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OUTSOURCING

Using FMEA To Assess Outsourcing Risk
by Cliff Welborn

O

utsourcing has become a growing trend among many U.S. companies.1 Two common examples of the practice are outsourcing IT jobs to India and outsourcing product manufacturing to China. Some say the practice is a

In 50 Words Or Less
• Outsourcing has become common for many U.S. businesses, but assessing the risk involved in such arrangements hasn’t. • A modified version of failure mode effects analysis (FMEA) is one way businesses can evaluate the risk of outsourcing options. • Risk priority numbers can be calculated to rate any potential failures.

normal and healthy part of the evolution in the U.S. workforce.2 Lower costs are often the driving factor, and there have been many success stories of companies that enter this global supply chain and realize significant cost savings.3, 4 However, outsourcing does not guarantee business success. There is risk involved and not all sides benefit from such arrangements.5 The advantages of outsourcing should be carefully weighed against risk and must go beyond evaluating just price. So much more goes into judging the business impact of an outsourcing decision. Without a systematic analysis technique to assess risk, much can go wrong: unexpected cost, extended lead times, poor quality or other negative performance variables.

Risk Assessment Basics
Indeed, risk associated with outsourcing can offset the often more publicized benefits.6 Sometimes the risk doesn’t pay off. Some U.S. companies have joined the outsourcing trend only to be disappointed in the overall net effect

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18 I AUGUST 2007 I www. Calculate the risk priority number (RPN) for each risk.asq.9 But one thing is certain: Documenting and analyzing risk is an essential element to continued learning and process improvement. Other industry specific FMEAs use other variables to quantify risk. Identify potential risks. and little research has been done. probability. ability to detect the defect. Rating scales of 1-5 and 1-10 are often used to quantify each variable.13 A modified version of the tool can be used to help evaluate the risk of outsourcing options. the 1-5 2 16 scale makes it easier for a team to agree on rating values.10 It is critical to have an easily understood method to identify and manage risk.OUTSOURCING on business operations and eventually returned jobs back to the United States. A common RPN is the 2 30 product of: 2 1 2 4 5 16 20 20 40 25 Probability of failure X detectability of failure X severity of failure.12 There are documented procedures to complete an FMEA and examples of its application in various industries. However. The steps to complete a FMEA process are illustrated in Figure 1. A higher FMEA score indicates greater risk. FIGURE 1 FMEA Process Steps Identify risk categories. FMEA is a well documented. Develop actions to mitigate risks with high RPN. 8 Analyzing the risk associated with a supply chain and outsourcing is a relatively new subject. Analyze risks by RPN using a Pareto distribution.org .11 Failure mode effects analysis (FMEA) is tool used to collect information related to risk management decisions. probability of defect and severity of defect.14 Every potential failure studied is evaluated in terms of likelihood and severity. 3 48 A risk priority number (RPN) is calculated for each potential 4 32 failure. Common variables used to quantify risk are frequency of an activity associated with the defect. Rate the opportunity. and severity for each risk. Reassess risks with another cycle of failure mode effect analysis (FMEA). The 1-10 scale Risk priority allows more precision in estiSeverity number mates and typically creates more separation in scores 2 16 between risks.7. proven technique commonly used to evaluate the risk for failures in product and process designs. TABLE 1 Outsourcing Risk Assessment Opportunity 2 2 4 2 5 4 5 5 5 5 Probability 4 4 4 4 3 2 4 2 2 1 Risk Cost Unforeseen vendor selection cost Unforeseen transition cost Unforeseen management cost Lead Time Delay in production start-up Delay in manufacturing process Delay in transportation of goods Quality Minor cosmetic/finishing defect Major cosmetic/finishing defect Component will not fit with mating parts—requiring rework Structural defect—function failure quantity of parts associated with the defect.

