Global Sourcing: The HOW TO Question - with a focus on global sourcing of advanced services Peter D D. Ørberg Jensen Assistant Professor, PhD C Copenhagen h B i Business School S h l Handelshögskolan University of Gothenburg 7 October 2010 Agenda g 1. Background & current trends in services offshoring 2. Some theoretical foundation for the “HOW” question: Firm-internal offshoring g vs. offshore outsourcing g 3. A value-chain perspective on the global sourcing of advanced services 4. Case: “Offshoring Advanced Services to India: FirmInternal Offshoring or Offshore Outsourcing?” Timing: g - 10:15 – 11:15 Lecture - 11:15 – 12:15 Break + case work in small groups g p - 12:15 – 13:00 Discussion in class & wrap-up Why y is Offshoring g Interesting? g • Next wave of globalization: Advanced services, innovation, R&D (Lewin & Couto, 2007; Dossani & Kenney, 2007; Lewin & Peeters, 2006) • ”The globalization of markets, and rapid changes in economic and political systems, systems has forced a re re-thinking thinking of the meaning of location, of competitive advantage, and of the transmission of knowledge among countries” (Kogut, 2002) 3 important questions included in this course: – Location: Where? Why? How? – Competitive advantage: Which comp. advantage? Impact? – Knowledge transfer: Which knowledge? How to transfer? The New Realities of Gl b li ti Globalization… Events and Drivers of the Globalization of Services EVENTS Internet use mainstreamed i t d China Economic Reform (late 1970s) Financial Crisis Growth WTO GATS India Liberalization begins 9/11 Y2K Dotcom bubble burst Recession Labour Shortage ? 1990 1993 1995 1997 2000 2003 2006 DRIVERS The ”Tradability Revolution” (services) Maturation of Supplier Base in Host Countries Technology Development (Digitization) Transport and Communication Costs decrease (but recently TC increase, and decrease, and ) and…) 2008 Emerging Offshoring Trend: Globalizing Product and Process Innovation Cumulative Percentage of Firms Initiating Offshoring by Function 50% Cumulativ ve Percentag ge of Firms Initia ating Offsho oring 45% 40% 35% IT Product Development (R&D, Engineering, Product Design) 30% 25% 20% Admin. Business Processes (F&A, HR etc.) Call Center / Help Desk Procurement 15% 10% 5% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Duke University / Booz Allen Offshoring Research Network 2006 Survey Access to qualified personnel and improving speed to market are growing faster as offshoring drivers than cost reduction Growth Rate of Offshoring Drivers Over Time %o of Responses s Rating Driver as “Verry Importantt” and “Impo ortant” 90 80 Cost Reduction 70 Access to Qualified Personnel 60 Competitive Pressure Business Process Redesign 50 Increased Speed to Market 40 30 20 Access to New Markets 10 0 2004 2005 Survey y Year Source: Duke University / Booz Allen Offshoring Research Network 2006 Survey 2006 Theoretical foundation: Transaction Costs Economics (Williamson) • T Transaction: i A good/service d/ i transferred f d across a technologically separable interface • TC = Costs of designing, implementing and controlling the transaction – “the cost of running the economic system” (Arrow 1969; Williamson, (Arrow, Williamson 1991) • Central question: what are the costs of using the market compared with other models for governing the transaction? • Governance modes: “Market” Market – “Hybrid” Hybrid – “Hierarchy” Hierarchy • Types of TC – IInformation f ti and d search h costs t – Bargaining and contracting costs – Costs of monitoring/policing and enforcing the contract Theoretical foundation: Transaction Costs Economics (Williamson) • Assumptions p about human behavior – “Bounded rationality”: human beings are only rational up to a certain degree – “Opportunism”: fundamentally and ultimately human beings act in self-interest • The Th determinants d t i t off TC: TC – Frequency of transaction – Uncertainty U t i t ((caused db buy exogenous ffactors, t distorted di t t d information, human behavior) – Asset specificity (site (site, physical physical, human specificity specificity, aka aka. relationship-specific investment), the principal factor causing variations in TC – can be machinery, technology, knowledge – … has implications for power relations (symmetric/asymmetric), switching costs and “hold-up” (by supplier or by buyer) – Solution: S l ti th contract the t t mustt address dd the th TC off an inter-firm i t fi relationship The eclectic (OLI) framework – J h Dunning John D i • Ownership issues (O) • The MNC has certain assets that gives it a competitive advantage over indigenous firms • Necessary condition for competing on par with local firms • Location issues (L) • Assets are best p put in use in ((some)) p parts of the world beyond y the firm’s “country of origin” • Necessary condition for foreign production • Internalization