Urban and Regional Innovation Research Unit

Faculty of Engineering
Aristotle University of Thessaloniki

PRODUCT OUTSOURCING
IOANNIS KOMNINOS
Electronic Engineer, B.Eng M.Sc.(Eng)

Thessaloniki 2002
Product Outsourcing 2

CONTENTS

1. Introduction 3
2. Design of an outsourcing process 3
2.1 Assessment of outsourcing need 3
2.2 Establishment of the outsourcing relationship 5
3. Management of outsourcing 6
3.1 Contracting 6
3.2 Managing performance 7
3.3 Documentation and resolution of outsourcing disputes and issues 9
3.4 Key issues of managing outsourcing results 10
4. Common outsourcing mistakes 11
4.1 Outsourcer mistakes 11
4.1.1 Ignoring the customers needs 11
4.1.2 Ignoring the importance of leverage 11
4.1.3 Avoiding accountability for the outsourcing process 12
4.1.4 Using someone else to manage the outsourcing deal 12
4.2 Company – client mistakes 12
4.2.1 Relying too much on executive contact 12
4.2.2 Not letting the outsourcer lead the process 13
4.2.3 Interfering with the process 13
4.2.4 Signing an outsourcing deal with too long a term 13
4.2.5 Improper process management 13
4.2.6 Forgetting that the outsourcer is a business asset 14
5. Benchmarking outsourcing: when and why 14
6. Alternatives to outsourcing 15
Annex 1 – Outsourcing strategy checklist 17
Annex 2 – What to do and what don’t for successful outsourcing 18
Annex 3 – Popular types of outsourced services 19
Definitions – Glossary 20
References 21

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1. INTRODUCTION

Developing a new product or service requires additional time and resources that a
company or an enterprise may not be able to commit. It may also require engineering
tools or skills that it does not make sense for a company to purchase. In addition the
cost to new software and hardware tools, and the amount of money spent in training
staff could be too great. Also due to the progressive globalization and standardization
of many products, manufacturing companies are forced with the task of currying more
complex product development with limited and decreasingly time frames.

To overcome all or some of the above problems more and more companies turn to
Product Outsourcing i.e. hiring external contractors to develop a product for the
company. Outsourcing means that a company can buy a product rather than produce it
itself. It gives the work to someone that can do it more efficiently. It allows a
company to share risks, reduce operating costs; free tied-up resources minimize hard
to manage processes or functions, improve its market focus and keeps the company
flexible. So Outsourcing is a tool for a cost – effective service. As one its
effectiveness and whether it can be successful or not depends on how it is designed,
implemented and managed.

One should note that companies have always hired contractors for particular types of
work and have formed long-term relationships with firms whose capabilities
complement or supplement their own. That is why sometimes outsourcing is mistaken
with subcontracting. The difference between subcontracting and outsourcing is that
the latter involves the most efficient reconstructing of particular business activities by
utilizing external partnerships.

2. DESIGN OF AN OUTSOURCING PROCESS

2.1 ASSESSMENT OF OUTSOURCING NEED

Before any action to be taken by a company to outsource a product, an assessment

must be made of whether outsourcing is the appropriate route to take. This assessment

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allows a company to identify outsourcing opportunities and gather information about

outsourcing so that to form appropriate strategies. The primary objective of such an
assessment is to find out whether outsourcing is right for the company or not, whether
outsourcing services will be better that the ones already existing into the company and
what is the most appropriate outsourcing arrangement for the company.

For the above questions to be answered first the company must be self – educated on
the use and applications of outsourcing. To do that one must gather information and
collect other people’s experiences. The company must then determine how committed
senior management is to the idea of outsourcing and then identify the resources and
expertise needed. At this point a comparison must be made to the company’s
resources and expertise so that a true decision of whether or not outsourcing is needed
can be taken. Finally a strategic outsourcing plan to guide all outsourcing projects and
each outsourcing decision must be formed.

Using and completing such an assessment will enhance the company’s view on
outsourcing through assessment results as the ones described in Table “1” bellow.

