Outsourcing

Supply Chain
Strategy
Session- 6
DR. SASWATI
IIFT (KOLKATA)

CONTENT

STRUCTURE

Importance & Benefits of Outsourcing

Make versus Buy: The Strategic Approach
Identifying Core Processes
Business Process Route
Product Architecture Route

Market versus Hierarchy: The Economic

Perspective

The Make-versus-buy Continuum

Sourcing Strategy: Portfolio Approach

LEARNING

OBJECTIVES

How do firms take make versus buy decisions?

What is the underlying theoretical logic for make versus
buy decisions?

What are the costs and benefits of outsourcing ?

How to select the entities/partners to carry out
outsourced activities?
What should be the nature of relationship with vendor
firms?
Should the relationship be transactional in nature or
should it be a long- term partnership?
How can a firm design its sourcing strategy based on a
purchase portfolio matrix?

SOURCING STRATEGY: PORTFOLIO APPROACH

PURCHASING PORTFOLIO ANALYSIS

Portfolio approach developed by Krajilic classifies items

based on

importance of the item in terms of value of purchase (high versus low)

and associated supply risk in the supply market

High

Bottleneck
Bottleneck products
products

Strategic
Strategic products
products

Monopolistic
Monopolistic market
market
Large
entry
barriers
Large entry barriers

Critical
Critical for
for product
product
Dependence
Dependence on
on supplier
supplier

Ensure Supply
Performance-based
partnership

Performance-based
partnership

Supply risk
Routine
Routine products
products

Low

Large
Large product
product variety
variety

Systems contracting

Leverage
Leverage products
products
Alternative
Alternative sources
sources of
of supply
supply
available
available
Substitution
Substitution possible
possible

Exploit purchasing power

& minimize cost
Competitive bidding

Low

High
Purchasing value

SUPPLY
Supply
Supply
risk
risk
capture
capture
s
s two
two
dimensi
dimensi
ons
ons
Number
of
suppliers
in the
market
Deman
dsupply
gap in
the
supply
market

RISK

If
If suppliers
suppliers
are
are few
few and
and
supply
supply <
<
demand,
demand,
buyer
buyer faces
faces
a
a supply
supply
risk.
risk.

Items
Items with
with
many
many
players
players and
and
surplus
surplus
capacity
capacity fall
fall
under
lowunder lowrisk-supply
risk-supply
category.
category.

Packaging
Packaging
material
material
and
and
transport
transport
service
service
markets
markets
come
come in
in
this
this
category.
category.

Diesel
Diesel
engines,
engines,
diesel
diesel fuel
fuel
systems
systems
and
and
proprietar
proprietar
y
y
technolog
technolog
y
y items
items
with
with few
few
suppliers
suppliers
represent
represent
high-riskhigh-risksupply
supply
category.
category.

Bosch
Bosch
with
with 81%
81%
market
market
share
share in
in
fuelfuelinjection
injection
equipme
equipme
nt
nt
market
market
comes
comes
under
under
the
the highhighrisk
risk
category.
category.

REPRESENTATIVE DATA IN
PURCHASE PORTFOLIO MATRIX
High

Pur. vol. 5 - 8%
% of parts 10
15%
(Bottleneck
Products)

Supply
risk

Pur. vol. 15 -25%

% of parts 80-85%

Low

(Routine
Products)

Low

Pur. vol. 35 - 40%

% of parts 2 5%
(Strategic
Products)
Pur. vol. 35 40%
% of parts 2 5%

(Leverage Products)

Purchasing value

High

Focus should be on
aggregating
components into
systems and
sourcing the
systems.

A larger number of
items and suppliers
come in this quarter,
representing a noncritical, low-valued
supply.

ROUTINE PRODUCTS

Firm should
move to system
buying rather
than component
buying.

Focus is on
reduction of
Time saved
number of
here is used to parts and the
focus on
number of
strategic
suppliers
suppliers and
leading to the
bottleneck
reduction of
suppliers..
administrative
and logistics
complexity.

