OUTSOURCING AND MAKE OR BUY DECISIONS NOTES

3.1 Introduction

Many chief executives consider the make-or-buy decision to be among the
most critical and most difficult confronting their organizations. Not
only are billions of dollars needlessly wasted if the wrong decision is
made, but scarce management resources frequently are stretched past the
breaking point. Outsourcing is a term being used in relation to services
such as accounting, maintenance, security, promotion, stocking
and the like. The basic issues are the same concerning the question of
doing it yourself or contracting with an independent outside the buying
firm. The strategic issue requires the firm to identify its core
competencies-the things that differentiate it and make it viable. If an
item or service at or near the heart of the firm’s core competencies is
to be outsourced, it should only be supplied by a carefully selected
supplier under a tightly woven strategic alliance.

Top management has the ultimate responsibility for make-or-buy
decisions. In most cases, this responsibility can be satisfied through
operating procedures that develop and pool all relevant information
surrounding a make-or-buy issue. Purchasing is a source of much of this
information. Also, Purchasing frequently should identify candidates for
a make-or-buy analysis.
Five major problems are common in the make-or-buy area namely:

Make-or-buy decisions are made at too low a level in the organization.
Not all factors are considered when conducting a make-or-buy analysis.
Decisions are not reviewed on a periodic basis. Circumstances change!
The estimates underlying the cost of making are less objective and
accurate than the purchase facts.
Members of the buying company assume they
know more than the supplier about the material or service.

3.2 Make or buy issues

The Strategic issues
“What kind of an organization do we want to be?” This issue is the
first, and perhaps most critical, to be addressed. Pride or purely
emotional reasoning plays a major part in many decisions. Pride in
Self-sufficiency can become a dominant factor that can lead to many
problems. While self sufficiency in some areas is desirable or even
necessary, it is impossible for even a large firm to become entirely
self-sufficient.
These decisions influence the firms manufacturing operation shape and
capacity by determining;

What product to make
What investments to make in plant and equipment
The framework for short term tactical and component decisions.
Development of new products.

Tactical make or buy decisions
This deal with the issue of temporary imbalance in manufacturing
capacity e.g. changes in demand may make it possible to make everything
in house.
Component make or buy decisions
Made at the design stage, these
decisions have to do with whether a particular component should be made
in – house or is bought.

Costs
Two keys prerequisites are essential to a thorough and sound analysis of
the cost considerations of a make-or-buy decision.

Cost must be segregated between fixed costs and variable or
incremental ones. Such cost figures must include all relevant costs,
both direct and indirect, near term and anticipated changes.
Realistic estimates of in-house production costs must include
expected rejection rates and spoilage. These estimates also should
consider the likely effects of learning resulting from long
production runs.
Accurate and realistic data must be available on the investment
required to make or to buy an item. Frequently, the working capital
required in the manufacture of an item can equal and even exceed the
investment required for facilities and equipment. It is essential to
consider both the facilities and the working capital components of
an investment. Cost factor in make or buy decisions often require
the application of marginal costing and break – even analysis

marginal costing
this is a principle whereby valuable costs are charged to cost units and the fixed costs attributable to the relevant period written off in full against the contributions for that period contribution = purchase price – vc per them

Example;
D.T. Dobic requires 10,000 shock absorbers for the assembly of Nissan
pick ups in Kenya. The company could make this shock absorbers ltd which
sells its shocks at ksh 1560. Only 30% of the fixed costs are
recoverable if the component is bought. The following are the costs that
D.T. Doble would incur should it decide to make the shocks.

In consequences buying instead of making profits would reduce by ksh
1,000,000. (15c – 146). It is therefore advisable to make the shocks.
This decision is made in light of the fact that fied costs of ksh
600,000 would likely continue since the capacity would be unused the
fixed overheads would not be absorbed into production.

opportunity cost
This is the potential benefit that is foregone because one course of
action has been chosen over another. I.e. if the production facilities
used in making the item had been applied to some alternative purpose.
Using the D.T Dobic example, if instead of producing the shocks the
facilities could be used to make suspension springs with a contribution
of ksh 175 each. Should D.T Dobic make the shocks or buy.

example II – break when analysis
What would be the decision points if the price of the shocks were
reduced from 1560 to 1450/=

Using Break even analysis

They would need to produce 12,000 units to break even since the firm
needs 10,000 shocks then they would rather buy.

