05 June 2002

Want to outsource? Hold your horses . . .

Pressured by shareholders and Wall Street looking for quick bottom-line fixes, many corporate executives believe they have found the answer: Outsource anything that's not a "core competency."

However, a new study shows a quick outsourcing fix that's not well thought out could cut off a business's future.

"Executives need to think hard about what they are outsourcing," said Michael Leiblein, coauthor of an in-depth outsourcing study and assistant professor of management and human resources at Ohio State University's Fisher College of Business.

According to Dun & Bradstreet's "Barometer of Global Outsourcing," worldwide outsourcing expenditures should top $1 trillion by 2000.

Leiblein and Frederic Dalsace from INSEAD, a French graduate business school, studied 176 global semiconductor companies. They identified characteristics that predicted whether firms improved their technological performance-or lost it-after outsourcing computer chip manufacturing to outside companies.

While their study focused on semiconductor firms, Leiblein said the general results should apply to other technology-related industries as well. "I don't have empirical evidence, but we have a robust theory and a framework that suggests when [businesses] need to make an internal investment" and avoid outsourcing, Leiblein said.

"In the business press, many articles describe outsourcing as a panacea for the high fixed costs and complexity of today's business world. However, this approach is misleading," he said. "We identified the specific circumstances where outsourcing was successful for semiconductor firms. We believe that these circumstances may help managers in a variety of industries better understand when they can succeed with outsourcing and when it will be harmful."

For starters, "you need to know the critical characteristics of the end product and production process, how to reliably measure your suppliers' performance in terms of these characteristics, and be able to predict how the suppliers' process will interact with other elements of your engineering and production system," he said.

For example, he said, if a firm's product requires state of the art process technology, or a great deal of customization in the manufacturing process, "it would be difficult to use a supplier," Leiblein said.

"If it's a commodity product, it's a good candidate for outsourcing," Leiblein said. On the other hand, "if it is cost dependent, complex, requires a significant amount of technical language to coordinate between design and engineering, if you don't know where the project is going, and it's subject to 'surprises,' there is a need to make an investment internally."

The study, which will appear in an upcoming issue of the Strategic Management Journal, challenges the wisdom of outsourcing whatever the CEO or other executives arbitrarily decide is not a core competency.

"They need to think about what they mean by 'core competency,' " the Ohio State educator said. "If they sit back and say, 'That's something that requires a lot of judgment,' they'll figure out that's something we should do inside the firm."

In their study, the two researchers focused on situations where semiconductor firms worldwide outsourced-or chose not to outsource-production of a variety of semiconductor chips. Semiconductor company executives are often pressured by Wall Street and others to focus on what's perceived to be their core competency, designing chips, and encouraged to outsource manufacturing to other companies, regardless of a product's characteristics.

Firms need to be particularly careful about outsourcing when there is a great deal of uncertainty about future product demand, Leiblein said. "If the environment changes after you've invested time qualifying a supplier-providing them with details of your product and so forth-your supplier will likely have the upper hand in any renegotiations." For example, "if there is a great increase in demand, a partner might behave opportunistically."

Leiblein emphasized he was not opposed to outsourcing. "There's no one answer" on when to outsource and when not to outsource, he said. "You have to outsource when it is appropriate. Whenever there is a specific investment, you want to internalize it. You want to outsource commodities that don't require a lot of investment."

-Jim Strothman