Outsourcing Decisions In The FMCG Industry Information Technology Essay

ABSTRACT

The purpose of this study was to identify and understand the factors influencing outsourcing decision in the FMCG industry in Pakistan. Existing literature revealed that many FMCG industries were faced with challenges in the competitive environment to be competitive in the market and produce products at the minimum cost as possible yet meeting customer specification without affecting the quality and delivery schedule. Thus, outsourcing could be an alternative to solve most of the problems faced by many FMCG industries in Pakistan. This stirred these researchers to identify and understand the possible factors influencing the manufacturing industry in outsourcing decision whether these factors could really influence the management to opt for outsourcing and help in solving the problems. The theoretical framework was developed to hypothesize four components namely reduce operating cost, improve company focus, access to world class capability and unavailability of internal resources in relation to influence outsourcing decision in the FMCG industry. The proposed study utilized the exploratory approach, whereby the survey method was used. The data was collected through questionnaires in various FMCG industries in Pakistan. The findings were analyzed using a statistical software package (SPSS), and the main tools that were used were Cronbach’s Alpha, descriptive and linear regression analysis. The findings revealed that the factors or components identified for the study had significant effect on outsourcing decision except reduce operating cost. This study provided evidence that these factors would influence outsourcing decision in the FMCG industry in Pakistan. The recommendations are also offered more in depth guidelines for maximizing the benefits of outsourcing.

INTRODUCTION

Outsourcing decisions are those strategic decisions that change the operations strategy of an organization both in manufacturing and services. The most important step in any outsourcing decision is to clearly define the scope of the operations that are being considered for outsourcing. (Cook, Mary, F. and Gildner, Scoot B. 2008) Human resource professionals throughout the world are being asked to do more or less, to enhance productivity while controlling costs and to find out new ways to increase profitability. (Uddin, Gazi, M. 2005).

In the competitive environment of manufacturing concerns and evolving technology era, to enhance efficiency and productivity, cost remains a challenge to all manufacturing industry to compete with rivals in providing the best total lower cost to end customers and to secure the market share in order to add value to the shareholders. Having to invest heavily in capital investment such as machineries, buildings and land to expand space in supporting the production operation is a burden to most companies if the return of investment is not profitably. Most of the companies that were struggling to expand the capacity to support the ramp up demand at times were disappointed when there was a drastic downturn of demand cut. As a result, the sudden downturn would affect the resources and investment that were put into supporting the end customers’ demand. Pool of human resources and machineries that consumed production space and being idled would increase the overhead and fixed cost, thus affecting the companies badly in their financial statements. In addition, training and development to up skill internal resource skills set in terms of running the operation effectively, bringing up technical content expert, specialist ability to perform research and development to add value, effective management and maintaining the operation would require significant investment in human resources (David Mackey and Kaye Thorne, 2003). Thus, most of the companies started to explore opportunities to reduce cost and to improve profit margin in order to maintain competitive edge in the market. One of the identified opportunities was to outsource non-core business functions to external service providers at a lower operating cost.

Outsourcing is not a new notion. For decades, jobs have been migrated from other part of the countries namely American and European countries as well as other overseas countries to global service providers primarily India, China, Singapore and Malaysia due to lower operating cost. According to Cynthia A. Kroll (2004), a regional economist from University of California Berkeley, the recent wave of outsourcing affected a different mix of jobs, at different wage levels. It was not confined only to a small set of industries but cut across all industrial sectors in new geographic area rapidly (Cynthia A. Kroll, 2004). William P. DiMartini (2005), Senior Vice President at SunGard Availability Services said businesses in all industry segments found that limited internal resources would make outsourcing an attractive, cost-effective and prudent option that would allow them to focus on their core competencies (AccountingWEB.com, 2005).

Demand for outsourcing is a result of demand for organizational products by the target audience. On the basis of organizational estimate of total turnover, practicing managers can attempt to establish the nature and type of outsourcing required to that esteemed goal (Uddin, Gazi M. 2005). Outsourcing advantages to name a few include lower operating cost, improve competitiveness, low in capital investment, shift resources to focus on core functions, generate demand for new growth and market segment, access to world class capability, sharing risks and make capital funds available for core business investment. Bangladesh, least developed country, largely an agrarian economy with around 24 million acres of cultivation land employing about 14.5 million cultivators. Manufacturing industries have grown around Dhaka and Chittagong based on agriculture input of jute, cotton, chemical and gas based industries.

