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Janne M. Korhonen
A practical decision framework for sourcing product development services
Thesis submitted in partial fulfilment of requirements for the degree of Master of Science in Technology Espoo, 10 March 2009 Supervisor: Professor Kalevi Ekman Instructor: Roope Takala, M.Sc. (Tech.)
HELSINKI UNIVERSITY OF TECHNOLOGY Author: Janne M. Korhonen
ABSTRACT OF THE MASTER'S THESIS
Title of the thesis: A practical decision framework for sourcing product development services Number of pages: 222 + 37 Date: 10.3.2009 Faculty: Faculty of Engineering and Architecture Department: Department of Engineering Design and Production Professorship: Kon-41 Machine Design Supervisor: Professor Kalevi Ekman Instructor: Roope Takala, M.Sc. (Tech.)
In recent years, firms have increasingly sourced some or all of their product development functions from outside specialists. Although the phenomenon is well documented, research in the theoretical aspects of new product development (NPD) sourcing has been limited. Existing sourcing frameworks and decision models are based on studies of functions such as manufacturing, logistics and back-office services. This approach has biased the sourcing decision frameworks towards armslength contracts and cost focus, which are rarely the key drivers in NPD outsourcing. At the same time, it has ignored or downplayed the importance of interpersonal issues. As a result, there is a distinct lack of management toolkits for deciding how to properly outsource NPD-related functions. This study combines three research streams (outsourcing decision-making, new product development, and selection of service providers) and develops answers to two primary research questions, namely 1) what features make a product so essential to the firm that its development cannot be outsourced, and 2) how to determine what parts of the NPD process could be outsourced to a specific service provider? The research method is primarily conceptual, with emphasis on literary review from a wide range of sources. The results emphasize he importance of trust and relationships in NPD outsourcing. A systematic approach to sourcing is seen as a prerequisite to successful outsourcing. The study identifies three basic strategies followed by firms outsourcing their NPD services, and develops practical checklists to aid outsourcing decision-making. A framework that allows analysis of sourcing decisions is also produced, and practical implications discussed. The study also reports results from an industry survey featuring 60 respondents. The findings suggest that NPD outsourcing in Finland follows pan-European NPD outsourcing practices. Keywords: make or buy, outsourcing, product development, product strategy, design management, decision model, trust, best practices
TEKNILLINEN KORKEAKOULU Tekijä: Janne M. Korhonen Työn nimi: Käytännöllinen päätöksentekomalli tuotekehityspalvelujen ulkoistamiseen
Sivumäärä: 222 + 37 Päivämäärä: 10.3.2009 Tiedekunta: Insinööritieteiden ja arkkitehtuurin tiedekunta Laitos: Koneenrakennustekniikan laitos Professuuri: Kon-41 Koneensuunnittelu Työn valvoja: Professori Kalevi Ekman Työn ohjaaja: Diplomi-insinööri Roope Takala
Kuluneina vuosina yritykset ovat enenevässä määrin hankkineet tuotekehitysosaamista ulkopuolisilta spesialisteilta, ulkoistaen tuotekehityksensä kokonaan tai osittain. Vaikkakin ilmiö on hyvin dokumentoitu, on sen teoreettista taustaa tutkittu vain vähän. Olemassaolevat ulkoistamismallit ja päätöksenteon apuvälineet perustuvat suurelta osin valmistuksen ja logistiikan kaltaisten yrityksen funktioiden tutkimukseen. Näiden tulosten soveltamista tuotekehityksen ulkoistamiseen rajoittaa se, että ko. tapauksissa ulkoistamisella pyritään usein pääasiassa kustannussäästöihin. Lisäksi aikaisempi tutkimus jättää usein henkilökohtaisten suhteiden merkityksen vähemmälle huomiolle. Näistä syistä olemassaolevat ulkoistamismallit sopivat heikosti tuotekehityksen ulkoistamiseen, mutta kirjallisuudessa ei ole myöskään selkeitä “työkalupakkeja” liikkeenjohdon päätöksenteon tueksi. Tämä diplomityö yhdistää kolmen tutkimussuunnan (ulkoistamisen päätöksenteko, tuotekehitys, ja palveluntarjoajien valinta) löydöksiä ja kehittää vastauksia kahteen pääasialliseen tutkimuskysymykseen: 1) milloin tuoteominaisuus on niin tärkeä yrityksen kilpailukyvylle, ettei sen suunnittelua tule missään tapauksessa ulkoistaa, ja 2) kuinka päättää mitä tuotekehitysprosessin osia voidaan ulkoistaa tietylle palveluntarjoajalle? Tutkimusmetodi on pääasiassa konseptuaalisen teorian kehittämistä laajaan kirjallisuuskatsaukseen perustuen. Tutkimuksen tulokset korostavat luottamuksen ja henkilökohtaisten suhteiden merkitystä tuotekehityksen ulkoistamisessa. Systemaattinen lähestymistapa nähdään vaatimuksena onnistuneelle ulkoistamiselle. Yhtenä tuloksena tunnistetaan kolme perusstrategiaa, joita tuotekehitystään ulkoistavat yritykset seuraavat. Tutkimuksen tuloksia pyritään jalkauttamaan yrityksiin kehittämällä käytännöllisiä tarkistuslistoja ja toimintamalleja, joiden avulla tuotekehityksen ulkoistamista voidaan tarkastella järkiperäisesti. Lisäksi tutkimuksessa tarkastellaan löydösten käytännön merkityksiä eri toimijoiden kannalta. Työssä raportoidaan myös tulokset 60 teollisuusyritystä käsittävästä kyselytutkimuksesta. Tutkimuksen tulokset antavat syytä olettaa, että tuotekehityksen ulkoistaminen Suomessa noudattelee yleisesti ottaen Euroopassa vallalla olevia käytäntöjä. Avainsanat: osta/tee-päätöksenteko, ulkoistaminen, tuotekehitys, tuotestrategia, design management, päätöksentekomallit, luottamus, parhaat käytännöt
This thesis has been very much a learning process and very little just a task to be completed before graduation. Having to combine research and writing with the demands of starting up and working in a design agency – both something that the author hadn’t done before – is now, in retrospect, something that the author doesn’t recommend for the faint of heart, but it has definitely been an experience. However, all the hard work has been worth it. The subject, which surfaced when the author was working for TKK’s FutureLab of Product Design in late 2007, has been a fascinating yet understudied one; the process, where around 900 hours of research and writing were interspersed between long periods of subconscious thinking and – sometimes – even actually doing outsourced innovation has been very fruitful in depth of thought and insights into the subject. In the humble opinion of this author, the lengthy gestation period has greatly improved the thesis and how it is presented. At this point, thanks are in order. In addition to interviewees who generously donated their time for answering questions from the author, special mention is in order for the partners of Seos, our interdisciplinary design agency, for giving the author their support and allowing the author some time to work on the thesis. Both the advisor of the thesis, Roope Takala from Nokia Oyj, and the supervisor, professor Kalevi Ekman at TKK, deserve the author’s gratitude for enduring the process and giving helpful advice when it was most needed. Sincere apologies for not being able to complete the work sooner: hopefully the result is worth the wait. Finally, to Jaana, who kept me fed during the process. In Helsinki, 10.3.2009
able of contents
Foreword .............................................................................................................................................5 Table of contents ...............................................................................................................................6 List of figures ......................................................................................................................................9 List of tables......................................................................................................................................10 List of diagrams ................................................................................................................................11 List of abbreviations ........................................................................................................................12 1. Introduction ..............................................................................................................................13 1.1. 1.2. 1.3. 1.4. 1.5. 1.5.1. 1.5.2. 1.5.3. 1.5.4. 1.5.5. 1.5.6. 1.5.7. 1.5.8. 1.5.9. 1.5.10. 2. 2.1. 2.2. 2.3. 2.4. 2.5. 2.5.1. 2.5.2. 2.5.3. 2.5.4. 2.6. The need for a framework ..............................................................................................16 Research questions...........................................................................................................18 The purpose and the outline of the thesis....................................................................19 Research methodology ....................................................................................................21 Definitions.........................................................................................................................25 Outsourcing ...................................................................................................................25 Offshoring .....................................................................................................................26 Product ...........................................................................................................................26 Product development...................................................................................................27 Product development outsourcing.............................................................................27 Client...............................................................................................................................28 Provider..........................................................................................................................28 Original Equipment Manufacturer (OEM) ..............................................................28 Original Design Manufacturer (ODM) .....................................................................29 Independent Design Team (IDT)............................................................................29
NPD outsourcing in theory....................................................................................................30 A brief history of outsourcing........................................................................................32 NPD outsourcing as a phenomenon ............................................................................35 Theory base: outsourcing and outsourced innovation ...............................................39 Key research streams and positioning of the study ....................................................43 Strategic management......................................................................................................46 Make or buy decision-making.....................................................................................46 Outsourcing core competencies.................................................................................49 New product development .........................................................................................50 Modularity and design rules ........................................................................................51 Business to business services..........................................................................................57
2.6.1. 2.6.2. 2.7. 2.7.1. 2.7.2. 2.7.3. 3. 3.1. 3.2. 3.2.1. 3.3. 3.4. 3.4.1. 3.4.2. 3.4.3. 3.4.4. 3.5. 3.5.1. 3.5.2. 3.5.3. 3.5.4. 3.6. 3.6.1. 3.6.2. 3.7. 3.7.1. 3.8. 4. 4.1. 4.2. 4.3. 4.4. 4.5. 4.5.1. 4.5.2. 4.5.3. 4.5.4.
Design management .................................................................................................... 58 Selection and evaluation of service providers.......................................................... 63 Network theories ............................................................................................................. 67 Social capital.................................................................................................................. 68 Institutions .................................................................................................................... 70 Trust and relationships................................................................................................ 72 Introduction ..................................................................................................................... 75 Motives for outsourcing (why?) .................................................................................... 78 Motives for NPD outsourcing ................................................................................... 81 Risks in NPD outsourcing (why not?) ......................................................................... 85 Assessment ....................................................................................................................... 89 Identifying the objectives: three basic strategies ..................................................... 92 Determining process modularity ............................................................................... 96 Identifying the key value-added competences....................................................... 100 Assessment of implications of decision.................................................................. 107 Selection and negotiation ............................................................................................. 111 Information search and preliminary evaluation..................................................... 113 Request for proposals................................................................................................ 117 Shortlisting .................................................................................................................. 121 Selection and negotiation of relationship ............................................................... 127 Execution and relationship management................................................................... 135 Project transfer ........................................................................................................... 135 Project management .................................................................................................. 137 Lessons learned.............................................................................................................. 143 Renewal or termination of contract ........................................................................ 144 Master checklists for NPD outsourcing .................................................................... 146 Hypotheses ..................................................................................................................... 155 Survey design.................................................................................................................. 158 Operationalization of variables.................................................................................... 159 Survey execution and response rate............................................................................ 163 Results of the study ....................................................................................................... 164 Background data......................................................................................................... 167 Reliability and validity................................................................................................ 171 Hypothesis 1 ............................................................................................................... 172 Hypothesis 2 ............................................................................................................... 173
Outsourcing as a process........................................................................................................ 75
Empirical survey .................................................................................................................... 154
4.5.5. 4.5.6. 4.5.7. 4.6. 4.6.1. 4.6.2. 4.6.3. 4.6.4. 4.7. 5. 5.1. 5.2. 5.3. 5.3.1. 5.3.2. 5.3.3. 5.4. 5.5. 6. 7. 8. 6.1.
Hypothesis 3................................................................................................................175 Hypothesis 4................................................................................................................178 Conclusions about hypotheses .................................................................................180 Other findings.................................................................................................................181 Differences in product development process ........................................................181 Obstacles to outsourcing NPD ................................................................................184 Reasons for outsourcing NPD .................................................................................186 Previous outsourcing and NPD outsourcing .........................................................187 Limits of generalization.................................................................................................191 Impact on products and brands...................................................................................194 Impact on organizations ...............................................................................................196 Impact on business strategies.......................................................................................197 Offensive flexibility: shaping the marketplace .......................................................198 Opportunistic flexibility: real options approach ....................................................199 Defensive flexibility: contractors and crises ...........................................................200 Links to Open Innovation and crowdsourcing .........................................................202 Implications for service providers ...............................................................................205 Directions for further research ....................................................................................207
Discussion and practical implications .................................................................................192
Conclusions.............................................................................................................................206 References ...............................................................................................................................209 Appendices..............................................................................................................................223 8.1. 8.2. 8.3. 8.4. 8.5. 8.6. 8.7. 8.8. 8.9. Appendix A: Semi-structured interview protocol .....................................................223 Appendix B: Overview of outsourcing decision models .........................................225 Appendix C: The economics perspective...................................................................230 Appendix D: Baldridge criteria for core competences.............................................233 Appendix E: Discovery-driven planning....................................................................235 Appendix F: Bidder due diligence checklist...............................................................239 Appendix G: Key questions for a lean organization ................................................241 Appendix H: Empirical survey questionnaire............................................................247 Appendix I: E-mail invitation for the survey.............................................................259
List of figures
Figure 1. Sony Ericsson Xperia smartphone - designed and built by HTC ......................36 Figure 2. The positioning of the study, key theoretical areas, and research gaps.............45 Figure 3. Four different cases of integration and internalization........................................55 Figure 4. Social capital and firm innovation...........................................................................69 Figure 5. Losing competitiveness through outsourcing .......................................................88 Figure 6. How core competences create value.....................................................................101 Figure 7. Outsourcing options: make, buy or ally ...............................................................128 Figure 8. Outsourcing trade-off: flexibility need vs. control need....................................131
List of tables
Table 1. Different types of outsourcing in terms of motives.............................................. 31 Table 2. Primary theoretical foundations for outsourcing................................................... 42 Table 3. Primary research streams in outsourcing research................................................. 44 Table 4. Approaches used for selecting service providers................................................... 66 Table 5. Motives for outsourcing ............................................................................................ 80 Table 6.. Primary motives for outsourcing NPD and their rationales............................... 84 Table 7. Activities modular enough to be considered for outsourcing at Widgets Ltd. . 99 Table 8. Preliminary division of core and non-core activities at Widgets Ltd................ 106 Table 9. Spotting strategic skills............................................................................................. 108 Table 10. Providers identified by Widget Ltd...................................................................... 116 Table 11. 'Hard' qualifications................................................................................................ 123 Table 12. 'Soft' qualifications.................................................................................................. 124 Table 13. 'Pros' and 'Cons' of short-term versus long-term relationships in NPD. ...... 133 Table 14. Examples of measures of NPD quality, time, and cost.................................... 141 Table 15. Checklist for preliminary activities....................................................................... 147 Table 16. Checklist for identifying the objectives. .............................................................. 147 Table 17. Checklist for determining process modularity. .................................................. 147 Table 18. Checklist for identifying key competences. ........................................................ 148 Table 19. Checklist for assessing the strategic implications. ............................................. 148 Table 20. Checklist for information search and preliminary evaluation.......................... 149 Table 21. Checklist for request for proposals...................................................................... 150 Table 22. Checklist for shortlisting........................................................................................ 150 Table 23. Checklist for selection and negotiation of relationship. ................................... 151 Table 24. Checklist for project transfer. ............................................................................... 152 Table 25. Checklist for project management. ...................................................................... 152 Table 26. Checklist for lessons learned................................................................................. 153 Table 27. Key figures of survey respondent firms/SBUs.................................................. 167 Table 28. Top three obstacles to outsourcing NPD........................................................... 184 Table 29. Five criteria for successful user innovation. ....................................................... 204 Table 30. Benefits and assumptions...................................................................................... 238 Table 31. Assumptions grouped with milestones form a task list.................................... 238 Table 32. Core competences checklist.................................................................................. 241 Table 33. Existing partnerships checklist ............................................................................. 242 Table 34. Searching for new partners checklist ................................................................... 242 Table 35. Negotiating a partnership deal checklist ............................................................. 243 Table 36. Implementing a partnership checklist ................................................................. 244 Table 37. Outsourcing partnerships checklist ..................................................................... 245 Table 38. Management disciplines for partnerships and outsourcing checklist ............. 246 Table 39. Partnership culture checklist................................................................................. 246 Table 40. Technology enablers checklist .............................................................................. 246
List of diagrams
Diagram 1. Classification of respondents by category........................................................165 Diagram 2. Extent of NPD outsourcing. .............................................................................166 Diagram 3. Firm/SBU personnel...........................................................................................168 Diagram 4. Firm/SBU turnover, in millions €.....................................................................169 Diagram 5. Firms by field of business...................................................................................170 Diagram 6. The effect of client-provider relationship on NPD outsourcing. ................173 Diagram 7. The effect of key technology maturity on NPD outsourcing.......................175 Diagram 8. The effect of firm size to NPD outsourcing. ..................................................177 Diagram 9. The effect of product life cycle to NPD outsourcing....................................179 Diagram 10. Different product development approaches. ................................................183 Diagram 11. What of the following are obstacles to NPD outsourcing? ........................185 Diagram 12. Reasons for outsourcing NPD. .......................................................................187 Diagram 13. The extent of previous outsourcing initiatives..............................................188 Diagram 14. Previous NPD outsourcing experience..........................................................189 Diagram 15. Why firms aren’t outsourcing NPD any longer............................................190
List of abbreviations
AEI: Abductive Explanatory Inferentialism CEO: Chief Executive Officer GT: Grounded Theory IDT: Independent Design Team NDA: Non-disclosure agreement NPD: New product development ODM: Original Design Manufacturer OEM: Original Equipment Manufacturer RFP: Request for Proposals SBU: Strategic Business Unit
New product development – the ability to identify the needs of customers and quickly create products that meet these needs at low cost - is widely recognized to be the mainstay of economic success of manufacturing firms (e.g. Hart, 1993; Wang and Ahmed, 2004; Ulrich & Eppinger, 2008). Without effective new product development, practically every firm will struggle and eventually fail in today’s heavily competed markets. To make matters worse, in most cases product development is a continuous race against time, budget, technology constraints, changing trends, shortening product lifetimes and, ultimately, competitors. Nevertheless, product innovation is the lifeblood of great companies. When conducted effectively, it blunts competitive pressures, raises internal growth potential and adds an aura of excellence (Teresko, 2008a) that helps to bring about a virtuous circle of continuous improvement. In recent years, increasing complexity has made product development far more expensive. At the same time, decreasing product lifetime has made rapid product development even more important than it used to be. Competitive advantages are fleeting and short-lived, and creating new competitive advantages necessitate more and more effective new product development. However, simply pouring more money into same product development processes as before faces the law of diminishing returns. Furthermore, many large companies have outgrown their internal ability to innovate fast enough to sustain investorpleasing growth rates: a 70-billion euro firm seeking a 10% yearly growth needs to invent ways to make seven billion Euros more in what is already a competitive market (Huston and Nabil, 2006). New approaches are needed. In many cases, this means that firms sharing mutual interests - and sometimes even competitors - must learn to cooperate and network with each other, with other firms in the market, and with the customers that are ultimately buying their products.
More than perhaps any other function, new product development has traditionally been shrouded in secrecy. New product development is intimately tied with the key technologies and the strategy of the firm, and few firms want to share their secrets. Nevertheless, the challenges outlined above, as well as opportunities awaiting innovative companies, have spurred several firms to try out new and more open approaches to both new and traditional problems. What we have, as a result, is a dizzying variety of options available for product managers and CEOs in an uncertain, rapidly developing environment. From ‘traditional’ product development outsourcing - using consultants for tasks such as mechanical engineering or industrial design - to novel, Internet-enabled approaches such as Open Innovation (Chesbrough, 2003) and crowdsourcing (Howe, 2006), the range in both choice of partners and variety of options has exploded. The practice is collectively known as the ‘extended enterprise’ (Jagdev and Browne, 1998; Dyer, 2000). Firms across the globe and across the industries have entered short and longterm arrangements with other firms to acquire some aspects of product development they have deemed important for the firm’s long-term success. What is missing, on the other hand, are guidelines for choosing the right option. Outsourcing manufacturing and infrastructure functions, and related decisionmaking, have been discussed at length (for example, see Walker, 1988; Venkatesan, 1992; Quinn, 1994; Cánez et al. 2000; Jennings, 2002; Kakabadse and Kakabadse, 2002; Kumar and Eickhoff, 2005; Brannemo, 2006). Outsourcing has also been criticized for being dangerous to long-term innovativeness of the firm (for example, Tisdale, 1994; Chesbrough and Teece, 1996) and for being a product of management fads, internal politics and political ideologies (Hendry, 1995). Different approaches to ‘internal’ new product development processes have been comprehensively covered by a variety of authors (for just some examples, see Brown and Eisenhardt, 1995; Cooper, 2001; Ulrich and Eppinger, 2008). Researchers have also been active in trying to find the economic and managerial rationale for outsourcing innovation-related activities (some prominent examples
include Quinn, 2000; Chesbrough, 2003 and 2006; Hoetker, 2005; Love and Roper, 2005). Some of the drivers for outsourced product development have been identified (Calantone and Stanko, 2007) and even the make-or-buy decision in product development has been discussed, at least to some extent (Morin, 1999; Barragan et al. 2003). However, despite the fact that companies consider sourcing decisions as complex and tend to lack models supporting the decision process (Brannemo, 2006), so far there have been no studies that provide firms interested in outsourcing their product development tasks a prescriptive framework for dealing with issues such as what to outsource and to whom. Although providing a comprehensive framework for such a wide-ranging issue is beyond the scope of this thesis, this study attempts to partially rectify the situation by developing a prescriptive framework for choosing what to outsource, and to whom.
1.1. The need for a framework
This lack of knowledge has implications beyond product managers and product development teams. Any outsourcing decision should be viewed as a strategic decision that has potential long-term implications, but outsourcing product development, an activity central to the economic success and continuity of the firm, should be treated with extreme caution. Therefore, even a sketch of an unified framework on which to base the product development outsourcing decision-making should be useful to general managers, product and line managers, and product development teams. As Kakabadse and Kakabadse (2003, 61) conclude,
‘…unless top management has a clear view for both the strategic pathways to pursue and the contribution of outsourcing in determining the shape and nature of their organization, outsourcing may well be transactionally competently handled, but still not achieve the desired outcomes.’
Although firms that routinely outsource product development often have their own frameworks and procedures, to date no general model has been published. As especially smaller firms may lack the resources to develop such models, this study should be especially helpful to managers in smaller companies and business units that are considering their options, but do not know how to proceed. Furthermore, without a careful consideration of the future needs of the firm, outsourcing critical functions piece by piece - ‘outsourcing creep’ - can spell disaster in the long term. This is a real danger, given the fact that today many manufacturers have expanded their businesses by providing design services for their clients (Schweber, 2003). This can make it all too easy for stressed managers to make decisions with potentially disastrous consequences for the long-term competitiveness of the firm.
The absence of a structured framework affects suppliers of product development services, too. Without knowledge of the factors that should be considered when a client outsources a product development task, providers and their clients, run the risk of committing mistakes that can have serious consequences to the success of the project. Ultimately, this means reduced client satisfaction and damage to the provider’s reputation and prospects of repeat business. Of course, having - and using - a framework does not eliminate the risk. Frameworks can only help the involved parties avoid some most common mistakes. A framework can also help stimulate the thinking about the entire process, and raise awareness about importance of involving different functional areas of the firm in the outsourcing decision. As Ulrich and Eppinger (2008, 7) note, structured methods 1) make the decision process explicit and allow everyone on the team understand the decision rationale, reducing the possibility of moving forward with unsupported decisions (again, helping to avoid the ‘outsourcing creep’), 2) act as a ‘checklist’ of the key steps, and 3) are largely self-documenting for future reference, evaluation and education. In fact, previous research has found structure and documentation being virtual prerequisites for successful decision-making in production outsourcing projects (Cánez et al., 2000). Of these, of particular importance is the role a structured process has in the continuous development of the firm. Without a documented process, development efforts grind to a halt. Even some hypothesis and a process is usually better than none, and the process described in this thesis should serve as a basis for more detailed framework which can then be customized to fit the specific needs of a firm.
1.2. Research questions
The research questions of this thesis can be stated as follows: To produce a decision-making aid and guidelines for outsourcing product development activities to external product development consultancies, especially
1) How to determine what functions or products could be outsourced to a specific
2) What features make a product or a function so essential to the firm that know-
how to develop it must be kept within the company and cannot be outsourced?
1.3. The purpose and the outline of the thesis
Focusing on core competencies while outsourcing the peripheral functions is becoming more and more important, not to mention attractive, to firms in hypercompetitive markets. However, as stated in the Introduction, increased outsourcing may easily backfire. In particular, valuable competencies can be lost. On the other hand, equally valuable opportunities may be lost if the firm hesitates to make a decision. In new product development (NPD) settings, the choice is often between starting a project with external help, or drastically reducing its scope to fit it into busy schedules of internal NPD staff. Unprepared, both decisions can be harmful to the firm. But how to make sense of the subject? How to build a ‘mental model’ of NPD outsourcing, when existing research on NPD outsourcing is fragmentary and limited? What’s more, due to interdisciplinary nature of the phenomenon (see e.g. Hoetker, 2005; Hätönen, 2008), simply re-using old outsourcing frameworks may easily result to misleading conclusions. A framework based on one discipline – say, cost-minimizing, transactional outsourcing of easily standardized component parts of the final product1 – is not just inadequate for NPD outsourcing; at worst, it can be outright harmful to the firm. This thesis tries to address the issue of NPD outsourcing based on most relevant disciplines and help managers build a mental model of what NPD outsourcing is about. Developing this mental model requires some background in phenomena related to the subject, such as social capital. As a result, this thesis should be treated more as a literature review and a sketch on the subject rather than a definitive study. It is hoped by the author that this review helps firms struggling with the question of outsourcing their core competencies to make some sense of the subject – at least as far as new product development is concerned.
That is, the ‘traditional’ view of outsourcing as utilized in manufacturing industries.
The outline of the thesis is as follows: after a discussion of research methodology and defining the terms used, the historical context of the thesis is briefly sketched out by short histories of outsourcing in general and outsourced innovation in particular. These, in turn, build foundations for short treatise on theories underpinning outsourcing research. Research streams used in the thesis are identified and briefly outlined. The arguments from theory are then introduced. The thesis also includes an empirical research on NPD outsourcing in Finnish export business. The study aims to map the extent of phenomenon, as well as highlighting challenges inherent in the field. A number of hypotheses are developed from foreign literature, and are tested against empirical data. Finally, the thesis includes a brief discussion on phenomena. Practical implications are identified and presented. Discussion is based on literature review, empirical research, and semi-structured interviews with various managers and other personnel with experience in NPD outsourcing.
1.4. Research methodology
A challenge that both inspired and shaped this thesis was lack of available data on the new product development outsourcing. Although prominent authors (e.g. Hagel and Singer, 1999; Quinn, 2000; Rifkin, 2000; Friedman, 2005) have been declaring the 2000s as the age when even core competences can and should be considered for outsourcing, the phenomenon of outsourcing new product development is still far from widespread. In addition, several journalists and researchers (e.g. Engardio et al., 2005; Carson, 2007; Calantone and Stanko, 2007) have noted that even firms that practice NPD outsourcing are often reluctant to talk openly about the subject. Both of these difficulties were encountered during the research. Nevertheless, the growing strategic importance of the subject became very clear from nearly every interview of NPD professionals conducted by the author. Since the subject was considered important but hard data – especially from Finnish firms – was difficult to come by, the research relied heavily on literature, secondary data, and semistructured interviews and other discussions with professionals from various fields. As outsourcing and new product development are in themselves broad subject areas, understanding a phenomena as complex as NPD outsourcing by using a single theoretical framework or only through qualitative or quantitative studies and surveys would almost certainly lead to an oversimplified analysis. As stated above, several authors (e.g. Hoetker, 2005; Hätönen, 2008) argue for an interdisciplinary approach to the phenomenon. As a result, the research approach used in this thesis is a generation of theory from various forms of data and various theoretical backgrounds. The author recognizes that this approach results to a relatively lengthy thesis; however, it is felt that the breadth is necessary for explaining the outsourcing phenomenon. The data has been primarily qualitative, but quantitative data (e.g. Holopainen and Järvinen, 2006) has also been used where appropriate. Of special importance have been in-depth interviews of NPD professionals from companies A
and B2, whose comments helped to shape especially the final revision of this text. The insights from the interviews are attributed in the text as Firm A interviews (2008) or Firm B interviews (2008), respectively. These interviews were conducted according to semi-structured interview protocol outlined by Bryman and Bell (2007, 474) and detailed in Appendix A. In addition, a survey of 60 Finnish export-oriented firms was conducted as a preliminary to the study to determine the extent of the phenomena in Finland. This study, its methodology, and results are detailed in Chapter 4. Although this thesis has been structured according to a standard theory-hypothesistest model, in reality the research has gone iteratively back and forth as new data, literature, and ideas have emerged. Of course, this is what most researchers do anyway: it is simple common sense to retrospectively formulate new hypotheses to fit the data during the research process. Where this thesis differs is that hypotheses were deliberately formed late in the research process, instead of picking a hypothesis based on limited research and trying to prove or disprove it in some manner. The latter is an example of ‘hypothetico-deductive orthodoxy’ (Haig, 1995) that may cause researchers to be perhaps too concerned about empirical adequacy and testability of their theories (Haig, 1995). In Master’s theses read by the author in preparation to this research, this has sometimes led to low-content, underdeveloped theories being prematurely tested with empirical methods. It is the opinion of philosophers of science Thagard (1992) and Haig (1995), and also of this author, that in social sciences - business research included – the focus should be on establishing theory’s explanatory coherence. Explanatory coherence means, in short, that theories developed should have more explanatory breath than previous theories, be as simple as possible in terms of special assumptions made, and be supported by analogies to theories that scientists already find credible (Thagard, 1992; Haig, 1995).
The names and details of participating companies and the interviewees have been obscured for reasons of confidentiality.
The research approach of this thesis resembles, but does not entirely follow, socalled ‘grounded theory’ methodology (Glaser and Strauss, 1967; Glaser, 1978; Strauss, 1987; Strauss and Corbin, 1990; Glaser, 1992). Grounded theory (GT) contradicts the traditional model of research, where the researcher chooses a theoretical framework, and only then applies the model to the studied phenomenon. The research principle behind GT is neither inductive nor deductive, but combines both in a way of abductive reasoning (Glaser, 1998; see also Kantorovich, 1993). This leads to an iterative research practice where data sampling, data analysis and theory development are not seen as distinct and separate, but as steps to be repeated until one can describe and explain the phenomenon that is to be researched, and new data does not change the emerging theory anymore. As the goal in grounded theory is to generate concepts that explain people’s actions regardless of time and place, instead of accurately describing the events or ‘proving’ a hypothesis, it is particularly suitable for generating aforementioned ‘mental models’ and frameworks to help decision-makers do better decisions. Where this thesis differs from ‘pure’ grounded theory approaches is in details and some practices of research. Grounded theory expects the researcher to start with as few preconceptions as possible (Glaser, 1992) and, for example, start with research, not with literature review. Grounded theory also demands more systematic coding of research data than was actually practiced during this research, although given this text’s highly iterative creation process3 the end results might not have been very different. Nevertheless, simply because the author came into contact with grounded theory methodology only late in his research, this study cannot be said to follow the ‘textbook’ grounded theory approach, and fits better with a more general account of scientific method called ‘abductive explanatory inferentialism’ or AEI (Haig, 1995). This means that the theory is generated heuristically, or abductively (Kantorovich,
11 substantial revisions with a total of nearly 850 pages, some 250 pages of notes, and nearly 500 references.
1993), and is appraised in terms of what philosophers have come to call inference to the best explanation (Haig, 1995), i.e. whether the theory provides a better explanation of the evidence than its rivals. Thus, it is a hope of the author that this study be evaluated on its explanatory coherence, rather than methodological purity.
Evolution of practice and theory over the last decades has caused researchers, managers and trade press to use often inconsistent and sometimes contradictory terms for many activities that fall under the outsourcing paradigm. For this reason, this section seeks to define the important terms used in the study. Most of the terminology follows current practice in electronics industry (see Schweber, 2003), with some additions from general outsourcing research (e.g. Gilley and Rasheed, 2000).
Generally, past studies about outsourcing have defined outsourcing so broadly that it can include virtually any good or service that an organization procures from outside firms (Gilley and Rasheed, 2000, 764). A narrow definition of outsourcing covers only situations where the ownership of an activity is transferred by divesting previously internal functions or processes4. However, for reasons of clarity and simplicity this thesis uses a broader definition that also includes other long-term contracts that seek to buy capabilities that the firm needs, even if the firm didn’t originally produce that capability5. Therefore, activities that are considered as outsourcing in this thesis include capability sourcing (e.g. Godfredsson et al., 2005) and strategic procurement (Venkatesan, 1992). A prudent choice is to use definitions that fit the phenomena under study. As this thesis deals mostly with outsourced R&D services, with the exception of cases where the NPD service provider also manufactures the final products (so-called Original
‘Outsourcing through substitution’ (Gilley and Rasheed, 2000, 764). ‘Outsourcing through abstention’ (Gilley and Rasheed, 2000, 765).
Design Manufacturing), definition of the word ‘outsourcing’ used in this thesis is purchasing any capabilities, activities, processes or functions from outside the company as a part of the new product development process.
An important differentiation is between outsourcing and offshoring, i.e. transferring jobs to low-cost countries in order to take advantage of cheaper labour (so-called labour arbitrage). Outsourcing may involve offshoring, but offshoring can also take place within the company, without involving any outside suppliers. As location decision is beyond the scope of this thesis, the text does not explicitly make a distinction between in- and offshored activities.
A product is something sold by an enterprise to its customers (Ulrich & Eppinger, 2008, 2). Today, this increasingly refers to a mix of physical products, software, and services - collectively known as the offering - but for reasons of clarity, the word product is used throughout this text. Although the focus of this text is on engineered, discrete, and physical products, most of the methods and findings are broadly applicable to development of services or software (however, for software NPD outsourcing, see Hätönen, 2008).
1.5.4. Product development
Product development is the set of activities beginning with the perception of market opportunity and ending in the production, sale, delivery (Sheldon, 2004; Ulrich & Eppinger, 2008, 2) and ultimate re-use or disposal (see McDonough & Baumgard, 2005) of the product. For the purposes of this thesis, product development is defined to include the following phases (Ulrich & Eppinger, 2008, 9):
1) Planning 2) Concept development 3) System-level design 4) Detail design 5) Testing and refinement 6) Production ramp-up
Reader may note that these phases correspond roughly to the famous and oftenused ‘Stage-Gate™’ model of product development and management (Cooper, 1992). However, since this thesis is more concerned with sourcing the individual tasks and sub-processes included in a product development process, rather than the management of the entire process, Ulrich and Eppinger’s generic model is used as a framework.
1.5.5. Product development outsourcing
Product development outsourcing, or NPD outsourcing, refers to product development activities performed by an external provider. In practice, product development outsourcing can be anything from buying ‘turnkey’ designs and
manufacturing from external sources, to engaging a consultant to design a particular component or perform e.g. industrial design for the product.
The word ‘client’ in this thesis refers to a person or organization that is purchasing product development services, i.e. the customer for those services.
In this thesis, the term ‘provider’ refers to a person or organization supplying product development services to a client. ‘Provider’ can also refer to a network of providers working collaboratively or competitively, as is the case in open innovation (Chesbrough, 2003) and crowdsourcing (Howe, 2006), respectively. These networks include, but are not limited to: 1) suppliers, 2) supplier’s suppliers, 3) distributors, 4) franchisees, 5) other middlemen, 6) customers, 7) customer’s customers, and other specialized resources such as university professors and consultants (Peters, 1992, 310).