Table 1: Assessment objectives vs. results

ASSESSMENT OBJECTIVES ASSESSMENT RESULTS

Identify outsourcing costs
Determine service levels
Check flexibility
Investigate the form of penalties
Pint point unexpected costs that are not
explicitly in the scope of outsourcing such
as personnel related costs, costs of
additional resources needed to manage an
outsourcing process and costs due to
confidential information leaks resulting in
legal liability or competitive disadvantage.
Define and agree to what is expected
through each stage of the outsourcing
process and set the level of commitment
required by the outsourcer to perform such
a process.
Determine outsourcer flexibility and
remove inflexible work practices mandated
by e.g. labor unions.
Pre – set standards that an outsourcer must
uphold and think about the size and form of
penalties possibly imposed to the

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outsourcer in case of substandard

performance by the outsourcer.
Source: Australian Queensland Government

2.2 ESTABLISHMENT OF THE OUTSOURCING RELATIONSHIP

To establish an outsourcing relationship five tasks must be completed. Those and their
outputs are described briefly in table “2”.

Table 2: Tasks and outputs to be completed in an outsourcing relationship

Task Output
Get ready Plan project and communications.
Lay the foundation Prepare the agreement documents.
Plan approach Decide how to manage the process.
Plan evaluation Decide hoe to evaluate the outsourcer.
Pick the outsourcer Do the outsourcer evaluation and decide
on the best one for the job.

Source: Australian Queensland Government

The first task addresses the action to be taken for the planning of the outsourcing
project and identifies the most efficient form of the communications between the
company and the outsourcer. The project plan details the outsourcing process
structure, requirements, approaches and milestones. The form of communications
details the person or persons that the company will be communicating with, when
these communications will take place and how these will be done. (For example will
the communications take place on a managerial level or a lower level? Will they have
the form of weekly / monthly / bimonthly meetings or the form of mail, phone and
email?).

The second task faces the action to be taken for the preparation all the necessary
documents needed to an outsourcing partnership. Contracts, service level agreements,

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and procedure manuals provide an explicit basis of what the outsourcing agreement
will be about, the legal framework behind it and the obligations of both company and
outsourcer. Refinement of these can be made during negotiations or during the
process itself.

Task three compromises of the decisions required so that the outsourcing process is
well managed. The managerial team is picked and their duties are defined.

Task five answers the question of evaluation of the outsourcer once the outsourcing
process has began. All the evaluation criteria and the mandatory outsourcer
obligations are decided. Also the levels of the standards during the outsourcing
process are picked.

When all first four tasks are completed, then according to the decisions taken during
those tasks, an evaluation of the outsourcer and its proposal is made. A summary of
the evaluation findings for each outsourcer candidate is formed and the decision on
which will take the job is taken.

3. MANAGEMENT OF OUTSOURCING

The essence of product outsourcing is that it shifts a company’s focus from managing
resources in managing results. So outsourcing demands a more advanced approach to
performance management, one that ensures that the desired results are defined clearly
and reflect the company’s true requirements. Also an outsourcing management
approach makes certain that the outsourcing results are reported regularly and quickly
adjusted as needed.

3.1 CONTRACTING

A rewarding outsourcing relationship begins with clearly defined expectations that

can be easily understood from both the company and the outsourcer and allow a more
shift and smooth outsourcing management process.

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The desired contract terms need to be introduced as easily as possible in the contract
and should include the scope of service, the resources required, the change in the
relationship management, the pricing structure and fees, the intellectual properties, the
termination options, the rights and restrictions of both outsourcer and company and
the liabilities. They also must include Service Level Agreements (SLA’s) whenever
this is feasible.

It is very important that all outsourcing contracts have terms for both termination of
cause and termination of convenience. Some exit considerations may be centered on
people, equipment and intellectual properties.

Contract elements are necessary to cover all aspects and specifications of the project
and the involvement of attorneys in the beginning of the process helps identify weak
points that would probably interfere with the management process later on.

3.2 MANAGING PERFORMANCE

One way that a company can manage outsourcing performance is through a

management tool called “scoreboard” The scoreboard must be put in place before the
services are delivered and measures the performance of both the outsourcer and the
end – result. It must be clear, complete and contain measurable terms. It should
contain an appropriate list of criteria, agreed from both the company and the
outsourcer, that will provide a complete picture of the outsourcing performance.

