What Happens When You Outsource Too Much?

What Happens When You Outsource Too Much?

What Happens When You Outsource Too Much? WINTER 2011 VOL.52 NO.2 REPRINT NUMBER 52208 By Francesco Zirpoli and Markus C. Becker COURTESY OF HYUNDAI MOTOR CO. WINTER 2011 MIT SLOAN MANAGEMENT REVIEW 59 WE LIVE IN AN ERA in which business disaggregation is the norm. In industry after industry, managers have taken deliberate steps to separate their value chains and shift important activities and functions to outside suppliers. The outsourcing trend became increasingly visible during the 1990s, when companies such as IBM began to outsource not just manufacturing but also design activities. The trend reached its peak within the past decade, when even companies such as Boeing started outsourcing innovation activities. But what happens when companies become too dependent on outside suppliers and cede them too much control if they lack the same degree of understanding and awareness about how important product or service elements fit together and what’s necessary? Once management lets go of critical internal levers, how does it go about reestablishing them? What Happens When You Outsource Too Much? With complex products such as automobiles, integration is a key element of performance. That means managers must understand which activities and competencies they can safely outsource and which they need to keep. BY FRANCESCO ZIRPOLI AND MARKUS C. BECKER THE LEADING QUESTION How can companies make the right decisions about outsourcing? FINDINGS ! Keep activities in-house that have direct impacts on product performance. ! Maintain control over activities that are highly interdependent with the technologies that impact on the performance of the overall product. ORGANIZATION STRATEGY THE ANATOMY OF AN AUTO: A complex product such as a car can be decomposed at different levels of granularity, from large chunks (e.g., the front end, including bumpers, lights, radiator, etc.) to small components (e.g., a brake disc) up to little metal parts. 60 MIT SLOAN MANAGEMENT REVIEW WINTER 2011 SLOANREVIEW.MIT.EDU ORGANIZATION STRATEGY These questions arose during a multiyear research project examining supply strategy relating to new product development at a major European automotive company (see “About the Research”). In the late 1980s, the company — which we call Alpha — had direct supply relationships with more than 3,000 suppliers, most of them small companies. The suppliers were mostly involved in the production of components, and only to a limited extent in the design of components. In the early 1990s, however, management began shifting increasing amounts of design and engineering work to suppliers. That trend was hastened by the proliferation of electronics in cars, which was beyond the traditional competence base of automotive manufacturers. Although all companies shift activities to outside suppliers, Alpha pushed outsourcing even further. By the mid-1990s, Alpha began to outsource the design of complete systems, such as dashboards, seats and safety systems, to suppliers that had the ability to provide entire systems. (See “The Anatomy of an Auto,” p. 59.) To senior management, outsourcing entire systems — including the design of those systems — seemed like the right direction. Similar supply arrangements were already common in other industries such as computers. By becoming less integrated, Alpha management hoped to increase flexibility (by being able to switch suppliers and technologies), reduce lead times (by taking advantage of concurrent engineering) and cut development costs while improving product quality (by utilizing suppliers’ specialized expertise). With its new networked innovation strategy, Alpha expected to build close relationships with 350 first-tier suppliers, mostly suppliers of systems, thereby significantly reducing the number of direct supply chain relationships. With independent suppliers, outsourcing coordination would become easier. Between 1996 and 2001, Alpha underwent structural changes to support the new strategy. As it outsourced design work, experienced engineers who had worked inside Alpha’s functional units designing suspensions, dashboards and electric systems went to work for suppliers. Alpha was still involved with establishing overall targets, specifications and overseeing costs; it set the technical performance targets of the components, provided the physical constraints and benchmarked the technology and cost in order to get state-of-the-art technology at the right price. But as the internal engineering teams got smaller and less up to date on the specific design and technical issues, more and more responsibility shifted to outsiders. Although internal engineers still managed key functions (development schedules, technical coordination, performance and costs), increasingly suppliers were the ones putting together the “black box” components that defined the overall product. The most influential suppliers went so far as to integrate entire chunks of the car. Consider how a vehicle’s safety system was designed, managed and integrated. In the 1980s, Alpha designed safety systems in-house and outsourced components such as the seat belts and brakes to suppliers, providing them with the technical specifications. During this period, it continued to maintain responsibility for integrating all of the purchased components. But in the 1990s the company’s responsibilities and those of its suppliers changed (see “How Alpha’s Supply Chain Changed”). Rather than dealing directly with dozens of smaller suppliers providing components for the system, Alpha asked larger suppliers to provide entire systems, thereby shifting responsibility for managing and integrating the safety system from the inside to the outside. It wasn’t long before management identified problems with this approach. By moving so much new-product design work to outside companies (in the space of 10 years, the percentage of design work being performed externally rose from between 25% and 35% to 85% of the value of a car, more than most comABOUT THE RESEARCH We systematically observed the consequences of a lean product development approach on a company’s competencies and knowledge domains and the extent that implementation of design outsourcing affected the sustainability of an outsourcing strategy. We chose the context of the automotive industry, one of the most complex in terms of technologies and players involved in innovation processes. We selected a major automotive manufacturer, “Alpha,” with products in all major market segments. The company had maintained a fully integrated design function internally before adopting an extreme outsourcing strategy. We studied the manufacturer’s two research centers and its first-tier suppliers. We observed changes over a 10-year period, during which we collected archival data and company documents and conducted interviews with its employees, its research centers and eight first-tier suppliers. We interviewed 34 managers, including most of Alpha’s top managers in charge of the product development process: the chief technology officer, the senior vice president of human resources, the vice president of product portfolio management, the director of vehicle concept and integration (the manager responsible for systems integration for chassis and vehicle), four of the five vehicle-line executives and key executives in the design and engineering division. Within supply companies, we interviewed account managers, project managers and in some cases the CEOs.