Industrial production growth has averaged more than 6% over the last 5 years. The export sector has been the engine of industrial growth, with ready-made garments leading the way, having grown at an average of 30% over the last 5 years. Primary products constitute less than 10 percent of the country’s exports; the bulk of exports are manufactured/processed products, ready-made garments and knit wears in particular. (www.euroitx.com)

There are many manufacturing concerns in Bangladesh that are looking into outsourcing opportunity to reduce cost and to overcome the internal limitations and achieve lower cost of operation. The country is now moving towards industry based economy from the agro-based one. Hence, this study was an attempt to access determinants influencing the outsourcing decision and to research the manufacturing concern in Bangladesh on how well the factors would influence the manufacturing industry in Bangladesh to outsource certain function of their business areas to external service providers. The study also aimed at finding out the influencing factors that influenced the companies in outsourcing decision and helped the companies to overcome the internal limitation barriers.

In the early 1980s, ‘outsourcing’ typically referred to the situation while organizations expanded their purchases of manufactured physical inputs, like car companies that purchased window cranks and seat fabrics from outside the firm rather than making them inside. Nowadays, outsourcing took on a different meaning. Presently it refers to a specific segment of the growing international trade in senices. This segment consists of arm’s-length, or what Bhagvati (1984) called ‘long-distance,’ purchase of services abroad, principally, but not necessarily, via electronic mediums such as the telephone, fax and the Internet. Outsourcing can happen both though transactions by firms, like phone call centers staffed in Bangalore to sen7e customers in New York and X-rays transmitted digitally from Boston to be read in Bombay, or with direct consumption purchases by individuals, like when someone hires an offshore firm to provide plans for redesigning or redecorating a living room (Bhagwati, J. et al. 2004)

In an era of rapid technological change and short product life cycles, companies were trying to reduce cost and maintain quality at the same time which implied that companies would need to specialize in what they did best and de-emphasize management attention from business processes that did not directly impact the business. Outsourcing was a means to partner with service providers so they could handle specific business processes – better, faster and at a lower operating cost (V. Krishna Polineni, 2001). It was defined as the transferring one or more internal functions of an organization to an external service providers. According to the analyst Dean Davison, the outsourcing was growing about 20 percent to 25 percent per annum (Dean Davison, 2006). Outsourcing has become an alternative, which all major corporations must consider in order to remain competitive. It helped to increase efficiency, improve service quality, accountability, values, decreased headcounts and cash infusion and gain access to world class capability and sharing risk (The Outsourcing Institute, 2006).

One of the primary advantages of outsourcing arises quickly from the reduction of overheads. This might give rise to an immediate, and possibly one-off, advantage in terms of the avoidance of future or recurrent capital outlay, and the savings in office space and equipment provisions if these could be released during the outsourcing decision. There was clearly a staff cost reduction possible here, and this could be the predominant element in directly-attributable, ongoing cost savings. The spin-off from this might benefit the business support services department where the outsourcing was partial, and could be especially useful where the capital cost was high and recurrent, particularly if there was uncertainty about the future costs of maintaining effective and competitive business support. It was an investment risk transfer, in other words. Where outsourcing is total, the benefit was accrued directly by the core business – it translated to a capital injection to the customer’s business. This was one of the major driving reasons of the outsourcing of IT provision in the early 1990s – generally agreed as having been led in 1989 by Kodak, which outsourced all of its IT operations to IBM (Jonathan Reuvid and John Hinks, 2001). This could also confer a great deal of flexibility on the company. For a centralized organization which was providing a range of its support services from its own personnel and offices, the move to outsourcing could allow a downsizing of the property commitments. Consider the impact on the organizational infrastructure requirements of a change to outsourcing IT provision, payroll and credit processing, pensions, catering, recruitment, training, Human Resource Management (HRM), cleaning, security, lettings, software development, estates and building management. It could also confer direct scope for downsizing or increased options for organizational re-structuring through property and HRM flexibility.

The transferal of a non-core service provision to a variable cost would allow economies of scale to be passed on from the supplier, and also would mean that incremental changes in the process capacity of the customer (upwards or downwards) could be covered at proportional rather than quantum cost changes. Where scope to vary the scale of the contracted supply was agreed, this has allowed the business organization to make maximum use of its marginal capital for core process change rather than non-core process support change. This could allow decreased time to market for new products or processes, and also increased scope for changes. Outsourcing solutions can provide an excellent chance to get the company service provision out of a rut and, if properly managed, to stimulate new solutions to problems from the mixing of different approaches.

