Linking outsourcing to business strategy

Academy ot Management Executive, 2000, Vol. 14, No. 4

Linking outsourcing to businessstrategy

Richard C. Insinga and Michael }. WeiJe

Executive OverviewIn today's husiness environment companies are driven fo conduct a few functions in-

house and to obtain the rest from other sources through aggressive outsourcing. Whileoutsourcing may seem attractive at the strategic management level, serious pitfalls areoften encountered as the strategy is pushed downward into operations. At the operationallevel, the strategic intent tends to be lost in a hectic day-to-day, problem-to-problembusiness environment. Outsourcing decisions made at the operational level can easilylead to dependencies that create unforeseen strategic vulnerabilities. These pitfalls areaddressed by a systematic methodology that can guide the operational level to achievestrategically appropriate actions.

Pressures to Outsource

The goal of companies that aggressively outsourcemost functions is to enhance competitiveness byachieving a higher return on assets through lesscapital commitment and increasing the ability toadjust quickly to a changing environment throughless commitment to in-house resources.' Their ad-age is: do more with less.

Outsourcing is motivated by growing pressureson management to remain competitive by accom-plishing more with fewer resources at a fasterpace. Competitive pressure is a constant driver toincrease efficiency. Organizations have been, orare being, restructured, downsized, and reengi-neered in a relentless attempt to achieve a state ofefficiency, effectiveness, and agility expected todeliver increased productivity.

In order to do more with less, a company mustfocus its limited resources on those activities thatare essential to its survival and must leverageactivities that are peripheral. The result is agreater use of partnerships, collaborations, andsimple buying to substitute for in-house capabili-ties.

Outsourcing's Pitfalls

While outsourcing may seem attractive at the stra-tegic management level, serious pitfalls are oftenencountered as the strategy is pushed downwardinto operations. At the operational level, the stra-

tegic intent tends to be lost in a hectic day-to-day,problem-to-problem business environment. In leanoperational management structures, implementa-tion is in the hands of semiautonomous teams thatare tightly focused on measurable objectives—most often, cost reduction.^ At this level, the dom-inant success metric of outsourcing becomes lowercost, period. As such, the stage is set for classicsuboptimization at its worst. Outsourcing at theoperational level can easily lead to the develop-ment of dependencies that create unforeseen stra-tegic vulnerabilities. These pitfalls prompted thecreation of a systematic methodology to guide theoperational level to strategically appropriate ac-tions.

Outsourcing at the operational level caneasily lead to the development ofdependencies that create unforeseenstrategic vulnerabilities.

A Methodology for Outsourcing

Presented here is a methodology that enables anenterprise to conduct a thorough and systematicreview of its functions and operations in order toestablish a consistent strategic basis for outsourc-ing. It can be used at either the macro- or micro-organizational level. We find that this methodol-ogy provides:

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2000. Insinga and Weile 59

• alignment of outsourcing with the businessstrategy of the enterprise;

• clarification of core capabilities and competen-cies;

• identification of strategic gaps and specific strat-egies for cost saving and asset shedding; and

• recognition of the enterprise's significant depen-dencies and vulnerabilities.

Stimulated by top management's interest in thevirtual corporation,^ a team of corporate, consult-ing, and academic specialists developed thismethodology. The team's assignment was to de-fine appropriate actions for a corporate researchcenter to take when faced with options of internaldevelopment versus external relationships. The re-sult was a two-dimensional matrix. This formatenabled the group to map out strategic actionsbased on an activity's position in the matrix. Wecontinued to develop the methodology for applica-tion to the broader organization.'' Appropriate ac-tions were drawn from an extensive review of busi-ness periodicals, combined with interviews ofhigh-level managers.^ In addition, the methodol-ogy was reviewed and revised based on discus-sions with more than 50 mid- and high-level man-agers from a variety of industries and functionalareas, and on test cases these managers supplied.Subsequently, the methodology was employed inseveral significant consulting assignments, andreceived excellent reviews from clients. The goalof recent efforts has been to refine the methodologyand make it theoretically sounder by linking itmore explicitly to management theories.

The methodology is grounded in recent outsourc-ing theories.^ The resource-based view argues thata firm's survival depends on the accumulation ofresources that are rare, valuable, nonsubstitut-able, or difficult to imitate. Thus, the firm achievesan advantage over its competitors. The relationalview adds another dimension—the network offirms. The relational view recognizes that sourcesof competitive advantage can exist outside the en-terprise, in its relationships with other firms.

As in the resource-based and relational views,we focus on the resources and the competitiveadvantage of the enterprise. We know from ex-perience that sources of competitive advantagecan Ue outside the enterprise. Our primary con-cerns are: Which of the enterprise's activitiesmust remain in-house? What is the enterprise'scompetitive essence or true core? For those ac-tivities that can be done externally, what form ofrelationship is most appropriate? A recent arti-cle' addresses these questions for human re-sources, indicating which human resources needto be in-house and which can be obtained byrelationships. This paper, however, covers morethan human resources.

Many authors^ cite two dimensions—contribu-tion to competitive advantage and level of organi-zational strength—as the key determinants for as-sessing resources. Our methodology is based onthese same two dimensions. Our first step is todefine metrics for assessing an activity's valueand an enterprise's internal capability to performthat activity. (See Figure 1.)

