New Trends in Organizations Flexibility: Outsourcing

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<ul><li> 1. NEW TRENDS IN ORGANIZATIONAL FLEXIBILITY: OUTSOURCINGFernando Casani Fernndez-Navarrete Mangeles Luque de la Torre Jess Rodrguez PomedaPilar Soria LambnUNIVERSIDAD AUTNOMA DE MADRID Madrid, April 1996 INTRODUCTIONIn recent years, the need for flexibility which has been forced on management by the new competitive environment has given rise to the development and the spread of outsourcing. In spite of its general use, we think that on occasion it has been used incorrectly and to a lesser degree as a simplistic tool for reducing staff. The object of this paper is to have a critical look at outsourcing along the following lines. Firstly, we look at the effect of technological change and of the globalization of markets on the new competitive environment and the reaction of firms adopting a more flexible organizational structure. From this base, we develop the concept of outsourcing and its process of implementation and its treatment in the literature. Our study is a critical analysis of the series of internal and external problems posed by outsourcing in firms which have introduced it but have not up to now taken advantage of its full scope. The final section gives a summary of main conclusions of the paper.1. TECHNOLOGICAL CHANGE AND THE NEW COMPETITIVE ENVIRONMENTTechnological development induces and subsequently is affected by changes in the economic environment. As history has shown, technology is the key factor in the creation or disappearance of a business, as a result of new products replacing older ones, the opening of new markets, and radical changes in production, sales and consumption; in other words, significant changes in the process of added value. Therefore, technological change appears as a social process, whose sphere of influence is as much within the firm (acquisition and development of know-how, learning patterns or management models), as it is on the environment in which its business activities take place (institutional changes which affect market regulation, tangible and intangible public infrastructure, etc.)Presently, technology is changing the competitive environment. It is characterized by two sets of interrelated factors. On the one hand, technological and organizational innovations foster cost reductions in communications and transportation permitting decentralization; while on the other, institutional changes facilitate liberalization of financial and commercial markets (Papaconstantinou, 1993, p.7).Firms try to respond to this complex situation by using a growing ability to adapt. The increase in commercial deregulation places a premium on rapid response to these changes because of greater ease of entry to wider markets and the shorter time frame in which to take advantage of the resulting competitive edge. The outcome is a qualitative change in the manner in which the firm carries out its activities. A consequence is the appearance of new production models based on the interaction of their components, which include the development of differentiated products, anticipated responses to the market, a multi-faceted workforce, and flexible organizational schemes which yield cost reductions while maintaining levels of quality (Boyer, 1995, p.107).In the new competitive environment, flexibility becomes a key factor in defining the strategy and the structure of the organization. The rapid changes in technology and the speed with which new products are introduced into the market force on firms a process of adaptation in order to be able to respond to the strategic moves of their competitors. Therefore, firms must have not only strategic management, but a flexible organizational structure. 1 </li></ul><p> 2. 2.ADAPTATION OF ORGANIZATIONAL STRUCTURESIn this context, the classical organizational structures based on vertical and hierarchical structure are giving way to horizontal organizations, broader and less hierarchical. Generally, it is alleged that the traditional vertical structure slows decision-making and the implementation of processes, while the horizontal structures, with the decision-making process decentralized to inter-functional teams, permit the development of creative forces within the organization, fostering their learning abilities, and, therefore, allowing the firm to better adapt to the new competitive environment, in which organizational learning is becoming ever more important. Nevertheless, as we will show throughout this study, creating horizontal structures does not eliminate the problems of the organizations, but on the contrary, they simply exchanged for others.As a result, smaller, more responsive and more dynamic organizations (learning organizations) arise with staff who assume more responsibility and, therefore, are more committed to the goals of the firm (loyalty). Firms are more customers satisfaction oriented, with special emphasis given to processes rather than functions, focused on the analysis of the value