Outsourcing: Cooperation Strategies
The majority of manufacturing companies would not even think of having strategies without resorting to outsourcing and offshoring – this has, in a way, become a fashionable trend – that is, relocating a share of production work to outside contractors in countries where the cost of resources is lower. Western companies simply cannot afford to miss such a golden opportunity to find cheap labour for software development in developing countries, especially when this labour source is so close by.
However, the purpose of outsourcing is slightly different. Behind each programme, initiative or project which is relocated to another country, there is a whole package of solutions which includes a selection of models suitable for the individual needs of the business in question.
Selecting a suitable offshoring model is the key aspect of any company's outsourcing strategy. This process includes such aspects as: an examination of the international business strategy, country selection, examination of the prospects for and development of the outsourcing strategy. There are currently three models which enjoy the greatest popularity in business circles, these are: joint venture, affiliate company and outsourcing.
Joint venture suggests merging with a local company or firm by means of acquiring an equal share or the creation of an independent company into which each of the parties (henceforth) invests its resources. The purpose of such ventures usually lies in concluding a deal where both organisations will be able to benefit from each others strengths. By converting the competitive advantages and strengths of the local partner into profit, the customer company can minimise certain risks connected with internationalisation. At the same time, the local party may benefit from its partnership with a stronger and more powerful company and from the opportunity to gradually increase its market value.
Companies may decide to completely abandon the joint venture model and deal directly with an affiliate or local company if the management finds it more convenient to conduct their everyday internationalisation activities and operations on the local market level.
An affiliate company acts as an independent business subsidiary in charge of executing projects and programmes. The way an affiliate company is run is similar to running projects and programmes according to the global development centre (GDC) model which is based on the provision of software-related services and on offshore companies.
The term “outsourcing” comes from the English term “outside resource using”. With regard to international business practice, it is used to define the sequence of organisational solutions, the essence of which lies in transferring functions which were previously independently performed by the external company – the executor or provider of the services. The term “outsourcing” was introduced as such with the purpose of referring to the new concept in 1989 when the Eastman Kodak Company hired outside companies for purchasing, launching and supporting its information-processing systems.
Outsourcing is often described as “the phenomenon of the XX century” since it was in the late 80s that this notion became firmly rooted in business practice and became widespread. The first experience in the history of outsourcing would probably be the services of legal firms in the United States and the United Kingdom. The origins of practical industrial outsourcing stem from the period of the “great confrontation” between the two great managers – Henry Ford (1863–1947) and Alfred Sloan-Jr (1875–1966) of the giant enterprises of the automobile industry – Ford and General Motors. Their competitive struggle proved that in the conditions of tough market competition no single company can be sufficient and independent when relying solely on its own resources. Research conducted by the American Management Association has shown that as early as by 1997 over half of industrial companies used outsourcing with regard to at least one component of their production process.
The United States is leading the way in the consumption of outsourcing services on the world market. According to 2001 data, the US accounted for 36% of all outsourcing services while Western Europe accounted for 29% and Japan for 13%. The percentage of US companies transferring a share of their functions to outsourcers amounted to 86% in 2002 as compared with 52% in 1992. There are also growing tendencies for the enlargement of the European outsourcing services market. According to analysts’ estimates, the last quarter of 2004 saw more outsourcing-related contracts being concluded in Europe than in any other period since 2000. As leading consultants remark: “the need to reduce the costs forces European companies to overcome their reluctance to entrust part of their business to sub-contractors.”
The development of the Russian software outsourcing services market is directly linked to the integration of Russia's economy into the global economy. Up to 70% of Russian enterprises resort to outsourcing services to some degree or other. These are most often cases of IT-outsourcing: supporting accounting and stock control, servicing computer and office equipment and local networks. However, at the same time we are observing the development of the outsourcing market for business processes, human resources, transport and logistics services, servicing the industrial infrastructure and certain types of industrial services. The practice of outsourcing is successfully employed at such major Russian enterprises as Severstal, United Machine-Building Plants, Leningrad Experimental Mechanical Union, Sayanogorsk Aluminium Smelter, Volgograd Tractor Factory, Gorky Automobile Factory, Joint Stock Companies NizhneFarm and Ferein. Outsourcing undoubtedly creates interesting opportunities for leading foreign manufacturers who decide to open their company branches in Russia. It is ideal when the company wants to emphasise its presence on the market yet without running significant risks. It thus becomes clear that the demand for outsourcing services in Russia is growing rapidly.