1.5.8. Original Equipment Manufacturer (OEM)
Original Equipment Manufacturer is a term that has, in practice, been used to refer to very different and even contradictory business practices6. The definition used in this thesis is that an OEM is a company that gains most of their profit from either manufacturing its own products or purchasing products or components from another company and reselling the products or components with the purchasing
The term ‘OEM’ is sometimes used to refer to firms that make products for others to brand and sell; in this thesis, this practice is called Original Design Manufacturing (ODM).
company’s name or logo on them. Thus, OEMs are clients for ODMs. Today, many OEMs are primarily product definers and marketers, leaving manufacturing and sometimes detailed design to ODMs and contract manufacturers. (Schweber, 2003, 68)
1.5.9. Original Design Manufacturer (ODM)
Original Design Manufacturers are companies that design and build products for marketing under another company’s brand and usually own the intellectual property rights of the product, in contrast to simple contract manufacturers who manufacture products designed by their clients. The clients of ODMs include Original Equipment Manufacturers (OEMs) and other brand-name organizations such as large retail chains or mobile telephone operators. It is important to note that the distinction between ODM and OEM is rather flexible, especially as many ODMs are in a track for becoming branded OEMs in their own right (see e.g. Engardio et al., 2005). For the purposes of this thesis, a company is considered an ODM if most of their profit comes from ODM activities. (Schweber, 2003, 68)
Independent Design Tam (IDT) e
IDT’s are vendors that provide for-hire design services and are capable of doing most if not all of the new product development process by themselves. In some cases, IDTs can have manufacturing capabilities (at least in limited amounts, such as for trial runs and prototyping) but they expect to make most of their profit from design rather than manufacturing phase. (Schweber, 2003, 68)
2. NPD outsourcing in theory
The world can doubtless never be well known by theory: practice is absolutely necessary: but surely it is of great use to a young man, before he sets out for that country, full of mazes, windings, and turnings, to have at least a general map of it, made by some experienced traveller. Lord Chesterfield (1694-1773), a British statesman.
This first part of the thesis aims to explain the theoretical and historical background for outsourcing phenomenon. To a large extent, the theoretical position of this thesis falls between several different but – to some extent – overlapping research traditions. This is largely because the complex and extensive nature of outsourcing phenomenon encourages the adoption of a highly interdisciplinary perspective (see also Hätönen, 2008, 35-37; and Hoetker, 2005). In fact, it could be argued that outsourcing, and particularly innovation outsourcing, cannot be fully understood from just one theoretical position alone. Understanding outsourcing requires also an understanding of historical developments that have made outsourcing first an attractive option for cutting costs, and later a viable way of acquiring competencies and transforming the organization in the ‘age of access’ (Rifkin, 2000): a world where ownership of activities matters less than access to world-class competencies. Both in practice and in theory, outsourcing has proceeded through several distinct phases. Hätönen (2008, 19 and 69) identified three distinct phases of outsourcing, which he dubs ‘big bang’ of outsourcing (1980s to early 1990s, with focus on cost cutting), ‘bandwagon’ (early 1990s to early 2000s; focus on cost cutting and capability enhancement) and ‘barrierless organization’ (from the early 2000s onwards; focus on organizational transformation). These phases are summarized in Table 1.
Table 1. Different types of outsourcing in terms of motives. Adapted from Hätönen (2008, 19 and 69) Type
Transactional outsourcing Resource-seeking outsourcing
Outsourcing aimed directly at cutting and reducing operational costs Outsourcing primarily aimed at acquiring resources and/or capabilities that are unavailable, inadequate or insufficient internally Outsourcing aimed at transforming the organization into a more dynamic, efficient, and more focused economic unit
Examples of motives
Reduce costs Cost discipline/control Lower operational costs Aim to achieve and acquire best practices Improve service quality Access to new technology and skills Lack of expertise in-house Access to a flexible workforce Focus on core competencies/activities Improve business focus/internal reorganization Flexibility Free up internal resources Accelerate projects
Big bang: 1980s-early 1990s Bandwagon: early 1990s to early 2000s
Barrierless organization: from the early 2000s onwards
In the following sections, these historical and theoretical developments are briefly outlined. First, a brief history of outsourcing in general is presented, followed by a discussion of history of innovation outsourcing. After this introduction, theory base underpinning outsourcing and innovation outsourcing research is reviewed and examined. Theories and research streams used in this thesis are also selected and outlined.
2.1. A brief history of outsourcing
There are very few new things under the sun. In practice, outsourcing traces its roots to Roman tax collectors who were sold rights for collecting taxes (Kakabadse and Kakabadse, 2000), and outsourcing as a theoretical phenomena has been around at least since the publication of Adam Smith’s famous thesis Wealth of the Nations (1776), where Smith argued that the specialization of labour would bring benefits to all. In the early 1900’s, both industrial practice and management theory argued for vertically integrated and self-sufficient firms in a belief that size and vertical integration were an advantage to a firm (Greaver, 1998, 77). This was challenged during the 1950’s when outsourcing was first suggested as a corporate strategy (Quinn and Hilmer, 1994). Since the late 1960’s, as the average size of industrial firms has decreased, outsourcing has been rising in importance. The importance of outsourcing has risen dramatically after the communications revolution of early 1990’s provided companies with ways to communicate even with far-flung suppliers and made outsourcing a viable strategy not just for cutting costs, but also for seeking valueadding skills, competences, and knowledge outside the organization (e.g. Quinn and Hilmer, 1994; Kakabadse & Kakabadse, 2000; Kakabadse & Kakabadse, 2005). This ‘strategic outsourcing’ (e.g. Quinn and Hilmer, 1994; Alexander, 1996a) involved more strategic functions and encouraged firms to build closer relationships with their vendors as arms-length, cost-minimizing approaches to relationship management became insufficient. Increased knowledge and practice in outsourcing led organizations to outsource many activities traditionally carried out in-house. By the end of the 1990s, outsourcing had become a standard operating procedure in nearly all industries (Hätönen, 2008, 18). Because standard operating procedures cannot provide competitive differentiation, during the 1990s outsourcing moved on from focusing primarily from divesting the peripheral, non-core activities of the business - such as
cleaning, catering and site security - in order to focus on ‘core’ businesses (Prahalad & Hamel, 1990; Kakabadse & Kakabadse, 2005) towards more critical areas such as design, manufacture, marketing, distribution and information systems (e.g. Jennings, 1997; Quélin and Duhamel, 2003, Gottfredson et al., 2005; Carson, 2007). Outsourcing previously internal activities is possible, because in an increasingly integrated world economy, there is no longer such a need to ensure reliable suppliers of raw materials such as iron and oil. In addition, uncertainties due to limited communications capabilities have diminished and communication in general has become ubiquitous; and, perhaps most importantly, brainpower, not raw material, is the source of most value added (Peters, 1992, 305). As the pace of change in every business is accelerating, business leaders have noted that leveraging the skills, contacts, and expertise of a network enables firms to grow much faster than they would by just internal growth and competency development (von Ghygzy et al., 2002). This, in turn, has attracted investors who have come to reward focus and innovation over size and diversity (Greaver, 1998, 77). The end result has been an explosion of outsourcing across industries as diverse as aerospace, automobiles, chemicals, computers, electronics, energy systems, financial services, healthcare, software, and telecommunications (e.g. Quinn, 2000; Dahan and Hauser, 2002; Carson, 2007). As a result, our current hypercompetitive economic system could be referred to as an outsourcing economy, given the increased focus on core organizational activities and the simultaneous leveraging of assets not controlled by the firm (Hätönen, 2008, 15). Formally, the discussion about outsourcing is a discussion about vertical integration of the firm. As scholars such as Hayes et al. (2005) have noted, the advice on what actually is the optimum vertical integration strategy has been changing with the times. For example, Hayes et al. (2005, 116) note that
‘In the mid-1980s, BusinessWeek, for example, warned from dire consequences that would result from extensive outsourcing and even coined the pejorative term ‘hollow corporations’ to
describe companies that possessed no manufacturing capabilities of their own. But in a more recent article the same magazine trumpeted the virtues of outsourcing and argued, ‘The effect on innovation could be huge…’’
In fact, it was BusinessWeek’s Pete Engardio who first coined the term ‘transformational outsourcing,’ (Engardio, 2006) referring to strategies that aim to create radically new business models that can change the game in a firm’s industry. In this view, the future competitive edge is seen to lie in flexibility achieved through a tight operational focus and the leveraging of external core competences outside of this focus area (e.g. Quinn, 1999). As rapid change across industries makes core competences only temporal, coping in the new economy requires firms to constantly refine and modify their existing pools of knowledge, skills, and resources. Fine et al. (2002) even suggest that a firm’s real value-creating competency, and perhaps the only sustainable one, might be its ability to continuously restructure its value chain. This leads to outsourcing more and more critical and knowledgeintensive business components, often in close cooperation with the provider (Hätönen, 2008, 19). The key management challenges lie in recognizing the key competence areas, creating a flexible organization that focuses on value-creating competences, finding providers to provide the value to the rest of the operations, and managing the resulting global network of providers (Hätönen, 2008, 16-19). In parallel with the new challenges, this industrial fragmentation also offers firms various opportunities.
2.2. NPD outsourcing as a phenomenon
Today, the focus of outsourcing activities has moved from ‘simple’ activities upwards in the value chain, towards more knowledge-intensive activities (e.g. Jennings, 1997; Quinn, 2000; Chesbrough, 2003; Quelin and Duhamel, 2003; Brannemo, 2006; Salminen, 2008; Hätönen, 2008). Even though manufacturing firms have long outsourced much of actual manufacturing of their products or components, most have insisted that all the important research and development work would remain in-house. As common wisdom and anecdotal evidence point out that ability to develop new products can be accidentally lost by ‘hollowing out’ the firm through outsourcing all production (Tisdale, 1994; Chesbrough and Teece, 1996; Hayes et al., 2005), outsourcing product development deliberately has been viewed with some suspicion. Nevertheless, considerable empirical evidence exists of the value of utilizing external resources for promoting new product development (e.g. Freeman, 1991; Karlsson, 1997; Koschatzky, 1998; Oerlemans et al., 1998; Love and Roper, 1999, Hätönen, 2008), and the use of outside consultants for product development has, for years, been routine in many if not most firms. Beginning with industrial design outsourcing in the 1980s and 1990s, the increasing complexity of products and their shorter life-cycles demanded expertise from a range of different sources, while the use of technology (i.e. CAD/CAM, embedded systems, etc.) in the design process facilitated a change in practice that increased the opportunities for changing organizational forms (Bruce and Morris, 1998). In short time, outsourcing has dramatically altered new product development in various industries where product development has come to be viewed fundamentally as a function dispersed across collaborating firms (Quinn, 2000; Dahan and Hauser, 2002). This decomposition of production activities from each other and from design (Ulrich and Ellison, 2005; Carson, 2007) has created market opportunities for several large and small firms, causing a shift towards buyers’ markets where firms of all sizes in nearly all
industries can capitalize on their external sources of knowledge and capabilities (Hätönen, 2008, 16). With services ranging from specialist expertise provided by design and engineering consultancies to so-called original design manufacturers (ODMs) who market complete, manufacturing-ready and rebrandable designs, these providers are playing an increasingly important part in the global economy. For example, in 2005, estimated 70% of PDAs, 65% of notebook PCs and MP3 players, 30% of digital cameras and 20% of mobile phones were designed either completely or at least significantly by ODMs and sold under other, better-known brand names (Engardio and Einhorn, 2005). Examples from less high-technology industries such as Procter and Gamble7 suggest that a trend towards greater outsourcing is not confined to high-tech consumer electronics.
Figure 1. Sony Ericsson Xperia smartphone - designed and built by HTC. (Photo credit: Sony Ericsson)
Procter and Gamble’s ‘Connect and Develop’ Open Innovation initiative aims to source 50% of its new products from outside the company; see e.g. Nambisan (2007).
As technologies mature, the borderline between mission-critical and commodity R&D is sliding year by year. As a result, NPD outsourcing has been steadily on rise for the last two decades (Roberts, 1995; Duga and Studt, 2005; National Science Foundation, 2005). Firms are increasingly turning to their providers for complete turn-key solutions, as even co-design with help from outside specialists is becoming too difficult, expensive, or slow. For their part, providers are hungry to expand the scale and scope of their services, so that parts suppliers build up capabilities in design, and (more rarely) design firms claim stakes in manufacturing. In other cases, firms turn to outsiders for big ideas, and then turn those concepts into actual products8. The fine line between NPD services and other business services is further blurred by developments where brand-building agencies have employed product designers and even engineers to help them build entire customer experiences for their clients, from establishing the brand identity to delivering products that follow and enhance that identity (e.g. Alviani, 2008; Merholz et al., 2008). When all goes well, these developments have resulted to impressive increases of productivity. Through adroit use of outsourcing and new information technologies, firms have been able to reduce their time to market for new innovations by as much as 60 to 90 %, decrease their investments by similar amounts, and radically increase the value added from innovation (Quinn, 1994, 2000; Narula, 2001; Harland et al., 2005). It is no wonder that, according to a preliminary investigation by Calantone and Stanko (2007), there appears to be consensus among researchers and managers that outsourcing of innovation-related activities is here to stay, and that it could conceivably become extremely important in the future. However, firms still need to guard some sustainable competitive advantage, whether it’s control over the latest technologies, the look and feel of new products, or the customer relationship (Engardio and Einhorn, 2005) or risk being surpassed in the marketplace.
For one example, see Helm (2007).
In practical terms, NPD outsourcing happens on two levels. Firms either purchase specialist expertise needed for a certain task from outside providers acting as consultants to the NPD process9, or they define the required product features and completely or nearly completely outsource the actual design work. Whether and how much firms work with these independent design teams or original design manufacturers during the process depends on the nature of the project and the firm’s strategy. Some product definers are actively involved in the externalized design process, while others prefer a hands-off approach. A borderline case that can also be counted as NPD outsourcing is when firms create designs themselves but work collaboratively with outsourced manufacturer to refine the design’s manufacturability. As contract manufacturers are eager to capture a greater share of the value in NPD process, this has increased to a point where most manufacturers offer some kind of manufacturing ramp-up or design services.
Examples include market research, industrial design, mechanical engineering etc.
2.3. Theory base: outsourcing and outsourced innovation
Research on using markets to conduct transactions previously conducted in-house dates back to 1970’s (e.g. Williamson, 1975), with the first mention of the concept ‘outsourcing’ occurring in the mid-1980s10. Initially, research focus was on transaction cost economics (Williamson, 1975; Coase, 1937), which suggest that transactions should be organized within a firm when the cost of doing this was lower than the cost of using the market. Since then, research has expanded to other fields and become interdisciplinary in nature (Hoetker, 2005). Hui and Beath (2001) analyzed 143 studies on outsourcing and identified four main theoretical bases underpinning outsourcing research:
1) Transaction cost economics, 2) Other economic theories such as agency theory and production cost economics, 3) The resource-based view of the firm, and 4) Social-exchange/trust/relationship theories.
Research on outsourced innovation, in contrast, remained for long a province of historians of technology. Before the 1980s and the rise of computer start-ups and specialized design agencies, typical examples of outsourced innovation were 19th century independent inventors who sold their inventions to burgeoning industries of the time (Howells, 1999). As a research concept, outsourcing NPD activities became under discussion after the initial wave of transactional outsourcing (see Nyström, 1985). However, research in outsourced innovation really took off only in the late 1990s. Of particular importance to the topic was the publication of articles and books on open innovation (Chesbrough, 2003, 2006). The idea behind open innovation is that in
According to Hätönen (2008, 39), the concept was first used by Pastin and Harrison (1987).
a world of widely distributed knowledge, firms cannot rely entirely on their own research, but should instead buy or license innovations from other firms while simultaneously using outsiders to help commercialize innovations that are developed in-house but don’t fit the firm’s business model. The similarities to historical examples discussed above (Howells, 1999) are readily apparent, although Chesbrough (2003) goes beyond simple licensing of external inventions by stating that firms should also out-license technologies they don’t see as attractive to commercialize by themselves. More recently, crowdsourcing, or outsourcing design problems to the public rather than to another organization (Howe, 2006; Tapscott and Williams, 2006) has attracted both attention and criticism in the business press. Again, this practice has deep historical roots in various prizes awarded for solving some particularly important problem, for example the 1714 ‘longitude prize’ offered by the British government to anyone who could solve the problem of time-keeping at sea. Such practices have continued to the present day; some prominent examples are DARPA Grand Challenges and Ansari X-Prizes, both intended to stimulate innovation by giving inventors an incentive to develop radical new solutions. Compared to other types of outsourcing, the relative lack of research on NPD outsourcing is partly due to the problem lamented in several of the studies about NPD outsourcing: the difficulty of getting hard data on the phenomena due to NPD’s sensitive role and the importance of confidential personal relationships (e.g. Engardio et al., 2005; Carson, 2007; Calantone and Stanko, 2007). Some data exists in form of industry surveys and benchmarking studies (e.g. Roberts, 1995; Love and Roper, 1999, 2004; Sobrero and Roberts, 2001; Howley, 2002; Duga and Studt, 2005; National Science Foundation, 2005; Holopainen and Järvinen, 2006, among others), and an abundance of less academic accounts such as trade press articles, case studies and books on NPD outsourcing can be found (e.g. Engardio et al., 2005; Huston and Sakkab, 2006; Tapscott and Williams, 2006; Helms, 2007; Alviani, 2008; Brown, 2008; Neumeier, 2008). The latter often include ‘how-to’ guides about best practices when outsourcing NPD activities.
Nevertheless, research literature has approached R&D sourcing and innovation outsourcing from a variety of theoretical bases, including knowledge flows (e.g. Tarun et al, 1998), location and industry clusters (e.g. Koschatzky, 1998), transaction cost economics (e.g. Love and Roper, 1999; Ulrich and Ellison, 2005; Calantone and Stanko, 2007) industry networks (e.g. Powell, 1998; Hagel and Singer, 1999; Zirpoli and Caputo, 2002; Baloh et al., 2008), Calantone and Stanko, 2007), resource-based view of the firm (e.g. Quinn, 2000), and intellectual property rights (e.g. Love and Roper, 2004; Hoecht and Trott, 2006). Outsourcing industrial design – often a precursor for more comprehensive NPD outsourcing – has also been discussed at length (e.g. Bruce and Morris, 1998; Best, 2006). One of the latest additions to literature discusses outsourced innovation in terms of real options (Vanhaverbeke et al., 2008), or small, initial investments that help firms deal with uncertainties by buying ‘options’ to new ideas or technologies, thus increasing their flexibility11. Hoetker (2005), discussing the problems of identifying a manufacturer for technically innovative components, identified three relevant research bases for analyzing component development and manufacturing relationships. These are
1) Transaction cost economics (e.g. Williamson, 1975), 2) Firm capabilities (e.g. Barney, 1991; Winter, 1987). 3) Inter-firm relationships (e.g. Gulati, 1995; Uzzi, 1996)
In summary, Table 2 presents main theoretical foundations for outsourcing research. As can be seen from the Table, this thesis is based primarily on the resource-based view of the firm and on social exchange/trust/inter-firm relationship theories. As NPD outsourcing is only rarely about cutting the costs, transaction costs and other economic theories are not as relevant to the thesis as they would be in more transactional outsourcing.
For an overview of real options approach and how it helps firms increase their flexibility and cope with uncertainty, see e.g. Kogut and Kulatilaka (2003).
Table 2. Primary theoretical foundations for outsourcing and innovation outsourcing. Research bases for outsourcing (Hui and Beath, 2001)
1. Transaction cost economics 2. Other economic theories (agency theory, production cost economics) 3. The resource-based view of the firm 4. Social exchange/trust/relationship theories
Research bases for R&D relationships (Hoetker, 2005; Hoecht and Trott, 2006)
1. Transaction cost economics 2. The resource-based view of the firm (firm capabilities) 3. Social exchange/trust/relationship theories 4. Intellectual property rights
Research bases primarily used in this thesis
1. The resource-based view of the firm (firm capabilities) 2. Social exchange/trust/ relationship theories
2.4. Key research streams and positioning of the study
Both Hätönen (2008) and Hoetker (2005) argue that to understand the trade-offs involved in outsourcing decisions, multiple viewpoints and multiple theories should be integrated. Hätönen (2008, 43) went on to identify four discipline-based research streams on outsourcing in general (Table 3). However, in contrast with Hätönen’s work on software NPD outsourcing in small firms, this thesis deals primarily with discrete, engineered goods and their design and development. Additionally, this thesis does not cover the location decision (in-shore or off-shore) and therefore lacks the explicit international business aspect. On the other hand, this thesis argues that the role of relationships and relationship management, specific features of service businesses, and the role social capital plays in the process have been undervalued by previous research. Therefore, relevant research streams for this thesis include strategic management, service businesses, and social capital, including institutions12. In addition, the author argues that research on external design services can provide insights into the practice and future of NPD outsourcing. (Table 3)
As defined by Akerlof (1970) and Holmström (1985); i.e. mechanisms and organizations that provide clients with more complete information in regard to services purchased.
Table 3. Primary research streams in outsourcing research, and those used in this thesis. Research streams on outsourcing (Hätönen, 2008, 43)
1. Strategic management 2. Supply chains 3. International business 4. Information systems /technology
Primary research streams used in this thesis
Key theoretical areas used in this thesis and an example of sources
1. Make-or-buy decision making (e.g. de Boer, 2006) 2. Outsourcing core competencies (e.g. Gottfredson et al., 2005) 3. New product development (e.g. Ulrich and Eppinger, 2008) 4. Modularity (e.g. Baldwin and Clark, 1997) and design rules (Ulrich and Ellison, 2005) 1. Selection and evaluation of service providers (e.g. Gallouj, 1997) 2. Design management (e.g. Bruce and Morris, 1998) 1. Trust/relationship and innovation (e.g. Mu et al., 2008) 2. Institutions (e.g. Holmström, 1985)
1. Strategic management
2. Service business
3. Social capital
The positioning of the study and its key theoretical areas are introduced graphically in Figure 2. The primary research streams and theoretical areas used in this thesis are introduced briefly in the following sections.
Figure 2. The positioning of the study, key theoretical areas, and research gaps to be addressed.
2.5. Strategic management
According to Hätönen (2008, 44), the literature on strategic management is largely focused on the resource base, the core competencies and the boundaries of the firm. Where outsourcing is concerned, the main focus in the literature is the rationale and incentives behind the actions leading to outsourcing. Strategic management literature used to see outsourcing as a tool for either trimming the cost base (transactional outsourcing) or acquiring resources that were insufficient or not internally available (resource-seeking outsourcing), but as increased competition and falling interaction costs have caused companies to outsource more critical functions and processes, the focus in strategic management literature has shifted to the creation of superior customer value (see, for example, Merholz et al., 2008). As a strategy, outsourcing is typically used either to outsource only a part of an integrated function while retaining responsibility for coordinating the function, or as a ‘turnkey’ or total outsourcing, where the client outsources an entire function to an external provider (van Weele, 2000, 54-55).13
2.5.1. Make or buy decision-making
In strategic management literature, outsourcing or make-or-buy decision has been approached from different perspectives such as economics, purchasing, operations research, accounting and strategic management (Cánez et al., 2000). Despite their outward differences, most outsourcing decision-making frameworks basically
According to Willcocks and Choi (1995), total outsourcing generally refers to a situation in which more than 80 percent of the function or process is outsourced. In NPD practice, the client commonly undertakes product concepting and gives the resulting specifications to the total service provider, who then performs detailed design and engineering for the product.
consist of a limited number of steps and share common aspects.14 The outsourcing process itself will be discussed in more detail in Section 3. The discussion about what actually causes firms to start the outsourcing process, beyond vague references to trends and market forces, is not present in all of the studies. Although some studies seem to make the implicit assumption that firms are always on a lookout for a ‘better deal,’ Cánez et al. (2000; see also de Boer et al., 2006) note that usually only ‘trigger’ events, such as changes in economic conditions, cause firms to re-evaluate their policies. Unless such events occur, firms only rarely start costly search and evaluation processes. Triggers also serve as bases for performance measures for the success of outsourcing initiative. For instance, if the trigger is cost reduction, cost saving is logically the key performance measure. An important addition from de Boer et al. (2006) is that the resulting search includes both cognitive (i.e. cost analysis and other analytical tools) and experiential (‘trying before buying’) evaluation, and continues only until the quality and/or quantity of information exceeds a threshold level, when a tentative solution is determined and evaluated. The primary contribution of de Boer et al. (2006) was to take explicitly into account concepts of bounded rationality and satisficing. Current strategic management theory recognizes (see e.g. Mintzberg et al., 1998) that most decision processes stop after first ‘good enough’ solutions are identified (satisficing) and the decision-maker is expected to work under conditions of bounded rationality, where all the information is not available, and the decision-maker cannot know whether s/he knows everything. Bounded rationality also allows for the fact that decision-makers are usually
The frameworks reviewed for this study were from Walker (1988), Venkatesan (1992), Welch and Nayak (1992), Quinn and Hilmer (1994), Apte and Mason (1995), Bruce and Morris (1998), Lonsdale et al. (1998), Greaver (1998), Vining and Globerman (1999), Sislian and Satir (2000), Fill and Visser (2000), Cánez et al. (2000), Chiesa et al. (2000), McIvor (2000), Probert et al. (2000), Milgate (2001), Jennings (2002), Kakabadse and Kakabadse (2002), Momme and Hvolby (2002), Offodile and Abdel-Malek (2002), Eklund (2004), Kumar and Eickhoff (2005), de Boer et al. (2006), and Hätönen (2008). For a reader interested in a more detailed description, Appendix B contains brief summaries of several more prominent frameworks.
operating under time pressure: even if they had resources to conduct an exhaustive search, most often they simply do not have time to do so. However, the most obvious problem with simply re-using existing outsourcing frameworks in this thesis is that most frameworks have been developed by researchers using data from manufacturing, logistics, and IT outsourcing.15 The need to support these functions in the most efficient way, and the resulting armslength models, tend to bias the existing outsourcing frameworks towards cost optimization and leave the purchasing process to hands of lower-level procurement professionals (Laios and Moschuris, 1999; Barragan et al., 2003). In a summary, these arms-length, adversarial approaches are still perfectly adequate for outsourcing less critical or non-core activities, but it is easy to see how they can lead the organization to eventually use them, unwittingly perhaps, to more strategic areas such as product development and thus inadvertently ‘hollow out’ the corporation. Therefore, the typology of three different outsourcing strategies (transactional, resource-seeking and transformational; see also Section 2) proposed by Hätönen (2008) is particularly valuable, since it allows practitioners to mentally separate cost-minimizing outsourcing from more strategic options.
Notable exceptions to this include Pisano (1990), who examined R&D sourcing decisions in the biotechnology industry, and Novak and Eppinger (2001) who studied automotive component sourcing, as well as contributions from e.g. Chiesa et al. (2000), Barragan et al. (2003), and Ulrich and Ellison (2005), of which only Barragan et al develop a prescriptive framework. In addition, Hätönen (2008) studied NPD outsourcing in context of Finnish small and medium software businesses. Design management research should also be mentioned here, as lessons learned from design consultancies can be extremely valuable in understanding NPD outsourcing (e.g. Bruce and Morris, 1998). These contributions will be explored in more detail later in this thesis.
2.5.2. Outsourcing core competencies
As outsourcing becomes more strategic and inches towards the organization’s core competencies, outsourcing decisions become more complicated and require input from a wider base of stakeholders and experts. In NPD settings, outsourcing decisions require input from technology, design and marketing functions to distinguish truly strategic and non-strategic activities (Barragan et al., 2003). Nevertheless, strategic management literature now recognizes that even outsourcing core competencies may be possible in certain circumstances (e.g. Gilley and Rasheed, 2000; Gottfredson et al., 2005). In this transformational outsourcing, new dynamic core competences are needed. Hätönen (2008, 44) refers to these competences as strategic restructuring competencies (see also Hagel and Singer, 1999; Fine et al, 2002). These mean competences that give the firm the ability to continuously restructure its value chain. This issue is often considered in terms of value-chain management, but it is also closely connected to core competency analysis: the firm undertaking transformational outsourcing must know which activities actually increase customer value or capture value from the network and concentrate on those activities that provide best return for investment. Outsourcing also requires many firms to develop another ‘new’ core competency in managing the geographically dispersed network of providers that results from outsourcing economic activities (Hätönen, 2008, 45; Kakabadse and Kakabadse, 2002). In the context of new product development, these networks of providers can either supply individual product development tasks, or they can supply the entire product development process as total outsourcing (van Weele, 2005, 54-55). In order to define what these tasks are, a brief overview of product development management is required.
2.5.3. New product development
Literature review finds that the coordination of product development activities has been a subject of much study. Numerous authors have attempted to develop generalized models of product development process, but most of the resulting models differ only in details. Predominant product development models focus on staged task sequencing (Cooper, 2001), the use of project management and crossfunctional teams, and the development of widely shared product concepts early in the process (Brown and Eisenhardt, 1995). All of the models reviewed divide the product development process into distinct phases or stages, with common elements including a problem-definition stage, a concept-generation stage, preliminary and detailed design, and concept embodiment (Seidel, 2007). The actual number of stages differs between four and six (Ulrich and Eppinger, 2008) but include essentially the same activities. For example, Ulrich and Eppinger’s generic product development process (Ulrich & Eppinger, 2008, 14) consists of six phases: 1) planning, 2) concept development, 3) system-level design, 4) detail design, 5) testing and refinement, and 6) production ramp-up. Each of these phases includes different responsibilities for organization’s key functions – marketing, design, manufacturing and other functions, which have a different technological profile, involve different risks and costs and therefore have unique risk/reward balances if outsourced (Love and Roper, 2005). A recurring question in product development literature is whether the product development should be integrated (so-called concurrent or integrated product development, e.g. Cagan and Vogel, 2001; Ulrich and Eppinger, 2008) or disaggregated to separate tasks. Concurrent product development became a buzzword during the 1990s, when it was seen as a way to faster time-to-market cycles and better product quality. Today, cross-functional, integrated product development is widely seen as a virtual requirement for innovative new products
(see e.g. Brown, 2008). But this raises a question: if product development needs to be integrated, either as a process, or with e.g. manufacturing, can it be outsourced at all?
2.5.4. Modularity and design rules
Much of the existing literature tend to address the decision to outsource a single activity in isolation, instead of considering interactions between two or more sourcing decisions. In case of NPD outsourcing, this gives a relatively limited view since, for example, decisions to outsource research or concept design may very well have implications to detailed design and manufacturing decisions. How these interactions and interdependences affect the organization is a subject of much research in modularity (e.g. Ulrich, 1995; Baldwin and Clark, 1997, 2000; Schilling, 2000; Brusoni and Prencipe, 2001; Fine et al., 2002; Langlois, 2002). Modularity reflects the degree to which the products and their production processes are decomposed into smaller subsystems and activities, which may be designed and managed independently yet function as a whole (Baldwin and Clark, 2000; Brusoni and Prencipe, 2001; Mikkola, 2006; Hätönen, 2008). Originally, modularity research arose from product design strategy research as product modularity (Ulrich, 1995; Baldwin and Clark, 1997). Product modularity refers to products where interdependencies between different parts and subsystems or modules are kept to a minimum and where these modules communicate and interact with each other through standardized interfaces and specifications. The idea is to decrease the complexity of the system by decomposing its complex tasks into simpler independent tasks or units that communicate with each other through standards without compromising the overall performance (Mikkola, 2006). However, in practice modularity can be at odds with performance, because
optimizing product’s ‘global’16 performance characteristics requires holistic view that is only achieved by having an integrated architecture (Ulrich, 1995). It is also worth noting that very few products are truly modular or truly integrated, and most products are instead somewhere along the integrated-modular continuum (Brusoni and Prencipe, 2001). Product modularity in itself makes products and their development more amenable to outsourcing, as subsystems can be designed, managed and produced independently (Sanchez and Mahoney, 1996; Baldwin and Clark, 1997; Mikkola, 2006). A systems-architecture view required by product modularity also enables a firm to better identify its area of core competences, and assists in making further outsourcing decisions (Helander, 2004). Yet by expanding the idea of modularity to process modularity (e.g. Sanchez and Mahoney, 1996; Baldwin and Clark, 1997; Brusoni and Prencipe, 2001; Fine et al., 2002; Langlois, 2002) and making the product development process modular, not just design of individual components but parts of the entire NPD process can - at least in theory - be outsourced at will. In theory, process or organizational modularity has significant implications for a firm’s product design and its underlying organizational process (Brusoni and Prencipe, 2001). A firm that creates well-defined standard interfaces could also escape the trap of sub-optimal ‘bad compromise cultures’ (see Hagel and Singer, 1999)17 by allowing individuals working on particular parts of the process to work autonomously in whatever departmental configuration or organizational culture they deem most desirable, and still be assured that the components would interact effectively (Schilling, 2000). Modularity also enhances the management of dispersed activities and simplifies their coordination (Sanchez and Mahoney, 1996; Schilling, 2000). It also increases the transferability of activities by requiring firms to establish
Global performance refers to performance of the entire product as a system, instead of performance of parts of the system. 17 For example, Hagel and Singer (1999) mention the cultural differences between innovationfocused organization (one that is focused on new ideas) and production- or process-focused organization (one that is focused on smooth production). New product development is difficult if the rest of the organization treats new ideas as threats to smooth running of operations.
visible rules covering the design process (Baldwin and Clark, 1997). Modularity enables parallel design, production and management of activities as output from one activity is not needed for input to another (Hätönen, 2008), and decreases the transaction costs arising from the attachment of new activities to existing processes (Hätönen, 2008). Modularization in product design could pave the way for a similar process in organizational design (Ethiraj and Levinthal, 2004). With enough knowledge about interactions between tasks in the product development process, ‘interfaces’ between different tasks could be codified and standardized, and tasks decoupled from each other.18 These tasks could, in turn, be bought from whoever is in a position to do it best or cheapest. This de-coupling of design activities is referred to as integration-disintegration question (Ulrich and Ellison, 2005), meaning whether or not two or more activities should be consolidated into the same organizational entity. Integration is desirable, if 1) the quality of precedent activity is difficult to measure and responsibility for both should be given to the same organization in order to avoid shirking19 without detection (e.g. Holmström and Milgrom, 1991), or 2) if iterative exchanges of information and cooperative problem-solving are required between two activities say, design and manufacturing (Ulrich and Ellison, 2005). On the other hand, disintegration is attractive if task quality can be assessed and interfaces between two tasks can be clearly defined. These interfaces between different tasks are known as design rules (Ulrich and Ellison, 2005). They can be thought of as codified standards that are used as a coordination mechanism in the sense of Galbraith (1974) and Baldwin and Clark (2000). Design rules are possible to establish when the component or knowledge production processes are stable and
However, product and organizational modularity do not necessarily correlate (see Sanchez and Mahoney, 1996; Brusoni and Prencipe, 2001), even though literature predicts this would be the case (Brusoni and Prencipe, 2001). 19 In short, shirking means doing less work than agreed.
well understood, and the constraints of the process can be expressed (Adler, 1995). For example, in manufacturing the existence of design rules means that designers can specify the geometry and material properties of the component in a way that it can be made without complication on the intended production process (Ulrich and Ellinger, 2005). It should be noted that informal ‘design rules’ in form of standards exist also for services; for example, certain market research processes are virtually standardized and can therefore be disintegrated from other activities (e.g. Hyysalo, 2006). Design rules need time to become widely known, and new, unusual, and/or poorly understood processes only rarely have such rules (Ulrich and Ellinger, 2005). If the process lacks design rules and other standards of behaviour, feasible designs must be produced through trial and error or through dialogue between process experts and designers. As the second alternative is often much more likely to produce satisfactory outcomes, design process is often conducted iteratively with the trial and refinement of the process, or at a minimum with strong communication between process experts and component designers (Fine and Whitney, 1996; Ulrich and Ellison, 2005). Monteverde (1995) calls this kind of interaction between designers and process experts ‘unstructured technical dialog,’ finding empirical evidence in the semiconductor industry that its presence is significant motive for integration of design and production (Ulrich and Ellison, 2005). However, advantages in information technology have enabled loosely coupled organizational structures become more common, since information technology allows firms to access and process more information at a lower cost. This has increased the firm’s options for development configurations (Schilling, 2005). Integration and disintegration should not be confused with internalization and outsourcing. Incentives for integration and outsourcing are completely different. Two tasks, A and B, can be 1) integrated and internalized (i.e. the client completes both), 2) disintegrated from each other with A internalized and B outsourced, or 3) integrated and outsourced (i.e. the provider completes both). A situation may also
arise when there are motives to internalize task A that needs to be integrated with task B, but where task B would benefit from outsourcing. What exactly happens depends on e.g. relationships between the client and the providers and their specific capabilities. These four cases are illustrated in Figure 3. (Ulrich and Ellison, 2005)
Figure 3. Four different cases of integration and internalization. Source: Ulrich and Ellison (2005, 320)
As technologies mature and newer practices in product development become more widespread, it is likely that more and more tasks that today are considered difficult or impossible to disintegrate gain design rules and become standardized commodities. This evolution of industry knowledge base will enable increased division of labour between firms. Methods used to increase product modularity, e.g. uncoupling integrated functions within the task and thus bringing the task modularity to a finer level (Schilling, 2000) can also be used. In combination with proper networking tools they can be effective at helping the internal NPD staff to focus on activities with the greatest value-add. For example, division to e.g. concept design and detailed design may allow the firm to achieve the benefits of internalized and outsourced activities (Ulrich and Ellison, 2005).
