OPM49 Logistics and Supply Chain Management Sample
1. Introduction
Supply chain outsourcing is the hiring of an outside organisations of logistics to manage and control the supply chain. With the context of DB toys, a second-tier manufacturer of toys in Massachusetts, is facing problems of decrease in market share and revenue. This was because of the supply chain expenses of $30 million alone. The CEO, asks for proposal to reduce the costs. This report aims at analysing the two outsourcing options or DB toys and identify the best alternative pricing option of the option.
The report will discuss the benefits and risks of outsourcing for DB toys, along with the different types of outsourcing available for the company. The report will identify the best outsourcing option for DB toys by calculating the return on investment on the options and analysing the three pricing options. The report will critically analyse the pricing options and the outsourcing options. The report will also summarize the context of outsourcing and recognise the best alternative and identify the potential impact on the DB toys supply chain metrics.
2. Supply chain management and Outsourcing
2.1 Types of outsourcing in Supply chain management
According to Tsay et. al. (2018), outsourcing refers to the practice of a business to hire a third-party organisation to perform activities and manage the operational services for an organisation. With regards to supply chain, supply chain outsourcing is the employment of a third-party organisation mainly operating in logistics to manage be activities or the entire function of supply chain (Yu and Xiao, 2021). Often businesses opt for supply chain outsourcing as it allows them to delegate storage, reduce costs and improve their supply chain efficiency.
There are several types of outsourcing options available for organisations. However according to the transaction cost economics theory, A balance organisational structure is the one which is able to minimise their costs of exchanging with economic efficiency (Altin et. al. 2018). By looking at outsourcing from the transaction cost economics perspective, every organisation wants to balance their cost by having to perform the function of outsourcing either internally or externally. This theory also suggests that with higher costs to transaction from an organisation is forced to internalise the functions of accounting (Zhang et. al. 2018).
Figure 1: THE IMPACT OF TRANSACTION COSTS ON OUTSOURCING CONTRACTS: THEORETICAL ASPECTS, 2006
(Source: Semantics scholar, 2006)
Another model which can be used to understand outsourcing in supply chain management is the resource-based view theory. This explains how an organisation can achieve a competitive advantage and sustain it (Altin, 2021). According to the resource-based view theory, the competitive advantage of an organisation is based on their unique abilities and resources (Zhang et. al. 2018). Outsourcing can help in accessing the external resources and abilities of other organisations who improved the overall effectiveness of the supply chain. This can help a company to develop a competitive advantage, as outsourcing can result in reducing costs and increasing efficiency.
Figure 2: A resource-based view of outsourcing and its implications for organizational performance in the hotel sector, 2004
(Source: Science direct, 2004)
Based on these concepts of supply chain outsourcing, there are seven different types of outsourcing.
- Process based outsourcing: This type of outsourcing individual process within a business and hiring a third-party provider to provide that service.
- Professional outsourcing: This type of outsourcing is when an organisation hires a specialist or an expert to handle a specific project or a task (Fathollahi-Fard al. 2022).
- Often organisations who do not have a specific team hire this type of outsourcing organisations for example consulting a legal organisation.
- Logistics outsourcing: This type of outsourcing is where a third-party provider is hired to manage the transportation, distribution and warehousing of the goods. However, this outsourcing does not include all of the supply chain activities.
- Operational outsourcing: This type of outsourcing is when and organisation is hired to delegate specific operations in an organisation.
- Manufacturing outsourcing: This type of outsourcing is when a manufacturer is hired in order to manufacture products for a business.
- Project outsourcing: Often organisations outsource an entire project to service providers in order to accomplish that project (Tian and Guo, 2019).
- Multi sourcing: This type of outsourcing is when an organisation makes a deal with another service provider for the accomplishment of a project.
However, in the case study of DB toys the two types of outsourcing mentioned are business application outsourcing and business process outsourcing. The business application outsourcing refers to providing the entire management of the supply chain management activities to a third-party provider like Inflection. Whereas business process outsourcing refers to process based outsourcing where certain processes are outsourced to a third-party service provider.