Example II – opportunity cost
Valuable D.T Dobic makes or buy the shocks

The contribution of the suspension springs reduce of from 175/= to
160/= – 15600000 – 160 000000 – same cost structure this indifference
The price of the shocks reduced from 1560/= to 1450/= with the
contribution of the suspension springs at
They should buy the shocks
They should buy the shocks.

If D.T Dobic buys the shocks and uses the facilities to make suspension
springs the cost structure for both activities will be 13,850,000/=
against a cost structure of 14,000,000 were the firm to make the shocks
instead. Thus in buying the shocks DT Dobic will have made/ earned ksh
150,000 (14,000,000 – 13,850,000)

Learning curves / skill acquisition / experience curve
This a graphical representation of the rate at which skills or knowledge
is acquired is a period of time. The basis of learning curves is that
“skill to do come by doing. I.e. A task is performed more quickly with
each subsequence replication until a point is reached where no further
improvement is possible and performance levels out. The learning curve
theorem states that each time the number of production units is doubled,
the cumulative average lab our hrs per unit’s previous cumulative average.

The learning curve equation is y = a x6
Where y = cumulative average time per unit
X = number of units produced so far
A = time taken to produce the first item
B = log (learning rate)
Log (2)

E.g. if the learning rate to produce shock absorbers is 80% and it
requests 1 day to produce one shock absorber, then to produce 2 shocks
is 1.6 days with a cumulative average of

0.8 days and for 8 shock is 4.10 days with a cumulative average of 0.51
days per shock etc

The graph is then plotted using cumulative average time against units
produced. When components are bought from specialist manufacturers there
may be little opportunity for learning. When items are new the costs of
making and buying may have to be adjusted for the learning factors.

Other considerations in make or buy decisions
Infavour of making

Cost considerations
The major elements of the cost considerations are:

Materials and labour costs
Follow on costs stemming from quality related problem
Incremental inventory carry on costs
Incremental factory overhead costs
Incremental management costs
Incremental purchase costs
Incremental costs of capital

Desire to integrate plant operations
Reproductive use of excess plant capacity to help absorb fixed costs
Need to exert direct control over production and /or quality.
Design secrecy required
Unreliable suppliers

Desire to maintain a stable work force (in periods of low sales )
Potential lead time reduction
Exchange rate risk
Greater purchasing power with bulk purchase of materials.

Quality
When there is a significant difference in quality between items produced
internally and items purchased or when a specified quality cannot be
purchased, then management must consider these quality considerations in
the make-or-buy decision. One argument for making over buying is the
so-called impossibility of finding a supplier capable or willing to
manufacture the item to the desired specifications. But further
investigation should be conducted before this argument can be accepted.

Why are these specifications so much more rigid than those of the rest
of the industry? The Manufacturer should reexamine the specifications
and make every effort to secure the cooperation of potential suppliers
to ensure that the quality specifications are realistic and that no
satisfactory product is available. Frequently, suppliers can suggest
alternatives that are just as dependable if they know the intended
purpose of the item. On the other hand, the firm may desire a level of
quality below that commercially available.
Suppliers may be selling only a quality far above that which would fully
satisfy the need in question and may, at the same time, have so
satisfactory a volume at the higher level as to have no interest in a
lower quality product. If this is the case, the user may be justified in
manufacturing the item.

Frequently, it is claimed that in-house production may better satisfy
manufacturing’s quality requirements. The user of an item usually better
understands the operational intricacies involved in the item’s use. With
a make decision, a better degree of coordination will probably exist
between those responsible for producing the item and those responsible
for assembling it. Communications
between the two groups are facilitated compared with the situation in
which the item is furnished by an outside supplier. If the firm has a
weak purchasing department, such assumptions may be true. But with a
professional purchasing operation, the flow of information and
coordination between purchaser and supplier should result in no more
problems than between two production
activities of the same firm.