In addition, increased knowledge on how abstract processes and needs should be specified and conducted eases the task of disintegrating and outsourcing these tasks. Research on how these specifications, often called ‘design briefs,’ should be prepared has mostly been undertaken within service business research and in particular within industrial design management research.
2.6. Business to business services
Service businesses in general have seen increasing research attention over past two decades, as the service sector has grown to the point where services are the primary sources of both value added and new employment in many countries, including Finland (e.g. Segal-Horn, 2003; Rikama, 2006). In contrast to manufacturing, the output from services is primarily information, advice, and experiences, rather than physical goods or objects. Service growth, in turn, has been driven by recent organizational trends towards de-layering, outsourcing, and downsizing (Segal-Horn, 2003, 475). Services can be defined as ‘something which can be bought and sold but which you cannot drop on your foot’ (Gummeson, 1987, 20). In the research literature, the distinctive characteristics of services, compared to physical goods, are well understood in both economics and management literature (see e.g. Gallouj, 1997; Kotler and Keller, 2006) and are given only a brief overview here. The most commonly recognized distinctive characteristics are 1) the intangible, non-material nature of services; 2) inseparability, or the fact that direct contact between suppliers and clients is required; the implied participation of the client, i.e. the simultaneous nature of production and consumption or 3) perishability; and 4) dependence on who provides the services and where or variability (Gallouj, 1997; Segal-Horn, 2003; Kotler and Keller, 2006, 406-407). Although the literature on subject of professional and business-to-business services is vast, for the purposes of this thesis, two research streams are particularly important. The first is management of services, and in particular design management. Design management deals with the problems inherent in managing and developing industrial design businesses. Industrial design has a long history of being an outsourced part of product development process (Perks et al., 2005) and lessons
learned from managing relationships between designers and their clients shed valuable insights to wider subject of managing outsourced product development. The second important field of research for this thesis is the selection and evaluation of service providers, which aims to develop the theory and practice of choosing the right provider.
2.6.1. Design management
Design management, in general, refers to design-relevant decisions and optimization of firm’s design-relevant processes. Although design management can be and often is strategic in nature (e.g. Best, 2006; Bedford et al., 2006; Borja de Mozota, 2006; Brown, 2008), this thesis is more interested in applications that belong to operational design management. Examples of operational design management include selection of external designers and creation of alliances. Therefore, design management is treated under the research stream of business services, rather than strategic management. Design management’s relevancy to this thesis stems from the fact that since the beginnings of industrial design in the 19th Century, design and designers have been increasingly involved with new product development. During these years, design has had three roles in NPD process, evolving from design as a functional specialism to design as a part of a multifunctional team to design as process leader (Perks et al., 2005) – a taxonomy neatly spanning the different levels of outsourcing20 identified by Lacity and Hirscheim (1993).
These levels are body shopping, or ‘renting’ an employee; project management outsourcing, where more decision-making authority is delegated, and total outsourcing, where the provider is responsible for significant part of the project. In addition, Lacity and Hirscheim (1993, 3) specifically define the use of outside specialists as outsourcing.
In fact, design has traditionally been a professional service that designers have provided to external clients, making design an early example of outsourced NPD services. Today, design consultancies, eager to increase their share in product development projects, are also increasingly taking part in non-design tasks such as detailed engineering and even production ramp-up. In other firms, thanks to ideas such as concurrent design, design21 and product development are increasingly interwoven in many projects, and many practices originally developed in design consultancies are now in a widespread use in product development in general (see e.g. Cagan and Vogel, 2001; Engardio et al., 2005; Buxton, 2007; Brown, 2008; Merholtz et al., 2008; Ulrich and Eppinger, 2008). This history of helping firms in their NPD tasks from the late 1800s (Perks et al., 2005) makes design management literature a helpful source of experiences on NPD outsourcing. However, the field suffers from relative lack of research and much knowledge exists only within heads of practitioners (see e.g. Hytönen et al., 2004). Nevertheless, previous literature on design outsourcing has, for example, considered questions such as client-consultant interaction levels in NPD projects (e.g. Seidel, 2000; Hytönen et al., 2004; Best, 2006), how using external design capabilities add value to the firm (e.g. Creative Business, 1994; Kristensen, 1998; Hertenstein et al., 2005; Bedford et al., 2006; Best, 2006; Breen, 2007), design networks (e.g. Verganti, 2006) and how objectives for design should be communicated within the firm and to external providers (e.g. Ulwick, 2002; Hytönen et al., 2004; Best, 2006; Borja de Mozota, 2006; Creative Business, 2007). What is particularly interesting for the purposes of this thesis is how client-provider relationships in NPD projects should be arranged, as one of the key questions behind outsourcing research concerns the most appropriate form of relationship22. Another interesting question that has been discussed in design management literature is the interface between external and internal design or NPD teams (e.g. Bruce and Morris, 1998). These interfaces are
Including industrial design, graphic design, services design, interface design, etc. That is, how the outsourcing is conducted; see Insinga and Werle (2000).
directly linked to the earlier discussion of modularity and design rules presented in Section 2.5.4. Bruce and Morris (1998) aim to identify best practices to help design managers to ‘get the most out of’ their external design relationships. They note that product development literature is biased towards the management of in-house expertise, and that a critical success factor for new product development is effective management of the different functions - internal or external - involved in this process. According to Bruce and Morris (1998), product development literature typically links positive outcomes with a culture of openness, good cross-functional cooperation and communication, mutual respect and trust, shared values and mutual goal commitments, and multi-disciplinary teams that work together from inception to completion of the process. All of these factors are, in one way or other, difficult to achieve with external designers. Using external designers tends to lead to formalized processes that reduce openness, building trust takes time and repeated interactions, and there are doubts concerning how much the external design professional can be truly regarded and treated as a full team member to the product development process. As a result, outsourced product development professionals may make mistakes in moving from the concept to development stages and slow down the design process (Bruce and Morris, 1998). In short, external designers suffer from problems in modularity of information and lack of explicit design rules, and these problems are compounded if there is not enough trust between the client and the provider. Lack of trust makes discussions difficult, as the client has to fear for leaks of sensitive information, and the provider has to fear that the bills are not paid. The strength of an in-house approach to product development and design is that the product development is integrated into
the firm and has trusted relationships with the rest of the firm, and is well aware of both explicit and tacit23 firm practices. Finally, Bruce and Morris (1998) identify six factors that influence the choice of design suppliers:
1) Matching the design capability to the design project as ‘clean sheet of paper’ and
‘improvement’ situations require different types of designers;
2) Matching inter-firm technologies so that the designer is sufficiently aware of the
client’s technological requirements;
3) Matching customer experience with the consultancy’s own insight, i.e. designers
need to understand the client’s customers;
4) Active versus passive experience, or the level of involvement from the external
5) Dependence, proprietary information, trust and control issues; and, 6) Cost issues.
All these factors can be relevant to wider NPD outsourcing projects. As discussed above, one of the critical problems when utilizing outsourced design is how the objectives of the NPD project are communicated to designers. Communicating technical specifications is relatively easy, but the problem lies in communicating more demanding, subtle and subjective factors such as ‘look’ and ‘feel’ of products. This problem of creating effective information interfaces24, called ‘design briefs’ or ‘creative briefs’ in designer parlance, has been tackled mostly in trade press and through experience (e.g. Best, 2006; Borja de Mozota, 2006; Creative Business, 2007; see also Block, 1981). In practice, these design briefs are used to help ensure that the provider always gets the basic creative and positioning information needed when
Explicit practices are those that are codified, i.e. rules and regulations; tacit practices are rarely codified rules of thumb, unspoken restrictions, and experiences learned from previous projects. 24 In sense of modularity; see Section 2.5.4.
starting an assignment. Typical questions to be answered in a creative brief include (Creative Business, 2007):
1) The objectives: what is the purpose of the project? 2) The target audience: Who are the customers? What motivates them? 3) Targeted features: Specifications, components, manufacture; use in everyday
application; differences compared to competitors
4) Targeted user benefits: How the user will be better off? What are the trade-offs? 5) The competition 6) Preferences and constraints for budget, schedule, etc. 7) The single most important point; the primary focus of the product
Source: adapted from Creative Business (2007)
In particular, the last point makes many design briefs different compared to many other briefings. Reminiscent of several leadership/management theories such as time-based competition (see e.g. Stalk, 1988; Stalk, 1993; Richards, 2004; Smock, 2007), identifying and communicating this single most important feature of the product may help the external provider make important decisions about what to do, and what not to do, when confronted with an ambiguous and perhaps fleeting opportunity. In addition, clearly identifying the key competitive characteristics of a product and communicating them is - whether NPD is outsourced or not – particularly important in a world characterized by hypercompetition and hyperchoice (e.g. Merholz et al., 2008). Another way of thinking the problem of communicating what is required from the designer is to explain how design creates value from the four perspectives of the Balanced Scorecard25 (Borja de Mozota, 2006, 48). These four perspectives are
1) The customer value perspective 2) The performance value perspective
For more information on balanced scorecard method, see e.g. Kaplan and Norton (1992 and 1993).
3) The innovation and learning perspective 4) The financial value perspective
Source: Borja de Mozota (2006, 48)
Following Borja de Mozota’s (2006, 47) suggestion that ‘what is not measured cannot be managed,’ firms should create balanced scorecards for improving the communication of these different value perspectives to the external provider.
2.6.2. Selection and evaluation of service providers
The selection and evaluation of service providers has also been a subject for much discussion. In general, purchasing process for services differ from that for manufacturing activities due to different risks and uncertainties involved. The questions of selection and evaluation are distinctive in consultancy activities. In a nutshell, the problem lies in the acute observation by Wittreich (1966) that the client of any consultancy does not buy a product per se, buying instead ‘the promise of a reduction of uncertainty for decisions in the field concerned’ (Wittreich, 1966). Theoretically speaking, provider selection involves considerations about the economics of quality, agency theory, and the economics of incentives in general. The specific characteristics26, in particular the intangibility, make defining and measuring the output of services very difficult. The effects of a provider intervention can also take time to appear and become visible only in the medium or long term27. This presents the client with the unique challenge of not being able to evaluate the provider’s ‘goods’ before purchase but only long after payment for the services has been made.
Intangibility, inseparability, variability, and perishability; see Section 2.6, p. 52. For example, effects of product design usually become apparent only after the product is on the marketplace, and often take time to become apparent.
These variables are accounted in the so-called Nelson-Darby-Karni model of consumer's search for quality. Following Nelson (1970) and Darby and Karni (1973), Zeithaml (1981) highlighted three essential groups of product attributes that apply for both goods and services.
1) Search qualities apply to products the client can analyze and evaluate before
2) Experience qualities apply to products whose qualities become apparent after
purchase, during consumption.
3) Credence qualities apply to products whose qualities cannot be evaluated by the
client, even after consumption, because the client lacks the necessary knowledge or capacity. Any service can be composed of any proportion of each of the above dimensions, and the perception of qualities varies considerably depending on the clients involved (Gallouj, 1997). Consulting in general, and product development consulting in particular, is strong in experience and credence qualities: unless the provider takes over the entire NPD process for a certain product, the output is often difficult to isolate or quantify, and therefore difficult to measure. Even if the client has a relatively precise idea of the type of benefit they are expecting (as would be the case with large firms and ‘routine’ product development projects), Mitchell (1994) and Gallouj (1997) note that the client cannot be totally sure of what is being acquired, even if he has previous experience with the provider. After all, buying a service always includes an original element; ‘the purchase of a consultancy is almost always a 'new buy'‘ (Mitchell, 1994). There is evidence that product R&D with outsiders is credence-intensive service, i.e. a service that has many credence qualities (e.g. Tapscott and Williams, 2006; Economist Intelligence Unit, 2008; Lichtentaler and Holger, 2008). Thus, for the purposes of this thesis, NPD consulting in general can be defined to be a credenceintensive service, even though it usually has search and experience qualities as well,
and some specific services are relatively standardized offerings with mostly search and experience qualities. Table 4 (p. 66) lists approaches used for selecting service providers, and presents results from Holopainen and Järvinen’s (2006) study on how Finnish firms actually select design service providers.
Furthermore, buyers of services in general and of credence-intensive services in particular suffer from asymmetries in information. Basically, the client cannot know as much as the provider does about e.g. the quality of the service, the time it will actually take to accomplish the service, and the fit to the client’s needs, and so forth. Because of these information asymmetries between the client and the provider, the market has developed a certain number of responses, such as social capital, relationships, and institutions. These all fall broadly under the area of network theories.
Table 4. Approaches used for selecting service providers, and research on how Finnish firms actually select design providers. Adapted from Gallouj (1997) and Holopainen and Järvinen (2006). General selection criteria General approaches to information search
Consulting the list of consultants already having worked for the organization Contacting work colleagues for suggestions Contacting work colleagues for suggestions Seeking suggestions among similar organizations which have already used consultants Consulting particular groups who are well informed about the available resources: chambers of commerce, universities, etc. Consulting the membership lists of various professional associations Considering the authors of specialized articles that have appeared in recognized journals or magazines Participating in specialized symposiums, meetings or seminars in order to be aware of the resources that are available Considering consultants who have approached the organization. Examining the advertising of consultants
How Finnish firms actually gain information about design providers
Recommendations from other firms (39% of respondents) Lectures and seminars (28%) Personal contacts (25%) Direct marketing (25%) Through Internet (19%)
Selection criteria Finnish clients actually use when sourcing design
Personal contacts (44%) References of previous work (41%) Ability to deliver complete solutions (28%) Knowledge of the client’s industry (24%) Quality of the work (19%)
Past experience with the firm
Personal contacts and recommendations from trusted sources Use in other firms
Reputation in general
Reputation in a specific area or function
Length of time the provider has been in the ‘community’ Interaction, relations, communication Advertising Samples of work and references Price, efficiency Understanding the needs and the problems of the client
2.7. Network theories
A traditional way of organizing integration between organizations is through hierarchies and formal contracts. For example, a firm could either hire a person to make a part, or it could buy the part from a provider. In the first case, the firm organizes the employee’s work through a hierarchy. In the second case, as the firm’s hierarchy does not extend to the provider, the firm and the supplier sign a contract that specifies explicitly what is to be delivered, and when. These approaches work well when the firm can either hire a person or can specify and codify what it needs, such as when buying commodity products. However, sometimes hiring a person is not possible or strategically sensible, and as tasks undertaken by the provider become more strategic and ambiguous, the contracts cannot be made to cover all eventualities. In addition, NPD tasks in particular require relatively free, wide-bandwidth28 transfer of information, which may be difficult to codify and even more difficult to regulate with contracts29. In turn, unless information can be transferred freely enough, practical integration between tasks and functions may become impossible. Nevertheless, firms do collaborate with external consultants in solving extremely sensitive, complex, ambiguous and strategic problems. Outsourcing works in practice, even where good coordination and integration between the client and the provider is required. The explanation lies in social capital, institutions, trust and relationships, and other non-hierarchical mechanisms for organizational integration30, which reduce coordination costs between partners in outsourcing relationships. Given low enough coordination costs, practical integration between different product development tasks (see Section 2.5.3.) can be achieved without a
Wide-bandwidth in the sense that large amounts of information need to be transferred in short time - not in the sense of technology such as computer networks. 29 In fact, overformalization inhibits free flow of information that is necessary for good results in NPD (see e.g. Carson, 2007). 30 For example, geographic proximity, use of face-to-face meetings, co-locating, joint design teams, and design reviews (Adler, 1995; Dyer, 1997).
need to consolidate these tasks within same legal entity (Adler, 1995; Dyer, 1997). In fact, several observers have noted (e.g. Rifkin, 2000; Wilenius, 2004; Tapscott and Williams, 2006) that increased opportunities for non-hierarchical organizational integration have made networks viable and important alternatives to consolidating tasks within one legal entity. Currently, much research is devoted to different business network studies (see e.g. Chesbrough, 2006). present an overview of research related to this thesis. The following sections
2.7.1. Social capital
Social capital can be defined as ‘the ability of actors to secure benefits by virtue of membership in social networks’ (Portes, 1998). In general, it refers to common cultural systems such as social networks, long-term interpersonal relationships, standards of behaviour, institutions and shared values that allow individuals to coordinate their activities to attain desired goals, thus enhancing the efficiency of economy (Ruuskanen, 2001; Kankainen, 2007). Social capital lowers the barriers and transaction costs for cooperation by building ties between different firms and functions (e.g. Mu et al., 2008) and helps to internalize the skills and expertise of partners as acquired knowledge becomes embedded in the organization (e.g. Kogut and Zander, 1996). Most importantly for the purposes of this thesis, previous research has strongly suggested that trust31 1) plays an important role in business collaboration in general (e.g. Ruuskanen, 2003; Gottfredson et al., 2005; Economist Intelligence Unit, 2007, 2008), 2) is a crucial element in circumstances where the markets for services cannot completely reduce the asymmetries of information (Gallouj, 1997), and 3) is a necessary condition for any knowledge transfer relationship (e.g. Hayek, 1945; Romer, 1990; Tarun et al., 1998;
Trust, in turn, is an aspect of social capital.
Blomqvist, 2002). Specifically, the higher the trust between parties, the better are the outcomes of knowledge and technology transfer (Tarun et al., 1998). As Mu et al. (2008, 88) noted,
‘…social capital provides the basis of trust, which can greatly reduce the transaction cost of knowledge sharing and enhance the willingness of partners to share knowledge…’. (Mu et al., 2008, 88) According to social network theory, firms can leverage their social capital in order to gain competitive advantage - for example, by gaining access to knowledge (e.g. Burt, 1997, Ruuskanen, 2003, Kankainen, 2007, Economist Intelligence Unit, 2008; Mu et al, 2008). The definition of knowledge includes technology, user and market knowledge – in other words, products of the product development process. Thus, outsourced product development process is more likely to succeed if there is a trusting relationship between the provider and the supplier (see Figure 4). Trust is here defined as inter-organizational trust, which refers to general confidence that the partner firm is trustworthy, and can deliver what is promised. Components of this confidence therefore include not just good personal relations but also more formal ‘due diligence’ methods such as good results from various audits and appraisals (see also Institutions, Section 2.7.4.).
Figure 4. Social capital and firm innovation. Source: Mu et al. (2008, p. 87)
It can be suggested that this is the theoretical explanation for empirical findings such as Holopainen and Järvinen (2006), who discovered that personal relationships and references are by far more important to clients of professional design services than features such as price and even quality of the work. In fact, the theory outlined above suggests such findings.
Institutions, as defined by Akerlof (1970), are a series of mechanisms and organizations that have the role of ensuring that the buyer’s limited information, and the lack of ability to assess quality, do not threaten to put the market's very survival in jeopardy. As highlighted by Holmström (1985), institutions such as certification, contractual guarantees, contingent contracts, various signals of quality and reputation provide clients with more information on the true quality of the services concerned, and may even offer the purchaser a form of quality assurance. In the outsourcing context of this thesis, the most important institutions are contingent contracts, various signals of quality, and reputation. Certification and contractual guarantees are rarely if ever used within product development services, and they are therefore not detailed here. The rest are briefly outlined. Contingent contracts, or payment by results, is the industry standard in some forms of product development. It is particularly common in the furniture industry where designers are typically paid with a fixed sales provision on their products. However, in other fields it is used far less often. Contingent contracts are useful in clarifying the provider's relationship with the client and establishing the ‘success criteria’ for the project. However, success is sometimes difficult to quantify, and because contingent contracts involve a large degree of risk for the supplier, they are
not very popular within the industry. Furthermore, they subject the provider to an asymmetry of information situation, since it can be very hard for them to verify whether – for example – the sales figures for a certain product are indeed correct. Nevertheless, there exists some suggestions that product development consulting might be heading towards contingent contracts, if the success of firms such as Jump Associates and Fahrenheit 212 (see Helm, 2007) is of any indication. Varied signals of quality include all the signals that the provider ‘sends’ to its clients and outside world that aim to make it’s offering more credible in the eyes of its clients. In a way, they reduce the asymmetry of information, but only if they are credible (that is, costly for the provider to send) and have an agreed value in the eyes of the client (Perrot, 1992, quoted in Gallouj, 1997). Signals for service consultancies in general include formal qualifications, publications and participation at conferences, advertising and prestigious location (Gallouj, 1997); for product development services in particular, success at competitions, appearances at popular or trade press, and favourable reviews of previous products can be added to the list. Reputation is an implicit promise that a party to a contract will not act opportunistically in the case of an unforeseen event (Gallouj, 1997). Thus, the establishment and maintenance of a good reputation is a very important strategic asset for firms, particularly within consultancy services (Holmström and Tirole, 1989), because by referring to their reputations, the providers can compensate for lack of information in the market (De Band, 1995, quoted in Gallouj, 1997). Numerous authors such as Haynes and Rothe (1974), Stock and Zinszer (1987), and Dawes et al. (1992) have highlighted the importance of the effects of reputation, Dawes et al. (1992) noting that the two most important criteria by which service providers are chosen by clients are the general reputation of the firm and its reputation in the specific functional area concerned.
2.7.3. Tust and relationships r
One of the most important ways to build up reputation is through mutual trust. Trust is always important, but it is a crucial element in circumstances where the markets for services cannot completely reduce the asymmetries of information (Gallouj, 1997). The notion of trust as a critical success factor in service relationships was introduced by Parasuraman et al. (1985), who suggested that customers should be able to trust their service providers, feel safe in their dealings with the providers, and be assured that their dealings are confidential. Later studies have offered several broadly similar conceptualizations and operationalizations of trust in relationships (e.g. Crosby et al., 1990; Doney and Cannon, 1997; Moorman et al., 1993; see also Arnott, 2007). Although trust can be either ‘offer-related’ (competence, customization, reliability, promptness) or ‘person-related’ (similarity, empathy, politeness) (Coulter and Coulter, 2002), in product development collaborations trust is typically between individuals. To build trust between organizations is therefore to build up relationships, and hence trust, between individuals working in those organizations. Studies involving professional services (e.g. Gallouj, 1997; Halinen Kaila 1997; O’Malley and Harris, 1999; Hytönen et al., 2004; Holopainen and Järvinen, 2006; Lien and Laing, 2007) have further illustrated the critical role of personal relationships in provider selection. In professional services, the complexity of services results in a premium placed on relationships as a means of managing the purchasing process. Although the central role of relationships has been acknowledged in marketing literature and it is described in detail, few studies of outsourcing have so far taken it explicitly into account32.
The argument that traditional transaction cost economics takes relationships into account is often regarded as incomplete; for details, see Appendix C.
To understand the pivotal role trust plays specifically within business services, it should be first understood that credence-intensive business services often create information and, more importantly, knowledge, instead of physical products or tangible outcomes. For example, product development process creates not products but knowledge about the technology, the users, and the markets. After this knowledge has been produced, it also needs to be transferred to actors that can utilize the knowledge and actually design, build and market the products and services. Thus, the question of outsourcing product development often turns out to be the question of where the knowledge is produced – inside or outside of the firm – and whether the client needs it and can acquire it, if it is created outside the firm. Knowledge acquisition, flow, transfer and application have attracted much attention over the recent years (e.g. Nonaka, 1994; Grant, 1996; Kogut and Zander, 1996; Nonaka and Konno, 1998; Deeds, 1999; Hansen, 1999; Gupta and Govindarajan, 2000; Spencer, 2000; Tsai, 2001; Okhuyzen and Eisenhardt, 2002; Borgatti and Cross, 2003; Reagans and McEvily, 2003; Dyer and Hatch, 2006; Szulanski and Jensen, 2006; Mu et al., 2008), resulting to a greatly enhanced understanding of how knowledge is transferred across organizational boundaries. Amongst the various authors, there seems to be a broad agreement that development of intellectual capital and innovativeness are positively correlated, and related, with the ease of knowledge transfer. This, in turn, is facilitated by social capital among the actors in the inter- and intra-firm networks. Furthermore, trust plays an important role in determining the control needs for the activity. As the extended enterprise model attempts to find a middle ground between completely internalized and completely outsourced activities, it turns the make or buy question into an examination of the desired level of control over the activity being considered for outsourcing (Barragan et al., 2003). The more specific the requirements of the client about, for example, form factors, details and materials used, the less flexibility is available to the firm. Higher trust in the provider, and very
good and detailed understanding of the client’s needs33 means that the client does not have to exercise tight control over the activities performed. Indeed, trusting the provider enough is a precondition for outsourcing any given service: if the client doesn’t trust the provider enough to relinquish control over the activity, it is kept inhouse by default. Empirical evidence from Miozzo and Grimshaw (2005) and Carson (2007) confirms that when outsourced NPD tasks are creative in nature – as they often are in new product development – tight control has adverse effects to end results. Trusting, long-term relationships with repeated interactions also reduce agency issues inherent in outsourcing situations (Ulrich and Ellison, 2005). Therefore, as tight control leads to suboptimal results, and trust required for looser control develops slowly over time, firms typically increase their outsourcing intensity and expand the provider’s responsibility over time as the relationship evolves and develops (Morgan, 2003; Kinnula, 2006; Hätönen, 2008).
Detailed understanding of client’s needs is usually a by-product of long-term relationship necessary to develop high trust in the first place (e.g. Bruce and Morris, 1998).
3. Outsourcing as a process
As mentioned in the theoretical part of the study, outsourcing has been approached from different perspectives such as economics, purchasing, operations research, accounting and strategic management (Cánez et al., 2000). Most frameworks for decision-making are relatively similar, illustrating a number of steps or phases in the process. The distinct phases present in most outsourcing studies are listed below.
1) Assessment and approval, assessment consisting of
• Definition of core competences and strategy • Assessment of integral costs; and • Analysis of suppliers and competitors
2) Selection and negotiation 3) Execution 4) Relationship management 5) Renewal or termination of contract
Source: adapted from Eklund (2004) and de Boer et al. (2006)
Although most models focus on the planning phase (what should be outsourced) instead of the whole process34 (see de Boer et al., 2006, 446), a cogent argument can and should be made for greater emphasis on later phases of the process such as relationship management and contract renewal. That relationship management is central to a successful outsourcing shouldn’t be any surprise, and including periodic contract renewal as well is also an act of common wisdom. After all, as Brannemo (2006) has pointed out, one-way strategy is very unlikely to lead to an optimum
34 Some exceptions to this include Cánez et al. (2000); Kumar and Eickhoff (2005); and Hätönen (2008); see also Greaver (1998); Lonsdale et al. (1998); Momme and Hvolby (2002). For a list of outsourcing frameworks reviewed, see page 47.
outcome, and therefore outsourcing decisions should be re-evaluated as time passes. What is interesting is that relationship management and contract renewal tend to receive only a cursory treatment in frameworks published in academic journals, while models based on personal experience (such as Greaver, 1998) tend to stress their importance. However, there are also reasons for focusing on the planning phase. Reported failures in outsourcing projects are often due to outsourcing wrong activities (e.g. Doig et al., 2001; Fine et al., 2002). The chosen model can also be inappropriate for the specific outsourcing situation (e.g. Miozzo and Grimshaw, 2005), and very often, project management failures contribute to poor performance and client dissatisfaction (e.g. Swoyer, 2004; Best, 2006). Lack of involvement from the upper management can also be a problem, since long-term, strategic thinking is required especially in NPD outsourcing, as NPD abilities are directly linked to the innovation and learning abilities of the firm (e.g. Kakabadse and Kakabadse, 2003). This section discusses outsourcing, and particularly NPD outsourcing, as a process. The outsourcing process framework used in this thesis is based on reviewed frameworks and incorporating their common features. It comprises four main phases, namely
1) Assessment 2) Selection and negotiation, including
• Information search and preliminary evaluation • Request for proposals • Shortlisting
3) Final selection 4) Execution and relationship management, and 5) Lessons learned and termination/renewal of the contract.
The framework used in this thesis broadly follows the outline of Hätönen’s (2008) work, but has a somewhat different focus and aims to be more of a practical guide for outsourcing. In this section, the motives behind outsourcing NPD, as well as some potential drawbacks, are first briefly explored. Then the process of outsourcing is described using the abovementioned framework. Because every firm and every situation is unique, one cannot give definitive answers to the problems and issues in NPD outsourcing. Instead, this thesis attempts to broadly cover the process of outsourcing and detail the most common pitfalls and issues identified in the literature while taking a broad enough view so that the entire process is exposed. Although the resulting broad scope may be somewhat beyond the requirements for a Master’s thesis, having a broad rather than deep approach is necessary. Focusing on a certain part of the process while overlooking others is almost certain to lead to a failure of the outsourcing initiative (e.g. Hätönen, 2008, 86). For instance, if a firm mislabels its competences and outsources something that should not be outsourced, even the best vendor selection or partnership management process cannot save the situation. For this reason, if we are to understand how firms can outsource successfully, we must look at the entire process and identify key managerial considerations for each stage.
3.2. Motives for outsourcing (why?)
Outsourcing in general is perceived as a way to either increase the value of the firm by appropriating skills and abilities from someone else, or to stop destroying value by getting rid of activities that the markets can do better than the firm (Hätönen, 2008). A torrent of studies has attempted to survey the reasons for outsourcing in general and for outsourcing specific functions in particular. The ‘top five’ lists circulating at any one time tend to give somewhat different results, which is not surprising given the differences in populations surveyed. For example, a survey of CEOs tends to result to different criteria than one aimed at chief financial officers. Their answers, in turn, differ from those of the chief technological officer (Greaver, 1998, 3). Nevertheless, the reasons for buying instead of “making” products or services in general are relatively well established in academic literature. The prevailing wisdom is that an organization should consider outsourcing when it is believed that a function can be completed faster, cheaper, or better by an outside organization (e.g. Kakabadse and Kakabadse, 2000). Some of the reasons given for outsourcing in general are given in Table 5 (p. 80), grouped under three main motives for outsourcing identified by Hätönen (2008, 67)35. However, most studies and authors (e.g. Landis et al., 2005, 5; Heikkilä & Cordon, 2002, 185) agree that one of the main outsourcing drivers is the prospect of freeing up resources that could be reallocated to the focused activities, and thereby enhancing core competences. Any organization has limited resources, and those resources should be concentrated on core competencies. In addition to expenses
Other sources for outsourcing motives include Greaver (1998, 4-5), as well as Welch and Nayak (1992), Lacity and Hirscheim (1993), Quinn and Hilmer (1994), Alexander and Young (1996), Bruce and Morris (1998), Inkpen (1998), Powell (1998), Bounfour (1999), Hagel and Singer (1999), Vining and Globerman (1999), Chiesa et al. (2000), Sislian and Satir (2000), Kakabadse and Kakabadse (2002) and Chesbrough (2003).
and personnel, managerial time and focus are important and scarce resources. Managing non-core activities increases the number of people that have to be managed and provided with (see e.g. Penrose, 1959 and Kor and Mahoney, 2004). Non-core competencies take up time, energy, and workspace, all of which cost money. Most importantly, they cause the management to lose sight of what is really important: satisfying customers by exploiting the organization’s core competencies (Greaver, 1998, 70).
Improving risk management Reducing investment in N/A assets (e.g. space) Generating cash by transferring assets to the provider Reducing risks inherent in innovation Reducing costs through N/A superior provider performance and provider’s lower cost structure Turning fixed costs into variable costs Improving operational N/A performance /e.g. quality, time to market) Acquiring skills and technologies Acquiring innovative ideas and knowledge Improving credibility and image by associating with superior providers Gaining market access and N/A opportunities through the provider’s network Being closer to primary markets and their needs Accelerating expansion by tapping into the provider’s capacity, process, and systems Expanding sales and production capacity when such expansion could not be financed Commercially exploiting existing skills N/A Access to flexible workforce Lack of expertise in-house Improving N/A management and control Bringing in fresh ideas, unhampered by the existing culture or rigidities of the firm Accelerating projects Freeing internal resources Giving employees a stronger career path Increasing energy and commitment in non-core areas of the firm
Type Definition Organizationally- Improvementdriven reasons driven reasons Table 5. Motives for outsourcing
Financially-driven Revenue-driven reasons reasons
Outsourcing N/A aimed directly at cutting and reducing operational costs
Outsourcing N/A aimed primarily at acquiring resources and/or capabilities that are unavailable to the firm
Outsourcing aimed at transforming the organization into a more dyna-mic, effici-ent, and more focu-sed econo-mic unit
Focusing on core competencies Increasing flexibility Transforming the organization Increasing product/service value, customer satisfaction, and shareholder value
3.2.1. Motives for NPD outsourcing
With few exceptions, NPD outsourcing has always been resource-seeking, rather than profit-maximizing in nature36 (Firm B interviews, 2008). Few firms have all the competencies required for increasingly complex products of today, and building competencies that may be needed once per project may not be cost-effective. As a result, firms have traditionally outsourced many speciality NPD activities such as market research and industrial design. Today, NPD outsourcing may also be transformational37; in recent years, many firms have focused on their core competencies and core product lines, while outsourcing the design and development of complementary products to so-called Independent Design Teams38 or IDTs. In many cases, the provider also handles production and even logistics39, and the client, known as original equipment manufacturer or OEM40, only handles product definition or marketing (Schweber, 2003, 68). As a strategy for new product development, outsourcing not only allows firms to release resource constraints on firms’ NPD activities by acquiring rare resources from outside the firm. External linkages may also help in reducing risk, and accelerating or upgrading the quality of the products developed. Using external providers may also signal the quality of firms’ activities (Powell, 1998) and even increase firms’ ability to appropriate the returns from undertaking NPD (Gemser and Wijnberg, 1995). Global competition during recent years has had direct effects on product development outsourcing by compelling firms to apply greater cost discipline and minimize their product-to-market time cycles (Quinn and Hilmer,
36 One of the few profit-maximizing approaches used in practice is off-shoring NPD tasks to cheaper countries. Especially ‘routine’ tasks such as coding, drafting and testing have been offshored to places such as India and Eastern Europe. See e.g. Hätönen (2008) for examples of software NPD offshoring. 37 Resource-seeking and transformational outsourcing: from Hätönen (2008, 69). 38 See Definition 1.5.10, p. 29 39 In which case it is known as Original Design Manufacturer or ODM; see Definition 1.5.9, p. 29. 40 See Definition 1.5.8. p. 28.
