Outsourcing

QUALITY PROGRESS I AUGUST 2007 I 17

utsourcing has become a growing trend

among many U.S. companies.1 Two com-

mon examples of the practice are out-

sourcing IT jobs to India and outsourcing product

manufacturing to China. Some say the practice is a

normal and healthy part of the evolution in the

U.S. workforce.2 Lower costs are often the dri-

ving factor, and there have been many success

stories of companies that enter this global supply

chain and realize significant cost savings.3, 4

However, outsourcing does not guarantee

business success. There is risk involved and not

all sides benefit from such arrangements.5

The advantages of outsourcing should be care-

fully weighed against risk and must go beyond

evaluating just price. So much more goes into

judging the business impact of an outsourcing

decision. Without a systematic analysis technique

to assess risk, much can go wrong: unexpected

cost, extended lead times, poor quality or other

negative performance variables.

Risk Assessment BasicsIndeed, risk associated with outsourcing can

offset the often more publicized benefits.6

Sometimes the risk doesn’t pay off. Some U.S.

companies have joined the outsourcing trend

only to be disappointed in the overall net effect

O

OUTSOURCING

In 50 WordsOr Less

• Outsourcing has become common for many U.S.

businesses, but assessing the risk involved in

such arrangements hasn’t.

• A modified version of failure mode effects

analysis (FMEA) is one way businesses can

evaluate the risk of outsourcing options.

• Risk priority numbers can be calculated to rate

any potential failures.

Using FMEATo AssessOutsourcing Risk

Using FMEATo AssessOutsourcing Riskby Cliff Welborn

on business operations and eventually returned

jobs back to the United States.7, 8

Analyzing the risk associated with a supply chain

and outsourcing is a relatively new subject, and little

research has been done.9 But one thing is certain:

Documenting and analyzing risk is an essential ele-

ment to continued learning and process improve-

ment.10 It is critical to have an easily understood

method to identify and manage risk.11

Failure mode effects analysis (FMEA) is tool

used to collect information related to risk manage-

ment decisions.12 There are documented procedures

to complete an FMEA and examples of its applica-

tion in various industries.13 A modified version of

the tool can be used to help evaluate the risk of

outsourcing options.

FMEA is a well documented, proven technique

commonly used to evaluate the risk for failures in

product and process designs.14 Every potential fail-

ure studied is evaluated in terms of likelihood and

severity.

A higher FMEA score indicates greater risk.

Common variables used to quantify risk are fre-

quency of an activity associated with the defect,

quantity of parts associated with the defect, ability

to detect the defect, probability of defect and sever-

ity of defect.

Other industry specific FMEAs

use other variables to quantify

risk. Rating scales of 1-5 and

1-10 are often used to quantify

each variable. The 1-10 scale

allows more precision in esti-

mates and typically creates

more separation in scores

between risks. However, the 1-5

scale makes it easier for a team

to agree on rating values.

A risk priority number (RPN)

is calculated for each potential

failure. A common RPN is the

product of:

Probability of failure X

detectability of failure X severity

of failure.

The steps to complete a

FMEA process are illustrated in

Figure 1.

18 I AUGUST 2007 I www.asq.org

OUTSOURCING

Identify risk categories.

Identify potential risks.

Rate the opportunity, probability,and severity for each risk.

Calculate the risk prioritynumber (RPN) for each risk.

Analyze risks by RPN using a Pareto distribution.

Develop actions to mitigaterisks with high RPN.

Reassess risks withanother cycle of failure mode

effect analysis (FMEA).

Outsourcing Risk AssessmentTABLE 1

Risk Opportunity Probability SeverityRisk priority

numberCostUnforeseen vendor selection cost 2 4 2 16Unforeseen transition cost 2 4 2 16Unforeseen management cost 4 4 3 48Lead TimeDelay in production start-up 2 4 4 32Delay in manufacturing process 5 3 2 30Delay in transportation of goods 4 2 2 16Quality Minor cosmetic/finishing defect 5 4 1 20Major cosmetic/finishing defect 5 2 2 20Component will not fit with matingparts—requiring rework 5 2 4 40

Structural defect—function failure 5 1 5 25

FMEA Process StepsFIGURE 1


Outsourcing options can be

evaluated in much the same

manner as product and pro-

cess defects. Risks are evaluat-

ed in terms of opportunity,

probability and severity, and

can be grouped into intuitive

categories.