The first step in creating a scoreboard is the definition of categories. These categories
are all the aspects of the outsourcing process that the outsourcer will be judged.
Secondly one or more attributes must be set. These attributes are unique to the
services being provided and the company’s business objectives. Next step is the
selection of a way to measure attributes. This measurement method must be metric
and must be supported by one or more tools used to collect data. Finally the scores of
the attributes and the categories must be rated against a desired outcome. The
following table is an example of how a scoreboard should look like (taken from a
telephone company that provides call center services to another company).

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Table 3: Management scoreboard

CATEGORY ATTRIBUTE METRIC

Quality Customer satisfaction % rating of excellent or very good call
processing
Effectiveness % rating or rep’s performance
Compliance % of calls handled according to
company’s policy
Timeliness Cycle time % of calls answered within 20 mins
Abandon rate % of calls abandoned by caller prior to
response
Financial Unit cost Total operating costs divided by call
volume
Productivity Average handling time Total number of seconds divided by total
calls

Source: Corbett M. F.

Some categories or criteria that such a scoreboard could be formed of are given
bellow. One should note that in cases that the outsourcing process or end – result is
complicated sub – categories or criteria should be set.

Table 4: Criteria and Sub criteria of Outsourcing Evaluation

CRITERIA OF OUTSOURCING SUB CRITERIA

QUALITY EVALUATION
Experience Specialized knowledge
Technology know-how
Communication Good presentations during development
Frequent update of company – customer
Right questions on details – problems
Contract uphold On – time delivery
Budget keep
Contract terms uphold
Efficiency Completion on schedule
High quality end - product
Goal achievement

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Source: Avlonitis G.

The above categories - criteria some times are the same that are used in the selection
of the outsourcer and failure of the outsourcer to comply with any of these (i.e. the
metric value is low or outside the set range), result in customer discontent and
dissatisfaction. The main reasons that a customer will not be satisfied with the
outsourcer performance are given bellow.

Table 5: Reasons of customer dissatisfaction

Main reasons Outsourcer actions

Customer need misunderstood No personal interest
Seem to want to avoid long term relationship
Communication Not receptive to questions and suggestions
Unstable communication
Limited cooperation
Unpleasant during communication
Contract uphold Late delivery
Over-spending
Not explaining reasons for delays or high costs
End – Result Not achieving goals set
Low quality end – product
Not done what was promised

Source: Avlonitis G.

3.3 DOCUMENTATION AND RESOLUTION OF OUTSOURCING

DISPUTES AND ISSUES

When an outsourcing process is set in motion, a lot of issues come to light that need
immediate attention so that the process will not deteriorate. The use of the
“Scoreboard” discussed earlier can not be helpful in this case since it only examines
the performance of the outsourcer and the end – result.

A company should form a mechanism of identifying and resolving outsourcing issues

and disputes. A team of managers charged with the quick review and resolution of

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such issues. It is imperative that the team consists of the right people in the right
places and with the authority to effect change.

For instance a sales manager will have little or no effect in an issue involving say the
change of specifications of a high-tech outsourcing product, and a product or a R&D
manager will have little or no effect in an issue involving an outsourced economic
service such as payroll.

3.4 KEY ISSUES OF MANAGING OUTSOURCING RESULTS

The following issues represent some of the best practices for managing the many
aspects of outsourcing relationships. A company should adopt these practices so that
the intended results are achieved with the greatest possible benefits.

• One should consider how to measure results and how to manage the
arrangement before contracting. The measurements should be introduced in
the negotiations and in the agreement. If already under contract one should
work with the provider to agree upon metrics and objective ways of obtaining
them.
• The formal organization, that will promote teamwork and provide
communications and decisions, should be defined. Organizational
effectiveness and refinement of organizational structure are key points for
good communications and decision making during the outsourcing process.
• Teamwork and positive relationship between one’s providers and one’s staff
should be encouraged. An environment of mutual respect should be set and the
attitude of us vs. them should be discarded.
• A process for the perpetuation of the knowledge and intent of an outsourcing
agreement should be created. Usually the initial team that have negotiated and
signed an outsourcing agreement is replaced and another is set to manage the
agreement. The later team of managers, frequently do not have the knowledge
of the small details of the agreement and sometimes are inclined not to follow
them. As a result the agreement is broken and the outsourcing process is
destroyed.