1994). Outsourcing has been seen as an effective tool for both. Outsourcing is especially important for complementary products that are not seen as strategically important by the firm and whose development, by definition, is someone else’s core competency. External providers can also be used to augment or temporarily increase the capabilities of the firm, and potentially help the firm to launch a strategic offensive aimed at redefining or ‘shaping’ the marketplace and customer’s expectations by introducing new products faster than the competition (see e.g. Stalk, 1988 and Richards, 2004). Finally, NPD outsourcing can also be seen as a form of uncertainty control: by buying, firms can quickly, cheaply and incrementally experiment with different capabilities, products, technologies or approaches instead of devoting significant resources for building their own capabilities41. Building capabilities in general, and product development capabilities in particular, may be prohibitively expensive and/or time-consuming for a firm to create or acquire because of path dependencies42, the need for socially complex capabilities43, and causal ambiguity44 (Barney, 1999). Producing a certain input might also require a corporate culture that is counterproductive for the rest of the organization45 (Vining & Globerman, 1999; see also Hagel and Singer, 1999). Since NPD capabilities can be argued to contain all these characteristics, obtaining NPD capabilities in the form of market transactions may thus become an attractive alternative to building the capabilities, even if transaction specific investments and the risk of opportunism are
This strategy is also known as real options approach; see e.g. Kogut and Kulatilaka (2003) and Vanhaverbeke et al. (2008). 42 The need to follow a certain path to create a capability; for example, firms often have to design simple products before moving on to more complex ones. 43 Effective new product development requires interdisciplinary team play that may be difficult to encourage and manage. 44 Causal ambiguity refers to uncertainties: firms may not know what factors contribute to improved NPD capability and how that capability should be built. 45 For example, Hagel and Singer (1999) mention the cultural differences between innovationfocused organization (one that is focused on new ideas) and production- or process-focused organization (one that is focused on smooth production). New product development is difficult if the rest of the organization treats new ideas as threats to smooth running of operations.
relatively high (Barney, 1999). However, the issues in outsourcing a NPD process are more complex than those in many other processes, owing to the uncertainty implicit in R&D contracts and the resulting difficulties in terms of contract formulation, property rights adherence and contractual compliance (Love and Roper, 2005). These issues have divided researchers over the subject, with some (e.g. Rubenstein, 1994; Quinn, 2000) arguing that by accessing resources and talent outside the organization, outsourcing innovation and NPD can be a major strategic tool, leading to enormous savings in NPD costs and risks as well as to markedly decreased product cycle times. Others argue that the benefits of NPD outsourcing have been overstressed, and that outsourcing NPD activities can be strategically dangerous if outsourcing is seen as a substitute for the development of long-term internal capabilities in core areas (e.g. Chesbrough and Teece, 1996). In practice, most NPD outsourcing situations are grounded on one or more of the following three motives. The first motive is capacity: the firm has capability to do the task, but its resources — especially in skilled NPD personnel — are limited and the firm contracts outside providers to temporarily relieve workloads and speed up the firm’s NPD projects. The second motive is focus: NPD tasks are outsourced if the firm doesn’t have the capability to do the tasks, and doesn’t see a strategic rationale for building the capability. The third motive is stop-gap/learning: the firm doesn’t have the capability that has suddenly become strategically important, and contracts the provider to supply the capability while building up internal capabilities, while learning as much as possible from the external provider46. (Bounfour, 1999; Firm A interviews, 2008; Firm B interviews, 2008) These motives and some examples of possible strategic rationales for them are summarized in Table 6 below.
‘Focus’ and ‘stop-gap/learning’ motives also cover situations where the firm seeks specialist expertise for some part of the product development process, such as market research, industrial design, or mechanical engineering.
Table 6.. Primary motives for outsourcing NPD and their rationales. Sources: Firm A and B interviews (2008); Bruce and Morris (1998, 57) and Greaver (1998, 4-5); Stalk (1988), Welch and Nayak (1992), Lacity and Hirscheim (1993), Quinn and Hilmer (1994), Alexander and Young (1996b), Bruce and Morris (1998), Inkpen (1998), Powell (1998), Bounfour (1999), Hagel and Singer (1999), Vining and Globerman (1999), Chiesa et al. (2000), Sislian and Satir (2000), Kakabadse and Kakabadse (2002), Chesbrough (2003) and Hätönen (2008, 69). Primary motives for outsourcing NPD Examples of strategic rationale
Cost savings through offshoring routine tasks to cheaper labour countries Flexibility Relieving workloads Unsuccessful projects are easier to abort Acquiring new ideas or technology Accessing hard to find resources Avoiding fixed costs caused by hiring new personnel Reducing time-to-market ‘Shaping’ the marketplace Developing alternative ‘second opinion’ to stimulate innovation and/or put competitive pressure to internal NPD teams Improving credibility and image by associating with superior providers Cost savings through offshoring routine tasks to cheaper labour countries Lack of expertise in-house Access to a talent base that’s wider than in internal NPD Hiring, managing and motivating skilled specialists may be difficult due to different focus in corporate culture Solving short-term problems Responding to sudden changes in market demands Learning from world-class provider New learning takes place during interactions between different organizations
Firm has own capability but lacks capacity
Firm doesn’t have the capability and doesn’t see a need for one
Firm sees a need for capability but doesn’t have time to develop one
3.3. Risks in NPD outsourcing (why not?)
As previously mentioned, outsourcing and NPD outsourcing in particular have divided researchers and practitioners over the years. For the most part, the criticism centres on the true costs of outsourcing and on the ‘hollowing out’ effects that outsourcing may have to the long-term competitiveness of the firm. Detractors of outsourcing have pointed out that very few outsourcing initiatives have accomplished their financial objectives (e.g. Bounfour, 1999) and that outsourcing seemingly mundane but tacitly important functions has resulted to dilution of competitive advantage (e.g. Chesbrough and Teece, 1996; Hayes et al., 2005). After all, if the firm buys everything from open markets, what exactly differentiates it from its competitors? Outsourcing has also been seen to lead to sub-optimal results for the organization as a whole when it has been used for solving acute problems in individual operations. Piecemeal outsourcing has, in the past, resulted to patches of overcapacity scattered at random throughout the firm’s operations, and end up with large numbers of subcontractors, which are more costly to manage than in-house operations that are individually less efficient (Milgate, 2001, 71). This danger is especially acute in cost-minimizing or transactional outsourcing, but it can also arise as a result from seeking external resources from multiple sources and failing to see the ‘big picture.’ However, a more common objection raised against outsourcing NPD activities is that the total competence necessary for the development of new products is found only in teams where professions (marketing, production, finance, design etc.) are integrated together (e.g. Wheelwright and Clark, 1992; Cagan and Vogel, 2001). Many researchers argue that splitting these activities from each other results to inferior products and services. Milgate (2001, 81-84) identified four critical issues in outsourcing, which apply to NPD outsourcing as well. These are detailed briefly below.
Transaction costs may threaten the competitiveness of outsourcing NPD, since effective outsourcing typically requires the client to spend considerable time managing the outsourcing relationship (e.g. Bruce and Morris, 1998). Time spent in this activity causes transaction costs, which need to be included in the cost-benefit analysis conducted before outsourcing any function. Transaction costs become a problem especially if the relationship or the project has problems, as in-house management time required for solving the difficulties can then rise dramatically. Transaction costs may be problematic especially when sourcing intangible activities such as NPD, since transaction costs are very difficult or impossible to quantify (Bounfour, 1999)47. Loss of key markets is a real risk for organizations that outsource all or part of the design and/or manufacturing of their product (see also Porter, 1980). There is danger that the provider could enter the market at a future stage in its own right, and if this happens, the client not only gains a rival that has learned from it, but also loses a source of supply in which it may have invested many years of effort48. To guard against this possibility, the client should erect a ‘strategic wall’ (Milgate, 2001, 81) between the provider and the client’s customers. Often this strategic wall is the core competence of the organization that forms a significant barrier to entry for providers. In case of NPD outsourcing, the strategic wall can be maintained by giving out only activities that are peripheral to the firm’s core business, or giving only limited ‘pieces’ of core design activities for outsiders to perform. For example, one interviewed firm always designed the baseline products in each product line, even though design work for line extensions (e.g. bigger capacity models) was normally performed by outside contractors (Firm A interviews, 2008). Other tactics include spreading the design of components and subassemblies among a range of providers, or owning the patent rights to key technologies used. However, the risks
See Appendix C for a short overview of transaction-cost theory and its applicability to NPD outsourcing. 48 An illustrative example of this danger is that today, HTC is much larger mobile device manufacturer compared to its long-time client Sony Ericsson (see Figure 1, p. 36).
of e.g. spreading the key technology of the firm should be balanced against the risks of not using an external provider to help. After all, most core competences are diluted simply through passage of time (Welch and Nayak, 1992). Loss of competencies can occur through lack of careful preparation. Core competencies — those competencies that give the firm definable pre-eminence and provide unique value to customers (Quinn and Hilmer, 1994) — might not be accidentally outsourced49, but outsourcing can affect supporting competencies that are not recognized as contributing to core competencies. Other competencies should be nurtured in-house to retain and enhance long-term competiveness. For example, a firm outsourcing its NPD market research function may easily lose contact with its customers and, as a result, fail to grasp changing user or market needs. Finally, today an organization can endanger its own future by outsourcing relatively simple tasks that have been used to train new employees (e.g. drafting production blueprints), to cheaper locations such as India. Loss of cross-functional synergies by outsourcing key functions is an issue in many NPD outsourcing considerations. In practice, problems typically arise when NPD function is separated from either sales (resulting to a loss of ‘customer voice’ in NPD process) or manufacturing (resulting to a loss of tacit knowledge and iterative development required to develop manufacturable products; see also Ulrich and Ellinger, 2005). A well-managed outsourcing process can avoid these losses, but only if the requirements for successful disintegration (Ulrich and Ellinger, 2005; see Section 2.5.4) are satisfied. Even then, there is a real danger that outsourcing some
What is alarming, however, is that managers are surprisingly often unclear about the concept of core competencies and their role in a business strategy, as evidenced in research by Milgate (2001, 26). When asked to name the core competencies of the firm, many managers reply by naming their main product or service, or by referring to a vague concept such as ‘market leadership’ or ‘customer service.’ Milgate (2001, 26-27) also identified a number of organizations that were embarking on alliances and outsourcing without first defining the core competencies that should be nurtured inhouse. This ‘reactive outsourcing’ often resulted to ‘hollowing out’ the corporation. Perhaps the best-known example of an entire ‘hollowed out’ industry has been American television manufacturing, whose excessive outsourcing of R&D and manufacturing to Japanese providers detached the industry from the key technological developments needed to be competitive in the next generation of products (Milgate, 2001, 28; see also Chesbrough and Teece, 1996; Hayes et al., 2005).
NPD activities results to a ‘relay race,’ where all work is performed sequentially and gains from integrated product development are lost (see e.g. Zirpoli and Caputo, 2002, for a study of practical problems in knowledge integration). At worst, loss of competencies and valuable synergies can, at worst, lead to a ‘death spiral’ illustrated in Figure 5.
Figure 5. Losing competitiveness through outsourcing. Adapted from Milgate (2001, 141)
Prior planning and preparation prevents poor performance. A British Army adage
As stated in the Introduction, proper planning is important for the success of the outsourcing project. To capture the benefits and avoid the pitfalls of outsourcing NPD, the outsourcing decision must be approached strategically (Quélin and Duhamel, 2003, 658; Hätönen, 2008, 57). The strategic approach must provide the firm with information about the reasoning behind outsourcing initiative and main activities that could potentially be outsourced, and identify the driving forces behind its success. In particular, firms need to establish whether the activity, resource or capability is responsible for competitive advantage (Lonsdale, 1999, 181). According to Hätönen (2008, 57), this internal assessment phase of the outsourcing process entails identifying the key value-adding competences and assessing the implications of the decomposition of the activities that are amenable to outsourcing. However, the author argues that one of the first tasks in any outsourcing process should be identifying the reasons why outsourcing should be considered and setting the objectives for the process (what is wanted to achieve), since clarifying why outsourced NPD is required has effects on all the other decisions made. Because making assessments and decisions from a single standpoint can easily overlook important factors, the assessment should be performed by a crossfunctional team that includes knowledge from three key functional areas in the firm: market & business, product architecture & design, and supply chain (Barragan et al., 2003).
Market and business model knowledge is required to understand which product features are highly valued by customers, and therefore help the firm to decide which design elements provide the greatest competitive advantage. Product architecture and design knowledge is required to assess, for example, the product’s architectural modularity and technology maturity, both important components in outsourcing decision-making. Supply chain knowledge brings experience on managing partner relationships, capability assessment, and market efficiency. Bringing the procurement professionals into the process increases the probabilities of successful partner selection (Barragan et al., 2003). As a result, the first task in any outsourcing initiative should be assembling a team of experts from these different areas (Greaver, 1998; Barragan et al., 2003). Once the expertise is identified and assembled, the team — termed outsourcing initiative team later in the text — should review the reasoning and objectives behind the outsourcing initiative. At this stage, the outsourcing process is just an initiative. Nothing has been decided yet: options are analyzed and reviewed, providers screened, and initial discussions may take place. Finally, the planning process should, from the start, follow so-called discoverydriven planning model (McGrath and MacMillan, 1995; see also Kawasaki, 2004). Traditional planning methods such as stage-gate planning work well if the planners have lots of experience in the subject area and there is high certainty that their assumptions turn out to be right. NPD outsourcing, however, is a relatively recent addition to strategic toolkit available to firms, and most firms have little experience in conducting NPD outsourcing. At the same time, the world is changing faster than ever before, eroding the validity of many long-held assumptions. Discovery-driven
planning (McGrath and MacMillan, 1995) concentrates on identifying assumptions underlying management thinking and finding inexpensive ways of testing these assumptions before major commitments are made. An overview of discovery-driven planning can be found at Appendix D. In brief, discovery-driven planning starts from a viable business case (e.g. how much better the provider should be for outsourcing to be considered) and tries to identify testable assumptions that would lead to such an outcome (e.g. the provider needs to be able to design our product in 4 months or less). From these assumptions flow tasks for the project team (e.g. find out from previous clients how fast the provider was) and milestones for the project (e.g. Milestone 1 would be finding fast enough provider). EXAMPLE: To illustrate the process as described here, a story of NPD outsourcing considerations at Widgets Ltd.50 is presented as an example. Widgets Ltd. is a company manufacturing and selling professional equipment called widgets. The firm currently has three main product lines, dubbed Alpha, Beta and Gamma, which are primarily sold to three different institutional customer groups in Finland and abroad. Widgets Ltd. also manufactures and sells ‘civilian’ versions of its equipment to some extent, but only as supplementary to its other business. In addition to its own manufacturing, Widgets Ltd. also functions as a systems integrator by integrating off-the-shelf support systems to products it sells. In its markets, Widgets Ltd. keeps close contact to its customers and end-users, and is considered a trusted partner by its long-term clients. The management of Widgets Ltd. assumes that the firm’s product development processes are not as efficient as they should be. Although workforce is skilled and the firm’s products are noted for their quality, CEO feels that product development is wasting its time on peripheral projects, many of which have only one or two customers. This, in turn, keeps NPD teams busy in endless modifications and custom orders, and the CEO fears that lack of focus may return to haunt the
Widgets Ltd. is a semi-fictionalized, simplified composite of several existing firms and case studies. It is used for purposes of illustrating actions taken according to framework presented in this thesis, and not as an example of ‘good’ or ‘bad’ practices.
firm in an eventual downturn. In addition, some customers have been hinting that the firm could be more innovative in its products and perhaps seek ideas and advice from outside the organization. To determine whether outsourced NPD would help Widgets Ltd., the CEO has called together an outsourcing initiative team that has members from sales and marketing, product development, manufacturing, and procurement. The initial assumptions need to be tested through more careful analysis, and the first two milestones are determined to be 1) getting a consensus on objectives and reasons for Widgets Ltd. to consider NPD outsourcing, 2) determining whether the Widgets Ltd’s NPD process can be outsourced at all, and 3) finding suitable providers for the tasks that can be outsourced.
3.4.1. Identifying the objectives: three basic strategies
Why would a firm consider outsourcing some or all of its new product development functions? The ‘trigger’ for considering outsourcing as an option can come either from the outside of the firm. It could be a result of changes in the environment (e.g. what competitors are doing or what customers are requesting; see Cánez et al., 2000) or a result of internal reassessments, such as concern about the capacity of internal NPD (de Boer et al., 2006). Whatever is the case, the team considering outsourcing should recognize and analyze the factors that have led to the initial decision to initiate the outsourcing project. This root cause analysis is important, because triggers usually influence the performance measures for outsourcing (Cánez et al., 2000; de Boer et al., 2006). For example, if one of the trigger events is concern for innovativeness, innovativeness of the provider’s solutions is likely to be a key performance measure for the outsourcing arrangement. As previously mentioned, NPD outsourcing usually happens because the firm needs extra capacity, it must sharpen its focus, or as a stop-gap measure while building up its own competences. Recognizing which motives, or combinations of motives, are
behind the outsourcing initiative is required for setting strategies and objectives. The following section discusses the implications from different objectives and examines briefly some possible alternatives for outsourcing. Capacity sourcing is probably the most straightforward case. In principle, the firm makes a decision to acquire skills and workers through providers and independent consultants instead of hiring them. The objective in this strategy is to increase flexibility and possibly raise output of NPD to meet a sudden need, or accelerate an important project. Capacity sourcing means that the firm has some internal capacity, and even more importantly, capability for managing the capacity. The result is that the firm can (and often must) clearly define what is required from the provider and under what constraints the outsourced NPD asset can work. While the provider may have some influence over management of the work, the situation is not very different from employing a worker or an internal team to work on the project. However, the client must understand that while capacity sourcing is an attractive strategy for achieving temporary flexibility, flexibility is a two-way street. At minimum, the client must have a contingency plan in place if the provider either cannot meet the contractual obligations, or is no longer available — perhaps not even in the business. With proper planning, the effects of sudden changes in provider availability can be mitigated. The client should, for example, ensure that the provider has enough manpower to handle the tasks even if some key personnel leave the provider or other unexpected situations arise. Even using two or more providers can be a wise precaution in critical projects. Above all, the client needs to avoid getting into a position where the provider can hold the client ransom with an implicit threat of stopping an important project. Of course, simply internalizing the activity does not eliminate the risks of availability: employees can quit or fall sick as well.
Focus outsourcing may sometimes resemble capacity sourcing in that the client only engages a specialist consultant(s) for some specific and limited tasks such as industrial design or mechanical engineering. On the other hand, it can also involve outsourcing entire product development and manufacturing to specialist ODM providers. No matter what the scale of the deal, the objective behind this strategy is to concentrate resources such as time and investment on building the client’s own core competences, and outsource supplementary or complementary tasks to providers who can do them more effectively. Compared to capacity sourcing, focus outsourcing can be trickier to execute, especially if the client has no capabilities or experience in tasks that are outsourced. Lack of experience in the task often means that the client has limited understanding and unrealistic assumptions about the task. If the provider cannot educate the client about e.g. the expected outcomes and time or resources necessary, the results may be less than satisfactory. In particular, providers often criticize their clients for not understanding the possibilities, and as a result not using the provider’s capabilities to the fullest (e.g. Bruce and Morris, 1998). These situations are more likely to arise in small-scale outsourcing of specialist expertise, as large-scale projects such as ODM deals are typically undertaken by large organizations that have specialized staff for handling outsourcing negotiations and eventual relationship (Bruce and Morris, 1998). Focus outsourcing can also result from a strategic decision to concentrate on selected products or product lines and hire another firm to continue development of discontinued lines (Firm B interviews, 2008). In these cases, the peculiarities of the product are typically well understood, and the client can — at least for a while before client’s knowledge becomes too dated — provide effective support for the provider. However, if the discontinuation is intended to be permanent, the provider should become relatively independent from the client and build its own capabilities for e.g. capturing user requirements for the product.
It is also important to note that today, firms undertaking both capacity sourcing and especially focus outsourcing seek capacity and competencies from across the world. Clients focusing on their core competences seek supplementary competences from best-in-the-world providers (Milgate, 2001; Firm B interviews, 2008), and those concerned about capacity and costs seek low-cost, high-capacity alternatives from wherever they can find them. Although this thesis is does not cover the outsourcing location decision, the effect this global search for talent has for — especially — resource-seeking focus outsourcing cannot be denied. In short, by intensifying the competition, global access has also made focus strategies possible, as firms today have access to a wider variety of skills and competences than they had just ten years ago (see e.g. Friedman, 2005). Finally, stopgap and learning strategy is essentially similar to focus outsourcing, but with an addition that the client seeks to develop its own competences in the area and eventually replace the provider. This situation is potentially unstable, as the provider may have little incentive to educate the client if it knows that its services will be discontinued as soon as internal capability and capacity are in place. To avoid this moral hazard, the client should be very clear from the beginning that the objective of the outsourcing arrangement is to support the client’s internal competency growth, and perhaps even promise bonuses if the competency can be brought ‘up to speed’ sooner than expected. As its name implies, stopgap outsourcing can also be undertaken in a hurry when the market or customer needs change suddenly51. The obvious danger in this strategy is the fact that it is undertaken in a hurry, and thus with less than desired deliberation. Furthermore, outsourcing motivated for stopgap reasons has a notorious track record of becoming permanent. Many firms that solve their shortterm problems through outsourcing fail to build their own competences even if the competence is deemed desirable for the future of the firm (Milgate, 2001, 27-28).
That is, faster than the firm can react.
EXAMPLE: During its initial sessions with the board of directors and the management, the outsourcing initiative team of Widgets Ltd. determines that the objectives of outsourcing initiative are to 1) sharpen the focus of the firm’s product development activities to those products that form the core of the firm’s competitive advantage, 2) acquire, if possible, improved although not necessarily best-in-the-world capability in product development in Widgets Ltd’s primary market segments, and 3) seek ways to increase flexibility in case it is needed. If learning can be achieved, that is considered a desirable bonus, but the main purpose of the effort is to enable the internal NPD team to concentrate on Widgets Ltd’s key products and thus build world-class expertise in them. As can be seen, the motives for NPD outsourcing in Widgets Ltd. are primarily focus-oriented, with some capacity considerations as well. Thus, the ‘successful outcome’ in Widgets Ltd’s case would now mean improved focus and flexibility. During the planning process, the outsourcing initiative team needs to determine under what assumptions these objectives can be reached, and find ways for testing the assumptions — preferably before major commitments have to be made.
3.4.2. Determining process modularity
At this stage, the outsourcing initiative team should make assumptions about how modular their NPD processes are. Some firms — especially many smaller start-ups — have highly integrated and informal NPD processes that rely on tacit knowledge and informal communication between specialists, making outsourcing any parts of this process problematic and probably not worth the effort. Other firms follow well-defined processes with clear ‘interfaces’ between tasks (Ethiraj and Levinthal, 2004), and substituting external resources for internal resources is relatively straightforward. Most firms fall somewhere in between, and have both informal and formal processes.
The first step in analyzing modularity is to determine what activities are performed during the NPD process, and analyze how the process moves from one activity to another, e.g. how the previous activity is documented and information transferred to the next phase. As previously discussed52, integration of two activities into the same organizational entity is desirable, if 1) the quality of precedent activity is difficult to measure and responsibility for both should be given to the same organization in order to avoid shirking without detection (e.g. Holmström and Milgrom, 1991), or 2) if iterative exchanges of information and cooperative problem-solving are required between two activities – say, design and manufacturing (Ulrich and Ellison, 2005). However, practical interaction can be achieved through other forms than consolidation within the same legal entity (Dyer, 1997). One practical example is division of the design process into concept design and detailed design phases. This division may allow the firm to achieve the benefits of internalized and outsourced activities (Ulrich and Ellison, 2005). Other ‘nonhierarchical’ methods for organizational integration include geographic proximity, use of face-to-face meetings, co-locating, joint design teams and design reviews (Adler, 1995; Dyer, 1997). These integrative methods can minimize coordination costs and thus mitigate the problems arising from conflicting motives to outsource but integrate at the same time. In other words, NPD tasks can be outsourced if their (relative) isolation from the rest of the firm is not a problem, and if the results can be somehow measured and judged. In practical terms, this means that typical NPD outsourcing happens at junctions where the results of preceding tasks are collated and formalized in e.g. market research and user needs reports, technical specifications, and design briefs (Firm B interviews, 2008). The outsourcing initiative team should review the existing procedures used within the firm, and note where suitable junctures for disaggregating the tasks may exist.
See Section 2.5.4, page 51.
Compiling a list of tasks performed within NPD process, and noting which tasks need to be performed within same organizational entity (without, for the moment, considering whether that entity is the firm or outsourcing provider) is a helpful preliminary for later stages of outsourcing process. The team should also consider whether the procedures could and should be adjusted so that outsourcing would become easier to achieve. For example, the firm could start an initiative that aims to standardize component interfaces, or it can begin to document technical specifications in more detail instead of relying on tacit knowledge. These modularization initiatives will help to improve the firm’s processes even if they do not lead to outsourcing (e.g. Schilling, 2000). Armed with a list of tasks and activities, the team can then move on to the next phase of NPD outsourcing process: identifying the key value-added competences of the firm. EXAMPLE: The outsourcing initiative team at Widgets Ltd. determines, through its own experiences and by interviewing other key personnel, that the firm’s product development process usually starts from a user requirement that the firm’s current products cannot adequately satisfy. This ‘voice of the customer’ is collected by sales and marketing staff, and through informal contacts and discussions between the users and the firm’s product development engineers. As the users are relatively specialized segment, the initiative team concludes that this initial market research and ideation stage is unlikely to be possible to outsource completely, although additional market research would be useful for validating the size of the market once a new user need is found. Another task the engineers at Widgets Ltd. find beyond their means is coming up with radically new product ideas based on user observation, as most of the time is spent on incrementally improving existing products. Typically, the engineers start the NPD process informally, and upper management is informed when the engineers have a ‘business case’ to present. At this point, the NPD team might need help from external professionals for visualizing and presenting their concepts. If a ‘Go’ decision is made, the engineers determine technical specifications for the product in collaboration with users. The
initiative team identifies these relatively detailed specifications as one possible juncture in the process: Widgets Ltd. could outsource either a) crafting these detailed specifications, or b) developing products to the specifications. After specifications have been drafted, the development proceeds towards optimum solutions in an iterative manner, where design engineers devise a potential design and test it with production engineers, making changes when necessary. Some workstreams such as design of certain parts and subassemblies are relatively independent from the main design work and could be outsourced: in these cases, the internal NPD team could define interfaces for assemblies and source them from best providers. This would save considerable manpower and, if the development work could be conducted concurrently with main design work, decrease time-to-market. In addition, the firm already uses industrial designers at the final stages of the NPD process, and as a systems integrator, it already buys a number of commercial off-the-shelf components that complement its products. In conclusion, the tasks or activities in NPD that could be easily outsourced are assumed to be:
1) Development of Subsystem A that is now developed for every major product revision and used
in nearly every widget manufactured by the Widgets Ltd.
2) Development of Subsystem B that is updated perhaps once every two years and installed in
most widgets manufactured.
3) Development of Parts Assembly C that is used in ‘heavy duty’ versions of the widgets. 4) Industrial design, which is already outsourced. 5) Development of radical new product ideas and concepts through user observation. 6) Complete development of a product from technical specifications.
Table 7. Activities identified modular enough to be considered for outsourcing at Widgets Ltd. Activities modular enough for outsourcing
Subsystem A development Subsystem B development Parts Assembly C development Industrial design Radical, user-centric innovation NPD from technical specifications onwards
3.4.3. Identifying the key value-added competences
Perhaps the most important determinant of what could be outsourced is the firm’s focus. Business and economics scholars have for long been advising firms to focus their energies on activities in which they shine (e.g. Williamson, 1975). Hamel and Prahalad (1990) conceptualized these activities later as core competences. Core competences are those competences in which the firm excels and which are valued by the customer (Hätönen, 2008, 57). In context of outsourcing, Quinn and Hilmer (1994) defined that the firm should keep core competences that give the firm definable pre-eminence and provide unique value for customers. However, defining the core competences in a given firm has proven to be somewhat problematic. As noted above, managers are surprisingly often unclear about the concept of core competences and their role in a business strategy (Milgate, 2001, 27), often referring to vague concepts such as ‘market leadership’ or ‘customer service’ when asked to define their core competences. Core competences are sources of long-term value for the firm, and these sources of value need to be carefully identified before any outsourcing decisions can be made. Hamel and Prahalad (1994) suggest three identification criteria:
1) Customer value 2) Competitor differentiation 3) Extendibility
First and foremost, a core competency must make a disproportionate contribution to customer-perceived value, either directly or through its outcome (e.g. core competency in reliability engineering leads to products with less downtime). Second, a core competency must be competitively unique and hard for competitors to
imitate. Third, a core competency should also be possible to extend to other products or businesses as well. Even though the idea behind core competences may be clear, identifying them may be less easy than it sounds. As Prahalad and Hamel (1990) explained via their analogy of core competences as the root system of a firm, core competences are typically out of sight and not necessarily noticed by a casual observer (Milgate, 2001, 29). Figure 6 illustrates how core competences create value in a firm.
Figure 6. How core competences create value. Adapted from Prahalad and Hamel (1990).
Generally, the identification of core competencies should be beyond the scope of an outsourcing initiative, especially in larger firms. Senior management should provide this information directly or indirectly, for example by putting certain core competency areas off limits, and in any case finding core competencies in a larger organization can be a very time consuming and expensive exercise (Greaver, 1998,
96). However, since this treatise is also intended for managers in smaller organizations, a short overview of the process is in order. Although situations vary so much that ‘laundry lists,’ i.e. simple checklists for determining core competences should be approached with caution (Snyder and Ebeling, 1992), some basic tests can and should be applied to identify potential core competencies for further analysis and validation53. For example, Milgate (2001, 30) suggests that core competences often have the following characteristics:
1) Architectural support 2) Continuously renewed and enhanced 3) Difficult to copy 4) Embodied, exploited in multiple products or services 5) Enduring and understood 6) Envied by competitors and benchmark organizations 7) Monitored through performance measures 8) Recognized internally 9) Reinforced through training and development 10) True competitive asset 11) Truly distinctive
May (1998) recommends that, in order to determine core competencies, every activity the firm undertakes should be assessed to determine whether:
1) It has a direct effect on satisfying customers’ needs; 2) Outsourcing would achieve comparable quality more cheaply; 3) Re-allocation of resources to other activities would earn a superior return; and 4) Other benefits might arise from outsourcing, such as lower inventory cost,
reduced management time, and improved production flow.
An example of criteria that could be used as a basis for defining core competences can be found at Appendix D. Additional core competency checklist can be found in Appendix G.
Once candidates for core competencies have been identified, Snyder and Ebeling (1992) suggest the following simple tests for uncovering an organization’s competences and for building management consensus about how they should be defined:
1) Does the core competence contribute significantly to the ultimate value of the
2) Does it represent a unique capability that provides enduring competitive
3) Does it have the potential to support multiple end products or services?
For determining whether the core competences are truly valuable, and measuring how valuable they are, Greaver (1998, 96-99) and Hätönen (2008, 58) suggest that their contribution to customer-perceived value should be established through market research, uniqueness through competitor analysis and benchmarking, and extendibility through internal analysis of core competencies — while noting that internal analysis of core competencies calls for a great deal of objectivity and as a result tends to be a tricky task (Hätönen, 2008, 58). Snyder and Ebeling (1992) suggest that compelling arguments about core competencies can also be derived from studying the organization’s internal configuration. By this, they mean examining where the current weight of effort and activity seems to be concentrated. However, simple insights can be as valuable as sophisticated analysis. For example, focusing on the product areas that make most profit may be a simple but effective strategy for many firms54 (Milgate, 2001, 37).
As an example, Charles Lazarus noted that the only product area where the then U.S.-based Interstate Departmental Stores made a profit was toys. As a result of his decision to focus on that line only, the organization — now named Toys’R’Us — built in fifteen years a set of impressive competences around toy retailing, and won more than 20 percent of the retail toy business in the United States while expanding overseas (Milgate, 2001, 37). Another example is Intel, whose switch in market focus from DRAM memory chips to in microprocessors started with a discovery that microprocessors had notably higher profit margins than memory chips (Grove, 1996).
Core competences and product development are often linked through core products. Core products are the components or subassemblies that actually contribute to the value of the end products (Prahalad and Hamel, 1990). A firm may well achieve a commanding position in a core product without possessing only a small share of the global market for the end product. Examples quoted by Prahalad and Hamel (1990) include Canon, which had a dominating position in the global market for laser printer engines, and Matsushita, which had a large market for key VCR components. As e.g. Venkatesan (1992) argued, firms should focus on these critical components that the firm is distinctively good at making, while outsourcing components whose suppliers have a distinctive comparative advantage or fundamentally lower cost structure. The core competencies evidently get attention at very high level in hierarchy. The end products, in turn, are tangible and known by the whole organization. But who decides what are the core products? Traditionally, core products have been defined by production personnel. However, for objective classification, a cross-functional team should categorize core products. This is especially important whenever there is a risk that a manager wants to strengthen his or her position by categorizing as core products as many products as possible from his/her responsibility area. Although this would seem self-evident, the roots of the production- or infrastructure-steered approach in the business models (see Hagel and Singer, 1999) are still strong – especially in the heavy equipment industry (Eklund, 2004). Therefore, in product development setting, outsourcing decision-making and partner selection should from the start involve expert participation from three key knowledge areas previously mentioned: market & business, product architecture & design, and supply chain (Barragan et al., 2003).
Example: Previously, the core competences of Widget Ltd. have been determined to be 1) flexible, high quality manufacturing, 2) good, long-term contacts with the users, and 3) long experience in incremental improvement of widgets. The activities identified in the previous phase as possible candidates for outsourcing are tested against different core competency criteria. The activities are first assessed against the checklist for core competences, with the emphasis on whether the activity has a direct effect on satisfying customers’ needs. A brief user survey is conducted with help from an external research agency and firm’s own sales representatives, competitors are benchmarked, and internal processes analyzed in a discussion between initiative team members. Development of Subsystem A is determined to be a core competency, because it satisfies customers’ needs and contributes significant value to the end product’s usability, represents an unique capability that isn’t readily available from the marketplace, and supports multiple end products — nearly every widget uses a version of the subsystem. In addition the situation is not expected to change in the foreseeable future. On the other hand, Subsystem B and Parts Assembly C development tasks are deemed non-core. Although Subsystem B supports multiple end products and is somewhat unique to the firm, it contributes only modestly to customer value and ties significant NPD resources to its development whenever it needs to be updated. Parts Assembly C doesn’t represent a unique capability, and it supports only limited range of products. Industrial design is already outsourced as Widgets Ltd. has recognized that industrial design is needed only intermittently, and hiring an internal designer would create additional management challenges. Development of radical new product ideas is not identified as a core competency of Widgets Ltd., as the firm’s capabilities are recognized to be somewhat lacking in, for example, user needs research. On the other hand, developing complete products from technical specifications is implicitly a core competence for the firm. The outsourcing initiative team then looks into Widget Ltd’s organizational structure. By headcount, the main effort is put to serving product line Alpha customers, followed by Subsystem A development. Other product lines and projects are served as resources permit.
For additional insight, the outsourcing initiative team analyzes the Widget Ltd’s product lines, Alpha, Beta and Gamma. Product line Alpha is the key product line both in terms of volume and profitability. Product line Beta is a supporting product line whose profitability is relatively good but whose sales are distinctly lower than those of Alpha; however, the management has high hopes for Beta’s future prospects as its sales have been steadily increasing. Product line Gamma consists of complementary products for Alpha and Beta customers; Gamma products are bundled with most orders, but their profitability — while positive — is poorest of the lot. At this point, the outsourcing initiative team has enough information to move to the next step of the process: assessing the implications of possible outsourcing decision.
Table 8. Preliminary division of core and non-core activities at Widgets Ltd. Core competences/products
Subsystem A development Product line Alpha Product line Beta
Subsystem B development Parts Assembly C development Industrial design NPD from technical specifications onwards Radical, user-centric innovation Product line Gamma
3.4.4. Assessment of implications of decision
Even if some competency is recognized as being non-core to the firm, the outsourcing decision is still not as straightforward as it would seem. Two-fold distinction between core and non-core (or ‘peripheral’) competencies oversimplifies the actual business situation (e.g. Heikkilä and Cordon, 2002). Existing literature has identified several reasons why some of the core competencies, even if they do not rank as best-in-the-world, should also be kept in-house (Hätönen, 2008, 59)55. These competencies, where the firm is not best-in-the-world but which are needed for other reasons, could be termed ‘strategic’ after Hussey and Jenster (2003)56. The current doctrine of outsourcing holds that in today’s marketplace, core competence has to be close to a best-in-the-world capability and not merely something at which the company is efficient (Quinn, 1999; Hätönen, 2008, 61). This has led to a market decrease in number of ‘core’ activities of a firm, while more and more activities become ‘peripheral,’ or at most, ‘strategic’ in nature. However, in certain cases peripheral competencies should be kept in-house. Hätönen (2008, 59) summed up the reasons for holding on to strategic competences, and these reasons are briefly summarized in Table 9. This reasoning can, and should, be extended to product lines and components as well.
