Make-or-Buy Decisions in Aerospace Organizations

Robert A. Goehlich

Make-or-Buv Oecisions in Aerospace Organizalions

GABLER EDITION WISSENSCHAFT

Robert A. Goehlieh

Make-or-Buy Decisions in Aerospace Organizations Essays on Strategie Effieieney Improvements

With a foreword by Prof. Dominique Demougin. Ph.D.

GABLER EDITION WISSENSCHAFT

Bibliographie information published by the Deutsche Nationalbibliothek The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographie data are available in the Internet at hltp://dnb.d-nb.de.

Dissertation European Business School, International University Schloss Reichartshausen. Oestrich-Winkel, 2008

01540

1st Edition 2009 All rights reserved © Gabler I GV'N Fachverlage GmbH, Wiesbaden 2009 Editorial Office: Claudia Jeske I Britta Göhrisch-Aadmacher Gabler is parl of the specialist publishing group Springer Science+Business Media. www.gabler.de No part of this publication may be reproduced, stored in a retrieval system or transmilted, in any form or by any means, electronic, mechanical. photocopying, recording, or otherwise, without the prior written permission of the copyright holder. Aegistered and/or industrial names, Irade names, trade descriptions etc. cited in this publication are part of the law tor trade-mark protection and may not be used free in any form or by any means even if this is not specitically marked. Cover design: Aegine Zimmer, Oipl.-Oesignerin, Frankfurt/Main Printed on acid-free paper Prinled in Germany ISBN 978-3-8349-1530-6

Forcword Roben A. Gochlich's doctorallhcsis analyzes Ihc incfficiencies in today's organillllions and Ihe polenlial explanalions for them. Aeeording 10 the thesis. Ihese ineOicieneics may bc rooted in corporale gOllcmanec. at leaSI panly as a rcsult ofpolilieal considcrations. as lI'ell as for reasons rclattd 10 the individuals involved and 10 globali7..ation. Spccifieal1y. the thcsis focuscs on Ihe make-or-buy dccision lI'ithin aerospaee organizations. The sceond ehapter olTers an eXlensive overview ol"the eurrcnl aerospaee scelor lrum an cconomic point 01" vie\\', The chaplcr has bencfited from Ihc background 01" lhc authoT. who has an exlensive 1I'0rk expcrienee lI'ilh JAXA. NASA and EADS. Tlte lltird ehapter presents the outsourcing strategies that hallC been employed by spacc organiwlions in Europc. tltc US and Japan. Tltc cltaptcr includcs valuable information with respcet 10 existing thcories on lhe makc-or-buy dccision and its interaelion lI'ith rcspcct to Ihc acrospace induSll)' in Ihc "big lltrec" rcgions of tltc world. Tlte lilerature used is weil explained and ils rclationsltip to dccisions of organi7..alions in lhc spcci/ie conlcxt analyzcd is well dcscribed. Thc fourth chapler dcscribes U Iltcory-bascd dL'Cision process and suggcsts a \'cT)' useful 1001 for guiding managemenl in ils makeoQr-buy dL'Cision process. The tool is designcd to induce Iransparency in a modular fashion, MClhodologically, lhe chapter presenls scquenlially each of the arguments related 10 makc vcrsus buy: Ihe pros and eons of IIcnical integration and outsourcing. Eaeh of Ihe tool' s dimensions Itas a Ihorouglt tltL'ürclieal foundalion with II solid underpinning in Ilte exisling lilCnllurc. The eomprehcnsillc method cmploycd by Ihis 1001 guarantces Ihat management will bc forccd 10 lhink Ihrough each of the possiblc pros and L'üns of olilsoureing IICrsUS intcgration. Ineluding argumenls for or againsl outsourcing in llte 1001 is simplifiL'd bccause lhe tool is SlruClurcd in modulcs, Although dcve10pcd for Ihc acrospace induSII)'. usc ofthc 1001 is by no means reslrieled 10 tllat illdustT)'. Overall. the thesis is weil written and prollides a very lIseful management tool for guiding Iltc nmke-or-buy dccision proeesscs in organiwlions. Prof. Dominiquc Dcmougin. Ph.D. 1·lead of Depanment of Lall'. Govemanee & Economics Emopcan Business School

