Strategic Importance of Outsourcing in U.S. Manufacturing Company
An increase in market competitions, decision to lower production costs and shortened time to market are the driving forces that make a large number of manufacturing companies adopting the outsourcing policy. Outsourcing is the management policy of allowing the third party external providers to take up the activities of non-core activities of an organization to make firms focusing on the core businesses. In the contemporary global business environment, firms are required to produce the innovative products, and developing a new strategy to increase profitability, outsourcing has become a new business technique that firms employ to remain competitive. Thus, outsourcing helps manufacturing companies to lower costs and remain competitive in the fiercely competitive business environment. However, there is an ongoing debate that outsourcing decision can be detrimental to organization business advantage.
The objective of the essay is to explore the benefits and shortcomings of outsourcing for the manufacturing companies.
Benefits and Shortcomings of Outsourcing for Manufacturing Companies
The goal to lower the costs of production is one of the major factors that makes the U.S. manufacturing companies to adopt the policy of outsourcing. Typically, outsourcing assists the manufacturing companies in reducing costs and competing in the global competitive environment. The outsourcing makes firms focusing on core activities because the core functions give them a clear leadership position and deliver greater value to customers at lower costs. Dabhilkar et al. argue that outsourcing high volume of materials to suppliers assist firms to lower the fixed costs because the higher capacity utilization of the machinery and plant space will be reduced. (146). Moreover, the outsourcing decision assists the manufacturing companies to lower the variable costs when entrusting higher volume of materials to a third party. When firms design the same type of materials for different customers, it leads to cheaper costs of sourcing materials. For example, "engineering/design capability for outsourced parts can lead to lower variable costs." (Dabhilkar et al. 146). When a firm outsources a design of large volume of the materials to a third party company, they will be able to reduce the variable costs by enjoying the economies of scale from outsourcing. For example, a company that outsources its operations to low-wage countries will enjoy a reduction in the variable costs.
The outsourcing can also assist firms to gain power over suppliers. Porter argues that pressures from suppliers can make firms increase product prices and lower the quality of the final products. (1). When there are few suppliers in the industry, their bargaining of power will be high compared to the availability of a large number of suppliers forcing the power of suppliers to be relative low. However, when firms have established good relationships with the third party materials providers and have developed expertise in negotiating with suppliers, they will develop capabilities to exert power over suppliers.
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As being pointed out by Dabhilkar et al., the "purchasing capability for outsourced parts can lead to lower variable costs by using buying power to get pre-specified components for several customers at lower cost." (146).
Additionally, manufacturing companies will be able to improve the supplier's relationships because firms-supplier interaction will improve the likelihood of leveraging operating capabilities. For example, firms and suppliers will be able to share the production systems, and plan, and develop a common framework for cost reduction. The strategy will assist in improving delivery performances and product pricing. Outsourcing also assists firms to be more focus on product differentiation to assist in producing superior products. A long time strategic collaboration with the third party company helps firms "to create distinct competence in the market." ( Dabhilkar et al. 147).
Despite the benefits that firms can derive from outsourcing, the decision to outsource can be risky. Rob uses the theory of transaction economics to explain the shortcomings of firms' decision to outsource. According to the transaction costs economics, a firm and third party provider are required to draw a contract agreement to finalize the outsourcing business. During the course of negotiation, one party may possess more information about the contract than other party leading to information asymmetry. The concept of information asymmetry in economics refers a situation where one party in the contract negotiation has more information than the other party. If the third party provider has more information than the firms, the issues lead to uncertainty in demand, moral hazard, asset specificity, and opportunist behaviors. For example, when a vendor possesses more information that the buyer, they will mandate the buyer to entrust specific assets or high-value assets at their disposal. When a firm transfers a high valued asset to the vendor when signing the outsourcing contract, the whole issue becomes risky, which always happens in the outsourcing that involves technical skills.
In the contemporary manufacturing environment, increasing number of manufacturing companies are outsourcing the IT functions to the third party providers. The goal of the IT outsourcing is to use the best competent IT professionals to develop best products. However, the issue of asset specificity can occur during the outsourcing contract where the vendors instruct the firms to transfer their IT assets at their….....
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