SESSION 9 - Just right outsourcing: Understanding and managing risk

Question 1

Whats the article about?

Answer 1

Just right outsourcing: knowing what activity to outsource and how to structure these activities so they can be outsourced most effectively
* goal of outsourcing: achieving best long-term risk-adjusted rate of return = important to understand risks
* 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
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 2

What are transaction cost economics? (TCE)

Answer 2

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
Move-to-the-middle hypothesis: although outsourcing would increase, it would take the form of stable bilateral working relationships rather than extensive use of spot market

Question 3

What are the four types of risks associated with outsourcing?

Answer 3

• four types of risks associated with outsourcing: strategic risks, operational risks, intrinsic risks of atrophy, intrinsic risks of location
  –> this paper emphasizes on strategic risks
  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 4

What is referred to as shirking/principal agent problem?

Answer 4

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

Question 5

What is referred to as poaching/misuse of information?

Answer 5

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

Question 6

What is referred to as opportunistic renegotiation?

Answer 6

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

Question 7

What are the three steps to redesign a process to reduce risks?

Answer 7

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 8

What can you do in order to prevent shirking, poaching and renegotiation?

Answer 8

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