Just Right Outsourcing: Understanding and Managing Risk – Aron, Clemons & Reddi

Question 1

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Just right outsourcing meaning?

Answer 1

Just right outsourcing: knowing what activity to outsource and how to structure these activities so they can be outsourced most effectively

Question 2

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is goal of outsourcing?

Answer 2

goal of outsourcing: achieving best long-term risk-adjusted rate of return = important to understand risks

Question 3

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is the aim of paper?

Answer 3

aim of paper: explain risk profile created by any outsourcing relationship & explain actions that client can take to improve risk profile

• technique used to improve risk profile: strategic chunkification

Question 4

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is Strategic chunkification?

Answer 4

Strategic chunkification: dividing any process into separate component activities (chunks) that can be outsourced in manner that reduces risk relative to that of outsourcing entire process

Question 5

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What are REASONS FOR GROWTH OF OUTSOURCING ?

Answer 5

• growth of business process outsourcing in India has been dramatic -> not because the reward portion of the risk-reward trade-off has changed (labour was cheap and skilled before) but because the risk portion of the risk-reward trade-off has changed
• reduction of risk in BPO (business process outsourcing) initiatives in India is result of cheap and ubiquitous bandwidth now available  now clients can prompt vendors actions and oversee their actions better

Question 6

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What are Transaction cost economics (TCE) ?

Answer 6

Transaction cost economics (TCE): developed to justify firm as economising on transaction cost  identifying most efficient governance structure & show under which conditions the firm and not the market provided ideal governance structure

• TCE shows that investment idiosyncrasy is main reason for vertical integration = vulnerability created by contracting that is avoided by ‘doing-by-itself’ (relates to principal-agent-problems)
• TCE is used to explain effect of IT on boundaries of firm  how improved IT systematically affects risks associated with interfirm contracting

Question 7

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What are the four types of risks associated with outsourcing: ?

Answer 7

strategic risks, operational risks, intrinsic risks of atrophy, intrinsic risks of location location
-> this paper emphasizes on strategic risks

Question 8

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Four types of risks associated with outsourcing: What is Strategic risk?

Answer 8

Strategic risk: arises from opportunisitic behaviour of supplier
-> caused by intentionally explotive and can be subdivided into 1) shirking/principal-agent problem
2) poaching/misuse of information
3) opportunistic renegotiation

Question 9

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Four types of risks associated with outsourcing: What is Operational risk?

Answer 9

Risk of suboptimal output result from for example misscommunication -> not on purpose

Question 10

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Four types of risks associated with outsourcing: What is Intrinsic Risk of Atrophy?

Answer 10

Over time as a company outsources activity completely it loses core group of people whop were familiar with it

Question 11

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Four types of risks associated with outsourcing: What is Intrinsic Risk of location?

Answer 11

caused by moving activities to different locations:exchange risk, sovereign risk, geopolitical risk

Question 12

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is SHIRKING / PRINCIPAL AGENT PROBLEM ?

Answer 12

SHIRKING / PRINCIPAL AGENT PROBLEM: Shirking: deliberate underperformance while claiming full payment
* occurs for two reasons: 1) agent’s incentives for work are not same as principals’ 2) lack of information available makes it difficult to detect shirking by agents

-> based on hidden + unobservable action
_> all 3 risks occur because incentives of client and vendor differ

Question 13

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is POACHING / MISUSE OF INFORMATION?

Answer 13

Poaching:
entails parallel effort that results in second, unauthorised revenue stream derived from data provided as legitimate part of contract; often damaging the party providing the data; eg front-runnig a customer order, reverse engineering critical proprietary business processes & then stealing/selling
* occurs for two reasons:
1) incentives of client and vendor diverge
2) lack of information available makes it difficult to detect action

-> Misues of information
-> based on hidden + unobservable action
_> all 3 risks occur because incentives of client and vendor differ

Question 14

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is OPPPORTUNISTIC RENEGOTIATION ?

Answer 14

Opportunistic renegotiation (vendor holdup): occurs when client discovers that it has no alternative source of support, goods/services and must pay current supplier price that it sets in future = loss of bargaining power & associated escalation of future pricing
* occurs for 1 reason: client has lack of resource = no alternative + cannot reinternalize process

-> based visible and clear threat
all 3 risks occur because incentives of client and vendor differ

Question 15

(Article: Just Right Outsourcing: Understanding and Managing Risk)

How can one REDESIGNING A PROCESS TO REDUCE RISK?

Answer 15

1) dividing the process into different activities
2) determining the risk profile for each activity
3) developing a risk mitigation strategy for each activity (horizontal/vertical chunkification)
= reduction of risk of overall process

Question 16

(Article: Just Right Outsourcing: Understanding and Managing Risk)

MANAGING STRATEGIC RISK: Shrinking ?