ROUTINE PRODUCTS

LEVERAGE PRODUCTS
This quadrant
consists of highvalue, standard
products.
In these supply
markets, there
are a large
number of
suppliers and
switching costs
are low.
Firms should be
aggressive in their
attempts to
encourage
competitive bidding
in order to leverage
their position.

A firm can reduce

number of suppliers
and focus on
operational-level
integration so that
apart from purchasing
costs inventory an
administrative efforts
can also be reduced.

Most of benefits
obtained by firms
in reverse
auctions have
been in this
category.

STRATEGIC PRODUCTS
This
This quadrant
quadrant
represents
represents highhigh- value
value
products
products with
with high
high
supply
supply risks.
risks.
Top
Top management
management of
of firms
firms
should
should get
get actively
actively
involved
involved in
in devising
devising a
a
strategy
for
this
category
strategy for this category
of
of items.
items.

Because
Because fewer
fewer parts
parts and
and
suppliers
are
involved,
suppliers are involved, firms
firms
can
can invest
invest in
in building
building
collaborative
collaborative relationships
relationships..

This
This quadrant
quadrant usually
usually
accounts
for
<
5%
accounts for < 5% of
of items
items
and
~
40%
of
purchase
and ~ 40% of purchase
value.
value.

Items
Items in
in this
this quadrant
quadrant are
are treated
treated as
as
strategic
strategic items,
items, and
and a
a firm
firm must
must work
work
towards
towards establishing
establishing collaborative,
collaborative,
long-term
relationships
long-term relationships with
with
suppliers
in
the
quadrant.
suppliers in the quadrant.

Firms
Firms must
must create
create
opportunities
for
opportunities for mutual
mutual cost
cost
reduction
by
working
together
reduction by working together
on
on all
all aspects,
aspects, including
including
product
design.
product design.

BOTTLENECK PRODUCTS
These items represent relatively
low value, but a firm is vulnerable
on this front because of the supply
risk inherent in this market.

Focus on
long-term
contracts or
by carrying
stock (or
both)

Here, the focus is on

securing supply, and
a firm should actively
keep looking at
alternative sources of
supply.

Since a firm is
likely to be
buying
relatively
smaller value,
it is unlikely
to have much
clout with
suppliers.

PURCHASE PORTFOLIO
MATRIX
Firm
Firm should
should
look
look at
at
substitutes
substitutes
that
that are
are from
from
low-risk
supply
low-risk supply
markets.
markets.
If
If required,
required, firm
firm
should
be
ready
should be ready to
to
pay
pay a
a premium
premium for
for
a
a reliable
reliable source
source of
of
supply.
supply.

Some
Some steel
steel producers
producers produce
produce
certain
grades
certain grades of
of steel
steel only
only
once
in
a
year.
If
an
interested
once in a year. If an interested
firm
firm knew
knew of
of their
their internal
internal
processes,
it
might
processes, it might be
be in
in
better
position
to
obtain
better position to obtain
reliable
reliable supply.
supply.

In
In diesel
diesel fuel
fuel
system,
system, there
there may
may
not
be
too
many
not be too many
suppliers
suppliers of
of
required
required
capability
capability and
and
competence.
competence.

A
A firm
firm might
might try
try and
and
develop
a
better
develop a better
understanding
understanding of
of supplier
supplier
priorities
and
their
priorities and their planning
planning
systems
so
that
it
can
systems so that it can align
align
its
its buying
buying plan
plan with
with
suppliers
suppliers operating
operating plans.
plans.

PURCHASE PORTFOLIO
MATRIX
In the analysis, firms seem to focus on items involved in direct purchases
or those that affect the cost of goods sold.

But firms buy a huge quantity of indirect goods ands services, such as
travel, advertising, IT and human resources.

In USA, direct purchases account for 47 percent of firms expenses and

indirect purchases 24 percent.
Firms like American Express and Chase Manhattan Bank managed to
reduce costs by 10-15 percent in their purchase of indirect goods and
services.
Ideas of portfolio analysis are equally applicable for indirect purchases.
Typically they are handled by marketing, human resources and IT
departments, who do not have the necessary skills of sourcing and end
up paying premium prices without getting anything substantial in return
in terms of higher services.