A noticeable feature of the global economy is the enhancing international products. Robert Feenstra (1998) describes the remarkable international specialization in the manufacturing products. For example, the raw materials of manufacturing products like Barbie dolls (plastic and hair) are obtained from Taiwan and Japan. Assembly used to be done in those countries as well as to lower cost locations like Philippines, Indonesia, Malaysia, and China. The growth in international specialization can also be observed in aggregate statistics. William Zeile and Gorden Hanson et al (2003) document the importance of trade within multinational firms. David Hummels et al. (2003) show that trade in intermediate inputs has grown faster than trade in finished products. While the globalization of production may yield important productivity benefits, there is a widespread view that it has also adversely affected low skilled workers. There are frequent media reports on how low-skilled labors in the first world countries are hurt when manufacturing jobs are relocated in the US and in many other countries have picked up on this theme to push for greater restrictions on trade with developing countries. Yet, despite its prominence in the public debate, there is little systematic evidence of the extent to which low-skilled workers are harmed by outsourcing to poor countries (Hsieh, Chang T. and Woo, Keong T., 2005).

Outsourcing has existed in the USA for over 30 years particularly the business process outsourcing (BPO). The Bank of America, Best Buy, Delta Airlines, Goodyear, IBM, the Marriott, Motorola, PepsiCo, Procter & Gamble, and Sun Microsystems are all outsourcing HR functions. US federal and state governments also spend billions each year doing so also. HR functions are not just being outsourced, they are being sent offshore. The US companies have off-shored their manufacturing and their R&D facilities in their semiconductors, computing, chemicals and pharmaceuticals to the UK,

Germany, France, Ireland and other developed countries (www.shrm.org).

In view of developing countries, outsourcing takes place more recently to India and China. In 2003, 1.5 million service jobs were outsourced to the developing world and the number was projected to surge to 4.1 million by year 2008 (El’millian Chew Saint Fey, 2005). According to the Offshore Location Attractiveness Index published by AT Kearny (2004), Malaysia, an emerging South East Asian nation, was the third most desirable location for offshore outsourcing in the world, after India and china. In Malaysia, the demand for outsourcing was not only from global multi-national companies but also from local companies. The demand for outsourcing was driven by the fact that companies could access a more reliable infrastructure that could ensure smooth core business operations at lower costs and with greater flexibility. Outsourcing also encouraged the pooling of resources for a more efficient use of resources to reap the benefits that could be derived from economies of scale. Bangladesh has potential in outsourcing in its competitive business environment with a relatively low cost structure as well as support from the government and non-government organizations. In view of outsourcing demand, Bangladesh could be very well take advantage of this fact by attracting quality outsourcing operators to the country. The availability of quality resources especially in the private sector to support the outsourcing demand, this could be made available to support off-shore and local outsourcers. HR outsourcing organizations in Bangladesh are in stage of booming up and most of the organizations have realized that they should play more attention to networking activities. Uddin, Gazi M. (2005) describes the challenges and prospects of effective HR outsourcing for managerial activities in the corporate world of Bangladesh. The study reveals that networking activities play a strong role in HR outsourcing and duration of outsourcing is temporary. The study mainly focused on HR outsourcing, not on the factors influencing outsourcing decisions.

Literature review shows that several comprehensive studies have been conducted in the world regarding outsourcing specifically HR outsourcing, general time management, managerial jobs, and managerial behavior and so on. But no significant study in the light of this research has been found. It is not claimed by the researchers that all of the literature regarding outsourcing decisions have been reviewed, but normally available literatures have been reviewed and none of them were found specifically written in the horizon of particular issue. In this research paper, the researchers would explore the extensiveness of factors influencing the outsourcing decision in the manufacturing industry of Bangladesh through the survey of the sample companies.

Outsourcing has a long-established feature of cost effective business practice. The necessity to review what to remain in house and what would be contracted to external vendors has been dramatically increased over time by two factors: the thrust for competitive advantage in the global economy and successful business focus on its core competencies (Sandra Ward, 2004). The attraction offered by significant wage differentials has therefore stimulated moves of in-house production facilities to lower wage economies, using both outsourcing and off-shoring approaches. From initial IT and software development, financial services, business process supports, the outsourcing approach was beginning to be seen in research, engineering design or development, production function and many others. The locations for off-shoring were growing especially in the Asia region such as India, China, Singapore, Malaysia and Bangladesh. Although cost savings was still a very important consideration factor (Sounders et al., 1997), companies were outsourcing for other reasons as well not only just due to lower operating cost.