Since quality must be controlled in either the purchased or manufactured
items, a competent quality assurance staff and a TQM (total quality
management) program must be employed. The purchase order may state that
the purchaser’s quality assurance inspectors have access to the
supplier’s manufacturing, inspection, and shipping departments. Thus,
the purchaser can maintain significant control and still not incur the
additional cost resulting from manufacturing the item.

Quantity
One of the most frequent reasons for making over buying is that a
requirement may be too small to interest suppliers. Small volume
requirements of unique, nonstandard items may be difficult to purchase.
The firm may feel that it is forced to make such items; however, it may
be economically imprudent to do so. The costs of planning, tooling,
setup, and purchase of required raw materials
may be exorbitant. It may be far more cost effective to purchase the
required item in larger quantities or to identify a suitable substitute.

If a large quantity of an item is required on a repetitive basis, then
the analysis described in the Cost section should be made. The company
should have a high degree of confidence that its requirements for the
item will continue to the point that it receives a satisfactory ROI
before deciding to make such an item.

Frequently a firm will follow a conscious policy of making an item at a
level of production sufficient to meet its minimum requirements and
purchase additional items as required. This policy builds a degree of
stability into the firm’s production activities and provides accurate
comparative cost data. Such a policy should be adopted only after
investigating the willingness and ability of
suppliers to fill such fluctuating demand.

Service
Service often is defined simply as reliable delivery. In a broader
sense, it includes a wide variety of intangible factors that lead to
greater satisfaction on the part of the purchasing firm. This
consideration must be judged fairly and the purchasing firm must not be
given undue credit with ] respect to service simply for emotional
reasons. Merely because the item is produced in-house is
not proof that service will be superior to that of a supplier. Assurance
of supply is a primary service consideration. When the lack of an item
causes serious problems, such as total production stoppage, and totally
reliable suppliers are not available, the decision to make rather than
buy may be justified.

When a purchaser is faced with a monopolistic environment, the service
accompanying the product is generally somewhat poorer than in a highly
competitive market. Such a situation may induce the would-be purchaser
to make the product. If an item is used as a subcomponent on a product
the purchaser is selling and is causing the entire product to be
unreliable, the resulting loss of goodwill
and sales may be significant enough to justify a make decision, even
though the cost analysis does not support such a decision.

Specialized Knowledge
Frequently, a supplier possesses specialized knowledge, abilities, and
production know-how that would be very expensive to duplicate. Suppliers
may have a large R&D budget leading to improved and/or less expensive
products. The protection of innovation achieved by the supplier is a
critical aspect of trust, that is, the buyer must not under any
condition give this innovation to a supplier’s competitor or use the
technology were it to make the item.

Design or Production Process Secrecy
Occasionally, a firm decides to manufacture a certain part because
additional industrial security can be provided, especially when the item
is a key part for which a patent would not provide adequate protection.
This justification must be used with caution, however, as the firm can
provide very little protection against design infringement after sale.
In short, if a patent will not protect a certain part, then in-house
manufacturing may not either. Frequently, a firm may have developed a
unique or proprietary production process. Such circumstances may support
a decision to make over buying.

Urgent Requirements
The firm usually can purchase a small quantity much more readily than
were it to produce the item. If the requirement is urgent, such as to
preclude stopping an assembly line, the payment of a higher price to buy
the item is justified.

Labor Problems
The production of any new item may require labor skills that the company
does not possess. The hiring, cross-training, and upgrading of personnel
may be a troublesome and complex process, especially if a union is
involved. The company may be entering a field in which it has no
experience and no adequately trained personnel. Labor problems are
easily shifted to someone else, namely, the supplier, through a decision
to buy. The presence of unions within the company also may be a
significant factor. Unions often have
clauses in their contract prohibiting the purchasing of items that can
be manufactured within the plant. The history of labor problems in the
supplier’s company also may influence the make-or-buy decision.

