In-House Inefficiencies – The Advantages of Service Outsourcing

The rise of inefficiencies that prevail in many business send many business owners on a quest to outsource product manufacturing or specific service requirements. When confronted with the opportunity to outsource, many opt not to pursue this direction because there is a feeling of loss of control. Used correctly, the ability to use outsourcing can improve operational performance and individual job quality no matter whether the outsourced activity provided is product or services. What has made this approach popular with some companies and avoided by others? Why is outsourcing a good idea for companies? Is outsourcing a viable strategy given the business environment of today? If so, to what extent is it appropriate for your business?

The idea of outsourcing has grown beyond the idea of product or component part production. The initial concept of supply-chain management coupled with lean manufacturing techniques support outsourcing components and can be illustrated well when reading Henry Ford’s comments on the subject:

“The task of putting business on better foundations depends on every department of the business and not alone on the manufacturer.”1

The resulting effects on industry have been substantial for large manufacturers and especially for businesses with smaller work forces where the ramifications have been substantial. In many cases, their ability to use this approach has fostered their competitive advantage and provided a sustained period of business growth.

Businesses are increasingly hiring specialized service firms that perform services that they used to provide for themselves. A company’s ability to specialize or provide a more sophisticated service creates opportunities not previously available for many businesses. Growth in the underlying need for services is driven by several factors including the need for increased sophistication, globalization, and the ever-increasing aspect of management complexity.2 Specialized forms of services have proliferated, as has the complexity of needs in such established service industries as advertising, accounting, consulting, information systems, market research, and investment banking. The companies that are able to create advantages by working smarter and staying cost competitive will be the companies that will have the ability to survive the increased competition, aggressive pricing, and sustain the threats from international competition.

Are products and services affected in the same way? Specialization and sophistication are occurring in both areas. However, services are actually being de-integrated or removed from the businesses. This de-integration result actually is a net increase in service provision being provided to the organization. The trend in graphic arts industries is toward integration, or in-house provision, though this industry is considered non-traditional and does not reflect the trend by the majority of other service industries.3

By far the greatest reason for lack of outsourcing within any industry, no matter whether product of service related, is the fear of loss of control. The pervasive thought that the product can be produced better or the service performed better can be an inherent part of a business culture that can cause stagnation and large inefficiencies. Individual managers or owners will many times decide that the opportunities to vertically integrate demand in-house functions to remain “in-house”. Thus maintaining quality standards that cannot be supposedly matched by outside sources or incur increased costs that will impact the sale of the product or service.

The services that are being provided have grown and are continuing to grow due to three underlying factors: the specific need for increased sophistication by service providers, the de-integration of services previously performed as an in-house function, and the privatization of public services.4 Many of these service firms have reinvented themselves during the last decade due to the increased use of information technology. It has allowed increased productivity from the individuals that are part of the firm as well as increased the amount of information and number of services each service firm can offer to their clients. Many of the services are now automated which provide immediate access without a need for direct customer interface. The airlines have taken automated ticketing to new heights via the telephone and the Internet. The new technologies are both the cause and effect of changes the industry structure and the source of major competitive advantage in many service industries.5

Multi-service firms allow their clients to tap into a broader selection of available services. At the root of the growth of these firms is a type of systemization that allows efficient and consistent replication of the services at multiple clients due to standardized employee procedures, internal methodology, automation of the actual service tasks performed by the individual. This has spawned another critical aspect that allows firms to narrow their focus of specialization for their clients. Take for instance, a consulting firm that offers multiple service functions but has true expertise in only a couple of areas. This broad approach has given way to increasingly specialized services such as human resource management, compensation modeling, and strategy definition to name just a few. Specialization leads the service firms to a much more narrow focus which provides better service in the specific areas of client need.

There are several advantages of having a narrower focus within the service firm. Among them are the economies of scale that the service firm can gain with the specificity of a narrow focus area. For example, diagnostic service programs that can be run via a phone modem at a remote location of the client can check software programs and often even correct the problem. Other types of enhanced communication can provide data processing, telemarketing functions, or answering services possible. These are closely related to the centralization needs of the client and are specifically scale-sensitive meaning that activities provided by the service firm are adapted to the client’s need to service their clientele on a regional, national, or on a world-wide basis.