Acknowlcdgements I would likc to thank my doctoral supcrvisor, Prof. Dominiquc Demougin of thc Europcan Business School, Dcpanmcnt of Law, Govcmanec & Economics, for the chance to pursue my doctoral studies under his supervision. His advice and guidance for finding the "path to bccoming an cconomist"' over the last years, starting from our first mccting in summer 2004, combined with the freedolll to develop creativlty in these studies, has been a very stimulating combination to me. My acknowledgement gocs to Prof. Andre Schmidt, field of international cconomic policy at the Europcan Business School, for his ideas, time and efron as a sccond advisor. His view ofeconomic policy in our meetings has given me a unique chance to incorporate them within my thesis. I am appreciative to the chairman of my doctoral eommil1ce, Prof. Hartmut Kreikcbaum, fic1d of business ethics and the membcrs, Prof. Stefan Waller and Prof. Michael Hcnkcl, field of supply chain management at the European Business School for accepling my thesis and the time spent on evaluations. I wish to thank Prof. Rose Rubin, University of Memphis, for helpful comments to the charactcristics ehapter. Many thanks go to Dr. Vcikko Thicle, University of British Colmnbia, for reviewing the case study chapter. Prof. Ralf Bebenroth of Kobe Univer· sity is the co-all1hor ofthis slUdy. I am very grateful for the opponunity to conduct research on this topic with him and for many fruitful discussions as a good friend. Valuable comments from Prof. Benjamin Bental of the University of Haifa on the make-orbuy decision chapter are highly appreciated. I would like to express my sincere thanks to my colleagues Dr. Sabine Altiparmak, Gudrun Fehler, Petra Ernst and Clemens Buchen of the Europcan Business School for their valuable comments on my thesis and research col1oquiutn regarding content and language, for being so supportive, and for providing a friendly working climate in the dcpartment. I would also like

{O

thank the panicipants at the 4th International Conference on

Economics and Globalizalion (EcoTrend) 2007 held in Targu Jiu, the International Conference on Applied Business Research (lCABR) 200S held in Accra and the ISth International Conference of International Trade & Finance Associalion (IT&FA) 2008 held in Lisbon for Iheir comments and suggestions.

viii

Aeknowledgements

My thanks to my fonner colleagues, Prof. Anja Sehöttner, Dr. Ria Steiger, Dr, Jcnny Kragl and Dorothee Schneider of the 2007 disbanded Walther Rathenau Institute for Organizmion Theol)' at Humboldt University at Berlin for the niee working elimate and answering evel)' silly question a new eeonomist eould have. Last, and most importantly, I would like to thank my parents, Rosemarie and Lothar Goehlieh, withOllt whom I would never have been able to aehieve so mlleh and who taught me to stay the course even when it is vel)' challenging. In panicular, I want to thank my girlfriend Naoko Ogawa, my parcnts and my sister Anja Wollenberg, for being so patient; the leisure time we spent together was definilely too Iillie in the last years. This research has been supported by the Alcxander von Humboldt Foundation, which is gratefully acknowlcdgcd, The views reported in this thesis are those ofme alone, and not those of any institution. All eITors and omissions, whieh may unwittingly rcmain, are the sole rcsponsibility of mc.

Roben A. Gochlich

Abstract Today's organizmions sufTer from ineffieiencies that may oceur for any number ofreasons. lnemeieneies may: bc rootcd in the eorporate govemance of an organization, result from politieal reasons, be due to individual reasons, and result from globalization as weIl. This study focuses on the strategie aspeets of deeision-making within aerospace organizations, eoneentrating on the make-or-buy deeision in an atlempt to examine organizational efficiencies. The present study ineludes an understanding of the existing or· ganizational structures of aerospace enterprises, and whi1c searehing for emeieneies, diseusses strategies to avoid inefficiencies and investigates the potential for implementing reeommendations into praetiee. The main rcsult ofthe study is the fonnation ofa process, in the fonn ofa eomputerizcd tool, that handles approximalely 50 propositions of make-or-buy decisions, systemmieally eonneeted to strategie objeetives, and organizational, produet and environmental ehar3eteristies. The strength of this process lies in its ability to eover the entire spcetrum of make-or-buy (the continuIIm from in-hollse to blly-ofT-thc-shelf) in order to suppon deeision-makers with holistie recommcndations. This proeess allows one to detennine the kind of organi7.ational arehiteeture that is best suited 10 a speeified activity.