2.2 Benefits and risks of outsourcing
Outsourcing is one of the most common practises used by businesses in order to reduce their cost and increase the efficiency also (Lou et. al. 2020). However, outsourcing can also come with a lot of risks attached to it.
The benefits of outsourcing are
There are several benefits of outsourcing which forces of business to choose outsourcing as a practice. Such as:
Reduced cost: According to Tian and Guo, (2019), hiring third party service providers to conduct a specific service or manager business function can help organisations in reduce costs. This is because conducting these functions by their own can often be deviating from the business competences and can be costly for the organisation.
Enhanced focus: Outsourcing also helps in allowing the top-level management to be focused on the core competences of the business and focus on their strengths (Feng et. al. 2021). This allows the staff to emphasise on the crucial tasks and future business development strategy.
Enhanced efficiency: By opting out for an outsourcing function, organisations can ensure increased efficiency both of the function outsourced as well as the employees. According to Agrawal and Singh, (2020), outsourcing can relieve burdens from certain employees who were tangled in other work rather than focusing on their major job responsibilities.
Competitive advantage. According to Taghipour et. al. (2022) outsourcing can have several benefits which lead to an organisation gaining a competitive advantage among its competitors. This is because outsourcing makes an organisation more agile and flexible which makes them sustain in the changing marketing conditions and challenges.
Figure 3: Benefits of Outsourcing Logistics to a 3PL, 2023
(Source: Beyound warehousing, 2023)
Risks
Opting out for outsourcing can also have some risks attached to it such as:
Quality of service delivery: When an organization carries out all their functions internally, the quality is insured according to the company standards (Tian and Guo, 2019). However, Outsourcing can sometimes fall below expectations or below time also.
Security and confidentiality: Providing the business function or operational activities to 3rd party service providers raise a risk of data security and confidentiality. For example, if a beverage company hires a manufacturing outsourcing company, then ingredients are recipe of their product may be at risk.
Management issues: Since the third parties are an outsourcing company, management is not in the hands of the major company which makes it difficult (El Mokrini and Aouam, 2022). Increasing conflicts because of changing management in the outsourcing company can lead to issues.
Instability: One of the major risks which businesses should consider before hiring in 3rd party organisations for outsourcing their business function or business application is the stability of the company. Outsourcing companies can go out of business which can create severe issues for the company.
3. Outsourcing for DB toys
3.1 Is outsourcing a viable option for DB toys?
Since DB toys have been struggling in the 2000 because of decreasing annual sales and market share, this has created several problems for the CEO Liz Jackson as well as the company itself. With the decreasing market share, the CEO identified that the spending on the supply chain activities was half of the entire IT budget on supply chain alone. Which amounts to almost 30 million a year. This creates a significant need to cut costs in the field of supply chain for the company to sustain in the competitive environment.
According to Yao et. al. (2018), supply chain outsourcing can have several benefits including cost cutting, which is the major the goal of DB toys currently. Outsourcing can help with different functions integrating with each other such as customer service, stock analysis and inventory management with efficiency. It is significant for DB toys to choose the option of supply chain outsourcing because of the following reasons:
Lack of focus on core competency: Because the company has been facing decreasing market share, the top management has been struggling to focus on the core competency of the business. The top management has been facing issues related to the high cost in order to sustain in the competitive market. According to the case study, the competitor’s revenue has been growing from $4.6 billion in 1999 to $4.7 billion in 2000. This shows an increase in market share. Whereas the revenue of DB toys falling from $1.7 billion two $1.5 billion is also a risk to the market share.
Help in competitive advantage: By opting out for a supply chain outsourcing option, DB toys will not only reduce their costs and increase efficiency but also gain a competitive advantage in the industry. The new entrants in the industry were penetrating the market with super low-cost production facilities. Which can be tackled with outsourcing the supply chain activities which amounted to almost $30 million and providing a third-party service provider to manage the supply chain. This will allow the top-level managers to focus on the core competences as well as increase their market share.