Additionally, the aspect of competition and focus are potent advantages for the outside service provider. In-house service departments are at the very least cost centers for the business. This is not to say that an in-house service facilitator cannot be profitable. It does, however, mean that the policies, procedural methodologies, and accomplishments should be regularly measured to not only justify the existence of the department, but also provide adequate pressures and performance incentives when faced with outside service alternatives.

At the same time, in-house service departments do face inherent constraints.6 Understanding barriers that are constraining for a business helps ownership and management better evaluate the performance requirements necessary for an in-house service department to function well. Given the limitations, such as compensation structures and employee benefit packages, those responsible for making the decision should probably opt to outsource the services instead of having them handled internally.

“In-house service units are housed at expensive locations, subject to corporate salary structures and benefit plans, constrained in some cases from using part-time workers, and live under other guidelines that are inappropriate for the nature of the service function provided. The independent service provider, conversely, tailors every aspect of its value chain to the particular service involved.”7

The concept of increased cyclicality should be considered by the organization facing inefficiencies. Cyclicality increases the inefficiency of maintaining a permanent service function in-house which provides companies alternatives to converting a fixed cost into a variable one.8 They need only to call on these companies, as the organization requires their services.

Recognized Opportunities to Outsource

Similarity of Service Needs – The aspect of service needs that organizations require have similarities whether competing at the local level or on a global scale. Some service needs may be industry specific, or even segment specific. For example, consulting services tailored to niche industries require years of expertise to understand specific nuances that affect industry trends requiring specific client recommendations. As the demand for services globalizes and competition becomes greater, the actual service performance at the local level may provide a cost advantage to the client. This allows for competition to be somewhat “equalized” for the local firm regardless of a whether the competing firm is considered to have global reach.

Mobility of Buyers – With increased information flow throughout the world, the opportunity for global service firms increases at the local level. In past years, buyers were confronted with minimum options when faced with the need to take in-house services out for bid. The buyer’s perspective has increased substantially providing the buyer’s organization opportunities today that may have existed in prior years, but were not available or familiar to the buyer. Additionally, the aspect of paying in different currencies is continuing to be less of a concern since many trading blocks have adopted a common currency thus relieving the concern of loss due to currency fluctuation. The Euro is probably the best and most recent example of this.

Rising Economies of Scale and Geographic Scope – The advantages that drive local service competition to open multiple offices or locations are prevalent at the global level as well. It is easier today than at any other time in history for companies to establish an international presence for services that can be outsourced. Economies of scale allow these companies to spread costs in areas such as information technology, personnel training, and capabilities to enhance topline sales revenues. The advantage of global positioning by an organization allows for growth in areas of brand cache, local personnel participation with global perspectives, and the overall advantage of serving other multinational firms similar in scope.

Greater Mobility of Service Personnel – The aspect of telecommuting has grown in recent years because many people prefer to work from home, or are unable to make the commute efficiently to the home office of the service firm. In-home workers are providing companies the opportunity to reap large benefits on productivity and employee satisfaction unobtainable in prior years. If travel is required, the ability to get to an international location is relatively easy and customer contact is relatively short. This again provides economies of scale for the employing organization which enhance the solution for their client.

Information Exchange – Buyer interaction at a distance today is to be expected given the overwhelming amount of information available via the click of a mouse. Samples are available via overnight delivery services. Emails and telephones provide instant access to other individuals needed in the buying process. Employee assessment and testing are available through many consulting service firms where the client has access to use licensed information technology at their discretion and the consulting firm has virtually no client interaction, unless required by the client, except to invoice for the services. This type of service function allows for more access to remote buyers whether face-to-face or not. Employee behavioral assessments illustrate this point well.