Plant Capacity
Obviously the more significant the item in question is relative to the
company’s size, the greater the probability that the item will be
purchased rather than produced in house. When the item would require a
significant investment, the smaller company has no rational decision
other than to buy. Generally the more mature company will try to
integrate items currently purchased into its production more often than
will a new company. The new company understandably concentrates on
increasing output and has very little excess capital or plant capacity
to divert to production of components. Quite the opposite is true for
the more mature company. Such a firm tends to have extra facilities,
capital, and personnel and, therefore, is in a better position to
increase profit by producing what was formerly purchased. Excess plant
capacity and the likely duration of the excess capacity should always be
considered in the make-or buy decision as should additional expenses
such as tooling, setup, and training.

Capital Equipment
Manufacturers sometimes find it necessary to make a needed item, simply
because a suitable supplier does not exist. This is most frequently the
case with highly specialized manufacturing equipment.

Use of Idle Resources
A make decision can prove profitable to a firm even when suitable
supplies are available. In periods of1 recession or business slumps, a
firm is faced with the problem of idle plant equipment, labor, and
management. By making a product that it may have been buying, a firm can
put its idle machinery to work, retain skilled employees, and spread its
overhead costs over a larger volume of production.

Perhaps the biggest benefits obtained from a make decision during a
slump are in the area of labor relations. Employee morale can be
maintained and layoff penalty costs can be avoided by timely use of the
make decision. Even in times of recession, most firms find it desirable
to retain highly skilled production personnel. These personnel can be
kept at work and a stable workforce maintained by a decision to make.
The long-run benefits from good labor relations are obvious. Great
caution must be taken when basing a make decision primarily on temporary
idle resources. Make decisions tend to be permanent. A decision to make
temporarily an item under such circumstances should be reviewed when
demand increases.

3.3 Make and Buy
Some firms make and buy critical nonstandard items to ensure that a
reliable second source is available in case of difficulty with the
supplier. Such a policy also provides data that are useful in reviewing
internal production and management efficiency.

Making the Decision
Make-or-buy decisions can have a critical effect on the economic health
of a firm, even on its survival. Frequently, these decisions are made at
too low a level in the organization. On many occasions, no conscious
decision appears to have been made. Things just happen! The decision to
make is often weaker than the decision to buy because buy costs are
known whereas make costs are estimates.
Obviously, the amount of time and effort and the level of managerial
attention appropriate are functions of the amount of money involved and
the criticality of the item to the firm’s well-being. Normally several
departments should be interested and involved in make-or-buy decisions:

Production, Purchasing, Engineering, Finance, and Marketing.
Any of the following situations should precipitate a make-or-buy analysis:

New product development and modification. Every major component
should be reviewed.
Unsatisfactory supplier performance. If purchasing is unable to
develop reliable sources for an item, the item should be reviewed
and analyzed to ensure that the specified quantity level is
essential and to ensure that suitable substitutes are not available.
If the item, as specified, passes these reviews, it becomes a
candidate for in-house sourcing.
Changes in sales. Sales demand that exceeds capacity calls for a
make-or buy review of those items produced in house that contribute
the lowest ROI. Declines in sales and production should prompt a
review of candidates for in-house production.
Periodic review of previous decisions. Changing costs and other
considerations can convert a good make-or-buy decision into a bad
one very quickly. Major make-or-buy decisions should be reviewed as
a component of the firm’s annual planning process.

WHAT IS OUTSOURCING

This is the strategic use of resources to perform activities
traditionally handled by international staff and their resources. An
alternative definition is the buying in of components, sub – assemblers
finished products and service from outside suppliers rather than
supplying them internally. It is strategy by which an org outstand. The
term “outsourcing” probably refers to buying materials or components
from suppliers instead of making then in-house. It also refers to buying
materials or components that were previously made in-house. In recent
years, the trend has been moving toward outsourcing combined with the
creation of supply chain relationships, although traditionally firms
preferred the make option by using backward and forward vertical
integration. Backward vertical integration refers to acquiring upstream
suppliers, whereas forward vertical integration refers to acquiring
downstream customers. For example, an end-product manufacturer acquiring
a supplier’s operations that supplied component parts is an example of
backward integration. Acquiring a distributor or other outbound logistic
providers would be an example of forward integration.