Potentialfor an

activitylo yield

competitiveadvantage

Absolutely

Probably

Possibly

Not Likely

None

Key activity, a competitive dilferentiator

Emerging activity,has the potential to become a

competitive differentiator

Basic activity,needed to be in the business

Commodity activity,teadi\Y available1 I

P / A

Weak Moderate Strong

Internal capability of the enterprise to performan activity in comparison with competitors

FIGURE 1Assessing an Activity's Value and the Enterprise's Internal Capability to Perform It

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Establishing value

For our purposes, the value of an activity to theenterprise must be set in a market. The value orpotential value should be established on the basisof market principles, not on operational principles.The fundamental issue is the level of the compet-itive advantage an enterprise can establish in thedelivery of its products and/or services to its cus-tomers.

As indicated in Figure 1, the valuation metric forcontribution to competitive advantage is semi-quantitative {"none" to "absolutely").^ We find thatthe level of this metric cannot be established froman internal perspective, since the marketplace de-termines competitive advantage. Thus only an ex-ternal, marketplace perspective is valid.

The vertical scale separates activities into fourmajor categories:

• key activities provide the enterprise with a sus-tainable competitive advantage in the market-place;

• emerging activities have the potential to be-come sources of sustainable competitive advan-tage;

• basic activities are needed simply to be aplayer in the enterprise's business field andare not significant sources of competitive ad-vantage; and

• commodity activities are readily available inthe marketplace and cannot be sources of com-petitive advantage.

In general, key activities need to be done in-houseand the rest are candidates for some form of exter-nal relationship. As one moves down from key, thestrength needed in the external relationship de-creases, with the weakest relationships being ap-propriate for commodity activities.

In general, key activities need to be donein-house and the rest are candidates iorsome form of external relationship.

An example of the usefulness of these categoriescan be seen in a study of banks.'° Observing thatbanks had outsourced some or all of their informa-tion system department functions, the researcherssought to answer the question: why would banksoutsource functions that were considered core tothe banking industry? Current theories suggestedthat core functions should be performed in-house,which was contrary to their observations. An ex-planation, which had been offered previously, wasthat banks were displaying imitation behaviors. In

the article, evidence from seven case studies ofoutsourcing arrangements demonstrated that, tothe contrary, banks formed outsourcing allianceswith vendors for sound financial and strategic rea-sons.

In our methodology, the question is answered byrecognizing that some core activities can be cat-egorized as basic. Though these activities maybe central to operations, they are not sources ofsignificant competitive advantage. Therefore, itis not necessary for them to be performed in-house, and the observations cited are consistentwith the theory.

The imitation behaviors could be explained sim-ilarly. When an enterprise observes that its com-petitors are outsourcing certain activities (i.e.,these activities are becoming basic), the risk oflosing competitive advantage through outsourcingis reduced. In fact, external sources are likely tostrengthen these activities through economies ofscale. Companies may appear to be imitating eachother, but instead there are sound strategic rea-sons for their behavior.

Assessing internal capabilities

To complete the assessment, a second dimensionof the enterprise must be considered—its abilityto perform the activity. There are many ways tomeasure the level oi resources.'' We approachthis assessment by asking a second set of ques-tions: What is the organization's in-house capa-bility to perform the activity competitively? Thatis, is it weak, moderate, or strong in capability?This metric is also semiquantitative and mustbe established from an objective perspective,possibly with the assistance of knowledgeableoutsiders.

The Planning Guide

Combining these concepts, we can construct a two-dimensional matrix to assess activities and to sug-gest appropriate actions. While others have usedboth dimensions to assess a situation, we foundthat by putting the measures in this matrix form,we were able to define recommended actionsbased on the position in the matrix. For example, acase study of Ingram Micro, a leading worldwidewholesaler of microcomputer hardware, usedthese dimensions to assess the contribution tocompetitive advantage of its internal strengthsand weaknesses.'^ Unlike our methodology, thatstudy did not display the measures in a matrixformat. To arrive at their recommendations, there-fore, the authors needed to consider and discuss

2000 Insinga and Weile 61

the strategic implications of the strengths andweaknesses that they measured. With our method-ology, placement on the matrix identifies the rec-ommended actions.

We call this matrix a planning guide because itassists management in identifying appropriate ac-tions that should be taken. These actions thenwould be incorporated into the organization'splans. The planning guide is shown in Figure 2,with each cell numbered for reference in the fol-lowing discussion. The guide recommends certainapproaches, depending on the position that an ac-tivity is given. These approaches involve eitherperforming the activity in-house or using sometype of relationship.

In the planning guide, activities can be made upof human resources, equipment, and special de-signs. The recommendations shown in the plan-ning guide can be compared to those by others. Forexample, in a recent article that addressed onlyhuman resources, the recommended actions areconsistent with our matrix.'^

In the discussion that follows, recall that ourmeasures are semiquantitative. That is, a grada-tion exists within the cells. The shade of differencefrom being at the top of the cell versus at thebottom can be significant in terms of the actionsthat are recommended. We reflect these shades ofdifference by recommending a correspondinglyweaker relationship as one moves down the

vertical axis. To illustrate each cell, we provide anexample of a publicly known situation that fits thecharacteristics of the cell. (See Figure 2.)

In Cells 1, 2, and 3, the activity is categorized askey and belongs inside the firm, because the ac-tivity is considered essential to sustaining compet-itive advantage.

Key Activities

Cell I: Get capability

If an enterprise's capabilities are weak in an areathat is discovered to offer significant competitiveadvantage to its competitors, it should move toobtain full ownership and control by acquiring thecapability in-house. That is, it should seek to movetoward Cells 2 and 3. For example, AT&T, a tele-communications company, is seeking to getneeded capability by acquiring a cable TV com-pany, MediaOne. AT&T, internally, is weak in ca-ble. When cable was identified as an emergingsource of competitive advantage, AT&T estab-lished a partnership with Excite@Home, a cable-based provider of high-speed on-line access (con-sistent with the recommendations of Cell 4a). Nowthat high-speed on-line access has been identifiedas a key source of competitive advantage, AT&Tdecided to acquire MediaOne and will let its ex-clusive contracts with Excite@Home expire in 2002.

