The Disadvantages of Outsourcing in an Operations Management Project

If the goal of outsourcing is to gain a competitive advantage in the marketplace, operations managers need to seriously weigh the outsourcing option. For some businesses, sharing intellectual property with partners is basically an invitation for trouble. This trouble, often referred to as an outsourcing trap, can manifest itself in a number of ways:

  • Creating your own competitor: If you outsource enough of the parts of your product to suppliers, another firm may be able to buy those parts (or ones very similar) and put them together to create a competitive product. This happened most notoriously in the U.S. television industry in the 1960s and 1970s.

  • Disconnecting with the customer: This is more of an issue with services than manufacturing. If a supplier is dealing with your customers, you may have a problem. The supplier’s personnel are representing your firm to the customer. They are effectively the face of your company! And those personnel may not have the same investment in your firm’s success that your own personnel do. (Witness this with call centers!)

    Another problem is that suppliers may subtly try to steer your customers to deal directly with their own business.

  • Experiencing leakage: The supplier who works for you also works for a number of other firms. Anything the supplier learns from you can be leaked to their other customers so that they can improve their products. This is true of suppliers in all regions of the world, but regions that traditionally provide less intellectual property protection (patents, trade secrets, and so on) pose a greater risk.

  • Forgetting your capabilities: Some firms successfully outsource all or part of the manufacturing of their products. Over time, when technology changes or people who understand the technology move on to other jobs, two problems emerge.

    One, you may not be able to specify to the supplier exactly what you want, so you may end up with a product or component that isn’t as well adapted to your needs as it could be. The other issue is that you’ll have less information on what the product or component should cost. This weakens your negotiating position with the supplier.

    One way to get around this problem is to design and produce a small percentage of the components in-house, while outsourcing the remainder. What you produce in-house may be relatively expensive on a per-unit basis, but by improving your knowledge of component level design and manufacturing, you may improve your bargaining position enough to make in-house component production worthwhile.

  • Getting taken hostage by your supplier: If you outsource a key component to your supplier and divest yourself of the means to make it, you may create a problem. If no one else makes it (or, worse, knows how to make it), then you become dependent on your supplier. Losing the leverage that comes with the option of taking your business elsewhere can become expensive.

    Outsourcing to multiple suppliers may help, but this too can get expensive because of managerial overhead.

    Related to hostage-taking (but a bit different) is depending on only one supplier (known as sole-sourcing). It is good practice to develop a second source for critical or high-cost parts. This fosters competition and holds costs down. It also minimizes problems if the supplier goes out of business or is disrupted by earthquakes or other natural disasters.

Another downside to outsourcing centers is linkage costs, which are the costs to administer an outsourcing relationship that you wouldn’t need to spend in-house. These costs can be very high, averaging as much as 60 percent of the expected savings from an outsourcing relationship. Because linkage costs can actually overwhelm any projected savings, some companies determine that bringing outsourced work back in-house is less expensive.

Here are some common types of linkage costs:

  • Co-location: Many firms send one or two of their employees to be present at the supplier plant to facilitate communication or vice versa. Such co-location usually costs much more than just the salaries of the employees involved — you need to consider housing and relocation expenses. You may also have to pay a premium to induce your employees to work offshore if an offshoring relationship is involved.

  • Logistics: If you ship components very far from the supplier to your firm, you incur significant logistics costs. You also experience a significant delay. Shipping components by sea to the United States from Asia takes several weeks. In contrast, air shipping is fast, but it’s very expensive for large components.

    In one case a company had to use air shipping so often to expedite orders that it burned up all its savings from outsourcing to an Asian supplier. Because most companies today run with very lean inventories, they don’t have a buffer against any disruption of the supply chain connecting the supplier to their firm.

  • Management: For various reasons, the number of potential miscommunications and disagreements increases in an outsourcing situation, which can be very expensive. Specialized managers can reduce these costs, but the managers themselves are expensive.

  • Secure data transfer: You don’t want your data to leak to other firms that may use it against you. Securing your data necessitates the use of appropriate software and training employees at both your firm and the supplier to use the software properly.

  • Telecommunications: You can significantly improve virtual conferences with appropriate virtual meeting software. The software, however, isn’t cheap.

  • Travel: Because most outsourcing involves suppliers at some geographical distance from your firm, your employees have to do a lot of traveling between your firm and the supplier. Virtual meetings can only do so much.

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