and can be grouped into intuitive 30 categories. items purchased from many different vendors. RSSF consolidates the impact to operations. supply all major furniture and fixtures. Risks are evaluated in terms of opportunity. Initial estimates indiRadioShack Corp. an activity that is 10 a one-time event or seldom takes place has an opportunity 0 score of 1. This procurement configuquality to the customer or other relevant cateration reduces complexity and shipping costs for gories. The impact might be in terms required construction materials from various venof cost. dors into one shipment. gondolas and shelves process can be performed again to evaluate residto display products. when RadioShack builds a new store or with a high severity score creates a significant remodels an existing one. and the items such as wall systems. The opportunity score for a 20 risk is the frequency at which that activity happens. Through Opportunity score X probability score a request for proposal (RFP) process. including Actions are then taken to mitigate risks.Outsourcing options can be FIGURE 2 Example of Pareto Distribution of Risks in Outsourcing evaluated in much the same manner as product and pro50 cess defects. mit bids to supply a fixture for a calendar year. When this design change was implemented. a division of sidered in the RFP process. Recently. Using the 1-5 scale. while a risk instance. the opportunity score is 5. If the activity is a common occurrence.. For Risk priority number ct ct ts co st tra rts ct tu od es pa oc de tc de de go ar g st pr n em tio rin sm sm tio m ct ag uc tu ru od ac co co rta fit an or se le no t po nd m pr uf or or an ns aj in en ve ill n M M tra yi w m nt la en se re De yi fo ne yi la Un po la De m De Co Un fo re se Un n n QUALITY PROGRESS fo re I AUGUST 2007 I 19 se en St ns iti o en in al ic ic of at ur et et n ct n g io n co os fe fe fe st p s s . The RPN for a risk is calculated as the product of: The supply of major store display fixtures is typically awarded on a yearly contract basis. A risk with a low severity score causes a minimal impact on operations when it happens. 40 probability and severity. espetions. Once the RPN is calculated for each risk. ual risk. loss of intellectual property. lead time. The severity score indicates the level of impact if the risk Risk materializes. vendors subX severity score. potential vendors in Asia were conRadioShack Store Fixtures (RSSF). RadioShack changed its fixture design direction from primarily wood based products to RadioShack Example metal based fixtures. The probability score is the expected likelihood that the risk will actually happen. procures and distributes furnicated that Asian vendors offered a significant cost ture and fixtures to RadioShack retail store locasavings compared with domestic vendors. RSSF used domestic manufacturers to risks are analyzed using a Pareto distribution. the Historically. RadioShack. RSSF serves as a consolidation warehouse for cially those vendors that provided metal fixtures.

Although this rating technique might not represent the utmost in analytical accuracy. The first step of the FMEA development process was to identify risk categories. it is a quick. This was a simple multiplication of: Opportunity score X probability score X severity score. “Unforeseen management costs” represented the risk associated with incurring additional cost to conduct business with a vendor from another country. the team brainstormed and generated a detailed list of potential risks. the risk of a delay in the manufacturing process was given an opportunity score of 5. global sourcing. The outsourcing risk assessment procedure illustrated in Table 1 was used to evaluate the risks of this relationship. probability and severity. operations and quality assurance was established to perform the FMEA. Although the quoted purchase price from the selected vendor was significantly lower than other domestic or offshore vendors. Outsourcing options can be evaluated in much the same manner as product and process defects. the risk with the highest RPN score was “unforeseen management costs. A cross functional team consisting of representatives from design. The probability score for a delay in manufacturing process risk is 3. the team evaluated each risk using the 1-5 rating system and the variables of opportunity. The 1-5 rating was determined by consensus following group discussion. In this example.” It had a RPN of 48. A delay in manufacturing was evaluated to have a severity score of 2. easy and commonly used technique that provides a quantitative measurement to a qualitative concept. The score indicates the overall impact to RadioShack if the delay materializes. ship with a relatively unknown vendor not based in the United States. The outsourcing risk assessment chart in Table 1 was used to collect the relevant FMEA data. the chance of a delay at this stage is recurring. Risks are evaluated in terms of opportunity. This evaluation was also based on the team’s understanding of the vendor’s manufacturing capabilities and performance history. This is the team’s evaluation of the chance that there would actually be a delay in manufacturing. The detailed risks were grouped under the risk categories established in step one. the risks were sorted in descending order based on their RPN score and graphed as a Pareto distribution.asq. The management team was concerned about the communication barrier and its ability to efficiently convey business transactions. Through group discussion. as shown in Figure 2 (p. the fourth step in the FMEA development was to calculate the RPN value for each risk. In the second step of the FMEA development.org . and can be grouped into intuitive categories. The opportunity score of 5 indicates that there were many instances when this risk could materialize. Since manufacturing is a recurring activity. lead time and quality. The final variable scored was severity. In the fifth step of the FMEA development. 20 I AUGUST 2007 I www. As described in Figure 1. For example. This representation of the risks was used to prioritize risk mitigation efforts. 19). probability and severity. the general categories were established as cost. there was a concern about the risk of entering into a long-term relation- Ratings and Scores In the third step.OUTSOURCING RadioShack decided to award the business to an Asian manufacturer. The score also suggests that the impact would not be greatly significant to the overall performance of the company.