Absolutely

Probably

Potentialfor an

activityto yield

competitiveadvantage

Possibly

Not Likely

None

1 Getcapabilily

4a Partner

4b Collaborate

7 Buy

10 Buy

2 Build strength

5a Partner

db Collaborate

5c Share risk

8cf Develop second source(external)

8b Buy

11 Exil/Buy(Sell, abandon, or allow to weaken!

3 Doin-house

6a Doin-house

6b Share risk

Sa Make ita pro/itcenfer

9b Considerselling/buying

12 ConsiderseUing/huying

Key activities

Emerging activities

Basic activities

Commodity activities

Weak Moderate Strong

Internal capability of the enterprise to perfornian activity in comparison with competitors

FIGURE 2Planning Guide to Identify Appropriate Actions

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Cell 2: Build strength

As in Cell 1, if an enterprise's capabilities aremoderate in an area that is discovered to offersignificant competitive advantage, it should investto build internal strength and move toward Cell 3.To illustrate, consider AT&T, which underwent aseries of revisions of its business strategy after itscourt-ordered breakup. At one point, its strategywas defined by its choice of a prime competitor,which at that time was IBM. AT&T therefore de-cided that it needed a strong position in the per-sonal computer and minicomputer product lines,but it had a relatively moderate position in theseproduct lines through its partnership with Olivetti.After redefining its business strategy to become acompetitor of IBM, the personal computer andminicomputer product lines became key to obtain-ing competitive advantage. So AT&T built strengthin its personal computer and minicomputer linesby acquiring NCR, which was later divested inanother strategic redefinition.

Cell 3: Do in-house

If cm enterprise has strong capability relative to itscompetitors and the activity clearly provides signif-icant competitive advantage, the enterprise shouldbe performing the activity in-house under tight con-trol. To illustrate, consider the example of a companythat decided to keep much of its production in-house.Sun Microsystems chose to maintain ownership ofhigh-value-added manufacturing processes. For in-stance, only one-quarter of the total value-added offinished products was produced extemal to Sun.With its strong market niche position. Sun clearlyhas strong capabilities in some areas of production,doing in-house those that it views as key to main-taining its competitive position.

Emerging Activities

In Cells 4, 5, and 6, where the activity is catego-rized as emerging, the firm can rely on some formof relationship to obtain its competitive advan-tage. Relationships can be short-term, followed bybringing the capability in-house, or long-term, oreven permanent. The deciding factor on whetherthese activities should be brought in-house is theircontribution to competitive advantage. For activi-ties in these three cells, there is a degree of uncer-tainty regarding the potential for creating compet-itive advantage. Once that uncertainty is resolved,these activities will move up or down in the guide,depending on the resolution. Unlike the first threecells, the shades of difference in the contribution to

competitive advantage within these cells (from topto bottom) result in corresponding differences inthe recommended actions.

Cell 4

Because competitive advantage is judged to bepossible or probable, activities in this cell need tobe watched carefully for movement either upward,which implies that competitive advantage has be-come more certain, or downward, which impliesless certainty. The result of this movement willdetermine the strength of the relationship neededor whether the activity should be brought in-house.

(a) Partner: When there is weak internal ca-pability in an activity that has a significantprobability of being a source of competitiveadvantage, the enterprise should seek to part-ner with a more capable group in order toremain competitively viable. If possible, thepartnership should provide a definitive own-ership posture, while positioning to acquiremore ownership if the activity truly becomesa key source of competitive advantage. Forexample, AT&T and PictureTel formed apartnership to develop and market video-conferencing equipment and software. AT&T

// possible, the partnership shouldprovide a definitive ownership posture,while positioning to acquire moreownership if the activity truly becomes akey source of competitive advantage,

was weak in coding and decoding technol-ogy, so it teamed with PictureTel, a recog-nized leader, to improve its position in thismarket. The teleconferencing market is aniche, serving mainly corporations and otherorganizations, and coding and decoding tech-nology was an emerging capability. The rela-tionship with PictureTel could be a probablesource of competitive advantage, since thelease or purchase of a PictureTel unit wouldget AT&T a foot in the door with customers inthis emerging market and allow the companyto maintain or add a new customer.

(b) Collaborate: When there is weak internalcapability and only a possibility of competi-tive advantage, collaboration with a more ca-pable group or groups is warranted. In thissituation, a less definitive ownership posture

2000. Insinga and Weile 63

is needed than in partnering. The goal of thecollaboration is to strengthen the enterprise'sposition, while limiting the risks inherent in acommitment, until the possibility of competi-tive advantage becomes more certain. For ex-ample, in the early 1990s USAir and BritishAirways each gained a needed capabilityfrom the other. USAir, which was weak ininternational travel, obtained access to inter-national routes while British Airways, whichwas prevented by regulation from flying do-mestic U.S. routes, gained entry into that mar-ket. With growing international travel, a siz-able portion of domestic travel was to connectto an international flight. The relationshipwas important to USAir, which wanted to geta position in this emerging market, possibly asource of competitive advantage, by beingable to offer a through-connection to thesetravelers. This collaboration ended when Brit-ish Airways switched to a new domestic part-ner, American Airlines.