RECONFIGURATION OF SUPPLY
BASE
Most Indian companies work with a large
number of vendors.

Purchasing managers preferred to have as

many suppliers as possible.
Toyota Kirloskar has just one strategic
supplier of logistics services with whom it
has a collaborative relationship.
Firms may not opt for single sourcing, but
they have to work on reconfiguring their
supply base as to reduce the number of
suppliers.
Reconfiguration involves two ideas
move to system buying
Reduce the number of suppliers per item/

RECONFIGURATION
BASE
80 percent of
items
constitute 20
percent of
value.
Firms should
buy systems
and modules
rather than
individual
components.
GM buys seat parts from
25 odd suppliers, while
Nissan buy the complete
seat from a supplier.

OF

SUPPLY

Auto assemblers, globally, have

minimized their coordination
costs by moving to
system/module buying, which
requires a pyramid-shaped
supply structure.

Difference between coordination

costs involved in procuring car
seats at GM and at Nissan is
significant

Nissans supplier is a first-tier

supplier who in turn buys subsystems from second-tier companies,
who in turn depend on third-tier
companies.

AN EXAMPLE OF A THREE TIER SYSTEM

A) TRADITIONAL STRUCTURE
SUPPLIERS
(a)

Supplier 1

B) TIERING IN

Auto
assembler

Supplier 2

(b
Tier I)

Supplier 3

Supplier 25

Auto
assembler

..
Seat System
Tier II

Seat
Seat
Seat
Seat
..
subsubsubsubsystem
system
system
system
Tier
III
1
2
3
25
Compone

nt supplier
1

Compone
nt supplier
2

Component
supplier 3

Compone
nt supplier
25

III TIER SUPPLY SYSTEM

Auto assemblers
work closely with
tier I suppliers who
are responsible for
design and delivery
of complete
modules like seats,
doors, dash boards
etc.

These system
suppliers buy their
own sub-systems
from tier II
suppliers, who in
turn buy individual
items from tier III
suppliers.

By working only
with tier I
suppliers, a firm
can

reduce
coordination
costs.

work on various
initiatives to
improve material
and information
flow across the
chain.

EXAMPLE
VENDOR RATIONALIZATION BY MARUTI UDYOG LIMITED
Maruti Udyog Limited(MUL) - leader of Indian automobile
industry
Under pressure to bring down costs

Started vendor rationalization programme

Slashed number of vendors from 350 to 220

Built a set of technically capable and financially sound vendors
to match its standards
In India, Toyota works with less
Mahindra & Mahindra has more

than
than

100 suppliers while

1,000 suppliers.

INTEGRATIVE FRAMEWORK OF MAKE VS

BUY
To resolve the make versus buy issue , a firm has to look
at the benefits as well as the costs involved in market
exchange.
Costs related to economies of scale, agency costs and
transactions
have been integrated
in the following
Given
the scalecosts
of
- Presence of
Extent of
framework :
internal
relationshipscontrol and
operations, how
important are the
differential
economies of
scale between
internal
operations
compared to
supplier
Additional cost
due to lower
economies of
scale in internal
supply

coordinatio
n problems
in making
part inhouse

Agency
cost of
internal
control and
coordinatio
n

specific assets
- Extent of
coordination
problems with
external supplier
- Possibility of
leakage of strategic
information

<

Transactio
n cost of
market
exchange

Make
Yes

No
Buy

MARKET VS.
HIERARCHY
Cost Due to Lower
Economies of Scale

MARKET VS. HIERARCHY

Make vs. buy decision is also known as market versus
hierarchy decision in economics literature.
Aim is to provide a bundle of goods and services at lower
cost for a given level of service required by customer.
In-house production should have economy of scale.
Firms that specialize in production of input can usually
achieve higher economies of scale vis a-vis vertically
integrated firms.
A vertically integrated firm produces only for its internal
needs, while an external supplier firm can aggregate
demands of many potential buyers and, thereby, enjoy huge
economies of scale.
Economies of scale can be achieved in manufacturing or
logistics activities..