payments. pp. the representatives from RSSF and the new vendor met to establish clear product specifications. ASQ Quality Press. He earned a doctorate in industrial engineering from the University of Texas at Arlington. The new vendor would be producing many different fixture components that would have to connect to components made by other vendors.” Harvard Business Review. 4.” Harvard Business Review. 16.Y. “Should I Stay or Should I Go?” Newsweek. These proactive risk mitigation efforts resulted in a smooth supply chain relationship. A.” International Journal of Production Research. 8. April 19. Roshan R. Carbone and Donald D. CLIFF WELBORN is an assistant professor at Middle Tennessee State University in Murfreesboro. J. Shi and K. “The Triple A Supply Chain. Failure Mode Effect Analysis—FMEA From Theory to Execution. 549-560. 1995. “Failure Mode Effect Analysis Over the WWW. Anand Pillay and Jin Wang. RSSF’s management team implemented mitigation efforts.” Harvard Business Review. pp. “Methods Toward Supply Chain Risk Analysis. 1. 114-121. 10. Ellworth. Kallepalli. 102-112.” Industrial Management & Data Systems. Reggie J.” Proceedings of Project Management Institute Research Conference. R. G. P.399. 2000. No.375-3. 3. 28-35.” International Journal of Advanced Manufacturing Technology. Rodgers. Vol. “Leading a Supply Chain Turnaround.” Reliability Engineering & System Safety. pp. 2004. 4.J. “Improving International Capital Project Risk Analysis and Management. The technique is easily implemented and understood. Sohal. No. pp. 79. 12-13. Caudill and MengChu Zhou. Further research should be undertaken to verify the risk assessment results with actual shortcomings and failures of various outsourcing options. No. 3. REFERENCES Future of the Analysis Tool Decision makers considering outsourcing options should use the FMEA based outsourcing risk assessment technique. Mohammed H. 2003. Walewski. returns and repairs. July 2002. Venkata R. Vol. 1.” Its RPN was 40. 5.L. pp. “The Triple A Supply Chain.A. T. pp. 69-85. Pai. This can be done through a comprehensive study of companies undertaking outsourcing programs.” Proceedings of the IEEE International Conference on Systems.The risk with the next highest RPN was “component will not fit with mating parts—requiring rework. Lee. Mak. schedules. D. Vol. Man and Cybernetics.560-4. Prototypes were produced and sent to RSSF’s warehouse for thorough evaluation before the vendor was allowed to begin production. “Building Deep Supplier Relationships. Vol. Choi.L. 7. pp. 5. Brad Stone. pp.565. No. No. Huang. 104-113. 11. Vol. 16. Vol.J. 16. Vol. 22. Additionally. 5. 10. No. 82. pp. such as communication of orders.S. 13.E. A small product/process development team was established to ensure smooth operations with the new vendor. Focus was on the development of a system to manage business transactions. H. Lee.H. “Risk Factors Associated with Offshore IT Outsourcing. QUALITY PROGRESS I AUGUST 2007 I 21 .” Harvard Business Review. Liker and T. 6. 10. 603-608. 1. 52-53. This three-person team made several trips to the vendor’s location in Asia. J. “Project Risk Management Using the Project Risk FMEA. 2005. pp.” IEEE Design and Test of Computers. the mating parts that were not to be produced by the vendor were sent to ensure proper fit. No. Vol. 82. unforeseen problems might have impacted the overall success of the global outsourcing efforts. pp.K. 43. 105. Vol. 2. Slone. 12. John A. “The Truth About Outsourcing. Tafti. Thomas A.Q. 82. There was a concern that components from two different vendors would have dimensional discrepancies resulting in a poor fit. With this quantified risk assessment. In some cases. Gibson and Vines F. No.” Engineering Management Journal. Samples from RadioShack’s existing product stock were sent to the new vendor to verify fit conformity. 9. “Strategic Supply Chain Management Issues in the Automotive Industry: An Australian Perspective. Vol. Tippett. Smith and A. 14. see reference 3. Without the FMEA based outsourcing risk assessment tool. Edward G. 12. Stamatis. 4. “Modified Failure Mode and Effects Analysis Using Approximate Reasoning. Singh.