Cell 5

Activities in this cell need to be monitored formovement either upward or downward, dependingon the evolution of their potential for competitiveadvantage. The result of this movement will deter-mine the strength of the relationship needed orwhether the activity should be brought in-house.

(a) Partner: This situation resembles Cell 4(a),except that the enterprise's position is stron-ger because of moderate internal capability.As in 4(a), the recommendation is to partnerwith a more capable group. Here, however,the partnership agreement can be structuredmore to the enterprise's favor because of itsstronger internal knowledge base and capa-bilities. As the level of certainty for gainingcompetitive advantage increases, the enter-prise should be prepared to shift the workin-house and/or under more direct control. For

As (he level of certainty for gainingcompetitive advantage increases, theenterprise should be prepared to shift thework in-house and/or under more directcontrol.

example, SBC Communications Inc. and Bell-South Corp. created a new company contain-ing the domestic wireless assets of these two

telephone companies. Both companies hadmoderate positions in this market, and theirpartnership was formed to better enable themto compete with market leaders, such as BellAtlantic. National wireless networks wereemerging and becoming a probable source ofcompetitive advantage because consumerswanted to use their cell phones as they trav-eled and avoid the costly fees incurred whenentering another wireless provider's network.

(b) Collaborate: With a less certain potentialfor competitive advantage than Cell 5(a) anda moderate position in the capability, the en-terprise can be less definitive in its relation-ships. In this middle ground, collaborationwith a more capable group is warranted (as inCell 4b) to strengthen the capability in casethe potential for competitive advantage in-creases. For example, in the hope of getting aposition in the emerging online marketplacefor auto parts, SAP AG sought in mid-2000 tobe selected by DaimlerChrysler AG for ane-commerce venture with Ford and GeneralMotors. The other companies in this venturehad selected software technology partners(Oracle and Commerce One), and selec-tion by DaimlerChrysler would have givenSAP a big boost after a slow start in the e-commerce business. Though not in a strongposition in e-commerce at the time, a fieldthat would probably become a source of com-petitive advantage, European-based SAP hadan advantageous (i.e., moderate) position,since Daimler (another European-based com-pany) was one of its largest customers alongwith over one thousand automotive supplierswho currently use SAP software. Under pres-sure from the auto companies, the technologycompanies had to collaborate in order tocreate a single online parts exchange, givingSAP valuable experience in e-commercetechnologies.

(c) Share risk: As the level of potential forcompetitive advantage diminishes, the move-ment should be toward sharing risk and in-vestment with others. Sharing risk means theenterprise recognizes that it might not everneed full ownership in-house for this activity.Sharing risk also allows the enterprise tomaintain a level of involvement in the activ-ity, while conserving its resources for appli-cation elsewhere. If, in the future, the activityshows higher potential for competitive ad-vantage, then additional resources can be al-

64 Academy of Management Executive November

located to it. For example, from the perspec-tive of the major auto companies—Ford,General Motors, and DaimlerChrysler—thecreation of a single Internet company for autoparts was a means of sharing risk. Each autocompany had a moderate position in theemerging e-business on the worldwide Web,having their own Web sites (e.g.. Ford's Au-toXchange, GM's TradeXchange). Competi-tion for auto customers is fierce, but after-purchase parts sales are usually for thereplacement of OEM parts. An on-line partsexchange possibly could be a source of com-petitive advantage, but it is more likely todraw resources from each auto company. Bysharing the risk in creating a single auto-parts Web site, the auto companies reducethe potential for competitive advantage beingobtained by this route and conserve resourcesfor the primary field of competition—new carsales.

By sharing the risk in creating a singleauto-parts Web site, the auto companiesreduce the potential for competitiveadvantage being obtained by this routeand conserve resources for the primaryfield of competition—new car sales.

Cell 6

This is a strong position to be in for activitiesthat are emerging sources of competitive advan-tage. Activities in this cell need to be monitoredfor movement either toward or away from becom-ing key.

(a) Do in-house: If the enterprise has strongin-house capability relative to competitors,and the potential for competitive advantageis high, the enterprise should continue to dothe work in-house with full control and own-ership. For example, Microsoft kept its workon OS/2 for IBM separate from its work onWindows in order to retain ownership of thesubsequently successful Windows operatingsystem. Though IBM PCs were running on Mi-crosoft's DOS, the introduction of a Windows-like operating system (similar to Apple's) waslikely to emerge as a probable source of com-petitive advantage. Microsoft was strong inthis area, particularly since its DOS operatingsystem was widely used.

(b) Share risk: As in Cell 5(c), when the poten-tial for competitive advantage is less, themovement should be toward sharing risk andinvestment with others rather than trying toretain a strong position. This will allow theenterprise to maintain a level of involvementwith the activity, but to conserve its resourcesfor application elsewhere, or for when thisactivity shows clearer potential for competi-tive advantage. For example, Pratt & Whit-ney, with heavy funding commitments to newaircraft engine development, decided toshare the risk of one new engine with a lesscertain, emerging-market potential. It formedthe International Aero Engines consortium, amultinational group, to develop and producethis engine. Although Pratt & Whitney wasstrong in all aspects of design and manufac-ture of the engine, this engine was only apossible source of competitive advantage.The other engines under development weremore strategically vital to the company's con-tinued competitive position, because thoseengines were destined to replace its agingmainline engines.