ECONOMIES OF SCALE

Four major sources of

economies of scale:
Higher volume allows a firm
to spread its fixed cost over
a larger volume of operations
Higher volume allows a firm
to choose more efficient
technologies
Pooling of buffer capacities
and inventories
Learning curve effect

OUTSOURCING
In electronics industry, a bulk
of manufacturing has shifted to
electronics manufacturing
service providers like
Flextronics, Solectron and
Celestica.
Indo Nissin Foods Ltd.,
manufacturer of Top
Ramen Noodles,
outsourced its
distribution operations
to Marico.

Similarly, transport
and warehousing
firms are roped in
for logistics
operations.

IT operations are
outsourced to firms like
IBM and Wipro, which
have strong economies
of scale.

OUTSOURCING VS.
INTERNAL
PRODUCTION
A firm with large volumes and a reasonably stable
demand, internal manufacturing yields better
economics.

Marginal benefit of a buy decision starts coming

down if a firm has large volumes of operation.
multi-product firm may benefit from vertically
integrated operations.
Third parties will offer services at a lower cost,
provided there is enough competition in supply
market.
If there are not enough suppliers, then supplier may
use its monopolistic power and may not pass on
benefits of scale to customers.

MARKET VS.
HIERARCHY
AGENCY COST

MARKET VS. HIERARCHY

-INTERNAL CONTROL - AGENCY
COST
Bharti used to manage customer billing operations
through its internal IT department.

How to ensure that interest of IT dept and

marketing dept are aligned?

How to ensure that IT dept is putting its best

effort and not slackening?

This issue is known as agency problem

INTERNAL CONTROL - AGENCY

COST
IT dept is known as agent and marketing dept as
principal.
A firm with its own fleet of trucks faces a similar
problem of motivating transport dept, where internal
transport dept is agent and marketing dept is
principal.
In a hierarchical firm, there may not be enough
motivation for internal supplier to work on
innovations to reduce costs and improve service.

Cost involved in control and coordination of internal

supply is termed agency cost.

SBU CONCEPT IMPROVED

PERFORMANCE MEASURES
Managers and workers of
internal supply units
often do not act in the
best interests of the
firms.

Firm, as a whole, incurs

agency costs associated
with in- house supply.

In-house divisions within

a firm are usually treated
as cost centres and are
usually insulated from
competitive pressures.

SBU CONCEPT IMPROVED

PERFORMANCE MEASURES
Large firms, with
common overheads
allocated to different
units, finds it difficult
to measure individual
divisions contributions
to overall profitability.

Top management cant

evaluate current
performance and
compare with best
achievable one in
absence of market
competition along with
problems involved in
measuring divisional
performance.

Each division should

work as Strategic
Business Unit (SBU)
with own profitability
that can be aligned
with overall corporate
profitability.

MARKET VS.
HIERARCHYTRANSACTION
COST

MARKET VS. HIERARCHY

Make vs. buy decision market versus hierarchy decision
Decision of a firm to buy certain component from outside
independent firm, allows it to use market mechanisms to
procure necessary inputs .
Firm can take advantage of economics of scale and also

choose the supplier that supplies goods and services at

lower prices.

The supplier has enough motivation to innovate and the

firm, as a buyer, has the flexibility of changing the supplier,
which is not an option available to the firm that chooses to
make inputs internally.
Costs incurred in the control and
supplier are termed as

coordination of the external

transaction costs.

 Search and information Costs

Costs involved in locating and evaluating right
supplier
Bargaining and contracting costs
A Firm has to frst negotiate terms of exchange and
fnally prepare contract with agreed terms and
conditions.
Policing and enforcement costs
A frm has to constantly monitor suppliers to ensure
that supplier sticks to terms and conditions of the
contract.
Bharti has put in elaborate mechanisms for
monitoring the Service Level Agreements (SLA) with
IBM and Ericsson.