The opportunity score for a

risk is the frequency at which

that activity happens. Using

the 1-5 scale, an activity that is

a one-time event or seldom

takes place has an opportunity

score of 1. If the activity is a

common occurrence, the op-

portunity score is 5. The prob-

ability score is the expected

likelihood that the risk will

actually happen.

The severity score indicates

the level of impact if the risk

materializes. A risk with a low

severity score causes a mini-

mal impact on operations

when it happens, while a risk

with a high severity score creates a significant

impact to operations. The impact might be in terms

of cost, lead time, loss of intellectual property,

quality to the customer or other relevant cate-

gories.

The RPN for a risk is calculated as the product of:

Opportunity score X probability score

X severity score.

Once the RPN is calculated for each risk, the

risks are analyzed using a Pareto distribution.

Actions are then taken to mitigate risks, and the

process can be performed again to evaluate resid-

ual risk.

RadioShack ExampleRadioShack Store Fixtures (RSSF), a division of

RadioShack Corp., procures and distributes furni-

ture and fixtures to RadioShack retail store loca-

tions. RSSF serves as a consolidation warehouse for

items purchased from many different vendors. For

instance, when RadioShack builds a new store or

remodels an existing one, RSSF consolidates the

required construction materials from various ven-

dors into one shipment. This procurement configu-

ration reduces complexity and shipping costs for

RadioShack.

The supply of major store display fixtures is typ-

ically awarded on a yearly contract basis. Through

a request for proposal (RFP) process, vendors sub-

mit bids to supply a fixture for a calendar year.

Historically, RSSF used domestic manufacturers to

supply all major furniture and fixtures, including

items such as wall systems, gondolas and shelves

to display products.

Recently, RadioShack changed its fixture design

direction from primarily wood based products to

metal based fixtures. When this design change was

implemented, potential vendors in Asia were con-

sidered in the RFP process. Initial estimates indi-

cated that Asian vendors offered a significant cost

savings compared with domestic vendors, espe-

cially those vendors that provided metal fixtures.

Example of Pareto Distribution of Risks in Outsourcing

0

10

20

30

40

50

Unforeseen m

anagement costs

Component will

not fit m

ating parts

Delay in productio

n start u

p

Delay in m

anufacturing process

Structural d

efect

Major cosm

etic defect

Minor cosm

etic defect

Delay in tra

nsporta

tion of g

oods

Unforeseen ve

ndor selectio

n cost

Unforeseen tra

nsition cost

Risk

Risk

pri

ority

num

ber

FIGURE 2

20 I AUGUST 2007 I www.asq.org

RadioShack decided to award the business to an

Asian manufacturer.

Although the quoted purchase price from the

selected vendor was significantly lower than other

domestic or offshore vendors, there was a concern

about the risk of entering into a long-term relation-

ship with a relatively unknown vendor not based in

the United States. The outsourcing risk assessment

procedure illustrated in Table 1 was used to evalu-

ate the risks of this relationship. A cross functional

team consisting of representatives from design,

global sourcing, operations and quality assurance

was established to perform the FMEA. The out-

sourcing risk assessment chart in Table 1 was used

to collect the relevant FMEA data.

The first step of the FMEA development process

was to identify risk categories. Through group dis-

cussion, the general categories were established as

cost, lead time and quality.

In the second step of the FMEA development,

the team brainstormed and generated a detailed

list of potential risks. The detailed risks were

grouped under the risk categories established in

step one.