Basic Activities

As in the emerging activities depicted in Cells 4, 5,and 6, the enterprise can rely on relationships toacquire the basic activities found in Cells 7, 8, and9. For historical reasons, the enterprise may bestrong in some of these activities. In that case, theguide suggests moving toward relationshipsrather than keeping the activity in-house. How-ever, the firm might wish to take advantage of itsstrength to generate income from others, even com-petitors in its industry, without fear of harming itscompetitive position.

CeJi 7; Buy

If the potential for competitive advantage is low, andlittle intemal capability exists, the activity should bebought in the marketplace. Relinquishing a weakin-house capability avoids any further drain on theenterprise's resources. For example, the major steelproducers traditionally have sold surplus steelthrough a hodgepodge of middlemen. Enter theWorld Wide Web and e-STEEL Corp.'s new Web site,e-STEEL-com. Although important, the sale of surplussteel is basic to the major steel makers and is not alikely source of competitive advantage. USX Corpo-ration, parent of U.S. Steel, after a period of cautiousevaluation, decided to buy a small stake in e-STEELCorp. in order to take advantage of the move toward

2000 Insinga and Werle 65

sales of surplus steel over the Web. Since U.S. Steelwas weak in Web technology, its involvement withe-STEEL enabled the steel producer to buy the Webaccess that it needed, while maintaining its prerog-ative to buy this capability from other e-commercesites, such as MetalSite.net.

CeiJ8

In this cell, the enterprise has a moderate capabil-ity in an activity that might not be a source ofcompetitive advantage. Depending on the likeli-hood for competitive advantage, the enterpriseshould move toward more or less in-house capa-bility, as discussed below, to minimize its invest-ment as well as its operational risk.

(a) Develop second source: Dependency onthe internal capabilities could be reducedthrough development of one or more externalsources. Because the possibility of competi-tive advantage still exists, the internal capa-bilities should be maintained to help the en-terprise be a smart buyer in the marketplace.For example, in late 1999, IBM won about $2billion in long-term contracts to run computersystems for large lapanese banks, insurancecompanies, and even a few manufacturers.Where capability is at best moderate, infor-mation systems are considered a basic, butcostly, support center that was at most a pos-sible source of competitive advantage. Pres-sured by deregulation and stiffer competition,more Japanese executives are turning to de-veloping an external source as a way tosqueeze cost out of their computer operations.

(b) Buy: If competitive advantage is not likely,and only moderate internal capability exists,the activity should be bought in the market-place to avoid any further drain on the enter-prise's resources. Once a stable external sup

// competitive advantage is not likely,and only moderate internal capabilityexists, the activity should be bought inthe marketplace to avoid any furtherdrain on fhe enterprise's resources,

ply system is established, intemal investmentsshould be withdrawn and movement to the leftin the matrix encouraged. For example, SATX,Inc. contracted with Attaway Technology Group(ATG) to recruit installation and service organi-

zations to support its Alpha Trak paging-acti-vated GPS (global positioning satellite) sys-tems. ATG is responsible for developing anationwide network of automobile aftermarketdealers and service organizations capable ofinstalling and servicing the system. Having astrong network is an important source of com-petitive advantage, but the capability of recruit-ing that network is basic and not likely to be asource of competitive advantage. AlthoughSATX has moderate intemal capability to re-cruit its own organizations, the company statesthat this move is consistent with its policy ofbuying, through outsourcing, key functions re-quired for rapid market deployment.

Cell 9

While it might be attractive to be strong for its ownsake, those activities categorized as basic shouldbe carefully considered. Activities in this cell cantie up resources that could be devoted instead togenerating competitive advantage. One must becertain, however, that these are truly basic activi-ties.

(a) Make it a proiit center: When the potentialfor competitive advantage is less likely, yetin-house strength exists, the need to limit theactivity to support only internal requirementsis diminished. The enterprise should considerreducing the level of investments in this area,as appropriate for an activity with a low po-tential for competitive advantage. If prudent,the enterprise could create a profit center,selling to the market in order to generate cashto continue its strong position and for invest-ment elsewhere. In the event that the enter-prise chooses to make no further investmentin this activity, its strength might be allowedto diminish, moving toward the left in theguide. Honda's strong capability for engineproduction provides an example of a profitcenter. Within the technological and regula-tory environment, engines are basic to theauto industry, and at best are a possiblesource of competitive advantage. Hence, inaddition to producing engines for its ownproducts, Honda manufactures auto enginesfor other companies, including competitors.

{b) Consider selling/buying: When an enter-prise has a strong capability that is unlikelyto yield competitive advantage, it shouldconsider selling off the capability and rein-vesting the proceeds elsewhere. Since the

66 Academy of Management Executive November

capability is still needed, the newly soldcapability, which is strong, could continueas a source for the divesting company. Forexample, Siemens AG sold a 29-percentstake in its Infineon unit in an initial publicoffering valued at almost $6 billion. The In-fineon spin-off became the world's 10*̂ larg-est semiconductor maker. Though Infineonhad steadily built up its production of chipsfor mobile telephony, smart cards, and othermarkets whose price cycles were less severe, itwas more exposed to the commodity-like DRAM{dynamic random access memory) market thanother European semiconductor companies. Sie-mens pledged to cut its share of Infineon to aminority holding by 2001, before the semicon-ductor industry passed the peak of the currentgrowth cycle. Though Siemens would still buythe products made by Infineon, these productswere basic to Siemen's business and were notlikely to be a source of competitive advantage.Hence, Siemen's strong position in Infineon wassold off to raise capital for its other businesspurposes.

Commodity Activities

Cells 10, 11, and 12 are categorized as Commodity.The firm should buy these activities in the market-place. If, for historical reasons, the firm is strong inone oi these activities, then it should considerways of exiting that activity while getting value forits past investments.