The resuhing tool is applicd tO four ease studies taken from the aerospaee seetor: (A) Copy maehine usage (as a referenee), (B) Aireraft final assembly produetion, (C) Satellite rocket launeh operation and (0) Spaee tourism rocket development. In three of the four eases, the make-or-buy deeision [hat is reeommended by the tool mirrors instinctual, expcrienee-based eonclusions. lt is also shown that a well eonsidercd make-or-buy deeision approach is paramollnt to overcoming opcrational ineffieiencies for aerospaee organi7.ations. Keywords:

Aerospaee Organization, Aviation, Corporate Govemanee, Game Theory, Make-or-Buy Decision, Outsoureing, Strategy, Spaee, Venieallntegration

JEL Classifieation:

L25, 023, L93, C72, M55

Statisties:

136 pages, 23 figures, 15 tables, 182 rcferenees

Contaet:

E-mail: [email protected]

Table of Contents Foreword

v

Acknowledgemcn Is

\'ii

Abstract

ix

Tablc ofConlents

xi

list uf Figures and Tables

xiii

list or Abbrevialions

X\'

Definitions ...•.........•........................•.........................••......•..................................•......• x\,ii

2

3

Inlroduclion

1

1.1

1

Motivation

1.2

Structure and Analylieal ProceduTC

1.3

Thc Need for Effieiency, Organizmions and Multinational Acting

2 .. 3

Economic Characleristics or Aerospace Organizalions 2.1

lntroduction

2.2

Characleristics

7 7

. , , ,.. , , , ,..

... , , , ,.. , ,8

2.2.1

General....

2.2.2

Markel Struclllrc

2.2.3

Products .......

2.2.4

Contractor Classilicalion

2.2.5

lndustry Sizc

11

2.2.6

Organizational Arehiteeture

13

2.2.7

Pcrfonnanec

2.3

Diseussion...

2.4

Rcsults .......

.

8 9

,..

., , 9

, , ,....

.. 10

.., ,

20 ..

.... 21 ...23

Oulsourcing Stralegies in Europe, USA and Japan: A Case or Space .,.........••.•.. 25

Organizations 3.1

lnlroduction

, , , , , , , , ,..

.

3.2

Theorctical Approaches for Outsourcing.......

,

..

, , ,

, ,

25 27

3.2.1

General

27

3.2.2

Transaetion Cost Theory

3.2.3

Principal.Agent Thcory...

...28

3.2.4

The Human ResouTCc-bascd View

... 29

27

Tabte ofContents

Xll

3.3

3.4

Case Study of Spaee Organi7..ations ..... 3.3.1

General

4

.

30

3.3.2

Europe

32

USA

33

3.3.4

Japan

34

Diseussion

.... 35

General........................

..

35

3.4.2

Understanding of Coherenees

3.4.3

Alternative Theories

.

36

3.4.4

Limitations..

..

36

Results

37 ..37

Development of a Make-or-BlIY Decision-supporting Proeess

39

4.1

lntroduetion

39

4.2

The Proeess.

....41

4.2.1

General

....41

4.2.2

Qualitative Assessment.............

4.23

Quantitative Assessment...

43

4.4

4.5 5

,.............

3.3.3

3.4.1

3.5

30

.. .. .. ,

Application ofProeess 43.1

General................................

43.2

Case Studies

433

Results

45 72

..

78

..

78 ... 79 .

,

80

Diseussion

87

4.4.1

General

87

4.4.2

Choiee of ltems for "Settings" Submodule

4.4.3

Sensitivity Analysis

. 88 .... 89

87

4.4.4

Infonnal Versus Fonnal Statements.

4.4.5

Comparison With Other SlUdies

90

4.4.6

Limitations

92

Results

Concillsion

..