Help in controlling the cost: According to the case study of DB toys, the cost of supply chain activities amounts to almost $30 million which is a significant concern for the company as it is more than half of the entire it budget. By hiring a third-party supply chain manager, in this case Inflection, can allow DB toys to leverage their amenities and facilities in order to integrate the supply chain management with highly functional chain. Moreover, by opting out for supply chain outsourcing, DB toys can also leverage the expertise of Inflection in supply chain (Bhattacharyya and Mandke, 2021). Inflection has more than 200 outsourcing clients across the globe which can have a positive impact on the supply chain efficiency of DB toys.
Help in extend resources. By opting out for supply chain outsourcing to Inflection, DB toys can extend their resources by leveraging the amenities of Inflection. Inflection would provide infrastructure related to IT services such as LAN and WAN, computer systems with windows 2000 and an ATM network. It will also provide hosting services like web hosting to manage and operate the servers.
Supply chain outsourcing is a viable option for DB toys because their supply chain expenses are exorbitant. By opting out for the supply chain sourcing, DB toys can ensure the above benefits which are currently creating issues for the company.
3.2 Best outsourcing proposal for DB toys and their pricing alternatives
Out of the business application outsourcing and business process outsourcing options, the option one of business application outsourcing is the best alternative for DB toys. This is because of the benefits of the option. There are several reasons which makes the first option of business application outsourcing the most suitable for DB toys such as:
- Johnson who has been working in the IT industry for several years supported the first option and believed that by outsourcing the maintenance of the existing supply chain applications to Inflection can help DB toys to save a lot. By gaining the expertise of Inflection and the large-scale capacity of the company, DB toys can ensure a more efficient management of their IT applications which would allow the staff members to focus on attaining the lost market share.
- Another advantage of the first option is that the upfront fee is less than the option two. The upfront fee of the first option is $6 million whereas the second option requires and upfront fee of $34 million. This shows that the initial rate of investment is lower in the case of option one which makes it more lucrative. However, it is important to analyse the return on investment of the option. This will be calculated in the further sections of the report.
- Another reason why the option one is more lucrative for DB toys is the immediate savings of 20% every year on the spending of supply chain. Whereas the option two of Inflection will generate savings only after the nine months build phase. According to Devarakonda, (2019), the time of return of savings generated from an investment should be lower in order for it to be feasible for an organisation. This makes the option one more appropriate for DB toys.
- Another reason why the option one business application outsourcing is better for DB toys is the fixed rate per quarter which is $9.3 million for option one whereas for option two it is $11.7 million per quarter. This will result in an increase in costs for the company which would have an impact on the ROI. According to Edelheim al. (2018)) impact on the return on investment is often because of the increasing cost of the company.
- Under the transaction-based contract pricing, the option one won again. This is because the cost per purchase order for option one would be $55 whereas for option two would be $62. This will again result in an increase in cost for DB toys which would result in a decreasing return of investment.
As identified above, the first option is cheaper as compared to the second option which has more cost attached to it. Not only the upfront fee is high for option two, the cost per purchase orders, fixed rate for every quarter are also higher for the second option. This shows that the option one has lower costs attached to it. On the contrary Dadd and Hinton, (2022) suggests that investments with lower costs have a higher return on investment because of the lower cost. This can help DB toys in tackling their issue of decreasing sales by controlling the costs as well as increasing the efficiency of their supply chain.
For the chosen option the fixed price method would be the best because the client in this method provides a predetermined fee on the basis of a specific fixed scope. In this method the client is benefitted by the pricing option as the risks is related to the project delay and the actual costs is incurred are carried by the outsource provider (Hanafi, 2021). However, the client needs to forfeit any sort of benefit from the potential operation of the cost reduction that are provided. In order to do so the client needs to pay the contract fees to the provide in order to complete the work and also be able to ultimately end up paying the better services prior to the experiences which are related to the benefits. DB Toys will be able to attain immediate benefits by outsourcing through this pricing method. Under this method the DB Toys as the obligation for paying inflection in the fixed rate every quarter to support company in the supply applications. The fixed pricing for the would be essential for the providing benefits. However, it has the risk of increasing the complexity which is the fixed rate of $9.3 million every quarter. Moreover, under the fixed-price alternative, DB toys will also have to pay $4 million for each $0.01 increase in the yearly EPS. This is good for DB toys, as it is comparatively less from the cost-based pricing alternative.