Wide Disparities in Cost or Quality – Huge differences remain in costing methods and overall quality of services that can be outsourced. This is true at both the domestic and international level. It is becoming easier today to setup service facilities in India or China due to availability of personnel and the overall cost of the facility itself. Many countries have not made the jump to service outsourcing from manufacturing outsourcing as yet. However, as the world’s population continues to grow and the state of development by country is opportunistic, the proliferation of service industries will be advanced.

Buyer/Supplier Relationships – The relationship between the buyer and the supplier is pivotal in the use of service firms for the organization. There are two considerations that should be taken into account when mentioning this aspect. The first is without a local manufacturing base, the demand for outsourced services will be limited. The second is the actual structuring of the manufacturing sector which can strongly influence the types of services to be provided. A certain amount of sophistication is required in order for specialized service firms to exist and be successful such as specialized software application companies or consulting services.9 On the other hand, economies of many third world countries that are non-manufacturing based have no need or demand for out-sourced services. The point being that the more sophisticated service-based economies is more apt to take advantage of the out-sourcing opportunities.

Outsourcing is truly a quality of life issue that faces individual owners and corporate business entities alike. Mature industries where specialized firms are available to be used, should determine what their core competencies are and how they impact exploitation of the firm’s competitive advantage. The organization’s core competencies should be protected at all costs.

Firms are demanding more opportunities to use outside services that provide increased product quality or sophistication of services. The opportunity to find specific areas that will benefit from these services can make a company more profitable, time efficient, and productive. Employed as a viable company strategy, outsourcing will enhance an organization’s ability to sustain upward growth patterns and explore new opportunities by using redefined human resources within the business.

RESOURCES:

The Competitive Advantage of Nations, by Michael E. Porter, published by The Free Press, a Division of Simon & Schuster Inc., New York, New York, 1990.

Henry Ford’s Lean Vision: Enduring Principles from the First Ford Motor Plant, by William A. Levinson, published by Productivity Press, 444 Park Avenue South, Suite 604, New York, New York, 2003.

NOTES:

1Henry Ford’s Lean Vision: Enduring Principles from the First Ford Motor Plant, by William A. Levinson, published by Productivity Press, 444 Park Avenue South, Suite 604, New York, New York, page 292.

2The Competitive Advantage of Nations, by Michael E. Porter, published by The Free Press, a Division of Simon & Schuster Inc., New York, New York, page 243.

3Ibid., The Competitive Advantage of Nations, by Michael E. Porter, pages 244-245.

4Ibid., The Competitive Advantage of Nations, by Michael E. Porter, pages 244-245.

5Ibid., The Competitive Advantage of Nations, by Michael E. Porter, pages 244-245.

6Ibid., The Competitive Advantage of Nations, by Michael E. Porter, page 246.

7Ibid., The Competitive Advantage of Nations, by Michael E. Porter, page 246.

8Ibid., The Competitive Advantage of Nations, by Michael E. Porter, page 247.

9Ibid., The Competitive Advantage of Nations, by Michael E. Porter, page 253.

Larry A. Bauman, Ph.D., CMC, CLSFM

Dr. Bauman specializes in the service industries providing executive coaching, leadership development, change management, strategy definition, and training. He has over 32 years of experience in business serving as a corporate executive and consultant. He has worked with a diverse client base in both the domestic and international market.

He currently serves on the Chicago IMC Board of Directors as Immediate Past-President and holds the designation of CMC, Certified Management Consultant.

He has written numerous articles and four books on strategy and leadership. Dr. Bauman is certified and licensed for the web-enabled planning diagnostic One Page Planning and Performance System™ and Behavioral Assessment Instruments from TTI,Inc. and CPP, Inc. He serves as a visiting professor and teaches Strategic Business Management at several universities throughout the world.

He can be contacted at:

Phoenix Business Consulting, Inc.

18888 N. Woodale Trail

P.O. Box 6268

Lindenhurst, IL 60046 USA

TEL: 800-655-0422

TEL: 847-265-3779

FAX: 847-265-3780

E-Mail: Larry@bauman.biz

URL: http://www.coaching-stop-n-shop.com

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