Ratings and ScoresIn the third step, the team evaluated each risk

using the 1-5 rating system and the variables of

opportunity, probability and severity. The 1-5 rat-

ing was determined by consensus following group

discussion. Although this rating technique might

not represent the utmost in analytical accuracy, it is

a quick, easy and commonly used technique that

provides a quantitative measurement to a qualita-

tive concept.

For example, the risk of a delay in the manufac-

turing process was given an opportunity score of

5. Since manufacturing is a recurring activity, the

chance of a delay at this stage is recurring. The

opportunity score of 5 indicates that there were

many instances when this risk could materialize.

The probability score for a delay in manufactur-

ing process risk is 3. This is the team’s evaluation

of the chance that there would actually be a delay

in manufacturing. This evaluation was also based

on the team’s understanding of the vendor’s man-

ufacturing capabilities and performance history.

The final variable scored was severity. A delay in

manufacturing was evaluated to have a severity

score of 2. The score indicates the overall impact to

RadioShack if the delay materializes. The score also

suggests that the impact would not be greatly sig-

nificant to the overall performance of the company.

As described in Figure 1, the fourth step in the

FMEA development was to calculate the RPN value

for each risk. This was a simple multiplication of:

Opportunity score X probability score

X severity score.

In the fifth step of the FMEA development, the

risks were sorted in descending order based on their

RPN score and graphed as a Pareto distribution, as

shown in Figure 2 (p. 19). This representation of the

risks was used to prioritize risk mitigation efforts.

In this example, the risk with the highest RPN

score was “unforeseen management costs.” It had a

RPN of 48. “Unforeseen management costs” repre-

sented the risk associated with incurring additional

cost to conduct business with a vendor from anoth-

er country. The management team was concerned

about the communication barrier and its ability to

efficiently convey business transactions.

OUTSOURCING

Outsourcing options can beevaluated in much the samemanner as product and process defects. Risks areevaluated in terms of opportunity, probability and severity, and can begrouped into intuitivecategories.

The risk with the next highest RPN was “com-

ponent will not fit with mating parts—requiring

rework.” Its RPN was 40. The new vendor would

be producing many different fixture components

that would have to connect to components made

by other vendors. There was a concern that com-

ponents from two different vendors would have

dimensional discrepancies resulting in a poor fit.

With this quantified risk assessment, RSSF’s

management team implemented mitigation

efforts. A small product/process development

team was established to ensure smooth opera-

tions with the new vendor. This three-person

team made several trips to the vendor’s location

in Asia. Focus was on the development of a sys-

tem to manage business transactions, such as

communication of orders, schedules, payments,

returns and repairs.

Additionally, the representatives from RSSF

and the new vendor met to establish clear product

specifications. Samples from RadioShack’s exist-

ing product stock were sent to the new vendor to

verify fit conformity. In some cases, the mating

parts that were not to be produced by the vendor

were sent to ensure proper fit. Prototypes were

produced and sent to RSSF’s warehouse for thor-

ough evaluation before the vendor was allowed to

begin production.

These proactive risk mitigation efforts resulted

in a smooth supply chain relationship. Without

the FMEA based outsourcing risk assessment

tool, unforeseen problems might have impacted

the overall success of the global outsourcing

efforts.

Future of the Analysis ToolDecision makers considering outsourcing

options should use the FMEA based outsourcing

risk assessment technique. The technique is easily

implemented and understood.

Further research should be undertaken to veri-

fy the risk assessment results with actual short-

comings and failures of various outsourcing

options. This can be done through a comprehen-

sive study of companies undertaking outsourcing

programs.

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and MengChu Zhou, “Methods Toward Supply Chain Risk

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10. John A. Walewski, Edward G. Gibson and Vines F.

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and Effects Analysis Using Approximate Reasoning,” Reli-ability Engineering & System Safety, Vol. 79, No. 1, pp. 69-85.

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CLIFF WELBORN is an assistant professor at Middle Tennessee StateUniversity in Murfreesboro. He earned a doctorate in industrial engineeringfrom the University of Texas at Arlington.