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• Providers should be included in planning. A provider can be very helpful in

project planning once he knows what the company strategy is and where the
company is headed.
• Incentives should be used to increase benefits. If the providers are motivated,
they can be stretched even further to meat outsourcing objectives and thus
more benefits for the company.

4. COMMON OUTSOURCING MISTAKES

An outsourcing agreement is sometimes like a marriage. Neither of both parties

knows what to expect. Especially a company – client, that has never before
outsourced a product or a part of a product, frequently stumble into pitfalls. Some of
the mistakes that can pop up into a company – outsourcer relationship are given
bellow.

4.1 OUTSOURCER MISTAKES

4.1.1 IGNORING THE CUSTOMERS NEEDS

Sales people usually mistakenly view the sales process as a “game” that must be won
or lost. With this in mind the sales team of an outsourcing company usually focus on
the “game” of sales itself rather than the needs of their customer i.e. the client –
company. They tend to get lost in this “game” and forget that their customer just
needs an effective and cheaper way to manufacture a product.
Sometimes they worry about the size of their outsourcing company and their possible
lack of global reach, which in the eye of the customer gives the impression of
insecurity. Having in mind the fact that most of the times, the customer already feels
insecure about the whole process of outsourcing, the above attitude results in the
disqualification of their outsourcing proposal by the customer.

4.1.2 IGNORING THE IMPORTANCE OF LEVERAGE

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One of the biggest advantages of outsourcing is the ability to use “leverage”.

“Leverage” is when the outsourcer creates value for the company – client and thus
becomes needed. For an outsourcing company this means: access to scare materials,
the ability to substitute expensive resources by cheaper ones, the possession of
expertise and access to capital. So a client feels most satisfied and regards the
outsourcing company valuable when the outsourcer can provide all or some of the
above.

4.1.3 AVOIDING ACCOUNTABILITY FOR THE OUTSOURCING PROCESS

An outsourcer must always be responsible and accountable for its outsourcing

process. Not always this is the case. Outsourcers tend to avoid accountability since
this results in greater risks. Greater risks simply mean that the outsourcers are
responsible for everything that can go wrong in an outsourcing process. So they do
whatever they can so that they can legally remove the risk. But by doing so the risk
moves to the client, which now has the ability and the right to intervene to an
outsourcing process, something that always leads to disaster.

4.1.4 USING SOMEONE ELSE TO MANAGE THE OUTSOURCING DEAL

Outsourcing as mentioned before is like a marriage. So the relationship between the

outsourcer and the company – client is very intimate. One cannot manage such a
relationship by using a third party. Usually a managerial team, different from the
outsourcing team and sometimes hired to do this job, take over the outsourcing
relationship as soon as the outsourcing deal is signed. This results in dissatisfaction
and disappointment of the customer since he cannot get in touch with the outsourcing
team.

4.2 COMPANY – CLIENT MISTAKES

4.2.1 RELYING TOO MUCH ON EXECUTIVE CONTACT

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Once a company has decided to outsource, usually hurry’s up to get the outsourcing
deal done and put the transaction on a fast track. To do that, executives from the
company and the outsourcer, meet, agree and let the next level of management to sort
out all the details of such a relationship. Since an outsourcing process is a complicated
one, it sis advisable that various elements of a company must be involved in the
original meetings and have a say to the agreement. Top-level executives are rarely
enough to review such a process.

4.2.2 NOT LETTING THE OUTSOURCER LEAD THE PROCESS

The essence of outsourcing is that a company transfers the process of product making
to the outsourcer and then buys the results of that process. The quickest and most
certain way to destroy an outsourcing process is to let the company – client dictate
how this process is done. When a company tells the outsourcer what to do, removes
from the outsourcer the ability to add value to the process and produce a cheap
product.