According to the Outsourcing Institute executive survey (2006), the top ten reasons why companies would outsource are as follows: Reduce and control operating cost, Improve company focus, Gain access to world class capability, Free resources for other purposes, Resources are not available internally, Accelerate re-engineering benefits, Non-core function that is too complex to manage, Make capital funds available, Share risks, and Cash Infusion

There were also reasons companies outsource due to lack of technology capability, strategic advantage to the companies, better service quality vendor and sound contract, lack of internal capacity in meeting production ramp demand and also possible limited space for expansion.

3 Research Model

3.1 Theoretical Framework

The literature review has indicated top ten factors according to the Outsourcing Institute that have major influence on outsourcing decision. These factors were primarily applied to offshore outsourcer and locally. Despite Bangladesh is ranked the third most desirable location for offshore outsourcing in the world, after India and china, Bangladesh could be a strategic hub for outsourcing too (El’millian Chew, 2005). The aim of the study was to perform a research in the Bangladesh manufacturing industries to validate the truth of the factors that indicated by the Outsourcing Institute that influenced the outsourcing decision by the management. The researcher would also assess on the effectiveness of the relationship between the factors as independent variables and the outsourcing decision as dependant variable.

The researcher selected partial of the top ten factors as listed in the literature review for the research and the remaining factors would be a good starting point for research in this area in the future. In this framework, the dependent variable being studied would be the outsourcing decision. The four factors influencing outsourcing decision as independent variables being studied would be reduce operating cost, improve company focus, gain access to world class capability and unavailability of internal resources. The research framework is shown as Figure 3.1 below.

INDEPENDENT VARIABLES

DEPENDENT VARIABLE

REDUCE OPERATING COST

• Capital investment

• Overhead and fixed cost

• Space

IMPROVE COMPANY FOCUS

• Focus on new product development and explore new market segment

H1

ACCESS TO WORLD CLASS CAPABILITY

• Availability of specialist

• Latest and high efficiency technology

• Established tools and support infrastructure

H2

H3

H4

OUTSOURCING DECISION

UNAVAILABILITY OF INTERNAL RESOURCES

• Limited production capacity and Space

• Lack of technical content experts and Support Infrastructure

Figure 1: Schematic Diagram of the Research Framework

3.2 Statements of Hypothesis

As shown in figure 1 above, based on the theoretical framework, the statements of hypotheses were

developed in the following sections based on the four selected independent variables which were

reduce operating cost, improve company focus, access to world class capability and unavailability of

internal resources.

3.2.1 Reduce in Operating Cost

This variable was a measure of the customers on how they considered outsourcing would help in

reducing the operating cost in their companies. The three areas being measured would be the capital

investment, overhead and fixed cost and space.

Capital investment was a measure of the extent on how outsourcing would help and has positive impact

in reducing capital investment such equipments, building and land for instance to reduce operating

cost. By outsourcing non-core operation function areas, inevitably, some portion of capital investment

could be saved and the investment fund could be diverted to core business investment to bring in more

revenues to the companies. The fund could also be used on researching and generating new market

segment development.

H1a – Outsourcing has positive impact in reducing capital investment that helps to reduce

operating cost.

Overhead and fixed cost was a measure of the extent on how outsourcing would help and has positive

impact to reduce operating cost for example human resources, fixed assets and utility cost. In most

companies, outsourcing would help to reduce number of headcounts or employees whereby the core

employees were shifted to focus on core functions. Thus, outsourcing would also reduce fixed asset

quantity such as machinery and reduced the concern on depreciation value. Utility cost could also be

reduced with less consumption.

H1b – Outsourcing has positive impact in reducing overhead and fixed cost that helps to reduce

operating cost

Reduce Operating Cost

• Capital investment

• Overhead and fixed cost

• Space

Improve Company Focus

• Focus on new product development and explore new

market segment

Access to World Class Capability

• Availability of specialist

• Latest and high efficiency technology

• Established tools and support infrastructure

Unavailability of Internal Resources

• Limited production capacity and Space

• Lack of technical content experts and Support

Infrastructure

Outsourcing Decision

Independent Variables Dependent Variable

H2

H3

H4

H1

Figure 1: Schematic Diagram of the

Research Framework

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Space was a measure of the extent on how outsourcing would help to reduce space consumption,

flexibility for core business use, capacity expansion to generate new revenues and cash infusion to

reduce operating cost.

H1c – Outsourcing has positive impact in reducing space that helps to reduce operating cost

Therefore, this study was proposed with three components of hypotheses related to reduce in operating

cost as highlighted above. As per the literature review, researchers have found evidence that

outsourcing led to reduce in operating cost. In the Outsourcing Institute survey (2006), it was found

that reducing operating cost was one of the top ten factors that influenced companies to outsource some

of their business functions.

