Giving Insourcing a New Edge

Juan Luis Martínez. Professor. Instituto de Empresa and José Gavidia. Professor. College of Charleston.

4 May 2006

Many companies are moving beyond their markets to offer their clients new services that improve efficiency and reduce costs and which were traditionally performed by outside professionals. This process is known as insourcing.

Insourcing occurs when a company decides to carry out internally a task that traditionally was performed by outsiders. In this way, the company uses a competitive advantage to gain greater overall efficiency in its business. Coase’s transaction costs theory foresaw the potential of this type of initiative. According to this neo-institutional theory, organisations seek to reduce transaction costs, either through outsourcing or through insourcing, depending on which proves more cost efficient for the company. Insourcing can best be understood within this framework. Indeed, the Value Chain is now a key concept for understanding what forces are driving this new business technique. Companies do not insource just any activity but rather only those that if performed in-house will provide value added for the client, be it in terms of cost or of efficiency. This process of performing tasks internally—rather than farming them out to other companies--is the exact opposite of outsourcing.

This new process requires a redefinition of what constitutes a sector or industry. It is no longer a group of companies that work towards satisfying a single need, but rather a group of companies that share the same professional capabilities and are efficient at carrying out similar tasks, known as Competitive Domain.

UPS (the United Postal Service) is a perfect illustration of this idea. Long known as a transport company, UPS now takes advantage of its world logistics network to offer services that have traditionally been the domain of other sectors. For example, when a client sends a Toshiba computer to be repaired, he or she sends it via UPS. But instead of Toshiba undertaking the actual repair, UPS (and Toshiba) take advantage of UPS’ own personnel and national distribution centre to repair the computer quickly and efficiently. Because the computers aren’t sent to Toshiba, the process results in a reduction of both costs and execution time. UPS has set up assembly lines within its logistics system to ensure maximum flexibility, speed and efficiency.

To ensure its success with insourcing, a company should develop new resources and combine them with existent strategic advantages. UPS has succeeded at this by using its logistics network to carry out assembly, repair and recycling operations. Companies that fail to add this feature to their operations may lose business by having to farm out specific tasks to more efficient corporations. On the other hand, companies that are able to combine existing areas of capabilities will see their business grow and expand into fields traditionally considered outside their usual scope of business.

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