International Outsourcing: A current Analysis
Alex Sharland Ph.D.
Alex Sharland Ph.D., Barry University, Miami Shores, FL 33161, 305/899-3525.
Larry Giunipero CPM, Ph.D.
Larry Giunipero CPM, Ph.D., Florida State University, Tallahassee, FL 32306, 904/644-8224.
79th Annual International Conference Proceedings - 1994 - Atlanta, GA
The study investigates the influence of three competing influences in international outsourcing; a) the characteristics of the sourced components, b) the transactions costs associated with supply contracts, and c) the competitive advantage of the product in the finished goods market. The data is collected from purchasing agents and tested using regression analysis. The findings indicate that a) the characteristics of the component have little effect on contractual arrangements, b) asset specificity has a weak influence on the negotiation process, c) uncertainty has a weak influence on the period of the contract, d) the quality of the finished product has the strongest effect (of all the variables included in the study) on the contractual arrangements, and e) the outcome variables of Cooperation, Trust, and Satisfaction are closely correlated. The implications of these findings are two-fold. First, it seems that purchasing managers should be less concerned with protecting transaction-specific assets than with protecting the firm's output in the finished goods market. Second, in order to achieve the above suggestion, purchasing agents should coordinate sourcing decisions with not only the production/manufacturing departments, but with sales and marketing too, in order to ensure that the final positioning strategy is supported by components procured from external suppliers.
The role of procurement within firms has become substantially more important in the last decade. The increasing importance is the result of several forces at work both within the firm and in the marketplace. Managers at all levels pay closer attention to the design process and to production costs. The rising costs associated with the above two areas have forced many firms to expand outsourcing as a means of increasing efficiency. Furthermore, customers in both the consumer and industrial goods market are more aware of the availability of alternative suppliers and demand higher levels of quality at equivalent or lower prices. Consequently, in response to market forces many companies have involved their suppliers to help achieve cost savings and improvements in quality. Being competitive today requires finding low cost, high quality suppliers, not only in one's own country, but also by pursuing a low cost worldwide sourcing strategy. For instance, Heinz Corporation's 1993 Annual Report states one of two ways to meet cost goals is through worldwide sourcing programs.
Even though international outsourcing can achieve significant gains in purchase costs and component quality, it can also lead to substantial management problems and expense in terms of scheduling, coordination, and quality control. Therefore, many senior managers seek guidance about when to use international or domestic suppliers and when to focus on internal improvements.
This paper presents the results of a survey that attempts to address the above issues. A questionnaire was sent to purchasing agents that source internationally. The items on the survey focus on:
- internal costs
- management control
- organization costs
- finished product market issues
The following sections of this paper discuss the practical, conceptual, and empirical issues that apply in the area. The results present an interesting picture of the driving concerns in the area of international outsourcing.
International outsourcing has been cited as a way to lower component costs, operating costs, and organizational costs while achieving higher quality. Previous studies have attempted to isolate important reasons to engage in international outsourcing. One school of thought suggests that international outsourcing is a means of achieving lower organizational costs (Williamson 1975, 1985). That is, when component production is sourced externally, the overall cost of being in business is lower than if production were achieved in-house. This approach is often called "Transactions Costs Analysis". As far as this group is concerned, the primary reason for external (including international) sourcing is to achieve a more efficient organizational structure.
A second perspective suggests that international outsourcing is really a response to finished product market concerns (Day and Wensley 1983 & 1987; Porter 1980 & 1985). This group claims that when a firm adopts or engages in international outsourcing it is really trying to achieve or develop a competitive advantage. Therefore, in this scenario, the firm is not driven by efficiency concerns (as in the case of Transactions Cost Analysis) but by competitive concerns, such as market share and competitive positioning.
Monczka and Giunipero (1990) cite multiple reasons/benefits from offshore sourcing, including 1) cost/price benefits, 2) stimulating competition, 3) assuring supply, 4) obtaining technology, 5) higher quality, 6) access to new markets, and 7) make or buy alternatives. These approaches stand in marked contrast to the traditional approach that claims international outsourcing is merely driven by a desire to achieve the lowest unit cost for that particular component. This last approach is out-dated because the procurement function now has a much more sophisticated relationship with the design, manufacturing, and marketing functions of the firm. If outsourcing was just a desire to achieve the lowest unit cost, then it would not be necessary to include the procurement function in so many aspects of the firm's operations.