Cell 10: Buy

If there is neither competitive advantage nor sig-nificant internal capability, any in-house activityshould be stopped as quickly and cleanly as pos-sible to avoid any further drain on the enterprise'sresources. Instead, the enterprise should buy whatit needs in the marketplace. For example, ThomsonTravel Group PLC, one of Europe's biggest traveloperators, needed to focus on its core business andcut inefficiencies. One of those inefficiencies wasThomson's in-house maintenance capability for itsBritannia Airways charter airline. This capabilitywas not a source of competitive advantage, andother sources of aircraft maintenance services arereadily available, so Thomson decided to buy thecapability rather than continue to perform it in-house.

Cell 11: Exit/Buy

If an enterprise determines that it has moderateresident strength in an area where no competitive

advantage exists, we recommend an exit strategywherein the capability is abandoned or allowed toweaken—with ultimate movement toward Cell 10,Buy. Once again, the enterprise should buy what itneeds in the marketplace. For example, food ser-vice in public schools is a commodity and is not alikely source of competitive advantage. Problemsin the supply and warehousing of food in 1995 forthe Chicago school district, as well as poor foodquality, brought a public outcry for reform. Newleadership established a pilot privatization pro-gram and contracted with Marriott and Aramark torun the food services in 190 schools. The resultswere positive. Under the plan, the jobs of schooldistrict food-service workers were eliminatedmostly through attrition, and new employees

New leadership estahlished a pilotprivatization program and contractedwith Marriott and Aramark to run thefood services in 190 schools*

were assigned to one of the contractors. With thesuccess of the pilot program, the eventual replace-ment of internal food-service operations with con-tractor operations seemed certain.

CeiJ 12: Consider Selling/Buying

Where an enterprise has strong capability, but cangain little or no competitive advantage, it shouldconsider selling off the capability and reinvestingthe proceeds elsewhere. As with the preceding twocells, the enterprise should buy what it needs inthe marketplace. For example, PG&E spun off its 68hydroelectric power-generating stations in Califor-nia. Although California's energy-deregulationlaw requires investor-owned utilities to sell asmuch as half of their generating plants, PG&E wasnot required to sell its hydroelectric stations. Thesestations were sold because the company believedthe sale would be lucrative. Electric generation isviewed as a commodity that is not likely to be asource of competitive advantage. With the sale ofthese assets, PG&E had to buy electric power fromits former generating stations and from others tosupply its customers' needs.

Using the Matrix

In the preceding discussion, we provided the frame-work for the methodology. We now demonstratehow the methodology is applied through two ex-amples. The usual approach is to utilize the as-

20tl0 Jnsinga and Weiie 67

sessment guide (Figure 1) to identify and placeactivities on the matrix. This matrix is employedbecause it does not show suggested actions, whichoften influence the placement of an activity. Afterplacing activities on the assessment guide, theactivities next are transferred to the planningguide (Figure 2), which shows suggested actions.The suggested actions are then discussed and in-terpreted. The result usually is new insight into thesituation that leads to a change in plans, or devel-opment of new plans, for the activity.

In the following two examples, we demonstratethe placement of activities in the matrix and ex-plain how this placement might be interpreted.These examples are intended to illustrate the useof the methodology, not to provide strategic direc-tions for any specific class of activities.

Banking and in/ormafion systems

Our first example explains the observed outsourc-ing of information systems in the banking industry.One study'^ identified three factors—businesscosts, information systems costs and informationsystems performance—as the prime determinantsof information systems outsourcing activities in 55major U.S. corporations in the banking industry.Since information systems were considered a coreactivity to the banking industry, the researchers

Absolutely

Probably

were surprised to find that such activities werebeing outsourced. Theory, they stated, would leadto the conclusion that these activities should bedone in-house. They sought an explanation, andused seven case studies to gain detailed insightinto the reasons behind information-systems out-sourcing. Information-systems outsourcing wastaking place in organizations that had higher busi-ness costs, higher information-systems costs, andlower information-systems performance.

We employ our methodology to interpret theseobservations. We start with the observed higherbusiness costs. To place information systems ac-tivities on the matrix, we make the assumptionthat higher business costs are contrary to attainingcompetitive advantage, and are a potential sourceoi competitive disadvantage. The availability,however, of external sources for information-services activities can level the playing fieldbetween the larger banks that can afford to havetheir own in-house information-services depart-ments and the smaller banks that cannot. There-fore, we place the information-services activity forthese banks in the basic category, since the activ-ity is necessary to be in the business, but might notbe a major source of competitive advantage.

Turning to the observed higher information-systems costs and lower information-systems per-formance, we view these clearly as signs of lower

P/A

Potentialfor anactivityto yield

competitiveadvantage

Possibly

Not Likely

None

lGetcapability

4a Partner

4bCo//aborate

7 Buy

2 Build strength

5a Partners

5b Co/iaborafe

5c Share risk

8a Develop second source

ISACTIVmES

10 Buy

8b Buy

U Exit/Buy(Sell, abandon, or allow (o weaken)

3 Doin-house

6a Ooin-house

6b Share risk

9a i^^aJteila profitcenter

9bConsider

selling/buying

12 Considerselting/buying

Key activities

Emerging activities

Basic activities

Commodity activities

Weak Moderate Strong

Internal capability of the enterprise to performan activity in comparison with competitors

Note: The example shown is based on observations from seven case studies, which were reported in McCIeJlan, K.. Marcolin, B. L., &Beamish, P. W. 1995. Financial and strategic motivations behind outsourcing. Jomnal of Infoimation Technology. 10: 239-321.