given to the customer by each of the activities.On the other hand, new trends in the organization of the firm tend to blur its limits when developing structures bases on strategic flexibility and on co-operation between competitors, while at the same time continuing to compete in the traditional way in other fields or sectors of activity. Similarly, technology has eroded the barriers to co-operation between firms, by permitting easier co-ordination of the activities of organizations which work together, reducing the transaction costs, especially in customer-supplier relationships (Halal,1994).As a result in some cases, internalization of activities by firms makes less sense, often resulting in a process of spinning off organizational units and causing a reduction in size of the firms resulting in smaller, more rationalized organizations, i.e. a learning organizations, with a variety of co-operation and outsourcing agreements with other firms.1The process of down-sizing organizations, which occurred mainly during the period of economic crisis in the early 1990's, put special emphasis on the areas of cost reductions, concentrating primarily on staff reduction and process re-engineering (Hammer and Champy,1993) with the aim of re-directing activities towards the customer.Since the mid-80's, the so-called Theory of Resources and Capabilities has gained increasing importance in strategic management (Giget, 1984 and 1986; Grant, 1991 and 1992; Peteraf,1993; Prahalad and Hamel, 1990 and 1994; Penrose, 1958; Selznick, 1957; Wernerfelt, 1984). One of the fundamental concepts of this trend is that of core competence. In its most recent form, it consists of three inter-related factors (Bueno, Morcillo and Rodrguez, 1995, pp.3).:-intent, what the organization wants to do in response to their future strategic vision of the business. -know-how, what the firm knows how to do as a result of accumulated experience derived for internal as well specific external sources. -capabilities, what the firm is able to do based on the professional skills and abilities it possesses.Management by competences consists in identifying what the firm knows how to do best (with respect to its competitors) based on its key organizational capacities and concentrate on preforming these1 A flexible structure would be, for example, the so-called Irish Shamrock, proposed by Handy (1989)2 3. activities. Starting from Porter's concept of the chain of value, each of the core and support activities of the organization are analyzed to determine those which generate low value or do not create core competence and which can be performed by other companies through contractual agreements or by means of a co-operative process (Bueno, 1996, p.233). It may even be assumed that each firm competes not only with its direct competitors, but with all its possible suppliers for each activity in its chain of value. Therefore, if an internal activity of the firm can be carried out more efficiently by a supplier, it may be preferable to sub-contract the activity and concentrate on those at which it is more efficient. In practice, therefore, the firm may analyze each task that it performs and concentrate on its core competence and critical strengths.Concentration by the firm in developing its core competence makes it worthwhile to co-operate with other firms to perform its non-basic activities (strategic outsourcing). As shown in Figure 1., the outsourcing process begins with the external sub-contracting of simple activities for which there are many suppliers, such as, security and building maintenance. Later, sub-contracting can de done of more strategic activities which require a closer relationship with the supplier, such as, logistics, distrubution and even product design. At the limit is the concept of the virtual corporation where the firm offering the product to the customer is perceived as a single highly-integrated company, when in reality it is an organization formed by multiple companies involved in the production of specific goods or services. Each of the companies focuses on its core competence and takes part in some of the necessary phases to produce a final product which meets the needs of the customer. Thus, maximum efficiency is achieved as each task in the chain of value is carried out by a specialist in that area.FIGURE 1.- THE EVOLUTION OF OUTSOURCINGVIRTUAL PERCEIVED COMPANIESPROXIMITY TO PRODUCT COREDEVELOPMENT DESIGN DE FINANCE MANUFACTURINGPRODUCTOS FUNCTIONSMARKETINGLYBRARY INFORMATION SYSTEMS DISTRIBUCIONPHOTOCOPYING TRANSPORTATIONSECURITYMESSENGERS CATERING RIA CLEANING TIMEVERTICALLY/HORIZONTALLY INTEGRATED COMPANIESSource: Arthur Andersen, EIU (1995) In the following sections we will make a detailed study of the characteristics that outsourcing exhibits in this process leading to the virtualization of the firm, and the internal and external problems associated with its implementation.3. OUTSOURCING: CONCEPT AND PROCESS 3 4. 