Transaction
costs comprise
of the
following:

Cost incurred because of loss of control

Underinvestment in relationship-specifc assets may
increase cost for buyers.
There is also risk of leakage of strategic information
that will hurt buyer frm in the long run.
Enforcing a perfect contract may avoid costs
incurred of loss of control.

TRANSACTION

COST

INCOMPLETE CONTRACTS

Inability to write
a complete
contract results
in a significant
increase in cost.
Includes
following
situations:

Presence of
relationship-specifc
asset
Poor coordination
affecting supply
chain performance
Leakage of strategic
information resulting in
adverse supply chain
performance

RELATIONSHIP SPECIFIC
ASSETS
Maruti Suzuki has asked
several of its suppliers to
locate either finishing
operations or stock points
close to its Gurgaon plant..

Mahindra & Mahindra , while

developing Scorpio, deciding
that they will ask vendors to
invest in the necessary tools
and moulds..
Toyota Kirloskar asked its
supplier to modify its
equipment so as to produce
a narrow range of grade of
output to suit buyers
requirements.

Bharti wanted
Ericsson to build
network capacity
on the basis of
its demand
projections.
Microsoft asked
its contract
manufacturers to
build additional
capacity in
anticipation of
huge success of
Xbox 360.

RELATION SPECIFIC ASSETS

In all these cases, a firm wants its supplier to invest in
physical or human capital assets (relation-specific
assets) so that it can improve its supply chain
performance.
The supplier will not be able to use these specialized
assets if the firm decides to change its supplier.
These investments make supplier vulnerable.
This is known as the hold-up problem.
Because of the possibility of hold-up, suppliers prefer to
make as little investments as possible in relationshipspecific assets.
Additional costs incurred by firm because of lack of
investments in relationship-specific assets by supplier
are captured in transaction costs.

RELATION SPECIFIC ASSETS

A relationship-specific
asset is an investment
made to support a given
transaction.

involve either
physical assets or
human capital.

known as
relationship-specific
assets, as they
cannot be
redeployed for other
customers without
any significant costs.

POOR COORDINATION
Because of differences in objectives and priorities, coordination on
all occasions is not guaranteed between buyers and suppliers.
Coke and Pepsi realized that they need to coordinate retailing
activities, traditionally handled by the local bottlers. They took
greater control over bottling plants and in some markets they
decided to even own the bottling plants.
While implementing computerized supply chain planning system,
Marico found it will not benefit if dealers do not implement the
same system. It got a buy-in from all the dealers for participation
in its system.
Bharti, an established market leader in innovations, could not
launch EDGE (enhanced data rate for global evolution) service
ahead of its competitors. Reason - Outsourced network operations
slowed down Bhartis speed of response due to poor coordination ..
Additional costs incurred by a firm because of poor coordination
contribute to transaction costs of market exchange

LEAKAGE OF STRATEGIC INFORMATION

If outsourcing
agency
extend
services to
more than
one
competitive
firms,
strategic and
sensitive
information of
one firm may
get leaked to
other.

It may
relate to
product
design or
customer
informatio
n or future
plans.

In such a
case, this
problem
can be
avoided by
making the
input
internally.

E.g., selection
of dyes and
designs for
new products
is regarded as
critical
information,
so Benetton
keeps dyeing
operations
within the
firm.

INCOMPLETE CONTRACTS
In a world of
complete
contracts, all
the three
issues can be
taken care of.

Relationshipspecific asset
Poor
coordination
Leakage of
strategic
information

But in a
world of
incomplete
contracts,
all these
issues
contribute
to
transactio
ns costs of
market
exchange.

If the
transactio
ns costs
are
substantia
lly high,
firm is
better off
by
bringing
the
activity inhouse.