4. Calculations of ROI of the two outsourcing options
Although, the cost of the first options are less for DB toys, as compared to the second option, it may not necessarily be the most feasible. According to Dadd and Hinton, (2022), low costs may not necessarily result in a higher ROI, as it also depends on the savings or return gained.
4.1 Option 1
Up-front fee: $6 million
Annual fees: $9.3 * 4 = $37.2 million
Annual savings: 20% of $30 million = $6 million
ROI = Net income / Total Cost*100
Net Income = Total income – Total costs
Net Income = $6 million – $37.2 million – $6 million = -$37.2 million
Therefore, ROI for option 1 is:
ROI = 37.2/6*100
ROI = 620%
4.2 Option 2
Up-front fee: $6 million + $28 million = $34 million
Annual fees: $11.7 * 4 = $46.8 million
Annual Run costs = $25 million
Annual savings: 2% of $30 million = $6 million
ROI = Net income / Total Cost*100
Net Income = Total income – Total costs
Net Income = $6 million – ($46.8 million + $28 million + $34 million) = -$102 million
Therefore, ROI for option 1 is:
ROI = -102.8/6*100
ROI = -1713%
5. Summary of the strategy of outsourcing and potential impact of outsourcing model on supply chain metrics
5.1 Summary of the strategy
From the above, analysis of both the options for outsourcing supply chain activities or applications to inflection, it is clear that the first option of business application outsourcing with the Fixed rate pricing method is the most feasible for DB toys. The outsourcing strategy according to the first option would be to outsource all the existing supply chain applications to Inflection. This will ensure that Inflection ahs the necessary resources needed to effectively manage the supply chain for DB toys. Inflection will bring their large-scale operations with more than 200 plus clients, and their expertise in supply chain management. It will ensure that the staff of DB toys are focused on more important factors to increase their revenue and market share. This strategy will reduce the system downtime for DB toys also, which will increase the overall productivity of the company.
From the above analysis it is clear that DB toys should opt for the option one of business application outsourcing as the return on investment is less for that options as compared to the second option. Although both the return on investments are negative, showing that both of them are not viable for DB toys, the increasing growth rate of purchase orders as projected can turn the investment into positive offer (Rossman et. al. 2019).
5.2 Potential impact on supply chain metrics
The above outsourcing strategy will help DB toys to reduce their costs and improve overall efficiency. Moreover, it will also result in impacts on the supply chain metrics such as:
- Inventory reduction: With the help of the new outsourcing strategy, Db toys will be able to reduce the inventory since the total inventory time will reduce for DB toys by around 20 %. With Inflection handling the applications, their expertise will ensure that the company is able to manage their inventory well.
- Improved customer service: The customer service will also decrease by 8% because of the on-time delivery. Often delays in deliveries lead to unsatisfied customers (Imani al. 2020).
- Reduced operational costs: With efficient supply chain applications, DB toys will reduce their order lead time which will result in reduction in their operating costs. This will also enhance the order lead time to reduce from 90 to close to 33 which is the best practice.
- Revenue growth: The revenue growth for the company is expected to be around 10 % since the increased customer satisfaction is expected to be 8% which will lead to increased sales. Moreover, the staff of DB toys can now focus on product develop strategies to increase their revenue also.
6. Conclusion
With the help of the above report, it can be summarized that the most viable option for DB toys in challenging times of reduced market share and revenue is to outsource their supply chain. The report analysed the benefits as well as risks of supply chain outsourcing for DB toys which shows that the company should opt for outsourcing as it helps in maintaining focus on core competency, increases efficiency and reduced costs. The business application option is decided to be the best alternative as it has a higher ROI, whereas the Fixed price strategy will ensure a healthy cash flow for the company. This supply chain outsourcing strategy also has potential impacts such as enhanced revenue, customer satisfaction and reduction in inventory levels and operational costs.
7. References
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