In NPD settings, these reasons include customer requirements (Quinn, 1999), high asset specificity (Lonsdale, 1999), protection of core competencies (Quinn, 1999), the interdependence of competencies (Bryce and Useem, 1998; Ulrich and Ellinger, 2005) and inadequate supply-base capabilities (Lonsdale, 1999; Fine et al., 2002). More examples can be found from Hätönen (2008, 59). 56 Other definitions have included ‘essential’ (Quinn, 1999) or ‘critical’ (Duarte et al., 2004).
Table 9. Spotting strategic skills. Adapted from Hätönen (2008, 59-61) Competency should be kept in-house if outsourcing
Has a negative impact on real core competences due to connections to them Provides no added value due to the absence of a competitive provider market
Examples of reasoning
If a task cannot be disintegrated from another (see Section 2.5.4), or outsourcing a task would make important competencies or processes dependent from the provider No available providers to provide the service at the required volume, performance level, and with the desired cost structure Core competencies are not static, and outsourcing a future prospect might have severe consequences (although keeping a nonpromising competence is a cost burden that takes resources away from real core competencies); also, some activities are useful training activities for new recruits, and losing them can hinder their learning Customers might insist that the company does not outsource some activities out of a fear that this might lead to decreased value or increased complexity in the supply chain; governments may have an impact on locational decisions
Might cause the loss of possible future core competences
Is required by certain stakeholders
EXAMPLE: The outsourcing initiative team now analyzes the competences and product lines to see whether they are strategically important for Widgets Ltd. The team starts by debating whether outsourcing NPD would have an adverse effect for long-term competitiveness of the firm. The strategic importance of Subsystem A and Product line Alpha is quickly established, but other tasks are more difficult to specify. Product line Beta, while promising, is nevertheless downgraded from its core product position due to lack of experience within Widgets Ltd. for designing its products as compared to competitors. However, as its outsourcing might cause the loss of possible future core competences, it is deemed strategic in nature. Although Widgets Ltd’s NPD process might not be the best in the world, the team determines that completely outsourcing it would provide no added value, because it is difficult to see a provider having same access to users, customers and manufacturing processes used by the Widgets Ltd. Therefore, the NPD process is also classified as a strategic competence. The ‘fuzzy front end’ of innovation causes much debate among the team. Some members argue that the firm is seriously lacking in capabilities for user-centric innovation, and that it should outsource this initial stage to a suitable provider, perhaps to a design agency. However, the R&D manager objects on the grounds that spending some time for developing new concepts now and then is important for many R&D engineers and an essential factor in their motivation and innovativeness. Outsourcing the ‘fuzzy front end’ completely would, in the long run, harm the firm’s capability for NPD — not increase it. As a result, ‘fuzzy front end’ is provisionally categorized as a strategic competence. Rest of the activities are finally determined to be peripheral to the firm. Subsystem B development ties significant NPD resources, and since its development is needed only periodically, the initiative team agrees that with some modifications to future products and procedures its development could be handled by an external provider. Similar argument holds for Parts Assembly C. Industrial design is already outsourced and the team does not see a need to change the situation.
In a similar vein, product line Gamma is deemed to be peripheral. Although important for most products, outsourcing the development of the Gamma line would free internal resources for more lucrative projects, such as improvements in Alpha and further developments in the promising Beta product line. Finally, the team holds discussions with internal specialists to ensure that the competences and key products are correctly identified. These discussions were motivated by one manager who remembered reading a cautionary tale about the dangers of not understanding what is actually happening in the production: when car manufacturer Jaguar streamlined its operations in the 1990’s, it laid off or outsourced several engineers from quality control. However, unbeknownst to the management, one of those engineers had been ‘tuning’ the doors of every Jaguar shipped out from the factory to ensure that they would close with a satisfying, metallic sound. After six months, long-term customers started complaining that their new Jaguars didn’t ‘feel’ like Jaguars, and only with much difficulty and expense the management traced the reason to doors that didn’t sound ‘right.’
Subsystem A development Product line Alpha
Product line Beta NPD from technical specifications onwards Radical, user-centric innovation
Subsystem B development Parts Assembly C development Industrial design Product line Gamma
3.5. Selection and negotiation
Provider selection is another critical success factor in outsourcing, It is especially important when outsourcing services, since the client cannot evaluate the provider’s ‘goods’ before payment for the services has been made. Buying a service always includes an original element (Mitchell, 1994), and even with previous experience, the client cannot be totally sure of what is being acquired. Furthermore, in service relationships such as NPD outsourcing, clients should be able to trust their service providers, feel safe in their dealings with the providers, and be assured that their dealings are confidential (Parasuraman et al., 1985). For this necessary level of trust to be achieved, the client and the provider must be a good match for each other. Although this thesis discusses selection and evaluation of service providers as an independent activity occurring after core, strategic and peripheral competences have already been determined, provider selection may shape the entire process for two reasons. First, outsourcing process is often initiated or ‘triggered’ when the firm learns that a suitable provider is available (Cánez et al., 2000; de Boer et al., 2006). Second, capabilities of known providers shape the outsourcing decision-making process and affect the decisions about core products and competences. In other words, what is offered for outsourcing is determined by what the providers can do. Only rarely is the outsourcing analysis performed before at least some suitable providers have been identified, as most managers (sensibly) decline to ‘go through the motions’ before ensuring that at least some providers exist for activities that are considered for outsourcing. For these reasons, this thesis assumes that the firm already knows that providers can be found for activities identified earlier, but specific providers are not yet selected. If provider selection is considered to be more important than determining the tasks
that should be outsourced, the selection and evaluation processes described in this stage can take place before core competence analysis. However, the author recommends that at least the objectives and reasoning for outsourcing NPD be considered before the provider is selected — whether implicitly or explicitly. As for the process of provider selection itself, O'Farrell and Moffat (1991) and Gallouj (1997) distinguish four significant stages in the process of selecting a consultancy. First, general information on consultancies is searched. Second, the firms are preliminarily evaluated and calls for tender or requests for proposals (RFPs) are made. Third, tenders or RFPs are evaluated and the consultancies shortlisted. Fourth, shortlisted consultancies give their presentations and the final selection is made. However, most real-life selection processes do not have such neatly defined stages. Research (e.g. Gallouj, 1997; de Boer et al., 2006) suggests that in reality, the selection and evaluation of a service provider appear to be a largely informal process where the choice, selection and evaluation of service providers are linked together as if in a single activity. In other words, the general information search on service providers gathers information about possible service providers while simultaneously evaluating them as ‘suitable’ or ‘non-suitable.’ As many real-life firms already have various provider evaluation and selection processes in place (e.g. Redman and Allen, 1992), this text outlines the process only briefly. However, the reader should note that evaluating and selecting a service provider — and especially NPD provider — differs somewhat from more traditional, transactional outsourcing of e.g. parts manufacturing.
3.5.1. Information search and preliminary evaluation
The goal for analyzing providers is to ensure that providers have the necessary capability and capacity to perform the NPD activities considered for outsourcing, while determining which provider would be the best cultural and strategic fit for the client. For this first phase of the search, the sources of information can be numerous and often include both formal and informal sources. Because the search for information is relatively costly in term of time and money, the client can only take into account a limited number of candidates. Looking for a quick and satisfactory rather than ‘optimal’ solution is therefore recommended, if searching for the optimal solution would require exhaustive evaluation efforts (Gallouj, 1997; de Boer et al., 2006). The project team needs to identify the greatest number of providers who might have the right qualifications and might be interested in providing the services. Possible methods are networking with contacts in the industry and doing desk research. When networking, “snowballing” the sample by asking knowledgeable people in the industry whether they know any organizations that have conducted a similar initiative is a good way to expand the initial contact list (Greaver, 1998, 172). After a list of potential providers is identified, it needs to be pared down to a manageable level. It is counterproductive for both the client and the providers to send detailed Requests for Proposals (RFPs) to suppliers who are probably unqualified, not interested, or incapable of pricing their services competitively, since contacting, reviewing, evaluation and decision-making take time for both the client and the potential providers. More than 10-15 RFPs sent indicate that the firm probably didn’t screen the list sufficiently (Greaver, 1998, 172). The initial contact list can be screened in a number of different ways. Above all, the needs of the client and the provider should match, as bad matches create unstable
relationships. This will be dealt in more detail when selection and negotiation are discussed, but as a rule of thumb, the client and the provider should match each other in strategic fit, strategic intent, and relative size (Milgate, 2001, 50-52; Firm B interviews, 2008). Matching strategic fit refers to matching the skills and needs of both the client and the provider. Providers have differing competences, and NPD projects differ from each other. At least the following aspects should be considered in NPD outsourcing (adapted from Bruce and Morris, 1998):
1) Matching the NPD capability to the NPD project as ‘clean sheet of paper’ or
‘radical” innovations and ‘improvement” or ‘incremental’ situations require different types of providers; incremental innovation is best left to specialists in a particular technology, while radical innovations tend to require generalists that can have a wider view at the problem
2) Matching inter-firm technologies so that the provider is sufficiently aware of the
client’s technological requirements, and is capable of dealing with them
3) Matching customer experience with the provider’s own insight, i.e. whether, and
to what extent, designers need to understand the client’s customers Matching strategic intent means that both the provider and the client can see the possible relationship as a win-win situation. Firms can and do outsource NPD activities purely transactionally and relying on contracts and payments as the means of motivating the providers. However, deeper relationships require that both the client and the provider view each other as a window of opportunity on their partner’s broad capabilities (Milgate, 2001, p. 51). This is especially important if one of the objectives for outsourcing NPD includes learning (Milgate, 2001, 51). Probing cultural compatibility is particularly important, as cultural compatibility is an important contributor to mutual trust. Trust, in turn, is a necessary ingredient for a successful NPD outsourcing process (e.g. Bruce and Morris, 1998). Some
questions every potential partner in such an alliance should consider are listed below (adapted from Milgate, 2001, 51):
1) What would be the broad, readily apparent objectives of this strategic alliance
for each partner?
2) How can the two parties complement each other to create common strengths
from which both can benefit?
3) How important an alliance would be within each partner’s corporate portfolio? 4) Would there be any problems with the alliance due to its relative closeness to the
core business of partners?
5) Are the potential partners sufficiently similar in culture?
Finally, the relative size of the client and the provider matters. Large providers are often a bad fit for small clients, since they would probably represent only a small percentage of the provider’s business and therefore receive less attention than they deserve. In addition, large NPD service providers tend to have cost structures that make their services unfeasibly expensive for small projects. On the other hand, large clients are more interested in provider’s reliability and its ability to rapidly scale up the development effort should a need arise. Therefore, they require equivalently large and capable providers (Firm B interviews, 2008).
EXAMPLE: Widgets Ltd’s outsourcing initiative team had searched for suitable providers and identified seven provider candidates. One of these is the design agency Widgets Ltd. has previously used for its industrial design needs, but other six are new and unknown to the firm. The team holds brief discussions with representatives of each provider, trying to establish their competences and motives for working for Widget Ltd. The results are collected in a table below.
Table 10. Providers identified by Widget Ltd. Firm
Able Assistants Big Bureau
New domestic firm, only 8 employees – mostly engineers. Not much experience, but very willing to try their hands on Parts Assembly C or even Subsystem B development challenges. Very large, well-known and respected engineering and design firm. Hundreds of employees across the world, small domestic office. Has lots of experience and a very structured approach to NPD process. A potential candidate for outsourcing development of Product Line Gamma, would also be willing to take over industrial design from Diamond Designs. An experienced foreign subcontractor that designs and manufactures custom parts and part assemblies for various clients in the industry. Has design offices in Europe and factories in Asia. Could develop Parts Assembly C or Subsystem B if desired; Product Line Gamma development might be possible. Medium-size industrial design and engineering consultancy that Widgets Ltd. has previously used for industrial design needs. Would be willing to increase the size of the account, e.g. Subsystem Beta development or Parts Assembly C development. Might be too small for Product Line Gamma development. An engineering consultancy that has a good track record and references, but mostly in incremental improvements. Could undertake Subsystem B and Parts Assembly A development. Product Line Gamma development a possibility, if subcontractors are used. An ODM firm serving various clients in the industry. A candidate for Product Line Gamma development and manufacturing. A firm that both sells its own branded goods and designs and manufactures ODM products for the industry. Competes with Widgets Ltd. in Gamma market; market leader. Could develop Product Line Gamma; Subsystem B and Parts Assembly A development also possible.
Is this firm big enough to handle the project? Do they have enough experience? Is this firm too large for us – will we be a big enough client for them? Do they have industryspecific experience? Can we work effectively with a foreign firm?
Can a design agency expand successfully from design to engineering? Do they understand Gamma customers? Are subcontractors reliable? Can this firm provide radical innovation that may be required in the future? Would this firm become our competitor? Do they understand Gamma customers? What would be the effects of giving NPD to our competitor?
The outsourcing team decides that this list should now be screened initially, but as there are only seven candidates, and not one candidate can handle all the tasks, they all should be contacted for further requests for proposals. However, team members raise concerns about strategic fit, strategic intent, and relative size: Big Bureau might be too big for Widgets Ltd., while Fine Factories might not understand Gamma customers as they should. The situation with Great Goods is problematic: they are already competitors in the Gamma market, and there is a risk of giving valuable knowhow and might easily become competitor in Product Line Gamma. On the other hand, Great Goods is a market leader in Gamma’s product segment, so their capability to develop Gamma-type products is unquestioned.
3.5.2. Request for proposals
A request for proposals (RFP) or ‘call for tender’ phase is often omitted from more informal selection processes (e.g. Gallouj, 1997). However, even though fullyfledged tendering processes may not be sensible to undertake for smaller projects or in smaller firms, going through the process of defining a request for proposals is nevertheless valuable for the client. Because the RFP should summarize the needs of the firm, as well as the findings so far made by the outsourcing initiative team, it is a valuable documentation of the outsourcing initiative and helps future learning (see e.g. Klein, 1998 and 2004). According to Greaver (1998), the RFP should include
1) Reasons to outsource (see Section 3.4.1) 2) Scope and brief, if available. What services the provider is being asked to
3) Provider qualifications; which qualifications are important? (For example,
references and key team member biographies)
4) Performance standards/measures: The level of required performance, and how
this will be measured.
5) Pricing: What is the preferred pricing model, and how the estimated pricing
should be presented (for example, absolute firm price, or reasonable estimates)
6) What decision makers are accessible, and when 7) Questions: how the firm is going to answer any questions resulting from the
8) Other special terms and conditions 9) Request for innovative ideas that would differentiate the provider’s services.
(Source: adapted from Greaver, 1998). The providers should be asked to 1) focus their proposals on these issues, 2) confirm specifically that the requested provisions can be delivered, and 3) specify what they will not deliver. One of the best recommendations is to ask the prospective provider for references of customers that have had products or projects with similar requirements and find out from the references how the provider met these requirements. Even better, the client may ask if the potential provider can offer the names of some customers for whom things did not work out and then find out why. If the failure of the partnership was the client’s fault, rather than the provider’s, talks may be continued. For example, a partnership might fall apart because the client cancelled the product, rather than because the provider failed to deliver the promised expertise (Schweber, 2003). Depending on the circumstances, the client may have a detailed creative brief or a draft of a brief ready at this stage of the process. The brief is usually sensitive enough to disclose only after non-disclosure agreements (NDAs) have been signed. If possible, the client should consider preparing the first version of the brief early in the outsourcing process and signing NDAs with the providers it sends the RFPs to, because knowing the details of the project helps the providers to respond more
accurately to the RFP. As detailed in Section 2.6.1 (p. 58), creative briefs should include answers to the following questions:
1) The objectives: what is the purpose of the project? 2) The target audience: Who are the customers? What motivates them? 3) Targeted features: Specifications, components, manufacture; use in everyday
application; differences compared to competitors
4) Targeted user benefits: How the user will be better off? What are the trade-offs? 5) The competition 6) Preferences and constraints for budget, schedule, etc. 7) The single most important point; the primary focus of the end product (Source:
adapted from Creative Business, 2007) Requests for proposals represent an important point in a possible relationship. Having a smooth, professional approach from the start helps to establish to the providers that the client is a serious, professional organization that should be taken seriously (Greaver, 1998, 184). However the RFP is delivered — whether through informal discussions or through detailed documentation — providers will want to be have four things:
1) A clearly written request for proposals, or a brief 2) Sufficient information to shorten their time investment 3) Reasonable time to respond 4) Access to the firm’s decision makers.
(Source: Greaver, 1998, 184)
EXAMPLE: As previously mentioned, Widgets Ltd. decides to contact all seven potential candidates for more information. The team sees no need for a formal Request for Proposals stage, but to clarify the thinking behind the outsourcing initiative, the team prepares a basic fact sheet for each possible sub project (Subsystem B development; Parts Assembly C development; Industrial design; Product line Gamma). An example is shown below. SUBSYSTEM B DEVELOPMENT 1. Reason to outsource: Widgets Ltd. wishes to concentrate on its core competences and is therefore seeking trusted providers for a long-term partnership where the provider develops Subsystem B for Widget Ltd’s products. 2. Scope and brief: The scope of this project is to independently develop subsystem B and its components. The idea is that this subsystem could then be installed to multiple end products manufactured by Widgets Ltd. Therefore, the end result needs to be modular design with standardized interfaces. This subsystem will need redesign approximately once every two years. 3. Provider qualifications: A provider should have experience in developing similar systems. References and key developer backgrounds are important for the selection process. 4. Performance standards/measures: Widgets Ltd. seeks a high quality provider that can reliably deliver the subsystem when it needs to be updated. Therefore, the performance standards emphasize end product quality and timeliness. In addition, the provider needs to constantly lower the costs of design and manufacturing of Subsystem B. 5. Pricing: The preferred pricing model is a flat fee for basic subsystem development, with performance incentives such as sharing savings in development and manufacturing costs, and with penalties in case of significant delays. 6. What decision makers are accessible, and when: The outsourcing initiative team is available for further information. 7. Questions: Widgets Ltd’s outsourcing initiative team will try to provide answers to any questions during the outsourcing process wherever possible. 8. Special terms and conditions: N/A 9. Differentiation: Widgets Ltd. welcomes any innovative ideas that would differentiate the provider’s offering.
Shortlisting should take place in a reasonable time after RFPs are sent to the providers. As a rule of thumb, preliminary planning for major projects requires anything from three weeks to six months, whereas proposals for well-defined auxiliary tasks such as market studies should be expected within a week. The objective of shortlisting is to arrive at a shortlist of two to five providers who will be invited to present their proposals. Shortlisting may involve several ‘rounds’ where the list of providers is winnowed down and the details of the project are clarified. A suggestion made by Stryker (1982, quoted in Gallouj, 1997), is that the client should consider the following four dimensions that cover the characteristics of the problem and the providers themselves:
1) Understanding of the problem 2) Validity and pragmatism of the approach 3) Availability and competence of the team of consultants 4) Experience and qualifications of the provider
Of these, the understanding of the problem and validity and pragmatism of the approach are very subjective, project-specific matters without any hard-and-fast rules for evaluating them. Availability and competence of the team of consultants, while more objective, matter more in NPD outsourcing projects where the client seeks specialist expertise to help with a particularly difficult problem. They are less important in projects where entire NPD processes are outsourced (for example, when seeking an ODM provider). However, providers’ qualifications and experience can and should be evaluated in all cases. Provider’s qualifications can be divided into “hard” and “soft” qualifications, i.e. those that are primarily historically based and can be reasonably verified, and
those that are more attitudinal, may or may not be verifiable, and could change based on circumstances. (Greaver, 1998, 173). Greaver (1998, 173-174) lists several examples of qualifications that are further divided into provider, process, and personnel qualifications. These mean, respectively, whether the qualification applies to the provider’s organization, to the processes the provider is using, and to provider’s personnel that would be dealing with the client. Although other qualifications can apply, and not all of these qualifications apply to each situation, these qualifications give a good starting point for the discussion and are therefore summarized below in Tables 11 and 12. The qualifications are divided between ‘hard’ qualifications that can be verified from data, and ‘soft’ qualifications that are more subjective in nature. The tables also indicate whether or not the particular qualification applies to the provider firm, provider’s processes, or provider’s personnel.
Table 11. 'Hard' qualifications. Source: Greaver (1998, 173-174)
Demonstrated ability to deliver today Experience to deliver Provider strengths Superior performance Deserved positive reputation
Y E S Y E S Y E S Y E S Y E S Y E S Y E S Y E S Y E S Y E S
Does the provider have customers to whom this service is being delivered today? How similar are their needs? How much of the provider’s revenue would the client’s business represent? Does the provider have the size and scope to handle the service? The experience to deliver: Is there a track record, either as a firm, and/or individually, in delivering the service? Is experience in the client’s industry important? Are strengths of the provider aligned with the project needs? Do their core competencies complement the client’s core competencies? Does the provider have superior performance compared to the internal capability? Particularly if the client is hoping to network through the provider to increase sales or improve its credibility and image through association with the provider, the provider’s reputation is important. If the client has previously had issues with other provider’s performance (of any type), this could become an issue. Is the provider responsive to the customer’s needs and requests? Do they measure customer satisfaction through surveys? What do the provider’s previous customers say? Is the provider responsive in a timely fashion when confronted with issues? The provider’s ability to meet their long-term commitments depends whether they are going to be around for the long-term. Since human labour is significant in product development processes, capability to effectively manage the people and the project is important. Even in best-case scenarios, problems are likely to arise. How does the provider address such problems? Are the provider’s people defensive when confronted with problems or do they try to work through them to a solution? Particularly in long-term contracts, does the provider continue to improve? Particularly if the client has little to no outsourcing experience, the provider needs to be able to guide the client through the process. The provider should be able to identify its key account team members, and commit to their involvement. What is the provider’s track record of turnover? Are the provider’s people satisfied and challenged? How are they organized? What is the emergency backup plan?
Y E S Y E S Y E S Y E S Y E S
Y E S
Y E S Y E S Y E S
Proven customer satisfaction
Y E S Y E S Y E S Y E S Y E S Y E S Y E S
Financial stability Proven management capabilities Shared approach to problem solving Commitment to continuous improvement Strong transition experience
Commitment of specific resources
Table 12. 'Soft' qualifications. Source: Greaver (1998, 173-174)
Y E S Y E S Y E S Y E S Y E S Y E S Y E S
What are the risks? A claim often made by opponents to outsourcing is that outsourcing providers cannot be trusted (Greaver, 1998, 176). This also applies to trust in simple things, such as keeping deadlines and other promises. What are the provider’s policies on trust issues? How does the provider screen and hire employees? How does the provider handle breaches of trust? How does the provider secure your information? What kind of contingency plan and disaster recovery plan for operation does the provider have? Only providers having high integrity and quality security should be considered. Positive attitude helps in product development, simply because it makes cooperation easier. Since trust issues are very important, open, friendly relationships are much to be preferred over arms-length, formal relationships. Different cultures tend to see, approach, and solve problems very differently. While this can be a good fit when the client is seeking new ways of looking at things and new ideas, it can also cause difficulties in some settings. Initial assumptions about projects will almost inevitably change If the provider is not able or willing to be flexible, the deal should be called off. The client doesn’t want to pay any more for the service than is necessary. How does the provider measure and monitor costs? What is the provider doing to avoid waste, errors, and rework, to improve productivity, and so on? If lower cost is the reason to outsource, how does the provider achieve its lower costs? Providers should be conscious of their costs and how they affect the client. How open are the provider’s personnel to inquiries? How willing are they to share that knowledge? The better the client understands what the provider is doing, and how they are delivering the service, the better it can integrate them to the firm’s operations. The best results tend to occur when both parties can share knowledge (not just information) in such a way that it can be turned into a competitive advantage. Especially important for early stage ideation and concept generation, the provider should know the market, where it will be in several years, and where they will be within it.
Positive attitude Good chemistry between key staff people
Y E S Y E S Y E S
Appropriate cultural fit
Flexibility to change
Y E S
Willingness to share cutting-edge knowledge
Y E S
Clear vision of their market
Y E S
It should be specifically noted that price is not included in these qualifications. Experience shows that in evaluating proposals, it is better to separate price from the other criteria, since knowing the price may unduly influence the evaluation (Greaver, 1998, 178). A suggestion by Greaver (1998) is that if formal weighing methods for different attributes or qualifications are used, the weightings should be assigned before any proposals supplied by the providers are even read. This helps to prevent any bias from a reviewer reading a particular proposal and setting the criteria and weightings to give that proposal an unfair advantage. Not all these qualifications are of equal importance. However, considering them all helps to communicate the necessary qualifications in the request for proposal, and makes the provider evaluation and selection phase as objective as possible. Collecting background information on potential providers is also advisable at this stage. Clients should be careful especially when dealing with unknown or foreign providers, and make sure that they have necessary information about the provider’s financial condition, ties to other firms, and other important factors. A provider background checklist can be found in Appendix F. If desired, shortlisting can be done in two or more stages, where the initial call for proposals is followed by a more detailed RFP phase. If the providers are required to do substantial work — for example, create detailed project proposals — the providers should be compensated for the time spent. Although the compensation can be nominal and some risk sharing is to be expected, most providers are loath to undertake major planning initiatives for free. After all, their good ideas might be appropriated either by the client, or leaked to another provider if they are not chosen for the project. Paying the providers for their ideas is good form and sends a message that the client is serious and professional about the project, while not paying for planning is often considered unprofessional (Firm A interviews, 2008).
EXAMPLE: All the seven candidates respond favourably to contacts from Widgets Ltd. Based on their meetings, material, and discussions, the outsourcing initiative team uses the tables 11 and 12 to rank the providers. For example, the important qualifications for Subsystem B development are given below. HARD QUALIFICATIONS Demonstrated ability to deliver today Experience to deliver Provider strengths Financial stability Shared approach to problem solving Commitment to continuous problem solving SOFT QUALIFICATIONS Trust/security/confidentiality Positive attitude Good chemistry between key staff people Flexibility to change Cost conscious In the end, the outsourcing team decides that Able Assistants and Big Bureau don’t make it to the shortlist. The reasons for this are primarily due to size: Able Assistants is seen to be too small and young, while Big Bureau seems to be too big and ponderous to be a successful match for Widgets Ltd. Another effect of this decision is that it practically ensures that Diamond Designs remains the industrial design provider for Widgets Ltd. They also seem to have a good case for developing Parts Assembly C, since that involves some product design-related decisions and is within the capability of Diamond’s engineers, and therefore the outsourcing team proceeds directly to further negotiations with Diamond Designs for Parts Assembly C’s design work. As a result, Epic Engineering, Fine Factories and Great Goods are now invited to do a preliminary evaluation, compensated by the Widgets Ltd., and to present their proposals.
3.5.4. Selection and negotiation of relationship
After the candidates have been shortlisted, the selected providers are usually invited to present their project proposals. Depending on the scope of the outsourcing initiative, the presentations can range from short, informal affairs — possibly even conducted over phone or e-mail — to long sessions where every aspect of the proposed project is exhaustively analyzed. In terms of outsourcing management, the final decision is about whether to make, buy or ally. Whereas ‘make’ refers to using hierarchies and ‘buy’ to using markets at arms-length, ‘ally’ represents integration without internalization, i.e. without ownership (see e.g. Milgate, 2001; Jacobides and Billinger, 2006). Quinn and Hilmer (1994) see the provider selection being governed by two variables: the degree of strategic vulnerability in the activity, and the potential for competitive advantage from outsourcing it. The higher the competitive potential and strategic vulnerability, the greater is the need to keep sourcing in-house (see Figure 7).
Figure 7. Outsourcing options: make, buy or ally. Source: Milgate (2001, 78). Originally adapted from Quinn and Hilmer (1994) and Child and Faulkner (1998)
According to Milgate (2001, 78), the methods used to choose a provider are governed by two important variables. The first is whether the function to be outsourced is strategic or tactical. The second is how many potential providers are available. In the final selection, the client often seeks to evaluate the inherent qualities of the individual or agency, and evaluate the quality of past services and their transferability to the current problems of the firm (Gallouj, 1997). Schweber (2003) suggests that selection checklist should include both tangible and intangible factors, including the contractor’s stability and resources, and the client should check whether the provider has the expertise to handle any special requirements of the project. Examples include industry certifications, and electrical or medical equipment standards. The same checklist that was used in shortlisting should be used as a basis for final selection. According to a review by Gallouj (1997), the evaluation criteria listed in the various studies about service provider selection generally focus on the following points:
1) The proposed approach and planned action (data gathering and processing) 2) The method of work, procedures and possible alterations (creativity, co-
ordination, distribution of tasks, etc.)
3) The characteristics of the provider (history, activities and organization) 4) The consultancy team and its skill levels, including the proportion of junior to
5) Project control, i.e. the ability to complete the mission within time and
6) Experience and references of the consultants in the field concerned, including
experience with the technology, relevant regulations and the certification processes if the latter are required (Schweber, 2003)
7) Background knowledge, possible references (very important in design
8) The attitude of the consultants 9) Availability, involvement and personal commitment of the provider, including
location (Schweber, 2003; Hätönen, 2008) During the selection process, the client should keep in mind what is actually being selected and evaluated. As Gallouj (1997) notes, selection and evaluation can relate to the provider’s representative personally or to the structure in which the provider operates. Often, when choosing a provider, the client also selects a method. Furthermore, in many cases the client chooses a person rather than a particular provider, even though the evaluation of the provider's organization can be equally important (Gallouj, 1997). Nevertheless, every organization will and should adopt the selection methodology and criteria that are most appropriate in its own particular case (Milgate, 2001, 79). The evaluators should also keep in mind so-called halo effect (Rosenzweig, 2007) if the shortlist includes famous or well-reputed providers. The halo effect refers to a cognitive bias whereby providers that have been successful in other projects or
contexts tend to be evaluated more favourably than providers that are less well known to the client. The existence of halo effect doesn’t mean that a well-regarded provider or consultant is necessarily bad for the proposed project. However, it means that clients should be wary about thinking that past performance is a guarantee for future success, especially in cases where the provider doesn’t have experience in specific types of project proposed. New product development is a tricky field as far as expertise is concerned, and expertise in one field may not be easily transferred to another57 (see e.g. Shanteau, 1992; Klein, 1998). Examples of the halo effect abound in business in general (see Rosenzweig, 2007); in NPD, the halo effect hinders judgment most often when a highly regarded industrial designer or a design agency is called in to ‘refresh’ the product line. At the same time, the desired relationship needs to be established. The desired relationship is determined by the desired level of control over the activity being considered for outsourcing (Barragan et al., 2003, 278). Quinn and Hilmer (1994) present a model relating the spectrum of sourcing relationships to different levels of control and flexibility. Generally, if the technology basis of the activity being outsourced is rapidly changing, a more flexible arrangement is desired (Barragan et al., 2003, 278). Short-term contracts are typically the most flexible but offer the least control. Alternatively, if the firm has specific requirements about — for example — form factors, details, and materials used, the less flexible relationships are desirable. In particular, outsourcing elements that contain the greatest competitive advantage requires higher level of control so that the firm can extract the greatest amount of value from the product and also develop a deep understanding of features and functions (Barragan et al., 2003, 278). A distinct trade-off must be made at this point: obtaining high control necessitates giving up flexibility, as illustrated by Figure 8. In addition to formal contracts, control can also be achieved through nonAdditional problem is that NPD professionals deal with uncertain future while basing their studies and expertise on the nonrepeatable past. In other words, as NPD professionals try to predict the tastes and preferences of future customers, they may become too constrained by their previous experiences and expertise to develop truly novel and innovative solutions. See Taleb (2007) for the problems of prediction in business.
hierarchical institutions for coordination. Most notable of these instruments are mutual trust and geographic proximity (Dyer, 1997). In some cases, tight ties between the client and the provider can allow the outsourcing relationship remain relatively flexible while the client retains good control over the activity. The downside is that such relationships tend to be very personal and are fraught with danger if, for example, key personnel change employers or the relationship turns sour for some other reason.
Figure 8. Outsourcing trade-off: flexibility need vs. control need. Source: Barragan et al. (2003). Adapted from Quinn and Hilmer (1994).58
The key considerations in selecting the relationship model relate to what kind of control mechanisms are built in to the contract (Hätönen, 2008, 73). It has been suggested that there are no optimal models for managing outsourcing relations, but
‘Call option’ means that the client has a right, but not the obligation, to buy an agreed quantity of work at a certain time. ‘Retainer’ means that the client pays the provider in advance for work before it is specified and completed.
often firms need to adapt both hard (contract-based) and soft (trust-based) governance mechanisms (Barthelemy, 2003b). Hätönen (2008, 73) and Barthelemy (2003b) argue that the mode of governance is highly determined and influenced by the nature of the outsourced activity and the underlying motives. Choosing the wrong governance mode for a specific outsourced activity is one of the prime reasons for outsourcing failure; for example, tight control over details of the work has a harmful effect on the results when providers are hoped to come up with innovative solutions (Miozzo and Grimshaw, 2005; Carson, 2007). As can be seen from Figure 8, the flexibility/control decision is essentially about deciding whether the relationship is a short or a long-term one. Long-term relationships are a must if areas that are outsourced are close to the core competences of the firm (Greaver, 1998, 121), but firms and providers should enter a relationship with a goal of making it a long-term relationship whenever possible. Long-term relationships have benefits such as stability, understanding the client’s needs and markets, and loyalty and trust, which can help the client to relax and give suppliers more creative freedom (Bruce and Morris, 1998; Greaver, 1999, 121). The advantages of short- and long-term relationships are summarized in Table 13 below.
Table 13. 'Pros' and 'Cons' of short-term versus long-term relationships in NPD. Adapted from Bruce and Morris (1998). Short-term advantages
1. Comparison purposes: having a relationship with more than one provider enables the client to compare quality and efficiency factors between consultants. 2. Cost: Relationships are open to market forces. 3. Access to different expertise: Gives the client more choice in the type of expertise required. 4. Time: Providers are used to relieve short-term in-house design workloads. 5. Compatibility: By maintaining a short-term relationship with a provider, if the relationship is “difficult” it gives the client the freedom to choose a more compatible partner
1. Familiarity: improves the effectiveness of the NPD input from project to project 2. Stability: Once a project has been completed successfully with a provider, management anxiety and uncertainty about the relationship and product development in general reduced 3. Continuity: Retaining the same provider ensures that the brand proposition within and, if required, across product ranges remained the same. It also makes the initial stages of each new project much easier because the “process” of using the same consultant remains consistent.
A final step in deciding contract length is to explore the firm’s strategies to see if there is a contract length that is best aligned with those strategies. For example, a firm that has major new product launches for next two years, followed by two years of research and redesign, could have a design contract that runs four to five years (Greaver, 1998, 122). A good policy is to consider annual business cycles when setting the actual dates for contract terminations, as many functions and processes have both volume peak and valley periods, and contracts should end in valley periods if possible (Greaver, 1998, 123).