I li i iissues (I) • Best use of the assets require an internal transfer when price of using the market is too high (transaction cost economics) • Necessary condition for conducting activities “in-house”. A decision-tree for FDI no No international activity O yes L Produce at home, then export no yes no I yes FDI Contract-out,, e.g. licensing Challenges to the OLI theory • A new form of capitalism is emerging a. Knowledge increasingly central to economies b. Asset creation is becoming g international c. The advent of alliance capitalism • A new form of internationalization a. Functional integration across borders b Changing motives behind internationalisation b. • Implications for OLI of these developments a. New types of OLI advantages b. Growing interdependence between OLI variables 12 Implications for OLI Previous view on firm challenges Present/emerging view on firm challenges O advantages Exploit existing O advantages Augment O advantages Develop O advantages jointly with other firms (Dunning: ”Alliance capitalism”) L advantages Limited number of potential countries to invest in Simple and relatively static comparative advantages Large number of countries potential locations Complex L advantages sought by investors Created assets at the fore I advantages Static advantages of internalization Internalize existing assets Focus on individual transactions Tangible assets internalized Dynamic advantages of internalization Aim of internalization increasingly to generate new assets Cluster of transactions (markets, networks and hierarchies) Intangible assets (knowledge) increasingly basis for internationalization 13 The ”Standard Model” in Global Sourcing/Offshoring: Location and Control . WHERE → Home country (onshore) HOW ↓ Contractual Partner (outsourcing) O Ourselves l (insourcing) Foreign country (offshore) (Onshore / Domestic) Outsourcing Offshore Outsourcing Captive C ti Offshoring (FDI) Beyond the Standard 2x2 Model High: MAKE Domestic In-house In house Captive Offshore Domestic Outsource Offshore Outsource Internalization Advantage Low: BUY Low: o O Onshore s oe Hi: O Offshore s oe Foreign Location Specific Advantage Implications of Simplistic Make-Buy x On-Off Perspective • Internal or External – Emphasizes p the riskiness of market transactions – Increases concerns about the potential for transaction partner opportunism – Portrays non-internalized transactions as avoiding transaction-specific investment (high level of asset specificity) or co-specialization, hence as relatively inefficient & low value-added • Onshore or Offshore – Emphasizes the liabilities of foreign g location – Emphasizes cost savings – “Commoditizes” foreign g locations Source: Mudambi & Tallman, JMS 2011 Quinn and Hilmer (1994) on the benefits of outsourcing • Strategic Outsourcing (building on the notion of ”core competence”) p ): • Two new strategic approaches (…) • ”Concentrate the firm’s own resources on a set of ’core competencies’ where it can achieve definable preeminence and provide unique value for customers.” • Strategically outsource other activities – including many traditionally considered integral to any company – for which the firm has neither a critical strategic st ateg c need eed nor o spec special a capab capabilities. t es Quinn and Hilmer (1994) on the benefits of outsourcing Benefits of Strategic Outsourcing: • Firms maximize returns on internal resources by concentrating on what it does best. • Well-developed p core competencies p formidable barriers against present and future competitors. • Allows for full utilization of external suppliers’ investments, i innovations ti and d specialized i li d professional f i l capablities. bliti • This joint strategy decreases risks, shortens cycle times, lowers investments, investments and creates better responsiveness to customer needs. FIRM STRATEGIC IMPLICATION No company can do everything on its own – it must make decisions on: what to make and what to buy (insourcing vs. outsourcing) where to locate production (onshore/home vs. offshore/foreign location) … and these two questions are connected t d Captive offshoring: GN ReSounds global network Cork: Distribution and production. Copenhagen: Headquarters. R&D, Brand development and production. Bloomington: Administration, di ib i distribution, sales l and d marketing k i Chicago: Sales & marketing, R&D. Xiamen: Production (largest factory). ? Offshore outsourcing: g Boeing’s g Dreamliner A value chain approach to global l b l sourcing i Porter’s contribution – focus on the ACTIVITY as the unit nit of anal analysis sis Disaggregating activities in the value chain (Jensen (J &P Pedersen, d 2010) Less advanced tasks R&D: More advanced tasks Test, patenting New inventions, design Production: Volume production Individual prototype or niche production Marketing: Canvas and tele