4.2.3 INTERFERING WITH THE PROCESS

Many companies willingly do not transfer the ownership of the outsourcing process to
the outsourcer and keep the process under control. When the company assigns
someone to look over the process this person becomes overwhelmed and incompetent
to manage something that has very little knowledge about. As a result the outsourcing
process fails.

4.2.4 SIGNING AN OUTSOURCING DEAL WITH TOO LONG A TERM

It frankly impossible to create boundaries or service level agreements, for an unknown

process as outsourcing. One must construct a contract that will last a long time but
will allow the service terms agreements to change during short periods of time. (For
example some companies are willing to sign up to five years outsourcing contracts
regarding web hosting, although no one can tell or predict what the internet will look
like after five years). So it is preferable for a company to develop a close relationship

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with an outsourcing company, but sign short term contracts that can be easily
negotiated and if necessary renegotiated or even broken.

4.2.5 IMPROPER PROCESS MANAGEMENT

Companies new to the outsourcing process often do not assign the right people to
manage the process. They often assume that since all the details of an outsourcing
contract are discussed and the contract is signed, that do not have to worry about the
outsourcing process any longer. The right person for the job should be someone that
understands the process and be able to focus and interpret the results in terms of the
best interest of the company. He should have a different way of thinking in respect to
most business managers and the oversight to recognize any problems or mishaps
before those are surfaced.

4.2.6 FORGETTING THAT THE OUTSOURCER IS A BUSINESS ASSET

Far too often the company forgets that the outsourcer is a business asset and must be
treated as such. The outsourcer can be from the person that manufactures a new
product or a part of a new product for the company, to the person that keeps the
books, to the one that prepares the payroll or hosts an application. All these are vital
parts of a successful and prosperous business. If the outsourcer is treated differently,
for example like one of many suppliers or one of many customers, then the one thing
that the outsourcer adds to a company will be lost. Its ability to make things easier and
more effective for the company.

5. BENCHMARKING OUTSOURCING: WHEN AND WHY

Most companies when they decide to outsource a product are confident enough that
this action will save them money in respect that is cheaper than producing the product
themselves. The most common mistake in this line of thinking is that the company is
usually under the impression, that its receiving a fair deal, simply because the
outsourcers cost’s are lower that their own. Typically outsourcers propose 15-20%
less than a company’s current cost. But many times this difference in costs results in

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poor quality products. So benchmarking is required to provide a baseline of costs and

service levels. A company can use it to compare results delivered by the outsourcer
against the same or similar results throughout the industry or market and consequently
negotiate or renegotiate the outsourcing deal.

During negotiations benchmarking knowledge is critical to setting the right

expectations for cost, performance and service levels. Any negotiation position is
reinforced by external validation of one’s requirements. Also when a company has
decided to outsource, with very little investigation, and wants to move fast through the
negotiation process, can use benchmarking data as a guide.

When an outsourcing deal is signed and the process has been set in motion,
benchmarking can be used for contract refinement. Most of outsourcing deals are
renegotiated within two years of being signed and during the process of outsourcing.
Usually dissatisfaction over pricing and service levels are the main drivers for
renegotiation. Benchmarking plays a key role in renegotiations since the company –
client need access to industry performance parameters in order to make a case with
the outsourcer.

Usually the requirement for benchmarking should and sometimes is, drafted into the
final terms of an outsourcing agreement.

6. ALTERNATIVES TO OUTSOURCING

Sometimes outsourcing is not suitable for a company after reviewing the pros and
cons of such a process. In a case like this, other in-house alternative management and
marketing strategies exist. Some of them are given bellow.

• Inaction: Do nothing. The company does not need to outsource a new product,
part of a new product or a service.
• Cut projects: A company can cut down some projects that are resource
wasteful so that it can start and manage a new one without turning to
outsourcing.

