MANAGING ORGANIZATIONS

Session 15 & 16: Interorganizational Relationships & Organizational Forms for the Future

PGP 2010-12 Section B Term 1:June-September 2010

Sourav Mukherji Associate Professor of Organization & Strategy Indian Institute of Management Bangalore, India

CONDITIONS FOR OUTSOURCING

Modularity and standardization of outputs
Tasks which have clearly defined output parameters (e.g., engineering goods) are easier to outsource than tasks that are characterized by performance ambiguity (R&D , brand building). Self contained modules are easier to outsource, even if they are knowledge intensive a characteristic of the overall architecture

Drawing and enforcing contracts Possibility of opportunistic behavior Conditions of uncertainty

Market relationships are premised on contracts. There are costs associated with searching for the right set of partners, negotiating terms of contracts with them and then being in a position for enforcing terms of the contracts, in case of breaches Overall system can suffer from shocks and collapse if buyers / suppliers behave opportunistically. This might happen due to uneven bargaining power asset specific investment inadequate safeguards against information spillover Pure market contracts fail to anticipate complications of uncertainty and are often difficult to implement under such conditions

Organizational hierarchies are often suitable to overcome the above problems

Organizations get formed when markets fail

S Mukherji

A NEW WAVE IS SWEEPING ACROSS THE BUSINESS WORLD

Bharti Televentures has outsourced its network management to Ericsson & IT management to IBM

Kingfisher Airlines has outsourced its ground handling facilities to Indian Airlines

Hindustan Levers have outsourced its human resource management to Accenture

S Mukherji

WHY IS EVERYBODY THINKING ABOUT OUTSOURCING ?

Outsourcing leverages the benefits of specialization Not about core versus non-core Not only about cost reduction

Outsourcing today is about value maximization Enabled by widespread availability of information and information technology Possible to separate the physical flow of resources from flow of information

S Mukherji

FOUR STRATEGIC REASONS FOR OUTSOURCING

Cost Minimization Accessing superior competencies and privileged assets Superior resource leverage Risk diversification

While these are collectively exhaustive, they are not mutually exclusive

S Mukherji

COST EFFICIENCY CAN ARISE FROM VARIOUS SOURCES

Moving beyond arbitrage

Cost Minimization Accessing superior competencies and privileged assets Superior resource leverage Risk diversification

Manufacturers derive scale economies by demand aggregation Services derive better utilization by demand aggregation Specialization and greater scale enabling innovation and automation, which finally leads to greater efficiency

Superior value at competitive prices Challenges of managing scale, variety and developing superior processes

S Mukherji

ACCESS RESOURCES THAT ARE DIFFICULT OR UNECONOMICAL TO BUILD

Cost Minimization Accessing superior competencies and privileged assets Superior resource leverage Risk diversification

Complementary assets take time to build. Such time cannot be afforded when time to market is critical - pharmaceutical distribution network Privileged assets are difficult to create - airport ground handling facilities Certain competencies are required only for a short duration. Owning them results in loss of flexibility - strategy consulting

Many of these command a price premium rather than being available at low cost

S Mukherji

LEVERAGE RESOURCES TO MAXIMIZE VALUE ADDITION

Review of activities within each function to determine which among them are

Cost Minimization Accessing superior competencies and privileged assets Superior resource leverage Risk diversification
- transaction intensive, non specific to organization, have scale economies - specific to organization A specialized player might be in a better position to do certain activities within the function. Therefore, ideal for outsourcing. Organization resources are better leveraged to focus on activities which are specific to the organization

Not a matter of core versus non-core but determining where is it that the organization can add value

S Mukherji

PORTFOLIO OF CLIENTS TO MINIMIZE DEMAND VOLATILITY

Outsourcer maintains a portfolio of clients whose demand profiles are uncorrelated with one another Transfer resources from one client project to another depending on demand Possible only if skills are fungible Application in people intensive service business - critical driver of scale

Cost Minimization Accessing superior competencies and privileged assets Superior resource leverage Risk diversification

Minimizes risks arising out of demand volatility that the client would not have been able to do on their own

S Mukherji

OUTSOURCING HAS ITS COSTS AND RISKS

Application of transaction cost theory to build a decision framework
Transaction specific investments create potential for opportunistic behaviour leading to an increase in negotiated prices Costs of searching, drawing, negotiating end enforcing contracts Costs get escalated when there is business uncertainty Risks of knowledge spillover and divulgement of sensitive information, often tacit and complex in nature Disruptive effect of supply shocks on business, where contractual compensation might not be a sufficient safeguard
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Other related organizational costs

Strategic risks

Transaction costs Production cost within organization Production cost of market

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What are some of the deterrents of opportunistic behaviour ? Do markets always fail when there are small numbers and need for transaction specific investments ? Can there be an economic rational for trust ?

S Mukherji

TO CONFESS OR NOT TO CONFESS

The Prisoners Dilemma: An illustration Confess X confession: 0 or 5 years X not confession: 2 or 10 years Individual strategy implies confession 2,2 10,0 If Y thinks similarly, he will also confess End result: 5 years each Does not confess

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0,10

5,5

X
Does not confess

Confess

Alliance strategy: 2 years each Based on trust , risky Cost of betrayal high (10 years) Most suitable for long run

Opportunism in an economic transaction may be curbed keeping long term interests in mind
S Mukherji

THERE IS NEED TO OVERCOME MINDSETS, BUILD SKILLSETS

Strategic risks are sometimes core rigidities Activities that are sensitive or comprise proprietary information are also being outsourced - strategy consulting - research and development Activities are outsourced even when there are small numbers and transaction specific investments - reputation capital as an effective safeguard Novel skill sets of outsourcing business Contracting skills Evolving norms and rules that protect client confidential information Communicating value, setting expectations Managing without owning, controlling without hierarchy Governance mechanisms

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S Mukherji

OUTSOURCING LIFES TOUGH AND MUNDANE TASKS

Illustrative examples of Personal Process Outsourcing
Offers a pool of assistants in India whom people could call or email to ask for help Outsource tasks that can be accomplished over phone or email is relatively short period of time ~ 20 minutes Doctors appointment, restaurant reservation, travel arrangement A lady outsourced breaking off a relationship

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Users wishing to outsource onerous or unpalatable tasks post them on the web and invite bids 50,000 users after 1.5 years of existence

A man sought bidders to clean his ears and found someone highly qualified
S Mukherji

Source: News item from AFP, appearing in Hindu, 29th June 2008