Answer 16

• strategic risk easiest to anticipate 
  1) low levels of effort (in primary activity or quality assurance)
  2) shifting of staff assignments (more poorly qualified workers)
  3) underinvestment (training, facilities) = all created because vendor has other uses for critical resources

OTHER OCCASIONS IN WHICH INCENTIVES DIVERGE
Commission related incentives: vendor may not negotiate best price for client when negotiating on client’s behalf just because he earns a commission directly related to price (the higher the price  the higher the commission)

Vendor competing with client: whenever vendor is direct competitor of client he has incentive to underperform and sabotage the clients’ operations

Question 17

(Article: Just Right Outsourcing: Understanding and Managing Risk)

MANAGING STRATEGIC RISK: POACHING ?

Answer 17

POACHING
* shirking can be reduced by attempting to align incentives more  does not work for poaching
FORMS OF POACHING
Opportunities for resale: resell software developed for client; resell engineering designs (or its research); resell list of attractive and profitable customers - all by vendor
Opportunities for reuse as direct competitor: vendor can become competitor by reverse-engineering designs
Opportunities for misuse: front-running a customer order in a range of industries

Question 18

(Article: Just Right Outsourcing: Understanding and Managing Risk)

MANAGING STRATEGIC RISK: OPPORTUNITISTIC RENEGOTIATION ?

Answer 18

OPPORTUNITISTIC RENEGOTIATION
* oftentimes even happens after the original bidding  vendor looked attractive for initial contract when bidding against competitors but whenever these aren’t existing (anymore), prices much higher (eg sometimes additionally due to maintenance, testing, 24/7 tech support)

Question 19

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Dimension and timeframe of risk for shrinking?

Answer 19

shirking: hidden action – vendor simply does not do what he is asked for in some form

-occurs during the contract

Question 20

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Dimension and timeframe of risk for poachingg?

Answer 20

poaching: vendor does really well what he is asked for and hidden action occurs later – when vendor uses the expertise (gained from doing good job) for his own gain (additional revenue stream)

-> occurs after the contract

Question 21

(Article: Just Right Outsourcing: Understanding and Managing Risk)

Dimension and timeframe of risk for opportunistic renegotiation?

Answer 21

opportunistic renegotiation: clearly visible action – no information asymmetry

-> occurs during contract renewal (when price is discussed)

Question 22

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is Horizontal chunkification?

Answer 22

Horizontal chunkification: dividing the volume of process/activity into subtasks among alternative vendors = mitigating shirking and opportunistic renegotiation; describes what portion or fraction of each activity will be allocated

-> two suppliers make same bike

Question 23

(Article: Just Right Outsourcing: Understanding and Managing Risk)

What is Vertical chunkification?

Answer 23

Vertical chunkification: dividing process into sequential non-overlapping activities – can greatly reduce knowledge transfer = mitigating poaching; describes which activities will be allocated

Question 24

(Article: Just Right Outsourcing: Understanding and Managing Risk)

How to reduce shrinking risk?

Answer 24

SHIRKING
1) closer monitoring: expensive but can produce better results
2) maintaining two or more competing vendors through horizontal chunkification: comparing their performance – then discipline, fine, drop worst-performing vendor = less expensive

Question 25

(Article: Just Right Outsourcing: Understanding and Managing Risk) How to reduce poaching risk?

Answer 25

POACHING * never use horizontal chunkification: can create plausible deniability whenever poaching occurs as no vendor would feel responsible and it is difficult to identify the poaching vendor 1) vertical chunkification: to limit knowledge transfer – assign non-overlapping tasks to different vendors ->the strategies used to reduce shirking & opportunistic renegotiation risk should never be used for poaching!

Question 26

(Article: Just Right Outsourcing: Understanding and Managing Risk) How to reduce OPPORTUNISTIC RENEGOTIATION risk?

Answer 26

OPPORTUNISTIC RENEGOTIATION 1) horizontal chunkification: reducing dependence on single vendor = mitigating risk of opportunistic renegotiation 2) retaining some value internally

Question 27

(Article: Just Right Outsourcing: Understanding and Managing Risk) What does quality assurance performed by vendor mean?

Answer 27

- quality assurance activities provide opportunity for both horizontal & vertical chunkification quality assurance performed by vendor: if client finds mistake, work will be rejected directly (penalty) but better than having both or even client alone perform inspection – much more expensive

Question 28

(Article: Just Right Outsourcing: Understanding and Managing Risk) What does qquality assurance performed by multiple subdivisions mean?

Answer 28

quality assurance performed by multiple subdivisions (‘peer review): best if one subdivision is also an internal one to the company (client)  any deviation between what internal division gave another center and what other divisions gave that center can be dealt with more effectively as it is visible then

Question 29

(Article: Just Right Outsourcing: Understanding and Managing Risk) What is the conclusion?

Answer 29

9. CONCLUSION * outsourcing has various components of risk: 1) strategically 2) operational  important to make outsourcing decisions correctly in order to reduce risk = strategic chunkification aids in making these decisions