with outsourcing and sourcing. An X in the table implies that the companies have made such statement in the interviews. Company
A
B
C
D
E
F
G
Outsource
X
X
X
X
X
X
X
Supplier transfer to LCC
X
X
X
X
X
X
Supplier evaluations
X
X
X
X
X
X
X
X
X
X
Organized process Sourcing strategy
X
LCC purchasing % goal
X
X
Conflict of interest within company
X
X
X
X
X
X
X
X
Outsource to LCC only at large volumes Development production Landed/total cost
close
to
H
X
X
X
X
X
X
X
X
X
X
X
X
X
The interviews show that all companies work with at least either outsourcing or supplier transferring in some way and even if all companies use regular supplier evaluations, only two of them have an organized process for outsourcing decisions. There is a pressure from owners on five of eight companies to increase their supply from LCC and four of these companies have conflicts of interest within the company depending on different views on the consequences of outsourcing and sourcing. This raises the questions of how outsourcing and sourcing decisions should be made in a way that not lead to sub optimization. A majority of the companies consider a need to keep development close to production and two of them have brought up the question of how large volumes are needed to be able to make a profitable outsourcing. Landed or total cost is used with different definitions of the companies and to be able to create a wider definition that includes more than price, cost of transportations and tied up capital is essential.
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3.2. Concerns The interviews have shown different causes of deep concern among the eight participating companies regarding outsourcing and sourcing. The areas have been divided into four categories outgoing from the focal company’s view of the relation. “Supplier operations” join up the focal companies concerns regarding the supplier products and production process, “Intra supplier context” shows the concerns regarding the internal non production processes of the suppliers and “Extrinsic supplier context” is the context connected to where the supplier is located in relation to the focal company. “Focal company conditions” are the areas of concern which consequences have to be handled within the focal company. The area “Test series completed under full scale production” shows the questions if the test series of the products really are performed under the same conditions as full scale production. “Price stability” is the worry that the supplier will increase prices when there are substantial costs connected to insourcing or transfer to another supplier and “Trust/misuse of intellectual properties” is if the supplier will respect and fulfill the contract. “Time between decision and full production” points on the fact that it can be several years between supplier selection and full scale production and which make the suppliers undertake without knowing the exact purport of the undertaking. “Flexibility of production” is how the focal companies’ production flexibility will be influenced when using a supplier in LCC or/and if outsourcing. “Longer distance to supplier harder to manage” implies that the more geographically distant a supplier is the more energy and funds have to be spent to keep the relationship work as smooth as the companies wish. The mapping of concerns in outsourcing or sourcing situations shows that there are several areas where the companies consider the situation not under full control. The wide range of areas that the companies have brought up exposes the great uncertainty that these questions are surrounded by and the spread of what the companies consider a concern show on big variation in experiences made. The main focus of the companies can be described as product and production process oriented. What influence will the suppliers’ performance have on our performance towards our customers? All the concerns in the category “Intra supplier context” are related to trust, the companies are becoming very dependent on their suppliers especially when outsourcing and it is necessary for them to know how the relationship will develop during the contract time. Will the supplier keep the agreed price and have the necessary financial stability to stay in business during the stipulated contract time. It is hard to say how the control over the company processes will be influenced by 152
an outsourcing and sourcing decision and there are companies that fear loss of control, there are also companies that think it is hard to predict the consequences for the rest of the company and the flexibility of production. The influence of an outsourcing or sourcing decision on the focal company conditions are needed to be well evaluated so the companies are prepared to handle all possible effects of such decisions. Otherwise good effects can get lost and bad effects can have a devastating result. Several companies’ are troubled by the fact that the start up cost and start up time are hard to estimate and one company even said that they have approved fewer outsourcing suggestions since the estimation of the start up cost improved. Interesting to note is what renders least concern is the extrinsic supplier context which is foremost very hard to tell what should be taken into account and how this affects the company. These are so called “qualitative areas” which are very hard to price-mark and to predict the effects of and it might be because of that few of the companies consider these areas.
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Table 3: Causes of concern among the companies. Company
A
B
Quality
X
X
Test series not completed under full scale production
X
Quality of materials and standards used
X
C
D
E
F
G
X
X
X
X
H
Supplier operations
X
Lead times Capacity
X
X
X
X
X
X
X
X
Competence
X
X
X
X
Communication/cooperation
X
X
X
X
X
X
X X
X X X
X
X X
Intra supplier context Price stability Financial stability
X
X
X
X
X
Trust/misuse of intellectual properties
X
X
X
Extrinsic supplier context Currency risks
X
Political stability
X
Environmental aspects
X
Time between decision and full production
X
Market position of the supplier
X
Focal company conditions Start up costs and start up time
X
X
Control
X X
Flexibility of production
X
Longer distance to supplier harder to manage Consequences for the rest of the company
X
X
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X
X
X
X X
X
X
X
X
X X
3.3. Conclusions Focus in this article have been to discuss and present how Swedish manufacturing and engineering companies work with and handle outsourcing and sourcing decisions from a logistic perspective. All the interviewed companies work with either outsourcing or sourcing though only few have an outspoken strategy or an organized process. There are many areas of concern regarding the consequences and the real costs of outsourcing and supplier transfers. The majority of the companies refer to start up costs and start up time as hard to estimate and which can have a crucial importance in the decision. How should a cost for an outsourcing and sourcing decision be calculated? To use the expression landed cost might be a good idea, but what costs should be a part and how should the “qualitative areas” be priced? Most concerns regard the effects on the focal companies’ production depending on the suppliers’ performance and their trustworthiness. Few bring up the questions surrounding the suppliers’ extrinsic context which surely have an influence though is very hard to say which. Other areas needed to be discussed are: What is the time perspective of an outsourcing or sourcing decision? Is the decision seen as an individual operative one or a strategic decision? The discussion accentuates the importance of this research area. It shows on the necessity of mapping the decision process and to asses which are the costs, concerns, considerations and possible solutions to be taken into account and under which specific circumstances and situations for the companies to make it possible for them to make well founded decision.
References Bardi, E., Novack, R. and Coyle, J. (2005) Management of Transportation.6 Edition, South-Western College Publishing, USA Bengtsson, L., Berggren, C. and Lind, J. (red) (2005) Alternativ till outsourcing, Liber AB, Malmö Christopher, M. and Towill, D. (2001) An integrated model for the design of agile supply chains, International Journal of Physical Distribution & Logistics Management, 31(4):235-246 Fine, C.H. and Whitney, D.E. (1996) Is the make-buy decision process a core competence, (Working Paper # 3875-96). Cambridge, Massachusetts, USA: MIT Center for Technology, Policy, and Industrial Development
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Freytag, P.V. and Kirk, L. (2003) Continuous Strategic Sourcing, Journal of Purchasing & Supply Management, 9:135-150 Jurgens, U. (2004) Characteristics of the European automotive system: is there a distinctive European approach?, International Journal of Automotive Technology and Management, 4(2/3):112-136 Lowson, R.H. (2003) Apparel sourcing: Assessing the true operational cost, International Journal of Clothing Science and Technology, 5(15):335 Tayles, M. and Drury, C. (2001) Moving from Make/Buy to Strategic Sourcing: The Outsource Decision Process, Long Range Planning, 34:605-622
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