EXAMPLE: The final decision at Widgets Ltd. is reached after several rounds of presentations and negotiations. The outsourcing initiative team confers with Widgets Ltd’s top management and top management decides that the contract for development of Subsystem B will be awarded to Epic Engineering. The reasoning for this is that the firm’s proposal was best overall, the price was acceptable, and the firm enjoyed a good reputation. Since Subsystem B development was deemed to be a ‘tactical’ task (i.e. its degree of strategic importance is low; see, for example, Figure 7), the decision was relatively easy. After the initial design on newest version of Subsystem B, the proper relationship is deemed to be a call option, i.e. a contract where Widgets Ltd. can acquire services from Epic Engineering as required and Epic Engineering agrees to provide the services when needed. By comparison, the deliberations on what to do with Product line Gamma are far more difficult. The offer from Fine Factories is satisfactory, but a lingering doubt remains whether they can really produce added value to the Gamma line. On the other hand, Great Goods has made a decent offer and expresses willingness to enter a long-term partnership where it develops the Gamma line with an exclusive contract to Widgets Ltd. The management and the outsourcing team are divided in their opinions; some argue that giving Great Goods control over one of Widget’s complementary products, they would be giving far too much power to their possible competitor. However, in the end, a decision is made to award the contract for supplying future Gamma line to Great Goods, as it is clearly the market leader and can potentially provide much better product for Widget Ltd’s customers. The terms of the contract call for long-term design contract with fairly clear specifications as to what Great Goods should provide, and when; specifically, the future Gamma products should employ equivalent technology as that used in Great Goods’ own products. Finally, Diamond Designs’ contract was modified to include Parts Assembly C development as well. In addition, the outsourcing initiative team started discussions about working together to build up Widgets Ltd’s competences in radical, user-centric innovation that was identified as a need earlier in the outsourcing process.
3.6. Execution and relationship management
Once a firm has decided to proceed with the outsourcing, it needs to manage the outsourcing process. Project planning and project management are somewhat beyond the scope of this thesis, but since poor management is one of the primary reasons why firms have been unsatisfied with outsourcing, the basics of NPD outsourcing management are discussed here. The management of outsourcing implementation can be divided into two distinct phases: project transfer and project management (Hätönen, 2008, 82).
3.6.1. Project transfer
Project transfer refers to the management task of actually moving production to the provider (Hätönen, 2008, 82). Transfer management in NPD outsourcing is about communicating to the provider the knowledge it requires to effectively embark on the project. If the groundwork for outsourcing initiative59 has been thoroughly prepared, this task should not present too many difficulties. However, every project is different and the client should be prepared to listen to the provider’s suggestions and iteratively develop the project plan. Although both project planning and project management lie beyond the scope of this thesis, in summary, projectimplementation planning in outsourced NPD projects fundamentally includes six key areas of activity:
Objective setting, modularization, design briefs and guidelines, etc.
1) Adjusting the internal NPD process to increase its modularity, if possible, by e.g.
2) Ensuring the client and the provider agree and understand the project brief, and
what will actually be delivered
3) Breaking down what needs to be done within each project stage into smaller
tasks and activities, prioritizing the tasks and estimating the time needed to complete each one; identifying relationships between tasks
4) Identifying project roles, responsibilities, lines of communication and team-
5) Identifying any additional resources or stakeholder involvement that will be
needed to complete the project
6) Ensuring the parties understand the system for information flow, the
documentation, record keeping and administration (Best, 2006, 150; Hätönen, 2008) The planning process in NPD-related tasks — especially when the goal is to create innovative new products rather than radical improvements — should follow discovery-driven planning model60 (McGrath and MacMillan, 1995, see also Kawasaki, 2004). Because new ventures call for a firm to envision what is unknown, uncertain and not yet obvious, extrapolating future results from a well-understood and predictable platform of past experience is not possible and new ventures inevitably experience deviations from their original planned targets. EXAMPLE: After the decision has been made, Widgets Ltd. holds a series of meetings with the providers. The objective of the meetings is to acquaint each firm’s key personnel with each other, and discuss problems and opportunities in the projects. As a preliminary for transferring NPD tasks to the providers, the documentation of parts and projects is improved. Meanwhile, Widgets Ltd’s management explains the reasons and outcomes of the outsourcing initiative to its staff to put rest to rumours about possible lay-offs related to the outsourcing deal.
A framework for discovery-driven planning (McGrath and MacMillan, 1995) is included in Appendix E.
3.6.2. Project management
Project management, on the other hand, is all about the ongoing management of the outsourced process. Bad project management is the main reason for unsuccessful outcomes and client dissatisfaction with many external NPD projects (e.g. Swoyer, 2004; Best, 2006, 154); hence project management and execution should be high priority for both the clients wishing to get the most out from their investment, and for the providers wishing to retain their clients. Although project management is by far too vast a scope to be covered in this thesis, and every firm and every situation are different, some of the issues particular to outsourcing and NPD outsourcing are discussed below. The problem with some firms is that network organization required for effective NPD outsourcing creates new organizational forms that, in turn, need new management skills. These new skills may not exist within the organization, especially if its previous relationships with providers have been characterized by a transactional, arms-length approach driven by cost cutting. According to Milgate (2001, 100), particularly important new management skills that clients should learn are 1) managing multiple relationships, 2) cooperating and competing simultaneously, and 3) learning from alliances with providers. To this list a fourth component, measuring outsourcing performance, should also be added. Managing multiple relationships is nothing new for most businesses, but strategic partnerships are increasingly more complex than traditional business transactions. A paradigm suggested by Snow et al. (1992) for the new role of managers is to consider the managers as ‘brokers’ that operate across rather than within hierarchies, assembling resources from both their own organization and from outside sources. Managers operating as brokers perform three important roles: first, as architects for the relationship, they design the network and identify the component parts that are
needed to form it. This requires vision to understand how new competitive advantage can be harvested from external resources, and this requirement for longterm vision, in its turn, is often one reason why strategic partnerships require attention from chief executive level or close to it. Second, managers as brokers have to lead the alliance network. They are often acting as an organizer who works more often through negotiation and persuasion rather than through the more traditional command and control mechanisms used in a conventional management hierarchy. Thirdly, the manager as broker has to act as a caretaker for the alliance, keeping the partnership moving forward and seeking new opportunities, while (often) simultaneously proving the partnerships’ worth and business benefits to other managers that are not close to the partnership (Snow et al., 1992; Milgate, 2001, 102). By definition, strategic relationships are deep relationships. Building these deep relationships and day-to-day management procedures with the provider is one of the most vital elements behind success in outsourcing (Morgan, 2003, 44). If the firm wishes to reap the benefits from non-hierarchical coordination — if it wants the strengths of integration without the burdens of financial ownership — it needs to build effective and trustworthy relationships with its network of providers. In practice, building strong relationships requires very active communication, even overcommunication, with the provider (Best, 2006, 148). Cooperating and competing simultaneously is often the factor that causes most tensions in many partnerships. In strategic NPD outsourcing, the provider may well be someone who competes with the client in some markets. This is almost an inevitable consequence of the fact that firms wish to outsource NPD to providers that have superior capability: after all, what would be better evidence for superior capability than competing successfully in the marketplace? According to Milgate (2001, 103), two factors need to be in place in order to manage the tensions. First, the partners need to be clear about their strategic intents
for the partnership, and those intents need to be communicated to the partners. Second, all the parties should come open with each other about what they expect to gain from the partnership to defuse suspicions. In addition, spelling out clearly at the outset of the relationship the areas of competition and the areas for cooperation helps to ease tensions as well. Particularly in cases where the provider can clearly pose a competitive threat to the client (or vice versa), information flow between the partners needs to be managed. One possibility is to establish ‘gatekeepers’ for technology areas or product lines (Milgate, 2001, 105). Only these gatekeepers are authorized to pass technological information to the partner. According to Milgate, this approach has two benefits: first, it ensures that the partner only receives precise information that is usable in decision-making, and second, it makes sure that what information is given away can be controlled and documented. The management should also realize that competences learned in one product or market — where there is no interpartner competition — can sometimes be transferred to other products or markets, where interpartner competition can be intense (Milgate, 2001, 108). Learning from alliances is arguably one of the most important challenges facing managers. Although learning is not always an explicit objective in NPD outsourcing, partnerships are always an opportunity for learning for both the client and the provider. At the minimum, the client should aim to increase its outsourcing skills, as elaborated in the next section. According to Milgate (2001, 108), learning requires managing and stimulating the in-flow of information, and using the information to promote learning throughout the organization. The management should also note that most of the valuable long-term organizational learning comes not from the formal information exchanges, but from the informal interchange of information that takes place between the client and the provider staff (Milgate, 2001, 109). Finally, measuring outsourcing performance needs to be discussed. The wellknown axiom states ‘you cannot manage what you cannot measure,’ and without an
appropriate measuring regime in place, judging the effectiveness of the outsourcing partner will be impossible (Milgate, 2001, 80). Although some of the most valuable gains from strategic partnerships — for example, organizational learning — are not susceptible to precise measurement, establishing and agreeing the criteria for what a successful outcome would be at the beginning of the project and following how these criteria are fulfilled is crucial for the success of NPD outsourcing initiative (Best, 2006, 170). Some possible measures of quality, time and cost are given in a Table 14 below. Measures should logically flow from the objectives of the outsourcing initiative so that the selected measures actually support the client’s strategy. Both what is measured and how it is measured must be agreed between the client and the provider before the outsourcing contracts are signed. If outsourcing performance or objectives in general are measured against a ‘baseline’ performance, this baseline must be clearly defined. Usually the baseline is a measurement period of three to six months immediately before the outsourcing arrangement comes into play (Milgate, 2001, 80).
Table 14. Examples of measures of NPD quality, time, and cost. Adapted from Best (2006, 149, 170-173). Measures of Quality
Performance Features Reliability Conformance Durability Serviceability Aesthetics Perceived quality/reputation Value for money Awards (e.g. for good design) Peer and press reviews Improved brand image and customer perception Increased brand awareness Improved customer satisfaction Manufacturing lead time Due date Rate of product information Delivery lead time Frequency of delivery Time to market Development costs Capital budget Manufacturing cost Reductions in costs Reductions in waste materials Value-added Selling price Running cost Service cost Units sold Annual growth in sales Increase in market share Reduced customer churn Profit Profit margins
Measures of Time
Measures of Costs and Benefits
When setting the measurements, the partners should also explore the possibility of building incentives into the agreement for exceeding the minimum requirements. Building incentives can be very difficult, but it is also very desirable for aligning the interests of the provider with those of the client. While cash penalties for not achieving the objectives may be even more useful, such arrangements are viewed with deep suspicion by service providers (see e.g. Gallouj, 1997; Holopainen and Järvinen, 2006). Typical incentives used in NPD outsourcing are royalties for units
sold61, performance bonuses, and profit sharing, where the provider gets an agreed percentage of e.g. cost savings generated. One problem with incentives is that they need to be thought through very carefully to ensure that they are structured so that performance is not skewed to hit certain targets at the expense of others (Milgate, 2001, 80).
EXAMPLE: One of the major ‘what-ifs’ in the outsourcing initiative was whether the relationship with Great Goods could be made to work, as Great Goods had been traditionally seen as a competitor in the Gamma market. Do dispel this fear before the contract was signed, Widgets Ltd. and Great Goods held (relatively) frank discussions about their respective strategic intents for the partnership. During the discussions, it turned out that Gamma line was relatively unprofitable for Widgets Ltd., while it had a relatively good fit for Great Goods’ product line-up. Great Goods had both the expertise and the scale to design and build better and cheaper Gamma products, and Widgets Ltd’s management conceded that its own resources could be better spent somewhere else. The two partners then decided that the cooperation was strictly limited to Gamma line of products and their interfaces with Widgets Ltd’s other products; a non-competition clause in the agreement stated that Great Goods was not to introduce products that competed directly with Widgets Ltd’s core products or the deal would be called off and sanctions would be invoked. The performance measurements were also agreed during this process. For Gamma products, key performance measures were deemed to be cost reductions, performance and features, and improved customer satisfaction. Great Goods would receive bonuses if these criteria were met. To manage the information flow between the alliance partners, both Widgets Ltd. and Great Goods appointed special ‘gatekeepers.’ Widgets Ltd. also gave its gatekeeper orders to promote information in-flow, and gather knowledge about Great Goods’ product development techniques whenever possible. Similar gatekeepers were identified for other providers as well.
For example, usual royalties for product design in consumer goods range from 1 to 5 % of sales for the first 5-10 years. Typically, initial royalty rate is higher and the royalties drop gradually to zero during the contract period. In some cases, royalty advances are also used.
3.7. Lessons learned
A difference between experience and expertise is that while increasing experience requires only participation, increasing expertise requires active effort aimed at learning from one’s successes and mistakes. In other words, if a firm wishes to become more proficient in outsourcing — if it wants to be able to make better outsourcing decisions — it must reflect on the lessons learned during outsourcing projects. As previously alluded to, gathering lessons learned should not wait until the end of the project. Keeping track of decisions made, the underlying assumptions at the time, and the subsequent results is an effective way of building managerial intuition regarding future outsourcing projects (e.g. Klein, 1998; Khatri and Ng, 2000; Dane and Pratt, 2007). At the very least, both the client and the provider should have internal meetings after the project has ended to discuss what could be learned from the project. Optimally, regular meetings with project staff from both the client and the provider should be arranged. Both the client and the provider would also do well if they disseminate the lessons learned throughout their organizations.
EXAMPLE: From the start, the outsourcing initiative team tried to keep records of its discussions and decisions. A Master’s student was later hired to compile these records and interview the key personnel to learn what went right and what could have been improved. A series of group discussions ensured that lessons from the project were spread to the organization.
3.7.1. Renewal or termination of contract
Eventually, all outsourcing projects come to an end, either because project has been completed or the client no longer requires the services of the provider. Whether to renew or terminate the relationship depends on the needs of the client, the results, and the relationship enjoyed. If there is a potential to establish a longer-term relationship, ongoing contact is required between parties to ensure that the clientprovider relationship is continued once the initial project has ended. Moving from a one-off project to an ongoing relationship takes time and commitment in building up a personal relationship (Bruce and Morris, 1998), as well as willingness to operate in a way that long-term relationship is possible (Greaver, 1998, 121). As previously mentioned62, long-term relationships are usually worth the effort and should be the goal for both the client and the provider. Client-provider relationships in NPD have a distinct life cycle of compatibility, familiarity and competency (Bruce and Morris, 1998). Initial compatibility — compatibility to sourcing criteria, initial ‘gut feel’ and the provider’s ability to understand the client’s business, etc. — is a requirement for outsourcing to occur in the first place. Success in this initial stage, represented in good outcomes, positive personal relationships and firm-level compatibility, typically moves the relationship to the next stage: familiarity. In the familiarity stage of the relationship, firms build mutual trust, understanding, and social and economic stability. Equally importantly, NPD competency rises as the provider understands the client’s business better, and the client understands how to work with the provider. Finally, some firms develop their relationships even further to gain competencies from the relationship. This stage is what is usually referred to as ‘strategic’ partnership in literature (e.g. Quinn and Hilmer, 1994; Milgate, 2001), and what is important to realize is that reaching the level where the relationship delivers unique, difficult-to-imitate competency —
See Section 3.4.1, Identifying the objectives.
where 1+1 equals 3 — requires going through initial stages of compatibility and familiarity. In short, shortcuts to strategic relationships are few and far in between. Decision-making about relationship renewal or termination is governed primarily by perceived future needs of the client. The decision itself is fundamentally a subjective evaluation of the experiences during the relationship. The most pertinent criterion, of course, is whether the client needs the provider’s services any longer. If not, there is little point in continuing the relationship. If the need persists, the decision-making is usually relatively straightforward: if the quality of the work has been satisfactory, the relationship continues. Ultimately, the decision whether to pursue an ongoing relationship with the provider is based on the client’s assessment of the relationship enjoyed and the results achieved. Both need to be satisfactory or at least show a credible promise of improvement, although in practice, good personal relationships can sometimes salvage a business relationship with poor results while even good results may not save a relationship burdened by bad chemistry between key players.
EXAMPLE: Although the relationship with Epic Engineering had begun well, after two years it became apparent that with personnel changes in Widgets Ltd. and Epic Engineering, the relationship wasn’t working any longer. The subsystems designed by Epic were lacklustre and behind Widgets Ltd’s competitors, and projects suffered from cost overruns and delays. Eventually, a decision was made to discontinue Epic Engineering’s services and seek new providers for a longerterm, strategic partnership. The outsourcing initiative team was called together again…
3.8. Master checklists for NPD outsourcing
NPD outsourcing can be somewhat complex process and the procedure described in this thesis may seem daunting to a newcomer. To help readers manage the process, the key themes and questions of this chapter are collected below in checklists. Although every firm has somewhat differing requirements and procedures, and checklists and process diagrams are not substitutes for common sense, a list of important actions is nevertheless a useful aid in avoiding the most common errors. The checklists are organized to follow the sections in this chapter. This does not mean, however, that the given order of actions needs to be followed. The ‘Notes’ column contains references to sections where the issues are discussed. In addition to this checklist, Appendixes D and G contain further checklists that may be useful for firms considering outsourcing as a strategic option.
Table 15. Checklist for preliminary activities. Action
Gain acceptance from top management Assemble the initiative team; include experts from: Market and business model knowledge Product architecture and design knowledge Supply chain knowledge
Management ‘buy-in’ critical See Section 3.5
Table 16. Checklist for identifying the objectives. Question
Are objectives of outsourcing initiative clear to management? What are the ‘triggers’ that started the thinking about NPD outsourcing? Have you analyzed the root causes why the firm should seek external NPD help? Is firm’s NPD capacity sufficient for future needs? Is firm’s NPD capability good enough compared to competition and market needs? Can the firm hire enough NPD personnel it needs? Is the firm’s culture conductive to innovation? Are the firm’s resources spread to too many different directions and objectives? Do NPD efforts provide good return for investment in all the product lines and categories?
See Section 3.4.1 I.e. what started the process
Table 17. Checklist for determining process modularity. Action/question
Create a list of activities performed during the NPD process Analyze the interfaces between the activities; how does information from one activity move to another? Is the information codified? Can the quality of information be measured? Do the two activities require iterative exchanges of information? Would it be a problem if the activity weren’t conducted inside the firm? What kinds of problems would it create? Can the procedures used today be adjusted so that outsourcing would be easier?
See Section 3.5.2
E.g. codifying tacit knowledge
Table 18. Checklist for identifying key competences. Action/question
Are core competences or off-limit areas determined by upper management? Use the list of activities created in table 17 to check whether these contribute to core competences OR determine core competences using Appendices D and G Divide activities to core and non-core activities
See Section 3.5.3
Table 19. Checklist for assessing the strategic implications. Action/question
Check each non-core activity for following: Is the activity or competence close to best-of-theworld capability? If not, Has outsourcing the activity a negative impact on real core competences due to its connections with them? Are there competitive provider markets for the activity? Could the loss of activity cause a loss of possible future core competences? Do certain stakeholders require that the activity is kept in-house?
See Section 3.5.4
E.g. customers may require keeping task in-house
Table 20. Checklist for information search and preliminary evaluation. Action/question
Draw up a list of provider candidates Determine provider’s strategic fit: match the skills and needs of both the client and the provider Is the provider a specialist in particular technique, or a generalist? Is the provider best suited for incremental improvement or radical innovation (‘clean sheet of paper’) type projects? Is the provider sufficiently aware of the client’s technological requirements? Can the provider deal with the client’s technological requirements? Does the task require customer insight or understanding the client’s markets or business? If yes, does the provider have such insights? Determine provider’s strategic intent: can the relationship be a win-win situation? What would be the broad, readily apparent objectives of this strategic partnership for each partner? How can the two parties complement each other to create common strengths from which both can benefit? How important an alliance would be within each partner’s corporate portfolio? Would there be any problems with the alliance due to relative closeness of the core businesses of partners? Determine effects of relative size What percentage would the task approximately represent in provider’s annual revenue? Is the provider’s cost structure unnecessarily topheavy for the planned project? Are reliability criteria important? Is the ability to scale up rapidly important?
See Section 3.6.1
Usually, specialists are best for incremental, generalists for radical innovation.
Bigger clients get more attention Does your firm need all the frills of a large provider? If yes, larger providers good If yes, larger providers good
Table 21. Checklist for request for proposals Action/question
Is ‘official’ RFP phase necessary for the project? Build a RFP document: Reasons to outsource Scope and brief (if available): what services the provider is asked to deliver? Provider qualifications: which qualifications are important, and why? Performance standards: what is the level of performance, and how this will be measured? Pricing: what is the desired pricing model? What decision makers are accessible, and when? How you are going to answer any questions from candidates? Are there other special terms or conditions? Could the provider differentiate through innovative ideas? What these could be? Does the provider have references of customers with similar projects? Can the provider provide names of some customers for whom things did not work out, and reasons why? Was the reason for failure the provider’s fault? Before sending, check that you have: A clearly written request for proposals or a brief Sufficient information on hand to shorten provider’s time investment Reasonable time to respond Access to the firm’s decision makers Budget to cover costs incurred by providers
See Section 3.6.2
Table 22. Checklist for shortlisting Action/question
Has a reasonable time been given to providers to respond? Evaluate the provider candidates using Tables 11 and 12, OR through following four dimensions: Understanding of the problem Validity and pragmatism of the approach Availability and competence of the team Experience and qualifications of the provider If necessary, have another round of shortlisting
See Section 3.6.3: 1-26 weeks
Table 23. Checklist for selection and negotiation of relationship. Action/question
Arrange for presentations of shortlisted candidates Determine whether the activity is strategic or tactical in nature Are there many providers competing to offer the same activity? Determine desired relationship: What is the control need for the activity? What is the flexibility need for the activity? Prepare a selection checklist, based on shortlisting criteria, OR determine the following: What is the proposed approach and planned actions? What is the method of work, procedures, and possible alterations? What are the characteristics of the provider, i.e. history, activities, and organization? What is the consultancy team and its skill levels? What is the proportion of junior to senior designers? Is the provider able to complete the mission within time and budgetary limits? What is the experience and references of designers in the field concerned? Experience with technology Experience with markets Experience with relevant regulations Experience with certification processes, if required What is the provider’s background knowledge and possible references? What is the attitude of the provider’s representatives or employees? What are the availability, involvement, and personal commitment of the provider’s personnel? Would their location or different culture present problems? Have you taken ‘halo effect’ into account?
See Section 3.6.4 I.e. whether to seek shortor long-term relationship I.e. what are your negotiation positions
Use examples from thesis
Table 24. Checklist for project transfer. Action/question
Adjust internal processes for easier modularization Improve documentation Codify tacit knowledge Contact the provider to start the planning process Do client and provider agree and understand the project brief, and what will actually be delivered? Break down what needs to be done within each project stage into smaller tasks and activities Prioritize the tasks Estimate time needed to complete each one Identify project roles, responsibilities, lines of communication and team-management procedures Communicate these to the provider Identify and communicate any additional resources or stakeholder involvement that will be needed to complete the project Communicate these to the provider Ensure the parties understand the systems for: Information flow Documentation Record keeping Administration
See Section 3.7.1
Table 25. Checklist for project management. Action/question
Can the project managers handle multiple relationships? Can the managers handle cooperation while competing? Are the partners clear about the strategic intents for the partnership? Are those intents communicated to the partner? Are the parties open with each other about what they expect to gain from the partnership? Are areas of cooperation and areas of competition clearly defined? Are gatekeepers managing the information flow? Are gatekeepers instructed of their responsibilities? Is learning from the partner promoted within the organization? Are informal exchanges between the client and the provider encouraged? Are performance measurements in place? Is the baseline clearly defined? Is the possibility of incentives discussed? Are the measurements/results followed regularly?
See Section 3.7.2
Table 26. Checklist for lessons learned. Action/question
Does the outsourcing initiative team keep track of their assumptions, activities, and decisions made? Are internal or external debriefing meetings scheduled for the project? Are there in place systematic ways for gathering lessons learned from the project? Are there methods for disseminating the lessons learned to the rest of the organization?
See Section 3.8
4. Empirical survey
While outsourcing in general has long been a subject of intensive study, research on product development outsourcing is more recent. The extent of the phenomena has been documented in various studies (e.g. Roberts, 1995; Love and Roper, 1999, 2001, 2004, 2005; Howley, 2002; Duga and Studt, 2005; National Science Foundation, 2005; Holopainen and Järvinen, 2006; Hätönen, 2008, among others), but studies that focus on outsourcing product development of physical products remain rare, with exception of studies that analyze industrial design outsourcing (e.g. Holopainen and Järvinen, 2006). Most of the previous studies, such as the PDS survey by Love and Roper (2001), suffer from being conducted during the midnineties. Since then, and especially after the turn of the century, increased adoption of information technology has lowered the transaction costs involved in outsourcing. In theory, this should make outsourcing more prevalent (e.g. Schilling, 2005). In addition, existing studies have rarely examined outsourcing in connection with dynamic firm and industry factors except size and location, even though more interesting observations could be made by linking the results to, for example, the product cycle or the intensity of competition faced by the firm. This study tries to explore quantitatively what parts of the product development process firms typically outsource and what are the reasons for outsourcing product development. The aim is to determine the relative importance of NPD outsourcing in firm’s NPD processes and thus guide future research while validating certain hypotheses developed through outsourcing theory.
Since this survey is intended to be exploratory rather than explanatory, research hypotheses are limited to confirming existing predictions about NPD outsourcing from elsewhere in the world. This is done in order to check whether the study gives results that are consistent with theory, whether they could be generalized on a wider scale, and to preliminarily analyze whether Finnish NPD outsourcing follows patterns recognized in other countries. First, Sobrero and Roberts (2001), echoing the distinction between systemic and autonomous innovation made by Chesbrough and Teece (1996) in their analysis of over 50 provider-manufacturer relationships, posit that there are two potentially optimal types of provider-manufacturer relationships: (1) Using providers merely as subcontractors, and assigning the specific tasks in parts of the project exhibiting low interdependence. (2) Externalizing completely the conception, design and realization of highly interdependent parts, and jointly working on their overall integration with the rest of the system (Sobrero and Roberts, 2001). This involves higher coordination efforts and associated transaction costs, but supplies more opportunities to access tacit knowledge bases and so encourages learning. Outsourcing limited, easily defined tasks doesn’t require finely honed capabilities in network development, coordination and management. Therefore, it should be expected that there is some correlation between the extent of outsourcing and the firm’s organization model in regards to its attitudes towards providers and suppliers. Thus, hypothesis 1 can be stated as
H1: Firms that outsource major parts of their NPD activities tend to follow network model of organization, while firms that control their suppliers tightly outsource less.
Second, Ulrich and Ellinger (2005) noted that NPD outsourcing is dependent on the ability to disaggregate design and manufacturing. This is achieved via design rules and standards that allow the designer to communicate clearly and unambiguously the requirements to the manufacturer, and the manufacturer to communicate the limits of the manufacturing process to the designer. Design rules and standards are related to a concept of modularity, which reflects the degree to which the products and their production processes are decomposed into smaller subsystems and activities. These activities may be designed and managed independently yet function as a whole (e.g. Baldwin and Clark, 2000; Mikkola, 2006). Design rules and standards take time to become established; therefore, firms whose technologies are relatively new should not, ceteris paribus, outsource design and development activities. This leads to hypothesis 2, viz.
H2: Firms whose key technologies are new and rapidly developing outsource less than firms whose technologies are mature and well known.
Third, according to Love and Roper (2001, 2005), NPD outsourcing is markedly more common in larger firms and business units. Their suggestion is that larger firms offer more opportunities for outsourcing and are often more focused on their competencies. Their study, based on survey data from European firms, found a significant increase in outsourcing as firm size increased over 100 employees. Therefore, hypothesis three can be stated as
H3: Firms with over 100 employees are more likely to outsource than firms with 100 employees or less.
Fourth, according to Welch and Nayak (1992), Greaver (1998) and Quinn (2000), NPD outsourcing can be used to accelerate new product development. Nevertheless, there is little data about the effects of firm’s time-to-market cycle on the need of NPD outsourcing. Traditional transaction cost economics posits that shorter intervals between product updates or market launches, i.e. greater utilization rates for internal R&D, should lead to less need for outsourced services; however, as outsourcing NPD can be used to develop new products in a ‘surge,’ fast time-tomarket cycles can also indicate a need to involve external services63. Depending on the nature of the firm and its products, a firm could either outsource the design of complementary ‘gap filler’ products to an outsider, or it could purchase temporary design capacity. A hypothesis therefore formed is
H4: Firms with faster time-to-market cycles are more likely to use external providers in supplementary roles, but less likely to completely outsource NPD functions.
63 See Stalk (1988) for a discussion about the practical application of overloading the market with the firm’s own products and thus building customer expectations about entire markets.
4.2. Survey design
Data was gathered from Finnish registered companies that export their products, as these firms were thought more likely to have an incentive keep their product development processes up-to-date. For contacting the relevant persons, a database search was made by a commercial databank Suomen Asiakastieto. Based on their data from 2006 and 2007, a total of 526 persons who were responsible for either research or products and production within their companies (product managers, product development managers, research managers, managing directors et cetera) were identified from the Asiakastieto’s register that included data from firms with at least 10 employees. These persons represented 389 distinct firms. According to official Finnish Statistics Bureau statistics, in 2006 a total of 2 254 Finnish firms conducted product development activities (Tilastokeskus, 2007). Therefore, the original sample represents roughly 17% of total Finnish firms with product development activities. Five product development professionals from various backgrounds tested the questionnaire (see Appendix H) and their suggestions for improvement were carried out. The group used for this pilot study was not part of the sample used in the full study to avoid problems with representativeness of the sample (Bryman and Bell, 2007, 274). The study was on firm or independent business unit level.
4.3. Operationalization of variables
The operationalization of variables is about finding suitable metrics that allow the researcher to make conclusions on the phenomena under study. In general, questions can be divided into four types:
1) Factual questions 2) Information questions 3) Opinion questions 4) Motive questions
Source: Laaksovirta (1988, 53). This study uses mostly factual questions to measure factors underlying product development outsourcing. Facts are easier to measure and therefore have a greater utility to, for example, service providers looking for a market opportunity and to researchers looking for general patterns. Factual questions are supported by opinion- and motive-related questions, partly to explain motives and partly to check for inconsistencies in respondent’s answers. In addition, the respondents had the opportunity to answer to open questions and to comment the study. However, this opportunity was not widely used. Since product development is often considered one of the most critical and sensitive functions of a firm, gathering direct data about precise tasks outsourced and R&D expenditures used for outsourcing was judged to be too sensitive a subject to yield meaningful answers from the respondents. In addition, defining in a concise and unambiguous manner what, exactly, is product development outsourcing is very challenging. For these reasons, the questions were deliberately broad and asked only the amount of work being outsourced in any particular phase of the project.
However, the amount of work outsourced correlates relatively well with the share of product development budget used for outsourcing, particularly because firms in this study were not likely to offshore significant amounts of their product development to countries with different cost structures. In the following, the factors under study and the questionnaire strategy used are explained. The detailed questionnaire (in Finnish) is included in Appendix H. The background variable and initial question used in the study simply asks the respondents to state whether their organizations (firm or business unit) outsource any product development related activities at all. If the respondent selected ‘No’ from two variables, s/he would skip the detailed questions and asked to elaborate on reasons why they are not outsourcing any product development. The first questions of the actual study were relatively straightforward. The respondents were asked to first approximate the amount of outsourced work in the different phases of product development process (Ulrich & Eppinger, 2008). In the next questions, they were also asked to evaluate the outsourcing of specific processes or tasks in different phases of the PD process. These tasks were identified by Ulrich and Eppinger (2008) and were complemented with several additions based on feedback from pilot study. The questionnaire also included open answer options so that respondents could describe other tasks or processes that their firm is outsourcing. In case the phases and processes described didn’t apply to their firm, the respondents were instructed to leave the question blank and/or describe their processes in a separate open form. Question 9 asked the respondents to describe the reasons for outsourcing product development activities. The answer options were gathered from a variety of sources described in the literature review section of this study and from discussions with product development professionals. An open field was also included.
Question 10 was included to determine the strategic approach used and the role played by the respondent’s firm or business unit. This question was inspired by Andrew and Sirkin (2003), who argued that companies generally play one of three basic roles in commercializing innovation, being either integrators, orchestrators, or licensers. Previous empirical studies such as Sobrero and Roberts (2001) have also identified two potentially optimal types of provider-client relationships (using providers merely as subcontractors vs. externalizing completely the realization of independent parts and integrating them) with specific trade-offs for efficiency and learning. Again, an open answer option was included. Question 11 asked the respondents to answer what they consider major obstacles to outsourcing product development. Respondents who answered ‘no’ to the background variable question started the questionnaire from this question. The answer options were derived from literature review and from discussions with product development professionals. An open answer option was included. Question 12 was included to test for variations in Ulrich and Eppinger’s generic product development process. The respondents were asked to answer what of the options best described the products or services of their firm or business unit. The options were from Ulrich and Eppinger (2008), with no open answer option. Question 13 attempted to measure the maturity of the technology and existence of design rules (Ulrich and Ellison, 2005). The respondents were asked to describe the key technology or technologies used by their firm, with answer options forming a two-by-two with technology (mature-new) on one axis and existence of standards (limited-widespread) on another axis. An open answer option was also included. Question 14 measured the competitive situation faced by the firm. The respondents were asked about their opinion of the competitive situation on a scale of 0 to 10, where 0 represented no competition at all and 10 represented an intense, cutthroat competition.
Question 15 measured the product cycle of the firm in question, in terms of new product launches or significant upgrades to an existing product. A drawback in this type of question is that it doesn’t differentiate between line upgrades (so-called ‘n+1 products’, see Buxton, 2007) and totally new products. Question 16.1 measured the amount of expertise the firm in total had in outsourcing any process or activity. As outsourcing experience in general correlates with a propensity to outsource innovation (Love and Roper, 2001), the answer to this question was expected to correlate with the amount of outsourcing of product development activities. Question 16.2 measured more specifically the amount of experience in outsourcing product development activities. Of particular importance would have been a case where the firm didn’t outsource product development activities any longer, after having done so for some period. Question 16.3 measured the size of the firm or business unit, in employees. Prior studies (e.g. Love and Roper, 2004, 2005) have found that there is a significant change in propensity for outsourcing innovation-related activities when the firm size grows from less than 100 to more than 100. Question 16.4 was included to check the accuracy of the questionnaire. The respondents were asked to evaluate how reliable their answers would be, in terms of whether the respondent felt s/he was the right person to answer this type of study. Any answers with two or less (on a scale from one to five) were disregarded in final analysis. Question 17 was included to categorize the firms by their industry.
4.4. Survey execution and response rate
The survey was conducted as an online survey, using web-based tool that allowed respondents to answer the questionnaire by clicking a link in invitation e-mail. After the questionnaire was tested with outside product development professionals and their suggestions for improvement were carried out, invitations were sent by email. Two follow-ups were sent later to remind the invitees to respond to the study if they hadn’t already done so. The e-mail also included instructions on how to contact the author in case the invitee wanted more information or didn’t want to be included in the survey, for example. A copy of accompanying e-mail (in Finnish) is included in Appendix I. The entire survey took place between 12.3.2008 - 1.4.2008. A total of 67 individual respondents completed the questionnaire, giving a response rate of 17 %, which is relatively good for an Internet survey. Of these, 60 responses were fully usable for the purposes of this thesis, with seven answers being either incomplete (1 occasion) or indicated lack of knowledge on the subject area by answering 1 or 2 to Question 16.4 and were therefore deemed to be unreliable (5 occasions).
4.5. Results of the study
After the questionnaire was completed, the data was operationalized and analyzed. First, incomplete answers and those answers with low internal reliability64 were expunged from the data, along with one response from a building contractor who indicated in a open question that the survey wasn’t suitable into their model of operations. This left 60 valid answers, of which 31 outsourced some aspects of product development, and 29 kept NPD completely internalized. Respondents who answered positively to a preliminary question on whether the respondent’s firm or business unit outsourced any NPD activities were then asked to evaluate the approximate percentage of outsourced NPD activities per phase of product development process. Based on answers from these two initial questions, the responses were grouped into four groups. The grouping is based on work by Willcocks and Choi (1995), who quantified 80% outsourcing level to mean ‘total’ or ‘turnkey’ outsourcing (van Weele, 2005, 54-55), and on Sanders et al. (2007, 7) who divide outsourcing into four categories in terms of the scope: 1) out-tasking, 2) comanaged activity, 3) managed activity, and 4) total outsourcing. The following classification criteria was used:
1) No NPD outsourcing: negative responses to preliminary question (‘Does your
firm or business unit outsource NPD activities?’)