93 95

References ..•................................................................•........................................•........ 99 Abollt the Allthor

117

List of Figures and Tablcs Figure I:

Research Strueture

2

Figure 2:

Investigmcd Charaeteristies of Aerospaee Organizations

8

Figure 3:

Nurnber of Manufacturing Plants and Associatoo Revenue for the US Aerospaee Industry (US Department ofCommerce, 1995)

Figure 4:

Dircct Labor Requirement and Annual OutpUl for Lockheed LIOll Aircraft Production (Benkard, 2000)

Figure 5:

12 16

.

Vision Versus Realit)' ofSpace Shuttle Operation (NASA, 2000b)

.. 18

Figure 6:

Illustration of Organi7Altionai Architectures

... 39

Figure 7:

Overview ofthe Make-or-Bu)' Oecision-supporting Process

.42

Figure 8:

Settings Submodule....................

..42

Figure 9:

Integration Pros Submodule

Figure 10: OUlsourcing Pros Submodule.

.43 .

Figure 11: Results Submodule.

.44 ..

.45

Figure 12: Exampleofa Vertical Integration Proposition

.45

Figure 13: Potential-probability Matrix for Vcrtical Integration Figure 14: Pmential.probability Matrix for Outsollrcing.............

73 .

75

Figllre 15: Integration and Outsourcing Sllb-bcnefit for Each Setting ltern (ResOl Output Mask)...

..78

Figllre 16: Application ofthe Makc-or-Bu)' Decision-supporting Process

80

Figllre 17: Extract frorn the MoB-Tool

81

Figure 18: Sub-benelit for Case Stud)' "(A) Copy Machine" (Rcs02 Output Mask)

84

Figure 19: Sub-bcnelit for Case Study "(8) Aireraff' (Rcs02 Output Mask)

84

Figllre 20: Sllb·benelit for Case Study "(C) Satellite" (Res02 Output Mask)

85

Figurc 21: Sub-benelit for Case Study "(0) Space Tourism" (Rcs02 Output Mask)

85

Figure 22: Outsoureingllntcgration Total Bcnefit Ratio (Rcs03 Output Mask)

86

Figurc 23: Rcsult ofSensitivity Analysis

.

89

List ofFigures and Tables Table I:

Typieal Aviation Market Strueture (marked in gray)

Table 2:

Typieal Spaee Market Strueture (marked in gray)

"

,,,.,

9 9

Table 3:

PrimaT)' Aerospaee Produets

Table 4:

Classifieation of Aerospaee Contractors

... I0

Table 5:

Plant Size Distribution ofUS Aviation Industry (modified from: US

Table 6:

Plant Size Distribution ofUS Spaee Industry (modified from: US

Table 7:

Aerospaee Companies Ranked by Revenue (based on: Anselmo, 2005)

20

Table 8:

Comparison of Space Market Structures for Commercial Launehers

31

Table 9:

Ycnical Integration Propositions

11

Depanmenl of Commeree, 1995)

.

Dcpanment ofCommcrcc, 1995)

Table 10: Outsourcing Propositions ....... Table 11:

.

" " . ".........

13

73 .. 74

Integration Pros Submodule ..

Table 12: Olltsourcing Pros Submodule

13

... 76 .

77

Table 13: Scttings Submodu1c (Input Mask 113)

82

Table 14: Settings Submodulc (Input Mask 2/3)

82

Table 15: Settings Submodule (Input Mask 313)

... 83

List of Abbrcviations ave.

average

BS

bmion US dollars

BERI

Business Environment Risk Index

BLS

Bocing Launch Services

eee

China Compulsory Certifieation

CEO

Chief Exeeutive Offiecr

CNES

Ccntrc National d'Etudes Spatiales

CSA

Chinese Spaee Ageney

EADS

European Aeronautic Defense and Spaee Company

ESA

European Space Agency

LU

European Union

FFP

Finn-Fixed Priee eontract

FPIS

Fi:<ed-Price Incentive Successive targets contract

GECAS

General Electrie Commcrcial Aviation Services

GDP GPS

Gross Domestie Product

GTO

Geostationary Transfer Orbit

[H[

Ishikawajima Heavy lndustries

ILFC

International Lease Finanee Corporation

IR&D

Investor Relations & Dcvelopmcnt

ISAS

Institutc of Space and Astronautical Science

[SO

International Organization for Standardi7.ation

ISRO

Indian Space Research Organization

ISS

International Space Station

JAXA

Japan Aerospace Exploration Ageney

KP[

Key Perfonnance IndicalOr

LEO

Low EaJ1h Orbit

LSE

Large Scale Enterprise

MS

million US dollars

Global Positioning System

MH[

Mitsubishi Heavy lndustries

"

number of units built

xvi

List of Abbrcviations

"0.