Whether to make or buy materials or components is a strategic decision
that can impact an organization’s competitive position. It is obvious
that most organizations buy their MRO and office suppliers rather than
make the items themselves. Similarly, seafood restaurants usually buy
their fresh seafood from fish market. However, the decision on whether
to make or buy technically
advanced engineering parts tat impact the firm’s competitive position is
a complicated one. Traditionally, cost has been the major driver when
making sourcing decisions. However, organizations today focus more on
the strategic impact of the sourcing decision on the firm’s competitive
advantage. Generally, organizations outsourcing noncore activities while
focusing on core competencies.
Finally, the make-or-buy decision is not an exclusive either-or option.
Firms can always choose to make some components or services in-house and
buy the rest from suppliers.

3.5 Reasons for buying or Outsourcing
Organizations buy or outsource materials, components, and/or services
from suppliers for many reasons.

Cost advantage: For many firms, cost is an important reason for
buying or outsourcing, especially for supplies and components that are
nonvital to the organization’s operations and competitive advantage.
This is usually true for standardized or generic supplies and materials
for which suppliers may have the advantage of economies of scale because
they supply the same items to multiple users. In most outsourcing cases,
the quantity needed is to small that it does not justify the investment
in capital equipment to make the item. Some foreign suppliers may also
offer cost advantage because of lower labour and/or materials costs.
Insufficient capacity: A firm may be running at or near capacity,
making it unable to produce the components in-house. This can happen
when demand grows faster than anticipated or when expansion strategies
fail to meet demand. The firm buys parts or components to free up
capacity in the short term to focus on vital operations. Firms may even
subcontract vital components and/or operations under very strict terms
and conditions in order to meet demand. When managed properly,
subcontracting, instead of buying, is a more effective means to expand
short –term capacity because the buying firm can exert better control
over the manufacturing process and other requirements of the component
parts or end products.
Lack of expertise: The firm may not have the necessary technology and
expertise to manufacture the item. Maintaining long term technological
and economical viability for noncore activities may be affecting the
firm’s ability to focus on core competencies. Suppliers may hold the
patent to the process or product in question, thus precluding the make
option, or the firm may not be able to meet environmental and safety
standards to manufacture the item.
Quality: Purchased components may be superior in quality because
suppliers have better technology, process, skilled labor and the
advantage of economies of scale. Suppliers may be investing more in
research and development. Suppliers’ superior quality may help firms
stay on top of product and process technology, especially in
high-technology industries with rapid innovation and short product life
cycles.

An organization also makes its own materials, components, service and/or
equipment in-house for many reasons. Let us briefly review these reasons;

Protect proprietary technology: A major reason for the make option is
to protect proprietary technology. A firm may have developed an
equipment, product, or process that needs to be protected for the sake
of competitive advantage. Firms may choose not to reveal the technology
by asking suppliers to make it, even if it is patent. An advantage of
not revealing the technology is to be able to surprise competitors and
bring new products to market ahead of competition, allowing the firm to
charge a price premium.
No competent supplier: If the component does not exist, or suppliers
do not have the technology or capability to produce it, the firm may
have no choice but to make an item inhouse, at least for the short term.
The firm may use suppliers development strategies to work with a new or
existing supplier to produce the component in the future as a long-term
strategy.
Better quality control: If the firm is capable, the make option
allows for the most direct control over the design, manufacturing
process, labour and other inputs to ensure that high quality components
are built. The firm may be so experienced and efficient in manufacturing
the component that suppliers are unable to meet its exact specifications
and requirements. On the other hand, suppliers may have better
technology and processes to produce better quality components. Thus, the
sourcing option ensuring a higher quality level is a debatable question
and must be investigated thoroughly.
Use existing idle capacity: A short term solution for a firm with
excess idle capacity is to use the excess capacity to make some of its
components. This strategy is valuable for firms that produces seasonal
products. It avoids laying off skilled workers and, when business picks
up, the capacity is readily available to meet the demand.
Control of lead-time, transpiration, and warehousing cost: The make
option provides easier control of lead time and logistical costs since
management controls all phases of the design, manufacturing and delivery
process. Although raw materials may have to be transported, finished
goods can be produced near the point of use, for instance, to minimize
holding cost.