2) Some NPD outsourcing in supporting role: respondents who indicated that
they do outsource NPD activities, but outsourced less than 40% of any single phase of the process
3) NPD outsourcing in a significant role: respondents who outsourced at least
40% but less than 80% of any single phase of the process
Those with score two or less on Question 16.4; ‘Evaluate whether you were the right person to answer to this questionnaire’ on scale one to five.
4) Some NPD activities completely or nearly completely outsourced:
respondents who outsourced at least 80% of any single phase of the process. Due to low number of responses (3) that indicated complete outsourcing (group 4), a decision was made to combine these answers to group 3 (NPD outsourcing in a significant role). However, the charts below show the answers of group 4 for comparison purposes, even though small sample size makes generalizations problematic. The results from this classification are summarized in Diagram 1 below.
Diagram 1. Classification of respondents by category (n = 60).
An average outsourcing level was also calculated for the entire sample and for different groups to illustrate the extent of outsourcing in different phases of product development. This was done by considering range band answers (i.e. ‘40 to 60 %’) to represent their average value (i.e. 50 %). Data for this diagram came from preliminary question 2 (approximate the amount of outsourced work in the different phases of product development process). It was decided not to use more detailed data gathered by
questions 3 to 7, where the respondents were asked to detail what tasks in the NPD process they were outsourcing. The reasoning behind this decision was that the respondents were very heterogeneous in terms of field of business, size, and location (see, for example, Diagrams 4 and 5), and therefore more detailed questions were deemed too likely to misrepresent the NPD process used by the firm. However, data from these questions was also analyzed and used as background material for the study as Grounded Theory methodology suggests (e.g. Glaser, 1992). The resulting Diagram 2 is shown below.
Diagram 2. Extent of NPD outsourcing, as percentage of respondents (n = 60).
As the graph indicates, outsourcing tends to become more prominent in detailed design and testing/refinement phases of the NPD process. Interestingly, firms that outsourced some functions nearly completely were especially eager to outsource production ramp-up, even though this was outsourced relatively less often by other firms. This could indicate that the firms in this group are OEMs that re-brand and sell products manufactured elsewhere.
4.5.1. Background data
The background data for the firms involved was determined through Asiakastieto’s register, which included the firm’s turnover in 2006, and by including questions about firm size and field of business. The key figures for 60 respondents included in the final sample are given in Table 27 below.
Table 27. Key figures of survey respondent firms/SBUs. Size (employees) Minimum Maximum Average Median Modal range band
10 1434 100 46 Between 20 and 50
Turnover (millions €)
1.3 975 46.8 6.6 Between 10 and 50
The background data from respondents is given in graphical form in Diagrams 3 and 4 below. Turnover ranged from 1.3 million € to 975 million €, with median turnover of all respondent firms/business units being 6.6 million € and average turnover 46.8 million €. Modal turnover range band was between 10 and 50 million € annual turnover. By employee count, firms ranged in size from 10 to 1434 employees, with average size being 100. Median size was 46 employees, and modal
size range band was 20 to 50 employees. The results are therefore relatively heterogeneous, especially When analyzing the data, the size and turnover were grouped into range bands as recommended by EU definitions for small, medium and large enterprises (2003/361/EU).
Diagram 3. Firm/SBU personnel, as percentage of respondents (n = 60).
Diagram 4. Firm/SBU turnover, in millions €, as percentage of respondents (n = 60).
As can be seen from the Diagrams 3 and 4 above, most respondent firms can be classified as small or medium enterprises65. Interestingly, those firms that support their activities with outsourcing (category 2) are relatively evenly spread across different-sized firms. The respondents’ field of business can be seen at Diagram 5.
Less than 250 employees and turnover less than 50 million €, see European Commission’s definitions for small and medium enterprises, 2003/361/EU.
Diagram 5. Firms by field of business, as percentage of respondents (n = 60).
4.5.2. Reliability and validity
A key assumption made during the study is that responses reflect accurately the true situation within the firm. If the questionnaire doesn’t capture what’s actually going on within the firm, the reliability of the study could be called into question. Reliability of measurements was determined primarily through inter-observer consistency (see Bryman and Bell, 2007, 163). As stated above, five different product development professionals were used as a pilot study group, and their suggestions for improvement were carried out. All five agreed that the survey questions were appropriate and reflected real NPD processes. Reliability depends heavily upon validity of data. If data is not valid, the study cannot be reliable. Primary test for validity used in this survey was its face validity (see Bryman and Bell, 2007, 163): the survey results were in line with both the predictions from theory and earlier studies of the subject (e.g. Love and Roper, 2001). Internal validity was controlled by checking whether answers from preliminary question 2 (approximate the amount of outsourced work in the different phases of product development process) and more detailed answers where the respondents were asked to evaluate level of outsourcing in specific NPD tasks were in line with each other. In general, firms that scored highly in preliminary question 2 also scored highly in more specific questions, supporting the internal validity of the survey. Another way internal validity was controlled was by asking the respondents to evaluate whether they were qualified to answer to the questionnaire in Question 16.4. As mentioned above, six answers that indicated low confidence (1 or 2 in a 5step Likert scale) were disregarded in analysis. In the end, the survey can be considered relatively valid and reliable, although heterogeneity of respondents in terms of firm size, turnover, location and field of business makes any generalizations uncertain.
4.5.3. Hypothesis 1
H1: Firms that outsource major parts of their NPD activities tend to follow network model of organization, while firms that control their suppliers tightly outsource less.
As can be seen from the Diagram 6 below66, firms that increase more NPD activities indeed choose more often to build networks with their contractors and suppliers. However, this finding can be criticized as somewhat context-dependent and deterministic: it is not clear from the answers whether major outsourcing initiatives came first, and organizational structure was adapted to fit the reality, or whether the organizational structure was designed in anticipation of outsourcing initiatives. In most cases, truth is probably somewhere in between: what actually emerges as an organizational form is the result of interplay between intended and unintended incidents and initiatives67. However, the conclusion from the results is that Hypothesis 1 is supported by available evidence.
Question 10 ‘Which of the following best describes your relationship with your suppliers and service providers?’ For a discussion about intended and emergent strategies, see e.g. Mintzberg et al. (1998).
Diagram 6. The effect of client-provider relationship on NPD outsourcing, as percentage of respondents (n = 60).
4.5.4. Hypothesis 2
H2: Firms whose key technologies are new and rapidly developing outsource less than firms whose technologies are mature and well known.
For this hypothesis, the results from the study are more ambiguous. Compared to those firms that don’t utilize NPD outsourcing, a larger percentage of firms practicing extensive outsourcing use well-known and standardized technologies68 (see Diagram 7). However, according to the findings outsourcing in a supporting role is more common among firms whose technologies should not, per se, be as
Question 13: ‘Which of the following best describes the key technology or technologies used by your firm/SBU?’
suitable for outsourcing. The solution to this dilemma might be found from the different strategies for NPD outsourcing: firms that use NPD outsourcing in a supporting role tend to outsource specific aspects of NPD process to gain specific competences from outside the firm (‘focus’ strategy described in Section 3.4.1; see also Diagram 12). These competences may be easier to standardize and specify, freeing the firm to concentrate on their own key technologies that may be less standardized. An interesting duality is that the majority of both non-outsourcers and significant outsourcers use key technologies that are well known and understood. The probable explanation for this would be that non-outsourcers are relatively small, traditional firms such as machine shops that do not have much reason for extensive new product development beyond their particular niche. In addition, it is probable that a majority of all firms use technologies that are relatively mature; hence, the result should not be surprising. In conclusion, the evidence supports Hypothesis 2.
Diagram 7. The effect of key technology maturity on NPD outsourcing, as percentage of respondents (n = 60).
4.5.5. Hypothesis 3
H3: Firms with over 100 employees are more likely to outsource than firms with 100 employees or less. Love and Roper’s (2001) study showed significant increase in NPD outsourcing when firm/SBU size exceeded 100 employees. As can be seen69 from Diagram 8,
Question 16.3: Personnel of your firm/SBU.
which depicts the distribution of firm size for each of the three categories,70 the division is not as prominent in this study. NPD outsourcing is most prominently used in relatively small firms (size less than 50 employees), with larger firms using NPD outsourcing more often in a supporting role. Interestingly, both the majority of firms that do not outsource NPD and the three firms that outsourced NPD nearly completely are small, under 50-person firms. Although the results may suffer from relatively small sample (n = 60), the logical explanation for the distribution is that many small firms, lacking resources, do not have the capability to conduct the entire NPD process themselves – for example, most smaller firms do not employ industrial designers (e.g. Holopainen and Järvinen, 2006). At one extreme are firms that act more like marketers or manufacturers while buying designs from external providers. On the other hand, small firms are often a brainchild of one or few specialists with relatively stable customer relationships and little need for external NPD resources, a description that fits many small firms in machinery and technology industries. Another explanation from the difference in results between this study and Love and Roper’s (2001) study is that the latter used data gathered during early 1990s; NPD outsourcing, especially in Finland, has become more widespread only during the late 1990s – early 2000s. Thus, it is to be expected that NPD outsourcing has spread to smaller firms as well. As the firm grows, it usually faces a challenge of finding new products and new markets, both of which may require external assistance in NPD. Larger firms also tend to have both the financial means and the readiness to utilize external consultants, while their larger size means that they conduct significant R&D themselves. The data can nevertheless indicate that larger firms do indeed outsource more, since the questionnaire didn’t ask questions about absolute amount of outsourced work
As with all the diagrams, the fourth category, NPD nearly completely outsourced, is shown for comparison purposes although it is integrated in the third category as described in Section 4.5.
done. As can be seen from Diagram 4 (p. 168), all surveyed firms whose annual revenue exceeds 50 million Euros use external NPD services. If we assume that the R&D budget consumes a fixed percentage irrespective of firm size, larger firms would indeed outsource more. However, the finding by Love and Roper (2001) and the resulting Hypothesis 3 were explicitly about firm size in employees, and in conclusion, the available evidence does not support Hypothesis 3.
Diagram 8. The effect of firm size to NPD outsourcing, as percentage of respondents (n = 60).
4.5.6. Hypothesis 4
H4: Firms with faster time-to-market cycles are more likely to use external providers for capacity and flexibility reasons, but less likely to completely outsource NPD functions.
Hypothesis 4 has some support from the results of this study. As indicated by Diagram 9, firms with shorter product life cycles71 are significantly more likely to utilize at least some form of outsourced NPD compared to those whose product life cycles are longer. While firms with fastest product life cycles (time between significant updates less than a month) use outsourcing only in supporting role, as predicted by theory, other results are more ambiguous. Most interestingly, firms that outsource significant parts of the NPD process seem to have shorter product cycles than average, but as the sample size for those firms is very small (n = 3) the results are inconclusive in one way or another. An explanation for this phenomenon could be that those firms either act as marketers for products designed by someone else, or have such a wide portfolio of products that their internal NPD is insufficient. Determining this would require further study as the respondents weren’t asked questions concerning the breath of their product portfolios. Another interesting finding is that firms with longer product life cycles are significantly more unlikely to use NPD outsourcing. This could indicate that the firms with longer product life cycles either rely heavily on the skills and expertise of their employees, and/or practice only limited new product development72 In conclusion, the evidence provisionally supports the hypothesis: firms whose product development cycles are faster need external help but since investments in R&D capability are more easily recouped and justified, complete outsourcing is unlikely.
Question 15: ‘How often your firm/SBU brings a new product or a significant upgrade to the market?’ See also Hypothesis 3.
Diagram 9. The effect of product life cycle to NPD outsourcing, as percentage of respondents (n = 60).
4.5.7. Conclusions about hypotheses
In conclusion, two hypotheses (Hypotheses 1 and 2) were relatively well supported by the evidence, while Hypothesis 4 received provisional support and Hypothesis 3 was unsupported. Thus, the study could be said to broadly agree with the general theory and past findings. The spread in answers was likely to be caused by small sample size and by the heterogeneity of the sample: anecdotal evidence73 suggests that respondents included several firms with very little actual NPD activities, such as machine shops doing contract manufacturing and one-off projects. The presence of these firms, who typically do not sell branded products, may have a significant effect on the results. Controlling for this factor should therefore be attempted in future studies of the subject.
For example, evidence from the respondent’s Internet home pages.
4.6. Other findings
In addition to finding answers to the hypotheses, the study attempted to map the NPD outsourcing phenomenon in Finland in general. To this end, the survey included questions about respondent firm’s product development processes, obstacles and reasons for NPD outsourcing, and previous experiences on NPD outsourcing and outsourcing in general. These results give further insights to the phenomenon of NPD outsourcing in Finland and in general, and will be discussed below. The findings should be considered preliminary and exploratory; a more detailed analysis of the data cannot fit the scope of this thesis and will be published separately.
4.6.1. Differences in product development process
All firms have slightly different product development processes. The generic product development process (Ulrich and Eppinger, 2008) used as a baseline in this study is closest to a so-called market pull or market driven product development process, where a firm begins product development as a response to a market opportunity and then uses whatever available technologies are required to satisfy the market need. In effect, the market needs ‘pull’ the development decisions. In addition to market pull process, several variants are common and correspond to the following: process-intensive products, customized products, technology push products, and platform products (Ulrich and Eppinger, 2008, 21). In addition, products that have high risk of marketplace failure, such as aerospace and medical products, often utilize a significantly different product development process compared to more predictable products.
Question 12 attempted to chart whether variations from generic product development process (Ulrich and Eppinger, 2008, 21) have any effect on NPD outsourcing intensity74. A prediction from theory would be that firms whose products are market-driven and hence the technology used is selected based on enduser need tend to use more mature technologies, as searching for mature technologies is easier than searching for technologies for which design rules do not exist yet, and therefore they would be in a position to outsource NPD more easily than firms whose products are technology- or process-driven. Although technologydriven firms should benefit from concentrating on their core technologies and outsourcing easily standardized parts of the NPD process (see also Hypothesis 2), especially process-driven firms should find outsourcing NPD relatively difficult, as developing new products would require intimate knowledge of the manufacturing process used. The findings, represented in Diagram 10, tend to reinforce this theory. Firms with market pull product development are clearly over-represented among firms significantly outsourcing NPD, and some firms with technology push products outsource significant parts of their NPD process. On the other hand, firms whose product features are determined primarily through process technologies used either don’t outsource NPD at all, or outsource certain specific competencies that are not needed regularly within the firm. When the survey data is analyzed in more detail, it can be seen that process technology firms outsource mainly tasks such as industrial design, development of marketing materials, and (in some cases) processes related to legal and other acceptances. This is very much as would be expected from the theory.
Question 12: ‘What of the following best describes the product development process used in your firm/SBU?’
Diagram 10. Different product development approaches, as percentage of respondents (n = 60).
4.6.2. Obstacles to outsourcing NPD
The respondents were also asked to evaluate a selection of statements about perceived obstacles to outsourcing NPD75. The results, presented in Diagram 11 below, indicate that non-outsourcers and significant outsourcers view the problems in NPD outsourcing somewhat differently. Broadly speaking, non-outsourcers tend to think that required knowledge exists only within their firm, and that potential providers do not understand the requirements imposed by the clients and customers. On the other hand, significant outsourcers think that providers are expensive and offer only limited services. Interestingly for providers of NPD services, respondents whose firms practiced limited NPD outsourcing lamented the lack of suitable providers, and lack of knowledge about suitable providers. This would indicate an unmet market opportunity. In summary, Table 28 shows top three obstacles76 to outsourcing for each type of respondent. All of the groups felt that providers had problems understanding the client’s products and their qualities, and difficulties in controlling the providers were major obstacles to NPD outsourcing.
Table 28. Top three obstacles to outsourcing NPD. Non-outsourcers
1. Required knowledge exists only in our firm / Need for secrecy/confidentiality 2. Provider doesn’t understand what qualities are important in our products 3. Difficulties in controlling the providers
Firms with limited NPD outsourcing
1. Lack of suitable providers 2. Required knowledge exists only in our firm 3. Difficulties in controlling providers
Firms with significant NPD outsourcing
1. The services available are too expensive 2. Difficulties in controlling the providers 3. Lack of suitable providers / Need for secrecy/confidentiality / Provider doesn’t understand what qualities are important in our products / Providers lack the ability to supply complete offerings that we need
Question 11: ‘What of the following, in your opinion, are obstacles to outsourcing NPD?’ Some top three positions are shared by more than one obstacle.
Diagram 11. The obstacles to NPD outsourcing, as % of respondents (n = 60).
4.6.3. Reasons for outsourcing NPD
Respondent’s answers to their reasons for outsourcing NPD gives preliminary support to the theory that predicts three primary strategies for NPD outsourcing77, that is, capacity, focus, and stopgap outsourcing. As Diagram 12 shows, focusing on certain competences is an important reason for nearly every respondent78. As answers to the control question (‘We focus on certain products and outsource complementary products’) indicate, firms tend to buy know-how and capability, not complete ‘turnkey’ new product development. A more detailed analysis is, however, required for further conclusions, and this finding should only be treated as provisional. An intriguing suggestion for further research is that all the firms that outsourced their NPD processes nearly completely cited time savings as their reasons for NPD outsourcing, while simultaneously considering cost savings as important reasons. This suggests that at least some firms indeed consider that outsourced NPD could compete favourably against investments in internal R&D, such as setting up internal NPD capability.
See Section 3.4.1. Question 9: ‘Which of the following describes your reasons for outsourcing NPD activities?’
Diagram 12. Reasons for outsourcing NPD, as percentage of respondents (n = 60).
4.6.4. Previous outsourcing and NPD outsourcing
Previous outsourcing in general is seen as a good indicator for firm’s potential to outsource further functions. This is also confirmed by the findings of this study, as indicated by Diagram 1379. The reason why firms tend to approach outsourcing incrementally is that developing capabilities for handling external relationships takes time and effort, and trust in providers is not built overnight. As a result, firms often outsource small parts as an experiment (see e.g. de Boer et al., 2006) and, if the experiment is a success, are encouraged to outsource further functions.
Question 16.1: ‘How much does your firm or SBU have experience on outsourcing any process of function?’
Diagram 13. The extent of previous outsourcing initiatives, as percentage of respondents (n = 60).
Since previous outsourcing is a good indicator of future outsourcing, it is no surprise to see that, in general, the more a firm outsourced its NPD process, the more previous experience it had in NPD outsourcing. This tends to reinforce the findings from previous studies (see e.g. Hätönen, 2008) that outsourcing proceeds incrementally, as trust to the provider and general ability to handle external relationships increases.
Diagram 14. Previous NPD outsourcing experience, as percentage of respondents (n = 60).
As can be seen from the Diagram 1480, most firms (42 out of 60) had at least tried NPD outsourcing in some form. Of special importance were those firms that had practiced NPD outsourcing previously, but weren’t continuing to do so. 18 such firms were identified. No single reason why these firms weren’t outsourcing NPD any longer could be identified, but examining the perceived obstacles to NPD outsourcing sheds some light to the issue. From the limited data, it seems that NPD outsourcing service providers should pay more attention to understanding their clients, since issues related to knowledge transfer and relationship seem to crop to the top of the list of obstacles in both Diagrams 11 and 15. Comparing Diagram 11 to Diagram 15, it can be seen that firms whose NPD outsourcing initiatives have
Question 16.2: ‘How much does your firm/SBU have experience on NPD outsourcing?’
ended have found suitable providers, but weren’t satisfied with the way the providers understood the client’s problems.
Diagram 15. Why firms aren’t outsourcing NPD any longer, as percentage of respondents (n = 60).
4.7. Limits of generalization
The study and its results are valid only for Finnish firms that export their products. Although the original sample was relatively large in comparison to total number of firms that perform innovation activities (17 %), the results of the study cannot be taken to constitute a generalized view of the situation. In particular, the sample is somewhat skewed towards small and medium enterprises. Although these findings might be more useful for general policy setting, the fact is that the relative lack of large companies with their specialized product development processes might leave out important insights and potential niche markets for small ‘boutique’ product development consultancies and other service providers. These problems are partially addressed through interviews of firms A and B, however. Another limitation of the study is that quantitative results in themselves are always subject to interpretation and depend heavily on logical reasoning. Therefore, the results should be taken as broad directions and not as ultimate truths of the subject matter. However, they do give a foundation for further studies and for studies that aim to explain the working mechanisms of product development outsourcing. A particular cause for concern is that the diversity of product development vocabulary and variety of theoretical approaches might cause a distortion in the results. Although the study tried to control for this factor by pre-testing the survey, distortion in the results remains within realm of possibility.
5. Discussion and practical implications
The results of this study show that transformative outsourcing is more complex phenomenon than traditional cost-minimizing transactional outsourcing. Transformative outsourcing seeks primarily to expand the capabilities of a firm instead of reducing its costs. It is a way to do more with same resources, instead of doing the same with fewer resources. To understand transformative outsourcing, a relatively broad, interdisciplinary view is necessary. The study has addressed these demands by considering contributions from strategic management, network theories, and service businesses. All these viewpoints provide a partial picture of outsourced new product development. Taken together, they sketch a picture of transformative outsourcing that helps managers to understand the potentially complex interrelationships between what to outsource, to whom to outsource, and how to outsource. The thesis argues that outsourcing seemingly ‘core’ competences can be a successful strategy. However, success requires that a distinction be made between ‘true’ core competences, strategic competences, and peripheral competences. In addition, outsourcing important activities that are not easily codified requires good relationships and high trust between the client and the provider. The thesis also makes a reasoned argument that lessons from design management can serve decision-makers well when outsourcing NPD activities. One limitation of the thesis is that it doesn’t explicitly take the locational decision (whether to outsource to e.g. low labour cost country) into account. However, this is taken implicitly into account if the thesis’s recommendations about the importance of relationships and process modularity are followed. The interviews and the survey conducted for this study indicate that NPD outsourcing follows broadly similar patterns in Finland as abroad. Firms are surprisingly often using external services to aid their product development efforts,
especially in industries with mature technologies and fast product update cycles. Firms are using NPD outsourcing both to temporarily increase their NPC capacity, and to source best-in-the-class skills from external providers. As stated in the Chapter 1 and evidenced by the survey and interviews conducted for this thesis, transformative outsourcing of new product development and other innovation-related activities is changing the competitive landscape in many industries. Literature review indicates that many firms are achieving remarkable reductions in time-to-market and NPD costs by using external R&D. Others have reaped significant benefits from innovations generated with help from external design and product development consultancies. Managing NPD outsourcing is possible and can be very important for the firm, and all evidence suggests that NPD outsourcing should become part of the strategic decision-making of the firm. Since nothing is constant with the exception of change, firms need also to realize that a strategy today day may have to be revised in the future. Outsourcing is not a one-way street, and by constantly balancing economic, technical, and relationship factors, managers should be able to make decisions that help their firms grow and prosper. The rest of this chapter discusses some practical implications of outsourcing NPD, including its impact on customer perceptions of products and brands, the effect it may have on organizations, and on business strategies. The linkages to crowdsourcing and Open Innovation are also briefly discussed. Finally, the chapter ends with implications to new product development service providers. Outsourcing is not a panacea for all ills, but if it is used with wisdom, it can be an important tool for better products and, ultimately, for more profits. Although managers in small and medium enterprises have probably the most to gain from this thesis, the author hopes that the text serves others interested in this relatively recent phenomenon in their studies and professional lives.
5.1. Impact on products and brands
If new product development is no longer performed within the firm, what remains of firm’s distinctive products and its distinctive brand? In theory, outsourced NPD means less differentiation between competing products and no distinctive competitive advantage between them, as product development skills are acquired from open markets where all competitors – at least in theory – have access to them. However, in real life, firms have several means at their disposal to differentiate their offerings –packages of products and services bundled under one distinctive brand. Designing every single part of a product in-house has never been a sensible strategy, and even if NPD would be partly or completely outsourced, the effect on product differentiation is not likely to be significant unless the product gains some distinctive customer value from being designed in-house81. Excepting those rare cases, customers do not typically care who, in fact, designed the product – providing it fulfils the customer’s needs. Much more important consideration is whether outsourcing affects the customer orientation and customer/end user understanding in new product development. Previously, this thesis has argued that outsourcing NPD should be approached with caution if there is a danger that valuable customer understanding would be lost in transfer. Losing touch with one’s customers can have such severe effects that reiterating the warning is appropriate, but the flip side of the coin is that in some cases, external service providers can be better positioned and/or have more experience in understanding the customers or end users. A long-term threat in such cases is the effect this may have on branding and marketing of the product line: unless marketing and NPD are coordinated, a situation may arise where marketing
An example of gaining marketing advantage from in-house design would be ‘Designed by Apple in California’ text found in Apple products.
department has one vision of product’s customer base, and the (external) NPD team has another. This challenge is not the only one posed to branding and marketing by the changing competitive environment and wide availability of external service providers. When knowledge and skills required to develop successful innovations become commodities, incumbent firms must be even more paranoid about new challengers popping up suddenly. Branding and marketing become more important as the role of technological differentiation diminishes or becomes marginalized; the best innovator is no longer the one with the best technology or R&D labs, but one who best combines different technologies and products together to a superior product line offering. A case in point is Apple’s development of iPod and iPhone product lines: technologically, both were inferior to existing competitors when they were launched, but they combined different technologies effectively enough while delivering superior overall customer experience and ease of use. Today, innovation increasingly means finding distinctive attributes of product and service offerings and concentrating on delivering those attributes using both internal and external expertise as required. Firms need to concentrate on overall customer perception and learn to coordinate various internal and external players – from product development and design consultancies to advertising agencies and delivery channels – to deliver a differentiated product.
5.2. Impact on organizations
The impact of NPD outsourcing on organizations is twofold: on one hand, outsourcing NPD could mean that employees in the client firm (particularly in the West) would have more time to spend on real value-add innovation while more routine improvements and non-core product lines would be outsourced to more efficient or cheaper providers. On the other hand, outsourcing relatively easy entrylevel tasks may be harmful for the long-term competitiveness of the organization, if those less important tasks were used to train new recruits to firm’s products and ways of working. Outsourcing in general is a subject that tends to raise strong emotions, and outsourcing NPD is no exception. Employees will fear for their job security, and that fear may become a liability unless the process and the transition are managed actively and humanely. Active, frank and direct communication is especially important if outsourcing results to layoffs, but proactivity will be beneficial even if this isn’t the case. Outsourcing high-value-added design and engineering tasks might raise a difficult question: if the firm outsources everything, what is its actual value? In particular, institutional investors may be asking this hard question, and unless the management can justify the outsourcing initiatives in terms of improved focus, better capability, or better future prospects through learning from the provider, the firm’s market capitalization may be in danger.
5.3. Impact on business strategies
NPD outsourcing opens new strategic opportunities for the benefit of incumbent firms while leveling the playing field for the benefit smaller challengers. In short, NPD outsourcing is another strategic tool for firms to use: it is simultaneously an opportunity and a challenge. The fundamental opportunity/challenge stems from the changing focus of innovation. In the 20th century, innovation was about processes, products, and services, and as a result, most boardrooms are still investing in lower-order innovation. However, higher-order innovation – business model, strategic, and management innovation – is associated with significantly more powerful and durable value creation. NPD outsourcing can allow business model and management innovation by freeing corporate resources – especially management time – from daily grind of incremental innovation. NPD outsourcing is a remarkably suitable tool for innovations that don’t depend on technological mastery or economies of scale, but rely more on new, innovative ways of organizing the activities of people. For example, Apple has successfully leveraged simple, relatively low-tech product innovations, like the iPod and iPhone, with disruptive new value chain designs such as iTunes and the Apps Market. As new product development has been commodized and made available through the marketplace, similar innovation opportunities are open to firms whose capabilities wouldn’t have been nearly enough to deliver just ten years ago. However, one should keep in mind that in Apple’s case, the key to value chain innovation was Apple’s mastery of user interface design: similarly, firms intent on higher-order innovation should leverage their strong competences and build new value chains around them.
The following sections will discuss some examples how outsourced NPD can bring strategic benefits. The sections will first discuss the benefits of flexibility inherent in using outsourced services, termed offensive, opportunistic and defensive flexibility in this thesis. In addition, this section will also briefly discuss capability strategies and using Original Design Manufacturers (ODMs).
5.3.1. Offensive flexibility: shaping the marketplace82
One strategic opportunity that becomes more easily available to firms via NPD outsourcing is shaping the marketplace through strategic agility. The aim of shaping is to saturate the marketplace with firm’s own designs, thus keeping the competition off balance while shaping the customers’ perceptions of what the product should look and feel like, and thus put competition on a disadvantage. To understand strategic agility or surge strategy in NPD, one has to think about product specifications that describe in some detail what the end customer wants from the product. The question is: who wrote the specification? In principle, customers ‘want’ something because a supplier has shaped the marketplace by offering something to them. If this is the case – if the competition has shaped the marketplace instead of your firm – a ‘discovery of customer wants’ represents not a strategy but a failure of strategy. A firm that desires to become more competitive must, therefore, find ways of shaping the marketplace with its own offerings. An example of this strategy from the 1980s is documented by Stalk (1988). In 1981, Yamaha opened a new, larger factory and announced that it would become the
This section is primarily based on Richards (2004) and Stalk (1988).
world’s largest motorcycle manufacturer, surpassing incumbent Honda in the process. Instead of competing directly via manufacturing capacity, Honda chose to fight through speed and agility: over the 18-month period of the ‘H-Y War’, Honda introduced 113 new models to replace the 60 it had in the beginning. In contrast, Yamaha was only able to bring out 37. Each model introduced by Honda helped it learn how the public accepted each model, and make changes accordingly. The end result was that both Honda models and public tastes evolved during the course of the campaign. By the end of the ‘war,’ Yamaha models weren’t selling any longer, and the firm conceded defeat. Although Stalk’s (1988) analysis was that Honda had managed structural changes that enabled them to execute their NPD processes much faster, another option would have been to use external NPD assets to overwhelm the markets in a coordinated campaign. In short, firms can use external assets to increase the speed of their ‘fire-aim-fire-fire-fire’ (McGrory, 2006) cycle that enables both learning about customer wants and shaping them at the same time. long reaction times when market or customer needs are in a flux. This contrasts to traditional ‘ready-aim-fire’ cycle of planning and execution, which can easily lead to
5.3.2. Opportunistic flexibility: real options approach
Building product development capability is a significant investment in time and money. Recruiting new personnel may take months; building effective teamwork and required expertise might take years. Making such investments in an uncertain, risk-laden environment is tricky and increasingly unlikely. However, by buying services on a case-by-case basis from external service providers, firms can make small investments in multiple options or approaches. If one approach proves successful, external resources can be shifted to pursue that opportunity.
These small, initial investments can be regarded as real options: real option is a ‘right, but not the obligation, to take an action in the future’ (Amram and Kulatilaka, 1999, 5) Real options are management tools for uncertainty reduction – making a small, initial investment under high levels of uncertainty allows one to create an option while waiting until the uncertainty about the opportunity has decreased. Firms approaching NPD from real options point of view can benefit 1) from early involvement in a particular product area, 2) from delayed entry or delayed financial commitment, 3) by offering the firm the advantage of an early exit, and 4) by allowing the firm to benefit from delaying an exit and either spin in the external product development function, or sell the resulting innovation to e.g. venture capitalists (Vanhaverbeke et al., 2008, 253-254). Anecdotal evidence suggests that firms are, in fact, using NPD outsourcing contracts as a way to evaluate service providers (especially ODM manufacturers) for possible acquisition. By using external services, a firm can start exploring the commercial possibilities of a particular concept without committing internal resources. External help also enables the firm to consider a broader portfolio of entry options at the beginning, and supports more ways to develop growth opportunities from a product line or technology (Vanhaverbeke et al., 2008, 254).
5.3.3. Defensive flexibility: contractors and crises
Outsourcing is often justified by its inherent flexibility. Traditionally, this has referred to the fact that getting rid of contractors is often easier than getting rid of employees, if economic situation so requires. In short, outsourcing allows firms to response to changing demand more flexibly than internal resources, and shed manhours if demand for new product development sinks. This uncertainty is usually priced into service provider’s fees: a long-term, binding contract becomes cheaper than a series of short-term contracts.
Although showing contractors the door is a viable response to a suddenly worsening economic outlook, firms should avoid hasty decisions. Cutting back product development during time of crisis can be a costly mistake that is regretted later when demand picks up again. For example, historical data suggests that increasing marketing and adjusting the product portfolio to better respond to customer needs can be a winning strategy during recessions, providing the firm has resources (i.e. capital) to do so (e.g. Linder and McCarthy, 2003; Srinivasan et al., 2005). New product development during recessions should concentrate on improving product’s value for money and researching customer needs more carefully. During recessions, firms need to know how consumers are redefining value and responding to the recession in order to respond with proper product portfolio. This suggests that clients may need to retain providers that have capabilities in these areas, even though new product launches might have to be shelved for duration.
5.4. Links to Open Innovation and crowdsourcing
Open Innovation has been defined as the use of purposive inflows and outflows of knowledge to accelerate internal innovation, and expand the markets for external use of innovation, respectively (Chesbrough, 2006). NPD outsourcing, and this thesis, is more concerned about inflows of knowledge to accelerate internal innovation. Hence, NPD outsourcing can be thought of as a special case of broader Open Innovation theory. It can be argued that many skills required to work effectively with external NPD providers are useful when managing Open Innovation, and vice versa: for example, mitigating the notorious Not Invented Here syndrome is a requirement for successful NPD outsourcing as well as for successful Open Innovation. The primary focus in this thesis has been in the ‘classic’ outsourcing scenario where a firm engages a specialist firm or a consultant to provide a service it cannot or will not do internally. However, specialist consultancies are not necessary for new product development: in fact, much of actual new product development happens when hardware or software suppliers collaborate with their clients, or firms collaborate with their customers, to develop new solutions that meet a previously unmet need. The framework proposed in this thesis can be used as a starting point for NPD contract negotiations with these suppliers as well. Another buzzword of the early 2000s – at least when the subject is new product development – has been crowdsourcing. Crowdsourcing refers to the act of taking a task traditionally performed internally or by a contractor, and outsourcing it to an undefined, generally large group of people or community in the form of an open call (Howe, 2006). Crowdsourcing thus differs from traditional outsourcing in that the client doesn’t know in advance who actually will provide the service. Some of the benefits include comparatively low costs and access to wider talent than present internally (von Hippel, 2005; Tapscott and Williams, 2006). While crowdsourcing
has attracted attention from several business practitioners, trade press, and from several researchers as a potentially extremely valuable addition to corporate problem-solving toolkit, the limitations of this approach to user-driven innovation are also becoming visible. Crowdsourcing seems to be suited mostly to problems and tasks that can be split into ‘chunks’ manageable by single persons or small groups. In addition, the tasks shouldn’t require significant initial investment or specialized knowledge from the ‘crowd.’ Breaking the tasks down into ‘chunks’ that are manageable by single persons or small teams is important, as well. Relevant, well thought out design briefs are especially important for crowdsourcing, since vague briefs result to vague projects as crowdsourcing lacks the constructive feedback that specialized consultants give as a part of their proposal. In essence, crowdsourcing seems to be a useful tool for tasks that rely on creating or manipulating (mostly) digital data, but its applications are somewhat more limited when real, physical objects need to be created. However, in some cases crowdsourcing can be a viable alternative for outsourcing NPD – especially if the product has a large number of users. Successful crowdsourcing requires that the product has value to external developers: in short, this means either a reward for successful design, or (more often) that developers themselves are using the product and thus have an incentive to develop a better version. Von Hippel (2005, 147-164) has identified five criteria for successful user innovation in non-software applications, which are summarized in Table 29. In addition, crowdsourcing is more likely to succeed if the product is also a so-called identity product for its customers, i.e. if the product is important for customer’s self image and identity83.
For example, Harley Davidson motorcycles.