FIGURE 3Outsourcing of Information Systems by Banks with Weak-to-Moderate Internal Capabilities

Academy of Management Executive Novemt'er

capability in this area. Therefore, we put bankswith higher information-systems costs and lowerinformation-systems performance in the moderate-to-weak category for information-systems activi-ties.

Considering these ratings, we place the activityon the planning guide (Figure 3). The guide recom-mends outsourcing for those banks in which rela-tive competence is weak or moderate. In the casestudy of seven banks, the researchers were able toidentify the characteristics of banks that displayedthe observed outsourcing of information-systemsactivities, but they still sought an explanation fromtheory. The guide confirms the observations of thisstudy and provides the explanation that althoughinformation systems are core, these activities arenot a major source of competitive advantage.Hence, outsourcing is possible, and, in banks withweak-to-moderate capabilities, is recommended.

Coca-Cola and bottling

Our second example comes from the Coca-ColaCompany and the bottling business.'^ It explainsthe decision by Coca-Cola to stay out of the bot-tling business at the beginning of the 1900s and toenter the bottling business in the 1980s. We coverthe strategic decisions about bottling at two impor-tant times in the company's history.

In 1899, Coca-Cola was already very successfulselling through soda fountains in Atlanta andthroughout Georgia, and was being copied widely.The company was seeking a path to extend itssuccess and to widen its market into new areas.The public was accepting bottled drinks, but pro-duction methods were somewhat primitive, andquality control was a high concern. Coca-Cola per-ceived that it had neither the money, brains, or thetime to take on the bottling business.

Considering the situation, bottling was anemerging source of competitive advantage, asdemonstrated by the concern over quality control.Bottling, therefore, belongs in the emerging cate-gory. Coca-Cola's internal capabilities, however,were weak in this area. The situation in 1899 isdisplayed in Figure 4. We place the 1899 marker inthe emerging category and in the weak sector. Theguide recommends that the company should part-ner or collaborate, which is what Coca-Cola choseto do.

The parent Coca-Cola Company agreed to li-cense a group of independent bottlers to whomthey sold their syrup, but imposed strict qualitycontrol. By this approach, it was able to stronglyinfluence the market situation, preserve and pro-tect its good name, gain a level of control over itscollaborators, and ultimately spread its productrapidly. By 1909, there were 397 new bottling plants

Absolutely

Probably

Potentialfor an

activityto yield

competitiveadvantage

Possibly

Not Likely

None

I Getcapability

4a Partner1979

2 Siiiid sifrength

5a Pa tner

1899

4b Co/Iaborate

7 Buy

10 Buy

5b Collaborate

5c Share risk

8a Develop second sourcefextemaU

8b Buy

11 Exit/BuyiSell, abandon,or allow lo weaken)

3 Doin-house

6a Doin-house

6b Share risk

9 a Make ita profitcenter

9bConsider

sellinglbuying

12 Considerselling/buying

Weak Moderate Strong

Key activities

Emerging activities

Basic activities

Commodity activities

Internal capability of the enterprise to performan activity in comparison with competitors

Note: The example shows thai Coca-Cola's decision to partner, rather than to enter, the bottling business in 1899 was appropriate tothe situation then. By 1979, the strategic situation had changed {indicated by the arrow), and Coca-Cola moved to acquire moreinternal capabilities appropriate to the new situation.

FIGURE 4 \Actions by Coca-Cola in Response to a Changing Strategic Situation

2000 /nsinga and Weile 69

in the U.S. This situation held through some roughperiods for the next 80 years and helped makeCoca-Cola a household name worldwide.

In retrospect, many have considered this a blun-der of sorts because it gave away so much profit tothe independents. Our planning guide recom-mends that Coca-Cola should partner with bot-tlers, which is what it did. This appears to havebeen the appropriate action to take for that time. Itcertainly helped Coca-Cola achieve its goal of in-creasing market share by enlisting many bottlersto aggressively attack local markets.

The situation had changed by 1979. Bottled productwas now an enormous element of every soft-drinkbusiness, and competitors were making significantgains against Coca-Cola, largely because its inde-pendent bottlers were not investing in and improv-ing their franchises. This situation also is reflected inFigure 4, showing that in 1979 bottling had movedinto the key category. In terms of its internal capa-bilities, we place these in the moderate sector, show-ing improvement over the situation in 1899, but stillless than full strength. The figure indicates that thecompany now should build strength internally, andchange its relationships with bottlers.

That is what Coca-Cola did. Following a long courtfight, in which Coca-Cola successfully put down anantitrust suit, the parent changed its relations withthe independent bottlers. Coca-Cola moved aggres-sively to get the right type of new owners by under-writing the buyout of the weak franchises. We see inthis example that a change in the strategic situationleads to a need for different actions. In both situa-tions, Coca-Cola took actions that were consistentwith the recommendations of the planning guide.These actions were appropriate to the situation andcontributed to making Coca-Cola the most recog-nized product worldwide today.

In both situations. Coca-Cola took actionsthat were consistent with therecommendations of the planning guide.

Implications for Practitioners

In today's business climate, every firm needs to giveserious and continuous attention to outsourcingstrategies for all functional aspects of its operations.The strategic intent of outsourcing, however, caneasily be lost as its control is pushed down to theoperational levels of an enterprise, where small,semiautonomous teams make outsourcing decisionsand operate in a hectic, day-to-day, crisis-to-crisisenvironment. To avoid this situation, the methodol-

ogy presented in this article utilizes a matrix, calledthe planning guide, which embodies the strategicaspect of outsourcing (i.e., competitive advantage),yet is easy to understand, apply, and communicate toall company levels.