Outsourcing can be described as the transfer of activities, that were
previously conducted in-house, to a third party. Ellram and Billington
(2001) see outsourcing primarily as the transfer of the production of
goods or service that had been performed internally to an external
party. Outsourcing means that the company divests itself of the
resources to fill a particular activity to another company to focus more
effectively on its own competence. The difference with subcontracting is
the divestment of assets, infrastructure, people and competencies.

3.6 Types of outsourcing
There are two different types of outsourcing namely :

turnkey integral and
Partial outsourcing.

Turnkey outsourcing applies when the responsibility for the execution of
the entire function (or activities) lies with the external supplier.
This includes not only the execution of the activities but also the
coordination of these activities. Partial outsourcing refers to the case
in which only a part of an integrated function is outsourced.

3.7 Strategic phase
During the strategic phase three essential questions have to be answered:
The question relates to the objective of the firm with regard to its
intent to outsource a certain activity.
what activities are considered for outsourcing.
what qualifications a supplier should be able to meet in order to
qualify as a potential future partner for providing the activity
concerned must be answered. The decision to outsource should support and
enable the company’s overall strategy. The motives that are cited most are:

Focus on core competence.
Focus on cost efficiency/effectiveness and
Focus on service

This motives and that strategy of the outsourcing company should be
aligned. These three motives and the outsourced activities should
contribute to this strategy. The second question relates to what should
be outsourced. Two important approaches are used to
answer this question;

The transaction cost approach and
The core competence approach.

The transaction cost approach is based on the idea of finding a
governance structure aimed at arriving at the lowest cost possible for
each transaction that is made. Transaction cost is defined as the costs
that are associated with an exchange between two parties.
The assumptions of the transaction costs approach is that an exchange
with an external party is based upon a contract. The (potential) costs
associated with establishing, Monitoring and enforcing the contract, as
well as the costs associated with managing the relationship with the
external party, are all considered to be part of the transaction costs
as well as the costs associated with the
transaction itself. Therefore all of these costs should be taken into
account when deciding between make or buy options.

The level of the transaction costs depends upon three important factors.
These factors are:

frequency of the transaction,
the level of the transaction specific investments and
the external and internal uncertainty.

The frequency of the transaction is an important factor because the more
frequently exchanges occur between partners, the higher the total costs
that are involved. The level of the transaction specific investments
also determines the level of transaction costs, because
transaction-specific investments are investments that are more or less
unique to a specific buyer-supplier relationship. Examples are
investments in specific supplier tooling (such as molds and dies) by a
large automotive manufacturer and the change costs involved when
choosing a new accountant (internal staff need to get accustomed to the
new accountant, the new accountant needs to be thoroughly briefed to get
acquainted with the company etc.). These examples show that investments
are made in assets as well as in human capital. Obviously the higher
these investments are, the higher the transaction cost will be. The last
factor that determines the transaction costs is the external and
internal uncertainty. Uncertainty is a normal parameter in the
decision-making process. It can be
defined as the inability to predict contingencies that may occur. The
higher these uncertainties, the more slack a supplier wants to have in
presenting his proposal and rates, and the more difficult it will be to
make a fixed price or lump sum contract that deals with all
uncertainties beforehand.

Therefore, the higher the level of uncertainty, the higher the
transaction costs will be. The other approach on which an outsourcing
decision can be based is the core competence approach. This theory is
based, among others, on the work of Quinn and Hilmer (1994). The core
competence approach is based on the assumption that, in order to create
a sustainable competitive advantage, a company should concentrate its
resources on a set of core competencies where it can achieve definable
pre-eminence and provide a unique value for customers … (hence it
should) strategically outsource all other activities’ (Quinn and Hilmer,
1994 p43). The important question
to be answered here is what are the firm’s core competence.
Characteristics of core competence are;

Skills or knowledge sets, not products or functions
Flexible, long term platforms that are capable of adaptation
Limited in number; generally two or three
Unique sources of leverage in the value chain
Areas where the company can dominate
Elements important to the customer in the long run
Embedded in the organization’s system

The competencies that satisfy these requirements are the core
competencies and provide the firm with its long-term competitive
advantage. These competencies must be closely protected and are not to
be outsourced. All other activities should be procured from the markets
if these markets are totally reliable and efficient.

