Understanding outsourcing

Ian McCarthy explores the hidden implications of third-party contracts.

While politicians and economic leaders continue to speak to the virtues or pitfalls of outsourcing by companies and countries, the resulting benefit or lack thereof accrue to organizations on a case by case basis – hinging on information, resources and skills – according to two new research papers from Beedie School of Business professor Ian McCarthy.

The articles – published in a special issue on outsourcing in the journal Production Planning and Control – come at a time when outsourcing has emerged as a global economic and political issue. US President Barack Obama spoke to it earlier this year in his second inauguration address, while the Financial Times in a recent headline maintained that the “outsourcing tide is not likely to turn.”

Outsourcing, defined as “an agreement in which one company contracts out a part of their existing internal activity to another company”, has become a growing business practice over the past two decades, and a growing theme for business research.

“No longer do business leaders obsess with creating large organizations that try to undertake all value adding activities and own as much of the supply chain as possible,” said McCarthy, Canada Research Chair and Area Coordinator, Technology and Operations Management at SFU’s Beedie School of Business.

The first research paper, entitled “Understanding outsourcing contexts through information asymmetry and capability fit”, and published as the lead paper in the journal, was authored by McCarthy, fellow Beedie professor Jan Kietzmann, and University of Winnipeg professor Bruno Silvestre.

McCarthy and his colleagues explain how two outsourcing challenges impact the design, control and measurement of outsourcing practices: information symmetry, which is defined as the lack of perfect information about others’ needs and offerings; and capability fit, which is the extent to which suppliers can satisfy buyers needs in terms of resources and skills.

In order to clarify the interplay between these two outsourcing challenges and the resulting implications for firms, the researchers proposed the concept of “outsourcing context” – a way to describe how variations in information asymmetry and capability fit combine to affect outsourcing.

Of four outcomes described in their framework, an optimal scenario for firms who outsource is having high capability fit and low information asymmetry – a combination where “outsourcing will be operationally fit with good performance that is enhanced by enlightening and developing behaviours due to high levels of trust, transparency and collaboration between both parties.”

Understanding the effects of outsourcing: unpacking the total factor productivity variable

Meanwhile, in the second published paper, McCarthy and University of Sheffield colleagues Ben Kitcher, Sam Turner and Keith Ridgway suggest that contrary to common practice, cost is only one factor that should be taken into consideration when companies decide whether to outsource.

“Cost is easy to quantify,” says McCarthy, “but what isn’t known are the indirect variables such as expertise, social issues, knowledge and problem-solving associated with the decision.”

In their paper, “Understanding the effects of outsourcing: unpacking the total factor productivity variable”, the researchers assigned quantitative measurements to qualitative total factor productivity (TFP) variables in the environment surrounding the business decision.

Previously, empirical studies analysing outsourcing focused on simple but easily quantifiable input/output, with mixed results; it was difficult to determine whether outsourcing was good or bad. Simplistic measurements didn’t reveal anything more than the numbers, ignoring unquantifiable factors unique to a company such as management or training.

“Do you really want to ignore these variables simply because they are difficult to measure?” asks McCarthy. “Imagine a company selling a low quality item. It’s easy to measure the defective items and returns, but not so easy to calculate loss of reputation, customers and credibility.”

Using an illustrative outsourcing example, the authors unpack the TFP as the third factor in the Cobb-Douglas productivity function, an economics production function used to represent the technological relationship between the amounts of two or more inputs and the amount of output produced. By doing so, the researchers were able to quantify the existing qualitative factors to create a suitable framework for making decisions.

“Good managers intuitively have a sense, where alarm bells go off in their heads when faced with certain situations,” says McCarthy, pointing out that through gut instinct they react to potential risks as diverse as location, social factors, environmental issues and safety.

Although he admits the unpacking model proposed is still imperfect and imprecise, it can aid better decision making with an appreciation of the short- and long-term impact to a company. “Unpacking the TFP is a way to understand the true cost of outsourcing beyond simple costs or benefits,” he says.

All of the articles in the recent special issue of the journal Production Planning and Control break new ground in that they further advance understanding of the challenges and responses needed for attaining improved outcomes for outsourcing.

“As outsourcing will continue to be important to both managers and researchers, it is our hope that the research in this special issue and the identified research avenues inform teaching and practice and help guide and motivate future research on the challenges of designing, controlling and measuring outsourcing practices,” said McCarthy.