The above discussion is an attempt to identify the primary variable in a firm's decision to engage in international outsourcing. From a more practical perspective, senior managers generally acknowledge the existence and influence of a number of forces. Purchasing managers are more interested in determining the most appropriate and strategically advantageous use of international or domestic outsourcing. This has been complicated by a marked increase in the number of long-term sourcing relationships. Long-term relationships provide a measure of security against market uncertainty, but conversely reduce the options of a firm in sourcing components. Managers seek a means of assessing the best way to approach international outsourcing both in terms of whether to use foreign suppliers and whether to use long-term or short-term contracts.
It appears that academics and practitioners have different perspectives on the international outsourcing arena. Academics seek to explain the influence of particular variables. Practitioners want to know how each variable is likely to affect his/her business, and whether international sourcing is a viable, secure, and practical solution to the existing business problems. The current survey develops an information base that can help answer both sets of questions. The results section presents statistics that address each issue in turn.
THE RESEARCH STUDY
The results of this research are based on 193 usable responses from NAPM members. When survey research is used in a particular area of business there are always problems concerning validity and reliability. One specific concern stems from the expertise of the respondent. If a respondent is not really knowledgeable about the area under consideration then the data collected is useless. This survey was sent to NAPM members working for firms in SIC codes 34, 35, 36, and 37, covering metal goods production, machinery production, electrical and electronic machinery and transportation machinery. These are areas of manufacturing that often utilize external suppliers and, consequently, the purchasing managers from whom responses were received often have to deal with international outsourcing problems.
A second concern revolves around the generalizability of the results. In addition, if the respondents have different characteristics from the rest of that business segment, conclusions may not be generally applicable. In this study, 193 responses were obtained which is more than sufficient for analysis concerns. Tests of the characteristics of respondents suggests that any conclusions drawn can be applied across the whole business area.
Key variables were measured based on past studies to determine the impact on international outsourcing. The four major groups were:
- Organizational Efficiency Variables:
- Asset Specificity (e.g. capital equipment versus component parts)
- Volume Unpredictability
- Technological Unpredictability
- Performance Ambiguity
- Competitive Advantage Variables
- Price Advantage
- Quality Advantage
- Technology Advantage
- International Sourcing Contract Variables
- Contract Time Period
- Contract Payment Method
- Contract Negotiation Process
Regression analysis was used to examine the correlation between the variables. The larger the correlation (in terms of strength of association) the more likely it is that the variable has a strong effect on management decisions regarding international outsourcing.
Effect of the characteristics of the component on the sourcing arrangements: The variables included in the study were the price/cost of the component, the extent to which the component could be easily substituted, and the relative value of that component compared to all other components in the finished product. None of these variables was a significant factor in the sourcing arrangements.
Effect of the organization costs on the sourcing arrangements: The variables in the analysis were asset specificity and the uncertainty as listed above. Asset specificity was found to have a weak, positive correlation with the negotiation process that is used to establish the sourcing arrangements. Both Volume and Technological Unpredictability (dimensions of uncertainty) were found to have weak correlations on the Contract Time Period. Performance Ambiguity was found to have a weak correlation with the Payment Method used in the contract arrangements.
Effect of the finished goods market variables on the sourcing arrangements: The price competitiveness of the finished product was found to have no significant correlations with the sourcing dimensions. The quality of the finished product was found to have a mild correlation with the contract period and the negotiation process. The technological competitiveness of the finished product was found to have a weak correlation with the time period of the sourcing contract.
Interaction of Satisfaction, Cooperation and Trust: In addition to the above tests, measures of cooperation, satisfaction and trust were included in the survey. The correlation among these outcome variables was very strong. Cooperation and Trust are exceptionally highly correlated, and Satisfaction is strongly correlated to the other two.
The above results have implications for the senior managers and the purchasing managers within a firm. For the purchasing managers, it seems that focussing on the characteristics of the product (that is, trying to find the lowest cost supplier) is not really important. Furthermore, trying to protect assets that are committed to one supply relationship is not as important as some researchers have claimed. The most important relationship found in this study was that between quality in the finished goods market and the sourcing arrangements (time period and negotiation process). This relationship suggests that purchasing managers should coordinate more closely with the design, manufacturing, and marketing managers to make sure that all components meet the actual requirements in the finished goods market.
For senior mangers the implications are equally simple. The costs associated with organizing the firm are less of a problem than has been claimed in some research (Williamson 1975 & 1985). Senior managers should focus more on customer issues than on the problems associated with organization costs.
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