sales Advertisement branding Advertisement, IT: Service operations Programming, architecture Administration: Bookkeeping & payroll Management The Wind-turbine company Vestas’ disaggregation of the value chain in R&D Attributes of manufacturing & standardized t d di d services i activities ti iti Stabell & Fjeldstad (1998), Thompson (1967) – Long-linked Long linked technology: “A long-linked technology involves serial interdependence in the sense that act Z can be performed only after successful completion of act Y, which in turn rests on act X, and so on. The original g symbol y of technical rationality, y the mass p production assembly line, is of this long-linked nature. It approaches instrumental perfection when it produces a single kind of standard product, d t repetitively titi l and d att a constant t t rate”. t ” P t ’ firm Porter’s fi value l chain h i th theory g = separate p the X,, Y,, Z process p and Offshoring relocate (+ modularization) Thompson (1967) – L Long-linked li k d Technology T h l A B UNDERSTANDING OF PROBLEM = UNDERSTANDING OF SOLUTION C What makes (advanced) services offshoring different? Thompson (1967) on ”Intensive Technology”: “The third variety we label intensive to signify that a variety of techniques is drawn upon in order to achieve a change in some specific object object; b butt the selection, selection combination and order of application are determined by feedback from the object itself. (…) “The intensive technology is most dramatically illustrated by the generall h hospital. it l At any momentt an emergency admission d i i may require some combination of dietary, x-ray, laboratory, and housekeeping g or hotel services, occupational therapies, social work services, and spiritual or religious services. Which of these, and when, can be determined only from evidence about the state of the patient”. ((…)) “The intensive technology p gy is a custom technology. gy Its successful employment rests in part on the availability of all the capacities potentially needed, but equally on the appropriate custom combination of selected capacities as required by the individual case or project”. Thompson, J. Th J D. D (1967) O Organizations i ti iin A Action. ti M McGraw-Hill, G Hill N New B Brunswick i k NJ Stabell, C. B. & Fjeldstad, Ø. D (1998) Configuring Value for Competitive Advantage: On Chains, Shops and Networks. Strategic Management Journal, Vol. 19, 413-437 Thompson (1967) Intensive Technology PROBLEM A SOLUTION B PROBLEM A1 SOLUTION B1 PROBLEM A2 SOLUTION B2 The solution/outcome The solution/outcome is not known is not known at the at the beginning of the process Offshoring and Learning in Home & Host Firms (Jensen, 2009) DK-1 India-1 DK-2 India-2 DK-3 India-3 STRATEGIC LEARNING - Use of offshoring as a means to rapid expansion - Bridgehead to Denmark/Scandinavia - Enhanced capabilities - Trust-building (internal and external stakeholders) - Inspires firm strategy process - Sets agenda for firm internationalization - Change of mindset re. offshoring - Enhanced internal confidence - Quick ramp-up ramp up of international operations - Bridgehead to Europe - Inspires p firm strategy gy process p - Sets agenda for firm internationalization - Input to business development in domain of public sector IT - Bridgehead to Denmark/Scandinavia SYSTEMIC LEARNING - Changes in project model - Streamlining of workflow - Absorptive capacity challenged - Quick ramp-up of operations - Changes in recruitment systems - Changes in project model - Streamlining of internal workflow - Enhanced experience w/ international project teams - Changes in recruitment systems - New training program - Changes in project model - Changes g in p project j model - Streamlining of workflow - New model for client collaboration Learning from Advanced Services Offshoring i Home in H and d Host H t Fi Firms (Jensen, (J 2009) Main argument of the paper: L Launch h Implemen Implementation Strategic Learning Strategic Business Development Systemic Learning Organizational Change E pe ience Experience -Beyond the ”cost-cutting paradigm”, highlights the importance of learning - Focus on the mutual benefits for home (Danish) and host (Indian) firms Case Exercise: Main Points • D Danish i h firm fi (DK-3) (DK 3) & IIndian di firm fi (India-3): (I di 3) • IT offshoring (product/solutions development, SAP) with focus on public sector IT • Advanced services, requires staff with university degree and professional experience • Launch of operations in March 2006 • Large (Top 5) Indian services provider p so far,, but also some • Positive experiences concerns • Question for future strategy: From offshore outsourcing to different governance mode (IJV or firm-internal offshoring)?? g) Case Exercise: Q Questions 1 What are the advantages and disadvantages of the current 1. engagement with the external service provider in India? How would yyou assess the relative importance p of the advantages/disadvantages? g the disadvantages g 2. What can the Danish firm do to mitigate of the current collaboration with the Indian firm? 3. What might be the potential advantages and disadvantages (risks) related to alternative offshoring models: a) establishment of an international joint venture in collaboration with India-3?; b) establishment of a new subsidiary in India, fully owned db by th the D Danish i h fifirm? ? 