INTEGRATIVE FRAMEWORK OF MAKE VS

BUY
To resolve the make versus buy issue , a firm has to look at
the benefits as well as the costs involved in market
exchange.
Costs related to economies of scale, agency costs and
transactions
costs have been integrated
in the framework
Given the scale of
- Presence of
Extent of
given
below:
internal
relationships-specific
operations, how
important are the
differential
economies of
scale between
internal
operations
compared to
supplier

Additional
cost due to
lower
economies
of scale in
internal
supply

control and
coordination
problems in
making part
in-house

assets
- Extent of
coordination problems
with external supplier
- Possibility of leakage
of strategic
information

Make
Yes

Agency
cost of
internal
control
and
coordinati
on

<

Transactio
n cost of
market
exchange

No
Buy

MAKE OR BUY
Capturing the true value of agency and transaction costs
requires a deep understanding of business.

Though

most garment frms outsource manufacturing

operations, Zara Corporation, a leading European garment
company, decided to keep bulk of its manufacturing facilities
within the frm.

Benetton decided to increase internal manufacturing capacities

for a quick response to market trends.

If
Costs due to poor economies of scale + agency costs of
internal control + coordination (MAKE) < transaction
costs of market exchange (BUY)
Then
the firm should settle for the make option, else the firm

MAKE VS. BUY CONTINUUM

Two extreme
positions

make an input or
buy an input
using the market
vertical integration
versus market,
where buyer has an
armslength
relationship with
suppliers..

MAKE VS. BUY CONTINUUM

exchange can be
organized in several
alternative ways;
two important
alternatives-

Tapered
integration, where
a firm both makes
and buys a given
input.
Collaborative relationship,
which could be a formal
contractual relation or a
long term informal
relationship, based on trust can lead to alliances or joint
ventures.

TAPERED

INTEGRATION
Tapered
Tapered integration
integration represents
represents a
a mixture
mixture of
of
market
market and
and vertical
vertical integration.
integration.
A
A firm
firm makes
makes part
part of
of requirement
requirement in-house
in-house and
and
procures
rest
from
market.
procures rest from market.
Firms
like
Pizza
Firms like Pizza Corner
Corner and
and Madura
Madura Garments
Garments fall
fall in
in
this
category,
wherein
they
own
some
outlets
and
this category, wherein they own some outlets and
depend
depend on
on franchisee
franchisee for
for the
the rest.
rest.
In-house
In-house manufacturing
manufacturing improves
improves understanding
understanding of
of
industry
cost
structures
that
helps
in
negotiating
industry cost structures that helps in negotiating
better
better deals
deals with
with suppliers.
suppliers.
Firms
Firms are
are able
able to
to keep
keep up
up the
the pressure
pressure on
on their
their
internal
supply
group
to
innovate
and
work
on
internal supply group to innovate and work on cost
cost
reductions
reductions by
by showing
showing them
them benchmark
benchmark numbers
numbers
from
from markets.
markets.
Suppliers
Suppliers are
are always
always on
on their
their toes
toes to
to perform
perform else
else
their
part
of
manufacturing
will
be
shifted
intheir part of manufacturing will be shifted inhouse.
house.
Tapered
Tapered integration,
integration, if
if not
not managed
managed properly,
properly, might
might
end
up
getting
the
worst
of
the
worlds.
end up getting the worst of the worlds.
By
By distributing
distributing production
production between
between internal
internal and
and
external
supply
groups
,
a
firm
may
not
have
external supply groups , a firm may not have
economies
economies of
of scale
scale at
at both
both places.
places.

TOYOTA: IN-SOURCING OF
ELECTRONICS PARTS

Denso was
sole supplier
for Toyota for
all electrical
and
electronics
parts till 1988.

Toyota recognized
that electronics
was going to play
an important part
in automobile
manufacturing.

Toyota opened
its own
electronics
manufacturing
facility in
1988.

TOYOTA: IN-SOURCING OF
ELECTRONICS PARTS

Today ~ 30%
of the total
vehicle
content is
related to
electronics.

Share of
electronics
in cars and
technologies
are
advancing
very fast.

Toyota identified
electronics as a
core and
strategic
function and
decided to
master it so that
it can manage
its suppliers
effectively.

They still
depend a lot on
Denso for
supply, but
they have
consciously
built design
and
manufacturing
capability
within the firm.