number

NAL

National Aerospace Laboratory of Japan

NASA

National AeronaUlics and Space Administration

NASDA

National Space Development Agency of Japan

NPV

Net Present Value

P R&D

1caming rate

RLV

Reusable Launeh Vehicle

Research and Development

RSA

Russian Spaee Ageney

SRB

Solid Rocket Booster

SSME

Spaee Shullle Main Engine

wlo

without

Definitions The foJlowing definitions muy be uscful for undeTStunding the teehnieal tenllS used in the present smdy. All numbeTS, physieul units und dutes refer 10 metric systems und ure in [uropeun style unless otherwise specified. Thc fiscul yeur of dollar vulues is the yeur ofthc referenee·s publication unlcss otherwisc specified.

[xpendable Launch Vchicle A vehicle that can only be uscd once, that is e;>;pendcd (bumt up) after a single use. All conventional TOckets fall under this category. Reusable Launch Vehiele

A vchicle thut can be used multiple times. Note that the

Space Shuttle is not atme Rcusuble Launch Vehicle (RLV) because it rcquircs a new fuel tank for each launch. Orbital Space Flight

The spacccraft is able tO rcueh and maintain Low Eanh Orbit (LEO), which is normally at an altitude of abollt

200 km. Space Tourism

Spuce tOllrism is the term broadly applicd to the concept of paying customers trnveling beyond Eanh 's atmosphere.

Suborbital Space Flight

111e spacceraft is able to reaeh astronam ahitude, but is not trnveling at a speed fast enough

{Q

maintain an Eanh orbit.

The total flight will last about Y, hour or maximal 3 hOUTS if using a curricr airernft dcpending on the type of vchicle and flight profile used.

Introduction This chaplcr aims to provide an overview of lhe motivalion, slmeture and analytieal proeedure ofthe present research series. Funher, the ehapler bricf1y introduces the need for efficiency, the need for building organizations as weil as the need for thinking and aeting on a mullinationallcvel. These are pivolal topies found in alJ thrce studics ofthc present research series.

1.1

Motivation

Thc primary purpose ofthis research series is to find strntegies Ihat promise to incrcasc the efficiencies of aerospaee organizations. Research in thc ficld of "cfficieney of organizations" is immense, but mostly disregards inefficiencies that occur uniquely for aerospaec organizutions. Economic literaturc typically addresscs the make-or-buy dccision with rcgard to only a fcw industry scctors (e.g., eoal, oil, gas, elcctric, agrieuhure, IT business, aUlomobile, lTUcking), bul seldom broaches the aerospace sector and docs not yel address lhc spaee scetor as a eenlral topie. Howcver, aerospace organizations offer much potential for effieicney improvcmcnls (see US Congress, 1995; A.T. Keamey, 2003). Their imponanee to global market OUlput strongly increases over the last several decades and this trend is expecled 10 continue in Ihe future. Thus, this research series aims 10 offer some insighls inlO Ihis relativcly uncxplorcd arcna. Among others, Ihe make-or-buy decision is a lrade-offbclween the diseconomies of scope (make) and the transaction costs that are caused by search frictions, incomplete contracts and relation-spccific invcstments (buy). CUlTCnt lhcorics indicatc why, whcn stressing efficiency gains in tcnns oftransaction and production costs, cenain activities mighl best be suited for oUisourcing; while other thearies show lhal panicular activities, e.g., core compctencies, are more efficienl when venically integrnted. However, real-world outsourcing deeisions are seldom based on lhe sound trade-ofT of risk, on the eosts imposed and the potential benefits of these risks. One reason for lhis is the overwhelming supply oftheories, each one concentrating on a single aspccl of the problem and thcrcfore eomplieating thc deeision-making process for managers. Thus, there is a need for a process thaI: (I) is simple to apply; (2) encompasses the vari-

