1. MANAGING ORGANIZATIONS
Session 11:
Inter -Organizational Relationships
Sourav Mukherji
PGP 2012-14 Section C & E
Associate Professor of Organization & Strategy
Term 1:June-September 2012 Indian Institute of Management Bangalore, India

2. 2
Will Robert Lutz succeed in his dream of producing America’s first luxury
racing car without creating an organization ?
© S Mukherji

3. 3
CUNNINGHAM MOTORS COMPANY: CASE FACTS
• 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 ?
© S Mukherji

4. CONDITIONS FOR OUTSOURCING 4
Modularity and • Tasks which have clearly defined output parameters (e.g., engineering goods) are
standardization easier to outsource than tasks that are characterized by performance ambiguity
of outputs (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 • Market relationships are premised on contracts. There are costs associated with
enforcing searching for the right set of partners, negotiating terms of contracts with them and
contracts then being in a position for enforcing terms of the contracts, in case of breaches
Possibility of • Overall system can suffer from shocks and collapse if buyers / suppliers behave
opportunistically. This might happen due to
opportunistic • uneven bargaining power
behavior • asset specific investment
• inadequate safeguards against information spillover
Conditions of • Pure market contracts fail to anticipate complications of uncertainty and are often
uncertainty difficult to implement under such conditions
• Organizational hierarchies are often suitable to overcome the above problems
Organizations get formed when markets fail
© S Mukherji

5. 5
A 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
© S Mukherji

6. 6
WHY 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
© S Mukherji

7. 7
FOUR STRATEGIC REASONS FOR OUTSOURCING
1 Cost Minimization
Accessing superior
2
competencies and
privileged assets
3 Superior resource
leverage
4 Risk diversification
While these are collectively exhaustive, they are not mutually exclusive
© S Mukherji

8. 8
COST EFFICIENCY CAN ARISE FROM VARIOUS SOURCES
Moving beyond arbitrage
1 Cost Minimization Manufacturers derive scale economies by
demand aggregation
Accessing superior Services derive better utilization by
2 demand aggregation
competencies and
privileged assets Specialization and greater scale enabling
innovation and automation, which finally
3 Superior resource leads to greater efficiency
leverage
4 Risk diversification
Superior value at competitive prices
Challenges of managing scale, variety
and developing superior processes
© S Mukherji

9. ACCESS RESOURCES THAT ARE DIFFICULT OR 9
UNECONOMICAL TO BUILD
Complementary assets take time to build.
Such time cannot be afforded when time
1 Cost Minimization to market is critical
- pharmaceutical distribution network
Accessing superior Privileged assets are difficult to create
2
competencies and - airport ground handling facilities
privileged assets
Certain competencies are required only
for a short duration. Owning them results
3 Superior resource
in loss of flexibility
leverage - strategy consulting
4 Risk diversification
Many of these command a price premium
rather than being available at low cost
© S Mukherji

10. 10
LEVERAGE RESOURCES TO MAXIMIZE VALUE ADDITION
Review of activities within each function
to determine which among them are
1 Cost Minimization
- transaction intensive, non specific
to organization, have scale economies
Accessing superior - specific to organization
2
competencies and
A specialized player might be in a better
privileged assets
position to do certain activities within the
function. Therefore, ideal for outsourcing.
3 Superior resource
leverage Organization resources are better leveraged
to focus on activities which are specific to
the organization
4 Risk diversification
Not a matter of „core‟ versus „non-core‟ but
determining where is it that the organization
can add value
© S Mukherji

11. 11
PORTFOLIO OF CLIENTS TO MINIMIZE DEMAND VOLATILITY
Outsourcer maintains a portfolio of clients
whose demand profiles are uncorrelated
1 Cost Minimization with one another
Transfer resources from one client project
Accessing superior to another depending on demand
2
competencies and
Possible only if skills are fungible
privileged assets
Application in people intensive service
3 Superior resource business
leverage - critical driver of scale
4 Risk diversification
Minimizes risks arising out of demand
volatility that the client would not have
been able to do on their own
© S Mukherji

12. 12
OUTSOURCING HAS ITS COSTS AND RISKS
Application of transaction cost theory to build a decision framework
Transaction specific investments
create potential for opportunistic Strategic
behaviour leading to an increase Other related risks
in negotiated prices organizational
costs
Costs of searching, drawing,
negotiating end enforcing contracts Transaction
costs
Costs get escalated when there
Production
is business uncertainty cost
within
Risks of knowledge spillover and organization
divulgement of sensitive information, Production
often tacit and complex in nature cost of
market
Disruptive effect of supply shocks
on business, where contractual
compensation might not be a
sufficient safeguard
© S Mukherji