The methodology has the following attractiveattributes:

• It is simple to use. Participants at all levels ofthe enterprise can easily grasp the fundamen-tals and become comfortable working with it.

• It gets to an answer quickly. It generally re-quires about a day to come to a decision.

• It is comprehensive in scope. It allows evensmall-scale activities to be reviewed within thebusiness context of the enterprise.

• It is easy to communicate to all organizationallevels. Graphical in nature, it provides easy-to-communicate concepts and results throughoutthe organization.

• It allows the practitioner to focus on the twomajor factors—competitive advantage and com-petitiveness of internal capabilities—that needto be considered in making good decisionsabout outsourcing.

Acknowledgment

An earlier version of this paper, entitled "Control-ling Interfirm Relationships in the Virtual Compa-ny," was presented at the 18th Annual Interna-tional Conference of the Strategic ManagementSociety in Orlando, Florida, in 1998.

Endnotes

' For example, see Guth, R. A. Japan's outsourcing contractsgive boost to IBM's Asian arm. The Wall Street Journal, 3 March2000: AH. Also: Prada P. Thomson's net tumbled 38% in '99; chiefplans cost-cutting, web moves. The Wall Street Journal InteiactiveEdition, 3 March 2000. Also: Burt, T. Component makers are assum-ing more responsibility for designing and supplying completesub-systems. Financial Times, 29 February 2000: 3.

^ The classic writings on the transaction-cost theory oi outsourc-ing are Coase, R. H. 1937. The nature of the iirm. Economica, 4:386-405. and the extensive works of Oliver E. Williamson.

^ Dcrvidow, W. H., & Malone, M. S. 1992. The viituai corporation.New York: HarperBusiness. Related articles are Byme, J. 1993.Business Week. The virtual corporation. February 8: 98-102; Tully,S. 1993. Foriune. The modular corporation. February 8: 106-115;and Copier, J. 1993. Database. The virtual corporation. August: 78.

' Harris. C, Insinga. R. C. Morone. J. G.. & Werle. M. J. 1996. Thevirtual R&D laboratory. ffesearch-TecimoJogy Management. 39:32-36.

^ Insinga, R. C & Insinga, I. J. S. 1995. The virtual company.Copyrighted unpublished paper.

^For the resource-based view, see Bamey. J. B. 1991. Firmresources and sustained competitive advantage. Journal ofManagement. 17: 99-120. For the relational view, see Dyer, J. H.,& Singh. H. 1998. The relational view: Cooperative strategy andsources of interorganlzational competitive advantage. Acad-emy of Management Review. 23: 660-879.

70 Academy of Management Executive November

'Lepak, D. P.. &; Snell, S. A. 1999. The human resource archi-tecture: Toward a theory oi human capital allocation and de-velopment. Academy of Management Review, 24: 31-48.

^For example. Black, I. A., 8E Boal, K. B. 1994. Strategic re-sources: Traits, configurations and paths to sustainable com-petitive advantage. Strategic Management/ournaJ. 15: 131-148.

^ Many have written on the sources of competitive advan-tage, and some have proposed measures of the level oi com-petitive advantage. See, for example, ibid. Also: Duncan, W. J.,Ginter, P. M., 8f Swayne, L. E. 1998. Competitive advantage andinternal organizational assessment. The Academy of Manage-ment Executive, 12: 6-16.

'° McClellan. K., Marcolin, B. L., & Beamish, P. W. 1995. Finan-cial and strategic motivations behind outsourcing. Journal ofInformation Technology. 10: 299-321.

" A good example can be found in Duncan, et al., op. cit.

'̂ Ibid. The measure of contribution to competitive advan-tage is addressed by four questions starting on page 10. Themeasure of relative organizational capability is assessed by sixvalues (e.g., inadequate, adequate) on page 12,

'̂ See Lepak & Snell, op. cit. Cells 1, 2, and 3 correspond toQuadrant 1: Developing Human Capital (36-38); Cells 4, 5, and6 correspond to Quadrant 4: Creating Human Capital Alliances(40-42); Cells 7, 8, and 9 correspond to Quadrant 2: AcquiringHuman Capital (38-39); and Cells 10, 11, and 12 correspond toQuadrant 3: Contracting Human Capital (39-40).

''' McClellan, et al.. op. cit. 301-302. The three factors are fromLoh, L., & Venkatraman, N. 1992. Determinants oi informationtechnology outsourcing: a cross-sectional analysis. Journal ofManagement Information Systems, 9: 7-24.

'^Oliver, T. 1950. The reai CoJte, (he reaJ sfory. New York:Random House.

Richard C. Insinga is an assis-tant professor oi operationsmanagement at SUNY Qneonta.He has over 25 years of experi-ence in industry, government,consulting, and academia. Hereceived his doctorate in man-agement from the Lubin Schooloi Business at Pace University.an M.B.A. irom Stanford Univer-sity, and a B.S. and M.S. in me-chanical engineering from Co-lumbia University. Contact:insingrc@oneon f a.ed u.

Michael J. Werle is the formerdirector for International andExternal Programs in the Sci-ence and Technology Group ofUnited Technologies Corpora-tion. He has a Ph.D. from Vir-ginia Polytechnic Institute andhas worked in industry, govern-ment, and universities. He iscurrently the president ofTEAMS LLC, a consulting com-pany providing technology,training, education, and man-agement services. Contact:mifceweWe@compuserve.com.