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• Hire stuff: A company can always hire more professionals if the economics
allow it so that it would not need to turn to outsourcing to develop a new
product or service.
• Relocation of resources: Frequently resources are badly managed. Due to this
a company reaches the point that the resources required to start a new project
are not enough and the company turns to outsourcing. Relocation and better
management of resources could help avoid this.
• Use of Joint Ventures: A company can form an alliance with others (of same
interests) so that the risks and turmoil of outsourcing can be shared. In this
case the alliance must be very well managed since experience has shown that
different strategies of the members of such an alliance can bring havoc to a
joint outsourcing effort.

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ANNEX 1 – OUTSOURCING STRATEGY CHECKLIST

BACKGROUND INFORMATION
Why outsourcing is needed?
How can outsourcing by used as a strategic tool?
What are the expectations from outsourcing?
DECISION MAKING
Who will decide what to outsource?
Who will select the outsourcer?
Who will approve variations to the outsourcing agreement?
Who will approve budgets, timelines and deliverables?
COMMUNICATION
With whom should the company communicate?
What will the outsourcer want to know and when?
What is the best way to conduct communications?
ENSURING A SUCCESSFUL OUTSOURCING PROCESS
What are the critical success factors?
What are the risks?
How does one overcome risks or problems?
What are the assumptions to be made before proceeding?
RESPONSIBILITIES
What are the company’s responsibilities?
What are the outsourcers?
What knowledge - skills are required?
ASSETS – STAFF AND LICENSES
What assets, staff or licenses need to be acquired?
What assets, staff or licenses need to be transferred?
What assets, staff or licenses need to be redeployed?
What assets, staff or licenses need to be disposed of?
OBLIGATIONS – LEGAL MATTERS
Are there copies of all arrangements and agreements?
Are there any consents to be obtained from third parties?
Are there any obligations after the outsourcing process begins?

Source: Australian Queensland Government

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ANNEX 2 – WHAT TO DO AND WHAT DON’T FOR SUCCESSFUL

OUTSOURCING

Five do’s of successful outsourcing

• One must outsource the “bottlenecks”, the things that are really keeping the
company from growing profitably.
• One must pick great partners, check them out and speak to their customers.
• Once outsourcing is done, the outsourcer must be regarded as part of the
company and treated as such.
• One must demand excellence, since outsourcing is what the outsourcer does
for a living.
• Outsourcing might scare employees. One must communicate honestly with
them.
Six mistakes in outsourcing
• Not really defining the desired results and they could be measured.
• Not talking to the outsourcer current and past clients.
• Failing to consider long-term relationship dynamics.
• Not planning up-front on how the company-outsourcer relationship will end.
• Treating the outsourcer as an outsider.
Four inhibitors to outsourcing
• Fear of loss of control.
• Work viewed as too strategic.
• Company’s unique culture.
• Measuring the value.

Source: Corbet M. F.

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ANNEX 3 – POPULAR TYPES OF OUTSOURCED SERVICES

1. Technology Services

• Electronic Commerce
• Infrastructure
• Software
• Telecommunications
• Website Development - Hosting

2. Business Services

• Customer Contact (Customer Relationship Management)

• Equipment
• Accounting – Finance
• Human Resources
• Logistics
• Security
• Supply chain management

Source: Bierce & Kenerson

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DEFINITIONS – GLOSSARY

Benchmarking Is a method of evaluating contract

services.
Joint Ventures Alliances of companies with similar
strategies and goals in order to share the
outsourcing of a service or a product.
Outsourcing (or sourcing) Is the transfer to an external service
provider the operation and day-to-day
management of a business process.
Quality of Service A good in terms of quality, outsourced
service or product.
Scoreboard Means of measurement outsourcer
performance and end – result.
Service Level Agreement (SLA) They are specifications for type, value
and conditions of the outsourcing
services to be provided. They also
sometimes define the overall relationship
between the company and the outsourcer
and the quality of service.

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REFERENCES

Australian Queensland Government “Queensland Government Guide to Best

Practices in IT Outsourcing”, (Jun 1997).

Avlonitis G. Strategic Industrial Marketing, Stamoulis, 2001.

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<http://www.outsourcing-law.com>

Bragg S. M. Outsourcing: A guide to … Selecting the correct business unit …

Negotiating contract … Maintaining control of the process, John Wiley & Sons, Jul.
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