Table 29. Five criteria for successful user innovation. Source: von Hippel (2005, 147164). Criteria
1. Learning by trial and error
Users must be able to go through complete trial-and-error cycles when designing the product. This allows the users to see the consequences of the design choices they make, and thereby decide more precisely what they really want. A solution space is defined by the flexibility in which the producer can produce the desired result. Any production process has a set of limiting factors, and these factors define the solution space. If the solution space is small, the chance of user innovations is small. The process must be available to the users so that they can use the skills and languages they already know. This frees the users from learning the different design-specific skills and languages associated with manufacturing. Custom designs are seldom made up of unique parts, but instead share a set of standard modules. Therefore a library of standard modules should be available to the user. This allows the user to focus on the unique parts that are truly important. ‘The result from the process must be easily converted into the language needed for the production system, and be without error. If the result of the process must be manually translated, much of the effect of the toolkit may be lost.
2. An appropriate solution space
3. A user friendly toolkit
4. Commonly used modules
5. Results easily created
5.5. Implications for service providers
The developments discussed in this thesis have several impacts to service providers as well. Perhaps the most important (even if the most obvious) implication comes from the fact that trust is an important factor in NPD outsourcing. Providers should consciously cultivate trusted relationships with their clients and actively promote practices that increase trust within the relationship. The second important finding is that outsourced NPD process and the relationship can and should be managed. The responsibility for educating clients in NPD outsourcing process management probably falls to service providers, as improving relationship management is ultimately in their interests. Third, if external service providers play their cards well, they have a role to play regardless of economic climate. During economic booms, external service providers can be used to explore attractive alternatives when their clients lack resources (notably manpower) to do so. This favours generalist providers that can take a broader look to the problem and possible solutions. During recessions, the focus on improving product value and increasing reliability, durability, safety and performance, as well as increased attention paid to user research, favour specialist firms that can supply skills in these sectors. Finally, a development with potential for significant impact to providers is that clients increasingly seek ‘one-stop’ solutions for their NPD needs. Other clients seek capacity and reliability that comes from large, integrated service providers. This calls for larger, more capable providers, or alternatively, for more effective networks of smaller providers. Mergers and acquisitions among NPD service providers and ODM manufacturers are likely to increase in the coming years, as firms seek to strengthen their service portfolios.
This thesis has given a broad overview of important issues influencing modern transformative outsourcing. The selected methodology has enabled broad scope and reduced the risk of one-sided conclusions based on too narrow theoretical viewpoint. The historical context of outsourcing and NPD outsourcing have been briefly discussed, and the current situation is shown to be a logical continuation of long-term, global trends. Key research streams affecting NPD outsourcing have been identified and outlined. The lessons from these research streams have then been used to build a framework of NPD outsourcing process, and an example case build on interviews, research, and experience has been detailed. For practical purposes, a checklist of important issues has been created. The current state of NPD outsourcing in Finland has been researched through empirical study with 60 respondents representing a diverse selection of firms and industries. Four hypotheses have been tested against empirical evidence, and the Finnish NPD outsourcing scene is shown to broadly follow examples from other countries. The importance of external NPD to firms has been established. Finally, the thesis discusses practical implications for both clients and providers of external NPD services. A selection of further tools and analysis has been included as appendices. By following the recommendations in this thesis, managers can ‘make sense’ of the subject of outsourcing NPD activities. Outsourcing new product development capability can be disastrous if thinking behind outsourcing decisions is based on limited viewpoints or frameworks that have been developed for transactional outsourcing. The primary limitation of the thesis is that it doesn’t explicitly cover international outsourcing, but given the emphasis placed on non-hierarchical coordination methods such as trust, this issue is implicitly covered. The secondary limitation, imposed by the thesis format, is lack of empirical validation for the framework developed in the thesis.
6.1. Directions for further research
This thesis follows the research tradition recently exemplified by e.g. Hätönen (2008) and Hoetker (2005) in taking a broad view of the subject of modern, transformative outsourcing. The exhaustive literature review and preliminary survey conducted for the thesis should form an interesting starting point for future research, and some suggestions are given below. First, the limitations of thesis format precluded a deeper study into how’s and why’s of NPD outsourcing selection and management. The framework developed in the thesis assumes that NPD outsourcing services resemble other outsourced professional services in general and design services in particular. However, this assumption should be tested, since the existence of e.g. ODM providers blurs the line between manufacturing and services outsourcing. Second, the applicability of the framework for real-life cases should be tested and the framework improved. The author is under no illusions of intellectual superiority and believes that the framework presented here is woefully incomplete and even misleading; however, it certainly can form a basis for more refined and – hopefully – simpler framework. Case studies of actual outsourcing decision-making would be particularly helpful, but this as reported by other researchers, the author found out that firms were reluctant to discuss the subject in detail and spoke only in general terms. Third, the empirical research could be deepened with case studies and more focused questionnaires. Specific industry segments should be targeted, as the homogenous sample in the survey makes drawing hard conclusions problematic. Special attention should be paid to firms that outsource major portions of their NPD, and to those firms that have used NPD outsourcing but do not do so any longer. Future studies should also seek to control for firms that do not actually perform NPD activities at
all. In addition, the diversity of product development vocabulary and a lack of commonly agreed definitions and practices may hinder research efforts. Fourth, linkages of NPD with Open Innovation and crowdsourcing are thesis subjects in their own right. Both of these organizational innovations have brought new opportunities and challenges for NPD. A research establishing the conditions of when Open Innovation or crowdsourcing could be used as an alternative to traditional NPD consulting would be welcome. Fifth, the long-term effects of NPD outsourcing have received relatively little attention. A particular problem in this case is gathering data from past decisionmaking, but if such longitudinal data source could be found, the case study would be valuable for both researchers and practitioners. For example, if simple tasks are outsourced to cheaper labour countries, is there a danger that new hires no longer have ‘entry level’ tasks that help them learn about the firm, its products, and its working practices?
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8. Appendices 8.1. Appendix A: Semi-structured interview protocol
A semi-structured interview, such as the one used in this thesis for interviews with product development personnel from Firms A and B, is a method for eliciting qualitative data from the subject matter experts. In a semi-structured interview, the researcher has a list of questions on fairly specific topics to be covered, often referred to as an interview guide, but the interviewee has a great deal of leeway in how to reply (Bryman and Bell, 2007, 474). The researcher can also depart from the guide as he picks up on things said by interviewees. Nevertheless, all the questions will be usually asked and a similar wording will be used from interviewee to interviewee (Bryman and Bell, 2007, 474). The emphasis must be based on how the interviewee frames and understands issues and events. According to Bryman and Bell (2007, 479), semi-structured interview is useful for addressing more specific issues when the researcher has relatively clear focus about the topic. As the interviews followed extensive literature research, this approach proved justified. The interviewees were preliminarily identified by asking knowledgeable sources, such as the supervisor of this thesis, for suggestions. Those identified were then contacted via phone and e-mail. In total, 13 subjects were identified, and of those, interviews could be arranged with five interviewees – one from Firm A and four from Firm B. The interview guide was then prepared according to suggestions by Bryman and Bell (2007, 482-483). The questions were checked with one knowledgeable NPD professional at Seos Design Ltd. before the interviews. The professional agreed that the questions were relevant to the aims of the study. The interviews were conducted in meeting rooms, and with one exception took place at the interviewees’ workplaces. The interview was immediately transcribed on
researcher’s laptop. Attempts were made to record the interviews as well, but technical failures prevented that in every occasion. However, given that the author’s typing skills, the transcript could be considered relatively reliable even without the recordings. Moreover, since the approach entailed detailed attention to subject matter instead of language used, lack of recordings presented no real handicap (see Bryson and Bell, 2007, 489). The interview sampling followed so-called ‘snowball sampling’ model (Bryson and Bell, 2007, 200), where interviewees are requested to identify other relevant interviewees until answers become saturated and no new data emerges. This was not possible with Firm A, but was used with success in Firm B’s interviews. The interview guide (in Finnish) is presented below. Tulosyksikön tiedot (koko, asiakkaat, tuotteet jne) Miten paljon haastateltavalla on kokemusta tuotekehityksen ulkoistamisesta? Millaista? Kuvaile lyhyesti tuotekehitysprosessianne (vaiheet, portit jne) Mitä yrityksessänne/tulosyksikössänne ulkoistetaan? Mitä ei ulkoisteta missään nimessä? Kuinka päätetään, mitä ulkoistetaan? Kuinka paljon ja millaista “luovuutta”/omatoimisuutta & itsenäisyyttä ongelmien ratkaisemisessa alihankkijalta odotetaan? Kuinka paljon alihankkijan odotetaan tekevän yhteistyötä tuotekehityksen seuraavan vaiheen kanssa? (Mikäli ulkoistetaan vain tietty vaihe tuotekehityksestä, esim. tutkimus tai konseptointi) Mikä “laukaisee” ulkoistamispäätöksen? Kuinka ulkoistamispäätös tehdään (vaiheet ja ihmiset joita siihen osallistuu, ihmisten työtehtävät) Roadmap? Miten palveluntuottaja valitaan? Mitä asioita palveluntuottajassa arvostetaan? Miten ratkaisun onnistumista mitataan? Millaisia palveluita, mitä nykyään ette saa, kaipaisitte palveluntarjoajilta? Mitä muuta kehittäisitte palveluntarjoajissa? Onko käytössä mitään menetelmää/viitekehystä ratkaisun tekemiseen? Olisiko viitekehys mitenkään relevantti tai tarpeellinen? Millaisia asioita hyvän viitekehyksen tulisi ottaa huomioon?
8.2. Appendix B: Overview of outsourcing decision models
To give the reader an overview of theoretical outsourcing frameworks, and of the parameters these frameworks contain, six “classics” of outsourcing literature are briefly outlined below. Walker (1988) proposes a strategic sourcing framework, based on: (1) strategic risk associated with an activity (appropriation risk, technology diffusion, end-product degradation), and (2) organization’s competence in performing the activity as opposed to that of providers. Walker’s approach is a good example of how outsourcing was viewed during the 1980s (the ‘big bang’ of outsourcing, see Hätönen, 2008) as a vehicle for cutting and reducing operational costs. However, its basic lesson – that the firm should concentrate on its own core competency and outsource the rest – is still sound. Venkatesan (1992) argues that firms had neglected the opportunity to develop proprietary components that are sources of competitive advantage. To avoid eroding the capability to design and manufacture components that are critical to the product and hard to manufacture, firms should (1) Focus on those components that are critical to the product and that the firm is distinctively good at making; (2) Outsource components where suppliers have a distinctive comparative advantage, greater scale, fundamentally lower cost structure or stronger performance incentives, and (3) Use outsourcing as means of generating employee commitment to improving manufacturing performance. Venkatesan’s core message is that not all components in a product produce equal customer value and satisfaction; some components are more critical than others, and the firm should not outsource their design or manufacturing.
Welch and Nayak (1992) propose a strategic decision matrix that considers three dimensions of process technology: (1) The process technology role in providing a competitive advantage, (2) The maturity of the process technologies under consideration, and (3) The competitors’ process technology positions In short, Welch and Nayak’s decision matrix recommends that competences which are important in the future should be developed, if the firm’s future position is likely to be tenable or superior to the competitors. If the firm’s relative position is likely to be inferior, however, the activity should be sourced from external partners. Quinn and Hilmer (1994) argue that core competence is a major strategic concept in sourcing decisions. The decisions should therefore consider (1) Competitive edge derived from the activity, (2) Strategic vulnerability introduced by outsourcing, and (3) Transaction costs incurred due to outsourcing. They also note that outsourcing always involves a trade-off between control and flexibility, and outsourcing an activity inevitably means that the firm loses some control. Quinn and Hilmer’s model has been quoted in length in various studies about outsourcing.
Apte and Mason (1995) propose a framework based on disaggregation of services. After services have been disaggregated from each other, the parts can be sourced from external providers. Eligible activities for disaggregation are determined through (1) Information intensity requirements, (2) Customer contact need, and (3) Physical presence need. Once a decision to disaggregate is made, Apte and Mason’s two-stage process postulates a further decision as to the sourcing of the activity. This should be carried out if (1) The activity is strategically not important, and (2) If the organization is relatively less efficient in performing the activity relative to competition. Greaver (1998), based on a long personal experience in managing outsourcing deals, develops a methodology for more complex outsourcing initiatives (significant asset transfers and multi-year contracts) that has seven steps: (1) Planning initiatives, such as risk assessment, project team formation, and objective setting; (2) Exploring strategic implications, where the initiative is aligned with, for example, the organization’s vision, core competencies, structure and value chain; (3) Analyzing costs and performance, where activity costs are measured and future costs projected; (4) Selecting providers; (5) Negotiating terms; (6) Transitioning resources such as people and equipment; and (7) Managing relationships.
Interestingly, more academic accounts rarely discuss or even mention the importance of relationships and relationship management. However, Greaver’s model is suitable primarily for major, strategic outsourcing initiatives, although its lessons apply to smaller-scale projects as well. Sislian and Satir (2000) develop a composite that attempts to incorporate factors thought important in previous studies into a single framework. Their two-stage process includes (1) Competitive advantage and (2) Demand flexibility for determining whether to outsource or not, while (3) Process capability, (4) Process maturity and (5) Strategic risk and managerial considerations required to implement the decision. Cánez et al. (2000) base their research largely on interviews and case studies. The authors develop and operationalize a make-or-buy framework, which addresses specific make-or-buy decisions by trading off relevant factors. In their framework, the external environment, on which the company has little or no influence, usually activates triggers for the make-or-buy analysis and usually forms the basis for key performance indicators - for instance, if the trigger is cost reduction, cost saving is logically the key performance measure. Relevant factors for make-or-buy decision can be clustered to four areas, namely (1) Technology and manufacturing processes, (2) Cost, (3) Supply chain management and logistics, and (4) Support systems.
Finally, performance measures for sourcing decisions feed back into the external environment and possibly activate other triggers that raise again the make-or-buy decision, thus adding a feedback link that is missing from other decision-making models. Based on their case studies, the authors repeatedly point out that two key issues that were associated with the success of the decision were (1) The involvement of a multi-disciplinary team in the decision-making process, and (2) The structure and documentation of the decision-making process. Kumar and Eickhoff (2005) start from Offodile and Abdel-Malek’s (2002) generalized outsourcing decision model, and modify it to include offshoring, intellectual property concerns, product obsolescence, inventory and currency risks and technology and communication needs. They also critique Offodile and AbdelMalek (2002) from suggesting that outsourcing of core competencies is acceptable, arguing that outsourcing a core competency should only be considered if internal capabilities cannot be brought up fast enough to meet market demands or when capital is limited. Finally, Kumar and Eickhoff (2005) note that as re-evaluating the outsourcing decision from time to time is important, outsourcing frameworks should be amended to a closed loop instead of one-way process.
8.3. Appendix C: The economics perspective
Economics perspective, closely linked with Transaction Cost Economics (TCE) (Coase, 1937; Williamson, 1985 and 1991) is concerned with efficiency, and the objective of outsourcing decision-makers is thought to lie in minimizing the total costs of “receiving” a good or a service. In the economizing view, the firm should compare the total cost of producing the good or service internally with the total cost of outsourcing, and choose the alternative that is more economical. In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange. Transaction costs consist of adaptation costs, which represent the difficulty in modifying contrasts to changing conditions; safeguarding costs, that represent the cost of an exchange partner acting opportunistically once investments in the relationship have been made (Pisano, 1990); and measurement costs, representing the costs involved in verifying that contracts have been completed as specified (Calantone and Stanko, 2007). A fourth factor was added by Williamson (1985) to account for transaction frequency, the reasoning being that firms are incentivized to perform internally those functions which occur more frequently since the costs involved are easier to recoup. Within the context of outsourcing, transaction cost economics can be used to find the theoretically optimal way of organizing production of a given product or service. A rule of thumb is that integration restricts the buyer’s choice to one supplier, hence production costs tend to be higher than for outsourcing - but integration reduces transaction costs by eliminating the need to gather and analyze a great deal of information about different suppliers and makes the risk of opportunism smaller. Thus, transaction cost view would stipulate that firms should outsource when information about suppliers is widely available and reliable, and when the threat from opportunism is low - for example, when scale economies are required to produce cost effectively.
However, pure transaction cost economics fail to address several pertinent viewpoints normally associated with business life by disregarding factors that are not directly related to costs, such as pre-existing firm capabilities and resources (Williamson, 1991), competitive situation of the industry (Williamson, 1991), learning (Langlois and Robertson, 1995) and innovation (Pajarinen, 2001), the effects of trust and relationships, and market power. However, an argument could be made that traditional transaction cost economics already takes coordination-related issues such as trust into account. Since TCE starts from an assumption that the objective of outsourcing decision-makers is to minimize the total costs of “receiving” a good or a service, lack of trust would translate to higher search, measurement, adaptation and safeguarding costs. Therefore, additions to existing frameworks would be unnecessary. However, most authors readily admit that TCE analysis typically disregards many relevant factors such as trust, primarily because operationalizing and measuring these factors is usually very difficult. In the context of this thesis, the argument can be disregarded simply due to the fact that the importance of personal relationships in design outsourcing has increased in the 2000s (Holopainen and Järvinen, 2006), not decreased as would be predicted thanks to lower search costs associated with Internet (Pereira, 2005). These problems, especially the importance of efficiency in transaction cost analysis and the resulting neglect of other factors such as learning make transaction cost economics somewhat problematical in analyzing outsourcing of innovation activities. Although transaction costs are often used to analyze innovation outsourcing - for example, Calantone and Stanko (2007) construct their hypothesis of innovation outsourcing’s drivers based on TCE - Love and Roper (2005) have empirical evidence that even highly respected economists that have been actively involved in developing transaction cost analysis cannot predict which new product
development activities are likely to be outsourced. Others, such as Pajarinen (2001), have pointed out the detrimental long-term effects of trying to minimize transaction and production costs may have on, for example, innovation in general. Nevertheless, there is strong support for using transaction cost explanations of the make-or-buy decision in the empirical literature, even in new product development contexts (Veugelers and Cassiman, 1999; Love and Roper, 2005). According to Buckley and Chapman (1998), the reason for this disparity could be that because managerial perception plays a large role in these decisions, objective measurement of transaction costs is very difficult. Other studies have found that property right factors dominate over transaction cost factors in innovation outsourcing (Gooroochurn and Hanley, 2007). Transaction cost variables are more important for process innovation, while property rights variables are more significant for firms involved in product innovation. According to Gooroochum and Hanley, the fundamental difference is that transaction cost literature predicts that large-scale process innovation should enjoy the protection of scale economies, while the property rights literature suggests that products may be innovative enough to enjoy patent protection or their returns may be uncertain enough to make opportunism by partners not viable. Gooroochurn and Hanley conjecture that the generic transaction cost literature is likely to explain a small part of outsourcing decisions (cost saving aspects), while the property rights literature has more to do with revenue maximization. Other way of looking into same problem is to predict that if transaction cost variables dominate, then innovation outsourcing behaves very much like any other type of outsourcing such as raw materials or janitorial services. On the other hand, if property rights variables are more important, knowledge transfer enters into the equation. (Gooroochum and Hanley, 2007)
8.4. Appendix D: Baldridge criteria for core competences
The first step in developing and nurturing core competences is to develop a clear understanding among senior managers of the three elements (technology, governance process, and organizational learning) that make up a competence. Prahalad (1993) advises managers to think of the factors that leverage the working of core competence in terms of an equation:
Competence = Technology x Governance Process x Collective Learning
In other words, a competence is a product of technology, governance processes, and collective learning within the firm. Core competencies should also stand the test of being core. In other words, the competence must be central to business success. Snyder and Ebeling (1992) suggest three tests for this:
1) Does the core competence contribute significantly to the ultimate value of the
2) Does it represent a unique capability that provides enduring competitive
3) Does it have the potential to support multiple end products or services?
Once competences have been identified, they should be benchmarked so that the firm knows where they stand relative to competition. Jennings and Westfall (1992) recommend that ‘strategic benchmarking’ should take place against three criteria: customers; competences; and competitors. They point out that one of the problems in benchmarking competencies is defining the criteria of excellence for the competencies themselves. They suggest one possible set of criteria are those used in the Malcolm Baldridge awards. In fact, these criteria do match off quite conveniently against the three competence elements defined by Prahalad (1993). (See also Appendix G for additional core competence checklist.) The Baldridge
criteria, which can be used as a basis for thinking about the organization’s core competences, are: 1. Leadership Senior executive leadership Quality values Management for quality Public responsibility 2. Information and analysis Scope of management Competitive comparisons and benchmarks Analysis of quality data and information 3. Strategic quality planning Strategic quality planning process Quality goals and plans 4. Human resources utilization Human resource management Employee involvement Quality education and training Employee recognition and performance measurement Employee well-being and morale 5. Quality assurance of products and services Design and introduction of quality products and services Process quality control Continuous improvement of process Quality assessment Documentation Business process and support service quality Supplier quality 6. Quality results Product and service quality results Business process, operational and support quality results Supplier quality results 7. Customer satisfaction Determining customer requirements and expectations Customer relationship management Customer service standards Commitment to customers Complaint resolution for quality improvement Determining customer satisfaction Customer satisfaction results Customer satisfaction comparison
8.5. Appendix E: Discovery-driven planning
In traditional planning processes, the feasibility of a business proposal is judged according to projected future benefits such as savings, increases in quality, and so on. However, planning by extrapolating from historical trends becomes increasingly questionable as firms look beyond incremental improvement to their existing operations and aim for radical, transformational change. As outsourcing and NPD outsourcing are both possible strategies for achieving transformational change (see e.g. Hätönen, 2008), it follows that firms should treat extrapolative models with caution when planning for outsourcing. However, many firms follow old models of planning, with all their limitations, simply because they see no alternative. The purpose of this Appendix is to briefly introduce the idea of discovery-driven planning (McGrath and MacMillan, 1995). Discovery-driven planning is originally developed for planning for new, uncertain ventures such as new product development, and as such is ideal for firms with little experience in outsourcing and/or NPD outsourcing. For more detail about the process and case examples, the reader is advised to study the original article by McGrath and MacMillan (1995), as well as contributions by Kawasaki (2004) and Christensen et al. (2008). In particular, Christensen et al. recommend that discoverydriven planning be used in innovation-related activities. Discovery-driven planning is based on McGrath and MacMillan’s (1995) observation that firms tend to make four kinds of planning errors:
1) Firms don’t have hard data but, once a few key decisions are made, proceed as
though their assumptions were facts.
2) Firms have all the hard data they need to check assumptions but fail to see the
3) Firms possess all the data necessary to determine that a real opportunity exists
but make implicit and inappropriate assumptions about their ability to implement the plan.
4) Firms start off with the right data, but they implicitly assume a static
environment and thus fail to notice until too late that a key variable has changed. Discovery-driven planning offers a systematic way to uncover the dangerous implicit assumptions that would otherwise be unnoticed in the plan. It concentrates on identifying assumptions underlying management thinking and finding inexpensive ways of testing these assumptions before major commitments are made. The most important features of discovery-driven planning are a reverse benefits statement, which models the basic business case for the venture; key assumptions checklist, which is used to ensure that assumptions inherent in the reverse benefits statement are checked; and a milestone planning chart, which specifies the assumptions to be tested at each project milestone. As the venture unfolds and new data are uncovered, each of the documents is updated. Reverse benefits statement is based on a simple logic: if the firm knows how good a business case for e.g. outsourcing should look in order for it to be accepted, why go through the charade of making and revising assumptions and projections in order to fabricate an acceptable set of numbers and business benefits (Christensen et al., 2008)? Reverse benefits statements begin with minimally acceptable business benefits (e.g. sales in x months, income, time-to-market, savings, quality), and continue by raising the critical issues: what set of assumptions must prove true in order for these benefits to materialize?
Key assumptions checklist is based on the reverse benefits statement. It is a list of things that need to prove true for the project to succeed. The items on the checklist are rank-ordered, with the deal killers and the assumptions that can be tested with little expense toward the top. When a project enters a new stage, the assumptions checklist is used as the basis of the project plan for that stage. Milestone planning chart is a plan for learning by testing the assumptions and monitoring the progress of new ventures. The basic idea is to postpone major commitments of resources until the evidence from the milestone event signals that the risk of taking the next step is justified. Assumptions are linked to the milestone chart so that a set of assumptions is verified between each milestone. In NPD outsourcing process, the milestone chart could include the following steps: 1) Need for external NPD confirmed 2) Suitable providers found 3) Initial compatibility established and candidates shortlisted 4) Preliminary scale and scope negotiations completed 5) Provider selected 6) Project kick-off 7) Project milestone 1 … Tables 30 and 31 below represent a simplified example of a project plan formed through discovery-driven planning process. First, the benefits are listed in the lefthand column of Table 30. Assumptions under which the results could be achieved are then listed in the right-hand column. After the assumptions have been listed, they are grouped with proper milestones in Table 31, with most important and easily tested assumptions being first to be tested.
Table 30. Benefits and assumptions. Benefits sought
Faster time-tomarket Improved quality Designs needs to use technology X Good integration with the provider
Provider can design the product faster than internal NPD Provider has experience in fast product introductions Provider has more experience than internal NPD Provider’s previous projects have been successful Technology X is ready and components are available Provider can work with the technology X Personal chemistry between key players works well Information systems can be made compatible with each other
Table 31. Assumptions grouped with milestones form a task list. Milestone
1. Technological feasibility 2. Provider compatibility
Technology X is ready and components are available Provider’s previous projects have been successful Provider has experience in fast product introductions Provider has more experience than internal NPD Provider can work with the technology X Personal chemistry between key players works well Information systems can be made compatible with each other Provider can design the product faster than internal NPD
3. Pilot project 1
8.6. Appendix F: Bidder due diligence checklist
The following ‘due diligence’ checklist for screening outsourcing and alliance partners has been adapted from Milgate (2001, Appendix A, 189-191). This list can be used as such or as a basis for the firm’s own due diligence checklist. • Firm/consortia Information o Name o Address o Telephone, fax, e-mail, web site o Incorporation date (and articles) o Incorporation place and business registry number o Brief history o Related firms o Associated firms o Net assets movements • Litigation o Historic litigation o Pending litigation • Addresses five years back • Personnel o List of directors, secretary, executives o Former directors o Auditors o Consultants (working for the proposed project) • Ownership o Twenty largest shareholders o Beneficial ownership • Financial information o Audited financial statements o Holding company financial statements, if any o Loans o Change to financial situations o Confirmations • Business affiliations o Director affiliations o Agencies and branches o Agencies o Changes of names • Credit rating • Government investigation o Investigation or charges o Corporate regulatory investigation
• Licenses o Software licenses • Corporate Structure o Corporate structure diagram o Joint venture details • Share structure • Business failure o Receivership/liquidation o Charges o Agreement/composition o Receiver/liquidator o Judgments • Relevant experience o Applications o References o Terminated contracts • Publicly listed corporations o Fines, suspensions for breach of rules o Media releases • Foreign corporations o Last year accounts o Last half-yearly accounts
8.7. Appendix G: Key questions for a lean organization
The following checklists, adapted from Milgate (2001, Appendix D, pp. 215-222), are intended as aids for thinking about outsourcing and the related issues. They are not comprehensive, but checking that the firm has answers to all these questions should help eliminate most common mistakes made in outsourcing.
Table 32. Core competences checklist Core competences
Can the board of directors and/or senior managers define the organization’s core competencies? If not, have core competencies been defined but not adequately communicated? If core competencies have not been defined, what action should be taken to do so? Who should play a part in defining core competencies: the board, strategic planners, SBU managers, line managers? Is everybody involved in defining core competencies clear about the three elements in a competence: technology, governance process, and collective learning? To what extent do the organization’s core competencies underpin the organization’s products and services? Have the competencies been benchmarked against other excellent competitors? If so, were the competencies found to be best in class? If not, what actions should be taken to improve the effectiveness of core competencies? If competencies have not been benchmarked, what needs to be done to gather performance data about them? Do products and services need to be more effectively aligned with core competencies? What proportion of investment is directed at building and developing core competencies? If this is low, do investment priorities need to be re-examined? Have managers looked at all the ways in which current core competencies might be exploited, for example, in related product areas? Are the core competencies strong enough to sustain the organization’s success in the medium and long term? If not, can the competencies be strengthened with internal investment and development? If not, can the organization acquire additional relevant competencies through strategic partnerships or alliances?
Table 33. Existing partnerships checklist Existing partnerships
Does your organization currently work with any strategic partners? How do these partnerships contribute to the organization’s overall business objectives? Is the contribution of these partnerships to business objectives regularly measured and monitored? Are there lessons from these successful partnerships that can be applied elsewhere in the organization? Has the organization entered any partnerships that failed to deliver their objectives? What lessons can be learned from those partnerships?
Table 34. Searching for new partners checklist Searching for new partners
Has the board a clear view of how its business strategy is to be achieved, with or without partnerships? In which area of your organization’s activities might the board need to search for new partners? Has the organization identified clear gaps in the fulfilment of its business strategy that could be filled with the aid of a partner or partners? What kind of partners might be needed in those areas, strategic or tactical, short or long term? In any given area, what contribution is your organization looking for from a prospective partner: assets, know-how, market position, intellectual property, cash, and so forth? In any given area, what can your organization contribute to a partnership: assets, know-how, market position, intellectual property, cash, and so forth? Has your organization established clear criteria for its prospective partner: cultural compatibility, financial strength, technical contribution, market contribution? Have prospective partners been fully evaluated against all relevant criteria? Can prospective partners on the short list realistically provide what the organization is looking for? Has your organization matched its core competencies against those of prospective partners? If so, is there complementarity or is there a risk of conflict? Do prospective partners on the short list have reasonable cultural compatibility with the organization? Is it likely that the prospective partners might be willing to enter an alliance with your organization? How can your organization frame its approach to the prospective partner(s) in an attractive and enticing way? At what level should the prospective partner be approached: board/director level, SBU level, departmental head? Who should lead the approach to the prospective partner? Has your organization considered what processes to use to consider any partnership offers that it receives?
Table 35. Negotiating a partnership deal checklist Negotiating a partnership deal
In your organization, is there high-level sponsorship (usually from the board) for the proposed partnership? Before opening negotiations, have you defined what you want to achieve from the partnership? Have you identified those areas where concessions or compromise would be unwise? Have you defined those areas where it will be possible to be flexible in negotiations? Who will be involved in the negotiation team? Does the negotiation team contain a range of skills and knowledge together with negotiating and presentation skills? What are the limits of authority of the negotiating team? Are consultants needed during the negotiation? If so, has the role of the consultants been adequately defined? Has a timetable been set for the negotiations? What form of partnership will best meet the needs of the parties: collaboration, joint venture, or merger? What is each party going to contribute to the partnership? Does what the other party is contributing to the partnership adequately match your own organization’s expectations? Can the organization deliver what it says it will contribute? Can the partner deliver what it says it will contribute? Does the memorandum of understanding (or what you have called your legal documentation) encapsulate the full terms of the agreement? Does the memorandum of understanding define responsibilities for implementation and set a timetable?
Table 36. Implementing a partnership checklist Implementing a partnership
Does the final agreement include all relevant matters including contributions, management of the partnership, conflict resolution, apportionment of profits, and exit provisions? What level of autonomy is given to the partnership operation? What type and frequency of reporting is required from the partnership operation? Does the partnership have clear milestone events at which progress can be judged? Has the purpose of the partnership been widely communicated within your organization? Has there been wide buy-in to the partnership or are there still pockets of resistance that need to be addressed? Have any change management issues raised by the partnership been adequately addressed? Is there adequate machinery in place for communicating with the partner(s)? In what ways might information technology be used in order to communicate more effectively with the partner(s)? Is there a need to define the limits of information that may be exchanged with the partner(s)? Does staff working in the partnership need special training, for example, in languages or understanding a foreign culture? Is your organization organized in order to learn from the partnership? What structures underpin the organizational learning? How will organizational learning be captured and disseminated throughout your organization? In the short, medium and long term, what criteria are you using to determine the success or failure of the partnership? How are you measuring those criteria? Are further opportunities for developing the partnership being adequately explored?
Table 37. Outsourcing partnerships checklist Outsourcing partnerships
Does your organization already use outsourcing? If so, are those arrangements working satisfactorily and what lessons can be learned from them? Has the organization developed a comprehensive view of the role of outsourcing in its business strategy? If not, should such a review be undertaken? Does your organization have a clear view of its core competencies and, thus, its peripheral activities that might be candidates for outsourcing? Should outsourcing be limited to support functions, such as IT and accounting, or should it include manufacturing functions or NPD functions? If manufacturing or NPD is to be outsourced in whole or in part, what are the risks that your organization will lose core skills in technologies? Do all manufacturing or NPD functions need to be integrated with each other and with other functions within the firm, or can they be disaggregated and outsourced? Alternatively, is it necessary to outsource some aspects of manufacturing or NPD in order to acquire key skills, for example in technologies or manufacturing processes? What are the risks that your provider might ultimately become a competitor in your core market? Are these risks acceptable and how can they be minimized? If manufacturing or NPD is outsourced, what steps can your organization take to erect a strategic block between the provider and your market? Before choosing provider, have you defined the criteria you will use in the selection? Have the outsourcing supplier’s claims been carefully checked and have references been thoroughly investigated? Are you confident that the provider can deliver what it says it will? What is the downside if it cannot and is there a contingency plan to deal with this situation? Has your organization made a realistic cost-benefit analysis of outsourcing, including the transaction costs that it entails? Do you feel there is a suitable cultural fit between your organization and the outsourcing provider? Is the agreement sufficiently flexible to deal with your needs and meet changing requirements? Are the criteria by which the provider will be judged defined with precision? What are the staffing implications of entering the outsourcing agreement and what are the costs of dealing with them? Are the circumstances and terms for ending the agreement clearly defined?
Table 38. Management disciplines for partnerships and outsourcing checklist Management disciplines for partnerships and outsourcing
Has your organization identified those managers who could be effective in working through partnerships and outsourcing? Is your organization’s culture adept at working in partnerships, for example in searching for win-win situations? What cultural changes do managers need to assimilate in order to become more adept at managing through partnerships and outsourcing? How will your organization define the roles and responsibilities of managers who work with partnerships and outsourcing? Does your organization have managers who would make good ‘brokers’ in partnerships and alliances? Do managers have the necessary skills to use partnerships and alliances as learning opportunities and to develop that learning into organizational knowledge?
Table 39. Partnership culture checklist Partnership culture
Is your organization’s structure compatible with developing a partnership culture? Do the values that underpin your organization encourage people to work in partnership? How far has your organization developed internal partnerships? Does your organization work with business teams that cross internal departmental or functional boundaries? What can be done to make those teams work more effectively? Can cross-functional teamworking be extended in the organization? How does your organization define roles and responsibilities for its staff? Does your organization truly empower employees and foster decision-making at the lowest possible levels? What steps does your organization take in order to manage conflict and personal stress, sometimes the unwelcome side effects of a networking culture?
Table 40. Technology enablers checklist Technology enablers
In which ways does the use of IT reinforce and develop core competencies? Do all employees have access to an appropriate level of IT support? Have they been trained to make the best possible use of that support? What can be done to enable IT to facilitate more effective business processes? In which ways can IT be used to promote more effective organizational learning? How can IT be used more effectively to promote communication within the organization and with external partners?
8.8. Appendix H: Empirical survey questionnaire
Questions 2-8. What NPD tasks are you outsourcing currently.
Question 9. Reasons for outsourcing NPD activities
Question 10. Relationship with providers.
Question 11. Obstacles to NPD outsourcing.
Question 12. What of the following best describes the products or services ofyour firm/SBU?
Question 13. What of the following best describes the technologies used by your firm/SBU?
Question 14. Intensity of competition.
Question 15. Product cycle of your firm/SBU.
Questions 16.1- 16.4. Expertise in outsourcing and NPD outsourcing; Size of the firm/SBU; Accuracy self-evaluation
Question 17. Field of business
8.9. Appendix I: E-mail invitation for the survey
The e-mail sent to the survey sample is included below.
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