4. What might the Danish firm do to prevent the disadvantages connected to each of the two alternatives, alternatives respectively the international joint venture and the fully owned subsidiary? Case Wrap‐Up: Question 1 re. Advantages & Disadvantages of Current Model Advantages of offshore outsourcing to Indian partner Access to superior technology k knowledge l d & skills k ll Avoids costs of building up capability Possibility of learning from partner p Flexibility Increased capacity Incentive for shaping up internal process & documentation Disadvantages of offshore outsourcing to Indian partner Initial costs in every project due to nature of knowledge fk l d workk Complicated and time‐consuming knowledge transfer/building High attrition rate g Limited domain knowledge creates problems Risk of unlearning process and content knowledge Risk of ressource dependency and hold up and hold‐up Question 2 – What can the Danish fi d i th firm do in the current t model? d l? • • • • Limited range of instruments due to contract ”S ”Scare t ti ” tactics” Bring problems into the open New KPIs e.g. bonus for keeping key personnel in account • ”Loyalty program” (implemented with good results) • Small client vs. vs large service provider – power relations problem? Case Wrap‐Up: Question 3 re. Advantages & Disadvantages of IVJ & Own Operation Foreign Operations Mode d IJV with Indian partner t Fully owned captive offshoring subsidiary Advantages More control… Shared Sh d investments, i t t shared risks Potential Potential for for synergies Full Full control and and integration with Danish operations Improve knowledge flows and performance of Indian staff f I di ff Disadvantages … but also more influence to partner t Challenge of managing a ”marriage” marriage Up‐front Up front /initial investments Liability of foreignness No brand name in labour market Only upstream, does not target local l l market k Still risk of high attrition rate Some illustrative quotes from recent i t i interviews… • “It is still costly to transfer knowledge to the I di Indians, b butt we gett b better tt allll th the titime. W We gradually understand better how to use the Indian staff in a way that matches where they are. This means we will not need them to travel to Denmark as much as we have done” (DK-3 Offshore Manager June 2010) Manager, 2010). Some illustrative quotes from recent i t i interviews… • “We develop products that are very knowledgei t intensive i and d it iis iincluded l d d iin th the contract t t with ith India-3 that there must be no transfer of knowhow to other organizations. But with our own large scale operation with many Indian consultants I would still feel somewhat uncertain that we can effectively hinder that” that (DK-3 (DK 3 Offshore Manager Manager, June 2010). Some illustrative quotes from recent i t i interviews… • “Right now we are beginning to relocate big parts of a solution to India and we ask the Indians ‘please please take care of this, we don’t need to know what is happening, just make it work’ work . This means we are in the high value part of the value chain. Presently we can still take these activities back to Denmark if need be be, but before too long – two years at a maximum – we will begin to locate activities in India where we don’t don t possess the knowledge in Denmark Denmark. At that point in the Indian operations will become really critical for us” us (DK-3 (DK 3 Offshore Manager Manager, June 2010) 2010). Conclusion S Some managerial i l challenges… h ll • Understand the specific nature of offshored activities and processes • Disaggregate and separate highly integrated and iterative work p processes ((”intensive technology”) gy ) • Transfer to and build up knowledge at offshore location • Establish effective communication channels and monitoring and coordination routines • Re-integrate R i workk done d and d knowledge k l d back b k to home h organization • Ensure knowledge upgrading & prevent un-learning of knowledge g and p processes Not impossible to do, but some challenges… END OF LECTURE!! Contact information: Peter D. Ørberg g Jensen,, PhD Assistant Professor of International Business Copenhagen Business School Center for Strategic Management and Globalization Porcelaenshaven 24 DK-2000 Frederiksberg Denmark Email: [email protected] Ph. +45 3815 2658