2

!ntroduction

aus prcdiclions thai afe typical1y tcsled in isolation in the empirieal literaturc; aod (3) allows significant conclusions 10 bc drawn thai are aligncd with cxtUllt thearies rclatcd [0

thc makc-or-buy dccision. The preseo! investigation also allempts [0 overcome litcrnlUrc sholtcomings by dcvcl-

oping a proccss through which tradc-olTis made essential (0 analysis. Partncrships have bOlh positive und negative cfTects. By cxplaining these cfTects, {he prescol slUdy

(1[-

tempts [0 cnhanee the CUITen! underslanding of both emdent vcnieal integration und

outsourcing.

1.2 Structurc and Analylical Proccdurc This research serics is structurcd in Ihree studies, slaning with one ovcrvicw slUdy (Chapter 2) followcd by two in-dcpth sludics (Chapler 3 and 4), as illustralcd in Figurc I. Eaeh invcstigatcd issuc and lhe rclated rcsults are prcscnled as aseparate ehapler, however, the investigalion is pcrfonned in eonjunction with alllhrce studies. The chapters titled "Introduclion" and "Conclusion" arc not rcprcsenled in lhis figure.

Chaptcr 2: ··Eronomic Chlll'llCleristics of Acrospace Organillllions"

I.

~

Characlcrislics ofaerospace orgamlat,ons aro umque as com, pared 10 Ihc o~erall charaClcrislics .... ofmost Olhcr industries. ~

~

Many cconomic thrones should be modificd ifapplicd 10 thc cases of aerospace organizations.

I Chaptcr 3: "OUlsourcing Stnll4:gies in Europc. the USA and Japan: A Case ofS~e Organizations··

I

Chapler 4: ··Dc,·c1opmcnl ofa Make-orBuy Dccision-supponing I'rocess··

"-

--

A 1001 is de\"eloped lhal facililales make-or-buy decisions for manag working in lhe acrospace SCClor.

~F

Figure 1: Research Slruclure Chapter 2, titlcd "Economic Characteristics of Aerospacc Organi7.ations," provides an ovcrvicw and discllssion of lhc typical charactcrislics of aerospacc organizations from an economic pcrspective, Chapler 3, tilled "Oll1sourcing Slralegies in Europe, the

lnlroduction

)

USA and Japan: A Case of Space Organi7.ations," examines the applieabililY of organizational theories to spaee organizations' outsoureing aelivities. Chapter 4, tit1cd '·Development of a Make-or-Buy Decision-supporting Proeess:' illvesligates the make-orbuy decision in detail and offers a tool to ineorporate all theoretical1y known advantages and disadvantages of vertical integration or oUlsourcing, respcetivc1y. For all lhree studies, the investigmed system architeeture within this research series is defined using system elements, geopolitical SlnLctures and time frames: •

S,'slcm Elements: In the prescnt study, lhe lerm "aerospaee organi7...lltion" means eompanies that operate in lhe aerospace industI)', as weil as aerospaee agencies and any other unions or al1ianees that eoneern aerospaee. The teml ·'aerospaee" ineludes: aircraft, aircraft engines, spaee vehicles, spaee vehiele propulsion unils, missiles and spaee systems.

•

Geopolilical Slruclures: The USA, Europe, Japan, Russia, China and India mainly eontribute to lhe spaee scetor, whi1c the USA and Europe nOI only eontribute to the spaee seelor, bUl also eontribute primarily 10 lhe aviation seetor. Therefore, this Study foeuses on these six regions. All six regions are stable in tenns of economic and politieal issucs within the investigated time frame,

•

Time Framcs: The time frame of the investigated ease studies and scenarios is 1980-2026.