3.2.2 Improve Company Focus

This following variable was a measure of the customers on how they considered outsourcing would

help to improve company focus in their companies. There would be one area being measured on

diverting resource to support core function that was to focus on new product development and explore

new market.

As per the literature review, the benefits of outsourcing article cited that by outsourcing, resources

could be diverted in value add activities that increased shareholder values. By shifting the resource to

focus on core business and new product development, this would significantly produce a tremendous

impact to the companies in exploring new market segment and reap new customers to boost the

revenues profitably.

H2a – Outsourcing has positive impact in focusing on new product development and explore new market segment to improve company focus.

3.2.3 Gain Access to World Class Capability

In this section, this variable was a measure of the impact of outsourcing in gaining the access to world

class capability. Customers would be measured on how outsourcing would help with the access of

supplier’s best in class specialist, latest and high efficiency technology that could produce higher yield

rate and would they gain the access of better established tools and support infrastructure at the supplier

site.

Based on the literature review, according to the Outsourcing Institute survey (2006), one of the top ten

factors or reasons companies outsource was to gain access to the world class capability that was not

available in-house.

Most of the suppliers that were specialized in their core service provider function have the best in class

specialist that has sound technical and hands-on experiences engineers or specialists compared to

outsourcer that were not specialized in the non-core business area. Suppliers would be able to provide

the content expert resource that would support the requirement effectively and efficiently as deemed

specialist.

H3a – Outsourcing provides the access to world class capability with supplier’s best in class

specialist

Service provider would usually have the best in class of the latest and high efficiency technology

considering that the providers were specific in the service business function area. This would give them

the added advantage to compete with their rivals in winning the business from outsourcer. Having

latest technology equipments and high efficiency would inevitable produce better quality and yield

outputs and at a higher capacity rate.

H3b – Outsourcing provides the access to world class capability with supplier’s latest and high

efficiency technology

As elaborated in the above, service providers would be deemed specialist and have the latest and high

efficiency technology would also necessary to be equipped with established supporting tools and

infrastructure. Service providers has well established training and development plan in place to support

the customers’ need and should have best in class of information technology systems and tools

infrastructure to support the specialized type of business transaction.

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H3c – Outsourcing provides the access to world class capability with supplier’s established tools

and support infrastructure

These three components of hypotheses above described that outsourcing would provide the access to

the world class capability in relation to the researcher’s survey. These hypotheses would be assessed

and analyzed the truth of the relationship to outsourcing decision in chapter four.

3.2.4 Unavailability of Internal Resources

In manufacturing operation industry, majority of the companies outsource due to the unavailability of

internal resources that was a limiter for the manufacturer to meet the customer requirements. This was

also one of the top ten factors quoted by the Outsourcing institute (2006) in the literature review that

led to outsourcing decision.

Two components of hypotheses were presented below. One was the positive impact to overcome the

production and space limitation and the other was the positive impact to overcome the lack of technical

content expert and support infrastructure internally.

Production and space limitation would be a limiter if capacity would be a constraint and space was

limited for expansion. By outsourcing non-core function, this would create space and capacity

flexibility for the companies to support the core business function or customers upside demand. Noncore

business could be negotiated for lower cost by outsourcing to service providers if the bulk of the

volume came from the outsourcer that could generate the service provider’s revenue. This could be a

win-win situation for both companies.

H4a – Outsourcing has positive impact to overcome production and space limitation if

unavailable internally

Concern on lack of technical content expert in non-core or niche business segment could also be

outsourced to seek best in class specialist for support. Likewise the unavailability of support

infrastructure could also be solved by seeking external providers’ solution.

H4b – Outsourcing has positive impact to overcome lack of technical content expert and support

infrastructure if unavailable internally

3.2.5 Outsourcing Decision

The dependent variable of this research framework study would be the outsourcing decision which

would be measured in terms of the consideration of outsourcing decision. As described in the ten

hypotheses of independent variables, the factors that influenced outsourcing decision highly dependent

on how customers perceive or consider the impact of outsourcing. The benefits of outsourcing varied

from one company to another and the initiative to seek outsourcing strategy would also depend on the

maturity of the companies in planning for strategic advantage and compete in the competitive market

environment. According to Maurice F. Greaver II (1999) in the literature review, outsourcing decision

would need a structured approach in planning and there would be associated risks of outsourcing if it

was taken for granted according to Dean Davison (2006).