MANAGING ORGANIZATIONS

PGP 2012-14 Section C & ETerm 1:June-September 2012

Sourav MukherjiAssociate Professor of Organization & StrategyIndian Institute of Management Bangalore, India

Session 11: Inter -Organizational Relationships

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Will Robert Lutz succeed in his dream of producing America’s first luxury racing car without creating an organization ?

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• Dream of selling a super luxury car from the US, to compete with Ferrari and Aston Martin

Price : US$ 250000 Target : 600 cars per year• Need to keep startup costs low: 20 employees • Extreme example of an organization that plans to outsource all activities of the

value chain , from engineering, to final assembly to shipping• Internet based information systems to link all members in the value chain designers – chassis developer - part manufacturers – assemblers – fabricators –

manufacturers• One of the partners, Briggs S Cunnigham III is the son of a racing legend

SOME IMPLICATIONS

• Cunnigham Motors does not intend to control either the material flow or the information flow - at any stage of the value creation process• Organization might derive some benefit (brand recall ) due to its association with son of a racing legend

QUESTIONS BEFORE THE CLASS• Will Cunningham Motors succeed and Robert Lutz’s dreams be realized ?• Will this model of “extreme outsourcing” succeed in the automobile industry ?

CUNNINGHAM MOTORS COMPANY: CASE FACTS

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Modularity and standardization

of outputs

• Tasks which have clearly defined output parameters (e.g., engineering goods) are easier to outsource than tasks that are characterized by performance ambiguity (R&D , brand building). Self contained modules are easier to outsource, even if they are knowledge intensive – a characteristic of the overall architecture

Drawing and enforcingcontracts

• Market relationships are premised on contracts. There are costs associated with searching for the right set of partners, negotiating terms of contracts with them and then being in a position for enforcing terms of the contracts, in case of breaches

Possibility of opportunistic

behavior

• Overall system can suffer from shocks and collapse if buyers / suppliers behave opportunistically. This might happen due to

• uneven bargaining power• asset specific investment• inadequate safeguards against information spillover

Conditions of uncertainty

• Pure market contracts fail to anticipate complications of uncertainty and are often difficult to implement under such conditions

• Organizational hierarchies are often suitable to overcome the above problems

Organizations get formed when markets fail

CONDITIONS FOR OUTSOURCING

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5A NEW WAVE IS SWEEPING ACROSS THE BUSINESS WORLD

Bharti Televentures has outsourced its network management to Ericsson & IT management to IBM

Kingfisher Airlines has outsourced its ground handling facilities to Indian Airlines

Hindustan Levers have outsourced its human resource management to Accenture

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6WHY IS EVERYBODY THINKING ABOUT OUTSOURCING ?

Outsourcing leverages the benefits of specialization

• Not about core versus non-core• Not only about cost reduction

Outsourcing today is about value maximization

• Enabled by widespread availability of information and information technology• Possible to separate the physical flow of resources from flow of information

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7FOUR STRATEGIC REASONS FOR OUTSOURCING

Cost Minimization

Accessing superior competencies and privileged assets

Superior resource leverage

Risk diversification

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While these are collectively exhaustive, they are not mutually exclusive

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8COST EFFICIENCY CAN ARISE FROM VARIOUS SOURCES

Cost Minimization

Accessing superior competencies and privileged assets

Superior resource leverage

Risk diversification

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Moving beyond arbitrage

Manufacturers derive scale economies by demand aggregation

Services derive better utilization by demand aggregation

Specialization and greater scale enablinginnovation and automation, which finallyleads to greater efficiency

Superior value at competitive prices

Challenges of managing scale, varietyand developing superior processes

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9ACCESS RESOURCES THAT ARE DIFFICULT OR UNECONOMICAL TO BUILD

Cost Minimization

Accessing superior competencies and privileged assets

Superior resource leverage

Risk diversification

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Complementary assets take time to build.Such time cannot be afforded when timeto market is critical

- pharmaceutical distribution network

Privileged assets are difficult to create- airport ground handling facilities

Certain competencies are required onlyfor a short duration. Owning them resultsin loss of flexibility

- strategy consulting

Many of these command a price premiumrather than being available at low cost

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10LEVERAGE RESOURCES TO MAXIMIZE VALUE ADDITION

Cost Minimization

Accessing superior competencies and privileged assets

Superior resource leverage

Risk diversification

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Review of activities within each function to determine which among them are

- transaction intensive, non specific to organization, have scale economies- specific to organization

A specialized player might be in a better position to do certain activities within the function. Therefore, ideal for outsourcing.

Organization resources are better leveragedto focus on activities which are specific to the organization

Not a matter of ‘core’ versus ‘non-core’ butdetermining where is it that the organizationcan add value

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11PORTFOLIO OF CLIENTS TO MINIMIZE DEMAND VOLATILITY

Cost Minimization

Accessing superior competencies and privileged assets

Superior resource leverage

Risk diversification

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Outsourcer maintains a portfolio of clientswhose demand profiles are uncorrelatedwith one another

Transfer resources from one client projectto another depending on demand

Possible only if skills are fungible

Application in people intensive service business

- critical driver of scale

Minimizes risks arising out of demand volatility that the client would not have been able to do on their own

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12OUTSOURCING HAS ITS COSTS AND RISKS

Application of transaction cost theory to build a decision framework

Transaction specific investmentscreate potential for opportunisticbehaviour leading to an increasein negotiated prices

Costs of searching, drawing, negotiating end enforcing contracts

Costs get escalated when there is business uncertainty

Risks of knowledge spillover and divulgement of sensitive information,often tacit and complex in nature

Disruptive effect of supply shocks on business, where contractual compensation might not be a sufficient safeguard

Production costwithin organization

Production cost ofmarket

Other relatedorganizationalcosts

Transactioncosts

Strategicrisks