3.1 CONCEPTThere are two basic types of outsourcing:a) The first type is defined as the process by which a task or activity traditionally performed within the firm is transfer out to an external supplier. b) The second type, used more in practice and which may cause confusion, defines the process as any activity carried out outside the firm regardless of whether this activity had previously been carried out by the firm.Nevertheless, and independent of the interpretation that is adopted, one must keep in mind that the process of outsourcing is not a mere service of classical sub-contracting, but implies a much deeper relationship between the client and the supplier. Outsourcing is a long-term link tied to the performance of certain essential tasks by specialists -but not in the area of its core competences- who over time become strategic partners.For the relationship to work efficiently, both organizations must accept the fact that each one has to share with the other certain strategic decisions. The financial remuneration received by the supplier may even depend on the results obtained, in such a way that both share in the risks and the profits of their co- operation. The fundamental characteristic which differentiates tactical outsourcing (or merely sub- contracting) from strategic outsourcing is the establishment of a co-operative relationship which grows proportionally with the interrelationship between the externalized function and the rest of the business process. However, in practice, it is not always easy to identify the boundary between sub-contracting and strategic outsourcing2.In parallel with outsourcing, and also in response to the need to modernize organizations, the concept of re-engineering has emerged. Both concepts may be considered instruments to use in response to the rapid changes in the business environment, with the aim of obtaining a clear improvement not only in one's competitive position but also in business profits through the management of business processes. Re-engineering is a radical internal re-structuring; while outsourcing is co-operation with external suppliers. According to Rueda and Molina (1995), the difference between these two terms from a conceptual point of view is to be found more in the temporal environment and the ability to control resources than in the content (see Figure 2.). FIGURE 2. EVOLUTION OF CO-OPERATION MODELS COOPERATION MODELS TRENDSinternalINSOURCINGactions forimprovementALlIANCEreengineering internalfiliation RESOURCESerna strategicCONTROLallianceexternal filiation OUTSOURCINGwith a partneroutsourcingagreementSource: Rueda y Molina (1995) CAPABILITY &amp; FLEXIBILITY TO REACH THE OBJECTIVES2 From here on, the term outsourcing will be used exclusively to mean strategic outsourcing.4 5. 3.1.1. SOME DATA ON THE USE OF OUTSOURCINGNo precise data exists which would permit us to accurately quantify the volume of economic activity that outsourcing operations have reached, nor the sectors nor principal activities in which it is being used. Nevertheless, a few studies and some partial estimates permit us to see the main trends. An empirical study published in the Economist Intelligence Unit in co-operation with Arthur Andersen (1995) contains the conclusions of a survey of 303 senior executives from global businesses throughout North America and Europe. The results (see Figure 3.) show that outsourcing is widely used in an extensive range of activities by major American and European companies, especially the later. FIGURE 3. A COMPARISON OF OUTSOURCING IN EUROPE AND NORTH AMERICAWAREHOUSING 34%17%FINANCIAL 32%FUNCTIONS21% 50%PRODUCTION21%51%INFORMATIONSYSTEMS27%66% TRANSPORTION &amp; SHIPPING24% 63%LEGAL56%EuropeNorth-America Source: EIU (1995)It is worth pointing out that in the telecommunications sector, the objective of the large consortiums which are being formed is to externally manage the communications of the major companies in the world. CONCERT, a global company formed by BCT and MCI, estimates that the outsourcing services in the sector today represent a $69,000m. business and that this figure will reach $156,000m. by the year 2000.Meanwhile in the financial sector, a study done at a world level by Ernst &amp; Young (1995) shows that the evolution of outsourcing has not only stablized, but that its rate of growth is quite high (see Figure 4.).FIGURE 4. THE EVOLUTION OF OUTSOURCING IN FINANCIAL INSTITUTIONS60% 50%outsourcing developed40% outsourcing in30%process20%10%0%MORTGAGES CREDITSCREDIT CARD RETAIL RETAIL LOCKBOXSOFTWARE CHEQUE PROCESSINGTREATEMENT NETWORK MANAGEMENTDATABASE CARDS ISSUESBALANCE STUDENS CREDITS CREDITS SCORING 5 6. INSURANCES Fuente: Ernst &amp; Young (1995) ATM DRIVING &amp; SWITCHINGSEGUROS Por su parte, EDS, principal proveedor mundial de servicios informticos con ms de un 25% del EDS, the world's leading supplier of data processing services with more than a 25% share of the market, estimated that in 1995 the European outsourcing market for computer services was $250,000m., which represents 6% of total expe...</p>

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