Advantages and Types of Outsourcing
Both the joint venture model and the affiliate company model of offshoring may demand serious obligations on the part of the customer which the management, particularly in more traditional companies, may not be prepared to undertake. In order to exclude the risks with which this model is fraught and capitalise on the profit from offshoring companies, it is often popular to outsource projects. Outsourcing in the field of service provision is yet another offshoring model. It embraces a wide range of projects, from short-term contracts to contracts that envisage years of cooperation and cost millions of dollars. Here are some of the most popular forms of outsourcing:
Onsite Subcontracting with Offshoring. This is probably the simplest type of outsourcing when the company places its experienced staff directly at the customer’s disposal. These people practically become part of the customer's team. This model is also called “personnel increase”. The majority of foreign outsourcing companies started life by providing software services and continue to provide project support. This outsourcing model is best for small businesses and companies that have both partnership relations with the customer and a means of hiring personnel.
Pure Offshore Projects. This model includes tasks which are clearly defined and the work may be executed by independent subdivisions which are located at a considerable distance from each other. Some examples of such outsourcing are: projects relegated to smaller organisations, private persons and freelancers all over the world by means of the internet. This model of offshoring is less widespread and is usually used when the level of development of software components or units is relatively low. This unit can also be adapted for the needs of innovation organisations which aim to capitalise on foreign assets which are immobile.
Offshoring Individual Projects. Organisations which employ a well-defined outsourcing programme minimise their own risks by dividing the entire bulk of work into more or less easily-managed projects which are then delegated to the executing organisations. Managers from customer organisations which have clearly defined units and programs intended for further development pass them on to outsourcers.
Global Delivery Onsite/Offshore Model. This is a classical offshoring model offered by the majority of software providers. The essence of this model lies in a group of software engineers taking the customer's projects, modules or programs and creating a small “in-house” team which works with the customer's managers and staff to coordinate work with the offshore company that is in charge of the main bulk of the work. This is the most advanced stage of customer project offshoring. For the outsourcer-organisation this is a step towards further profit, for the customer-organisation this service helps create added value because their staff do not have to manage day-to-day tasks. To a significant extent the executors concentrate on managing relations and programs, assuring that the seller fulfils their undertaken obligations.
Multi-vendor Offshoring (Multisourcing). We have been examining offshoring models that deal with the relations between the customer and one executor. However, in reality the customer may cooperate with many outsourcers working on the project. Organisations aim at minimizing the level of risk entailed by the implementation of outsourcing strategies by creating a list of preferred executors from which custom projects and managers will be able to choose and receive work.
Basis for Offshoring
Offshoring must be regarded as a complex strategic solution for lowering software development cost. Organisations spend a considerable amount of time developing the strategy and defining the model which will suit the specific needs of their business. The models described above are but a few of those widely practised. In the West, when analysing the arguments for and against implementing various outsourcing models, many companies choose to create a mixed model, adjusting the existing models to the needs of their business. Many major service providers offer their customers mixed options and sometimes describe the transfer from one model to another, adjusting it depending on how quickly the client grasps the essence of offshoring.
In order to assess whether offshoring is of benefit to the company it is important to analyse the situation at multiple levels:
Interior Processes Level. Sometimes it is enough to change the existing production technology to make it more effective than the hypothetical capacities in developing countries.
Structural Level. When switching to a “cheaper” region, it is sometimes more profitable not to transfer the entire production facility but simply the least complicated processes which do not require the adjustment of complicated technological processes or special qualifications and skills on the part of staff.
System Level. Sometimes it is easier to arrange an effective production system, i.e. correctly arrange production operations not in a developing country but in Western Europe.
Production Level. Unemployment creates significant limitations in work pay and labour conditions in developing countries in comparison with developed countries. However, even in the latter the labour unions have recently become more open to negotiations than a few years ago. For the sake of keeping the production facilities in the country, they are prepared to agree to significant concessions with regard to length of the working day, number of non-working days, plans for staff cuts etc. The optimal solution will also depend on the answers to the following questions concerning production processes and techniques:
- Are they registered (patented)?
- Are these the company's key competencies?
- Are they widely available on traditional markets?
- Are they more capital-intensive than labour intensive?
- Do they depend on corporate know-how?
The more negative answers we receive to these questions, the higher the chance that the software development facilities may be easily transferred offshore.