AIRTEL TAPERED INTEGRATION

Airtel shifts
bulk of its call
centres to
external firms.

But retains
support centres
for strategic
customers
internally so
that it does not
to face
coordination or
communication
issues with its
important
patrons.

COLLABORATIVE RELATIONSHIP
Firm
treats its
suppliers
as
strategic
partners.

Firm does
not indulge
in
competitiv
e bidding
every year.

Supplier is
assured of
business
for a
reasonably
long
period of
time.

Price paid
to
supplier
is based
on the
actual
costs
incurred.

Supplier
gets
involved
early at
the
product
design
stage.

Supplier is
encouraged
to invest in
relationship
-specific
assets.

COLLABORATIVE RELATIONSHIP
Major
concern is
to ensure
supplier
keeps
working
on
innovation
s.

Assured
business
may result
in
complacenc
y on part of
the
supplier.

Only if supplier
maintains leadership
on both these fronts
does Dell continue
with same partner.

Firms should
periodically
benchmark
partners
costs with
market so as
to ensure that
supplier
remains
competitive.
Dell Computers
bench marks all
its partners on
cost and
technology
leadership.

COLLABORATIVE
RELATIONSHIP
Firms like Toyota buy 80 percent of the required
components from the market.
Japanese manufacturers work with a network of
suppliers and maintain close longterm relationships.
This network, known as KEIRETSU, involves vendors,
bankers and distributors.
Firms within a keiretsu are linked by informal personal
relationships.
They do not worry about information asymmetry and
holdup problems.
This allows each firm within keiretsu to focus on its core
competence.
All get necessary economies of scale.

SUMMARY
Since outsourcing is a strategic decision, firms must look at long-term supply
costs and risks.

Paradigm
shift
Firms can identify core activities from a strategic perspective either through business
process route or by product architecture route.

When a firm decides to outsource some core process/sub-systems, it must keep necessary
architecture knowledge in-house.
Now,
Now, frms
frms want
want to
to

be
be
virtual
corporations
virtual corporations
Traditionally,
Traditionally, frms
frms start
start
where
where they
they start
start with
with
with
with assumption
assumption that
that
assumption
that
activity
assumption that activity
everything
everything to
to be
be done
done
must
be
must
be outsourced
outsourced
A firm must look at benefits
as well as costs
involved
in their
make
versus buy
internally
there
is
internally unless
unless
there
is
unless
there
decisions.
unless there is
is a
a
a
a compelling
compelling logic
logic for
for
compelling
logic
that
compelling logic that
outsourcing
outsourcing an
an activity.
activity.
justifes
justifes keeping
keeping ininhouse.
house.

If additional costs are due to poor economies of scale plus agency costs of market exchange, firm
should opt for make.

SUMMARY
Pure make and pure buy are
two extreme ends of the
make versus buy continuum.
Collaboration partnership can
effectively manage
outsourced relationships.

Purchase portfolio classifes

items based on the
importance of the item in
terms of purchase value and
supply risk.
Firms should reconfgure their
supply base using internet
and e-commerce.

routine items, leverage items,

strategic items and bottleneck
items

Purchase portfolio matrix is

one popular approach for
classifying items into four
categories:

DISCUSSION QUESTIONS
Bharti has entered into a 10-year contract with
IBM for IT services while its network
management contract with Ericsson is of 3 years
duration only. What factors determine such
differences in contract lengths?
Why do you think Wal-Mart owns a fleet of trucks,
though most retailers do not?
You supply steering wheels to Mahindra &
Mahindra for their existing products. Mahindra
approaches you to develop and supply steering
wheels for its product, the Logan. It wants you to
invest in the necessary tools required for the
same and this will involve substantial
investment. What can Mahindra do to reduce
transaction costs in this arrangement?

DISCUSSION QUESTIONS
Indo Nissin Food Ltd has outsourced its
distribution to Marico. How is this
decision likely to be affected in the
following situations?
Indo Nissin increases its size of
operations
Indo Nissin enters the premium
products market
Indo Nissin wants to enter rural
markets.