Long and Vickers-Koch (1992) distinguish five categories of a firm’s
activities, instead of two categories, core or non-core, (Quinn and
Hilmer 1994). These five categories are;

Cutting edge activities. The activities that determine the
competitiveness of the organization from a long term perspective.
Core activities. The activities that create the foundation and main
process for the organization and its possible competitive advantages.
Support activities. Those activities that are directly connected to
the core competences.
Separate activities. The activities that are part of the main
process, but easily separated from that process and not related to
the core competences.
Peripheral activities. The activities that do not concern the main
process.

Anorld (2000) also makes a further distinction in a firms activities. He
distinguishes between:

Company core activities. Activities that are directly to the core
activities.
Close-core activities. The activities that are directly related to
the core activities.
Core distinct activities. The supporting activities.
Disposable activities. Activities with general availability.

Both studies imply that the outsourcing decision framework based upon
the work of Quinn and Hilmer (1994) needs adjustment. Anold (2000) has
developed a general model for whom the function should be outsourced.
After the decision to outsource has it is essential that the right
supplier is chosen. A suppler has to be selected who has the necessary
technical and managerial capabilities to deliver the expected and
required level of performance. Also the supplier should be able to
understand and be committed to these requirements.

The supplier selection process is key to the success of the
buyer-supplier relationship. Companies that make extensive use of
supplier selection and monitoring practices in supplier partnership seem
to be more successful than the companies. An adequate supplier selection
model is crucial for the success of the outsourcing decision.

Momme and Hvolby (2002) present a four-phase model (figure below). This
model gives guidance on how to identify, evaluate and select outsourcing
candidates and therefore is an appropriate tool to use in the strategic
phase . it also gives a brief guidance for the transition (phase 2 and
3) and the operational phase (phase 4), but needs to be elaborated for
that purpose.

After the strategic phase in which the outsourced activities and
supplier have been identified, the transmission phase starts. The
transition consists of the contract negotiation and the project
execution and transfer. The most important issue in the contract
negotiation in an outsourcing agreement is often the start of a long
term relationship, so not only the contractual issues should be
dealt with but the people issues and the importance of a sound and
cooperative relationship should be covered as well.

The contract is the legal basis for the relationship and is therefore
the key document in the outsourcing process. It allows both
organizations to maximize the rewards of the relationship, while
minimizing the risk. This makes the outsourcing contact key success
factor for the establishment of a strategic outsourcing relationship.

The contract and the type of contract should reflect the business plan
(the goal of the cooperation) the two parties have and should be
seasonable for both parties. Performance management. There are different
types of contracts. The type chosen depends on the characteristics and
the scope of the contract and the functions or activities that are
outsourced. After the transition phase has successfully ended, the
operational phase of the outsourcing process starts. This operational
phase consists of two processes namely:

Managing the relationship and
Contract termination.

Managing the buyer-supplier relationship management is one of the, if
not the critical stage in the outsourcing relationship. Achieving the
goals of the outsourcing relationship is impossible without close
cooperation. When the relationship is not properly managed the
conditions for close cooperation will not be present and the outcome of
the outsourcing relationship will be far from optimal. The true value of
outsourcing comes after the relationship has had time to develop and
additional synergies have emerged. Creating sustaining, long
relationship with a supplier is exciting: it’s where the win-win is
really beginning to show.
Many researchers have written on the characteristics of a successful
buyer-supplier relationship.

The top five include

the factors trust,
flexibility,
team approach,
shared objectives and
open communication.

The factors found by McQuiston to be core to a successful outsourcing
relationship are presented in the table below.

THE PURCHASING AND NEW PRODUCT DEVELOPMENT NOTES

THE PURCHASE DESCRIPTIONS NOTES

THE PROCUREMENT PLAN NOTES

STANDARDIZATIONS AND SIMPLIFICATIONS OF MATERIALS AND COMPONENTS NOTES