1.3 Thc Nccd for Efficicncy, Organizations and Multinational Acting Herc, I briefiy introduee the nccd for emeieney, the need for building organizations as well as the need for thinking and aeting on a multinational level. These pivotal topies are found in allthrcc studies ofthe present research series. •

The Need for Efficienq': Due to high demand for the long-tenn reliability of aireraß systems, the aviation seelor is eost-intensive. Substantial demand for rcliability exists beeause a high eataslrophic failure rate docs not meet ethical standards and is too eostly. In a similar way, this phenomenon ean be applied to the space seetor as weil. Govemmenl funding was oßen approved only in the hope for politieal gains or for national security rcasons. As a result, spaee organizations have relied on gov-

!ntroduclion

4

cmmcnt subsidics, al10wing thcm 10 bccomc nOloriously incfficicnt in thcir lISC of working capiml (AT. Kcamcy, 2003).

In order 10 improvc sarety aod rcduce costs in [he lang tenn, grcatcr overall effideney is constantly requircd in [he industry.

•

The Need for Building Organizations: Becausc ofincrcasing labor returns, a team of workers can producc more output than the same number of single workcrs. This creales an inccntive for workers 10 build a team, which in turn, results in [he formation of organizations (Arrow, 1970; TiTolc, 1988). Potential sources of improving labor returns primarily includc (he division of labor within cach group ofthc organi-

zation that concentrates on a panicular task. Related 10 this is the possibiliry ofspecialization, with the etTect of1carning-by-doing when experience improves workers' skills. However, a team's output may marginally diminish from a cenain point when more workers are addcd to the team. First, emdeney dccreases when one worker's tasks interfere with those of a eol1caguc. Sccond, monitoring eosts inerease when another job or worker is neeessary in order to manage and monitor worker perfonn. anees. In addition, rnonitoring ereates also amoral hazard problem beeause monitoring predsion is not verifiablc (Bemal & Demougin, 2006). Thus, aeeording to Coase (1937), an organi7.ation should expand only so long as the eosts of an additional

transaetion within the organization do not surpass market eosts. Gibbons (2005) provides an overall integrative framework of the various clemental theories of organizations as put fonh by Grossman, Han, Holmstrom, Klein, Moore, Murphy, Simon, Williamson, ete. •

The Need fOT Thinking and Aeting on a Multinational level: In panieular, the very high eosts of aerospaee programs (e.g., the Spaee Shunle's Main Engine (SSME) development costs are S6,3 billion (Koclle, 2003), the Airbus A380's devclopment eosts are $12 billion (Phillips, 2005) and the International Spaee Station's (ISS) operational costs are S5,5 billion per year (David, 2002» neeessitate the fonnation and/or cooperation ofboth national and multinational aerospace organizations. Worldwide, aerospaee organizations adopt an approach of simuhaneous eooperation and eompetition. For example, the USA eooperates with Russia, Europe and Japan in endeavors thaI concern the International Spaee Swtion (ISS), but the USA

lntroduction

5

competes with these countries with rcgard to its commercial satellites. A dilemma, thcrcforc, cxists becausc Organization A (e.g., anational cntcrprisc), may dcsirc a collaborative rclalionship with Organization B (e.g., a forcign enlcrprise) that ellhances productivity and growlh. However, due to national sccurity interests, Organization A does not want Organi7..ation B to acquire sensitive technology that could be used for military purposes

OIlC

day or. does not want to suppon

Organiza~

tion B competition's effons. What kinds of interactions exist between the global aerospace players that are rcsidcnts ofthc USA, Europc, Japan, Russia, China and lndia? ls this ··gamc·' drivcn by fairness, compelitioll and/or cooperation? Game theory facilitates efficient decision-making givcn Ihis situation.

2 Economic Characteristics of Aerospacc Organizations This ehapter provides an overview of the eUTTent aerospaee sector from an eeonomie point ofview. along with possible projeetions. An aerospaee organizalion shows many different chamClcristics. These characterislics are sclcclcd, which fonn the basis for thc dcvclopment of follow-up studies within thc prcsent research scries. The CUTTent chapter discusses products manufaeturcd in this industl)' and the market environment, industl)' and organizational arehitccture that cxist amidst cconomic trends.

2.1

Illtroduction

The aerospace induSll)' has continued to develop since the first motorized flighl of the Wright Brothers in 1903. Today, the importance ofaerospace to the world's cconomy is immense. One option used

(Q

measurc the importanee of aeronamies to the world·s cconomy is

by its contribution to Gross Oomestic Product (GOP). For cxamp1c, direct contributions, such as air transportation and indircct contributions, such as aircraft manufaetllring or tourism, by the US aviation industl)' to the US GOP has been cstimated at $436 billion per year, or 5% ofthe US GOP (Anderson, 1999). Another way to eonsider the importanee of aeronalltics is the inereasc in passenger traffie and rclatcd airerafl demand. World passengcr traffic is expccted to increase by around 5% per year according to Airbus' (2008) Global Market Forecast for 2007-2026. Boeing prediets that the total market potential for ncw commercial airplancs in lhe course ofthc ncxt twenty years will bc around 29 000 airplanes (Boeing, 2007a). Such market share would require an average allnual output of over 1000 planes by the world's eommereial airerafl manufaeturcrs alone, which is substantially above the eUTTelll rate of produetion (Commission on En· gineering and Tcchnical Systems, 1999). The importancc of the spacc sector to the world's cconomy is lesser than that of aeronauties, butthe spaee sector plays an important role with regard to improvement in a eountl)"s quality of Iife. For example, operating satellitcs provide weather and natural catastrophe forecasls, hclp exposc environmental offenders, and facilitatc communication, education and tc1emedieine in remotc regions. The spaee sector is also a eritieal

Economic Characlcristics of Acrospacc Organizations

8

componcnt ofa country's lcchnology base for cnhancing
Thus, the incrcasing imponancc and potential of the acrospacc seelor (0 the world"s cconomy justifies, cncouragcs and neccssitalcs an cconomic-based invesligation of acrospacc organizalions, such thai it is providcd in [his research scrics.

2.2 Charactcristics 2.2.1

General

Figurc 2 liS1S the characlcristics of organizations that opcratc in the 3viation and/ar

space SCClor, which are invcsligatcd in this scction. Each chamclCristic could alone bc the subjcci of a lcnglhy volumc of investigation. Howcver, in order 10 produce a managcab1c documcnt, the prescnl study focuses on providing summary information for eaeh eharneterislic. An exeeption to these summaries is thc larger dcscription of organizational architecture found in this study, which is presented duc to its valuable infomlation and complcxity. Due to national sccurity concems that are the nature ofaerospace, detailed data availability is very limited. Therefore, the cha!'3cteristics presented in this section are orten based on examples from which 1 have drnwn conclllsions andlor insights. This overvicw of the economic charnctcristics of aerospacc organizlllions pro'lides only abrief, but not complete introduction to the topic. I selected those chamcteristics that are most promising 10 dc1iver importam facts for an effcctivc invcstigation of the make+or-buy dccisions tImt OCCllr in the case of aerospace organizations.

Figure 2: lnvcstigatcd Charactcristics of Acrospacc Organi7.atiolls

Eeonomie Charaeteristies of Aerospaee Organizalions 2.2.2

9

Markel Structure

Markel demand in the aviation and lhe spaee scetor is disparate. Thcrc is dcmand for Ihe take-off of an aireraft about every seeond somewherc in lhe world, while only approximately one rocket is launehed every third day worldwide. Typieal market stmetures, forme
10

bottom. Market power

is inversely rclated to the number of organizations, but is stronger for lhose organizations Ihal produee differentiated produets. In summary, eompctition among many organizations dominates the avialion market, while the spaee market is driven by only a few powerful organizations. Table 1: Typical Avialion Markel SlnJctUrc (markcd in gray) Numbu of Organi1.alions

Producl lIomogeneous

I

Many

P.:rfCCl Compel;lion L!e.g.. ",hcal fanners)

Diffcrent;atcd

J

Scveral Homogcneous Oligopoly kerosel\oC oducers

Monopolislic Compclilic)ll airlines)

Differenliale
Monopoly (e,g.. localte)ephone service)

Tablc 2: Typical Space Markel SlntClure (marked in gray) ProduCI

~umbuorOrganiulio"

...

Many

Scveral

Homogencous

Peneet Compet;lion (e.g., ",heal fanllcrs)

Homogcneous Oligopoly

Diffcrcnl;alcd

MOllopolislic COl11pclilion (e.g.• restauranIs)

2.2.3

Monopoly

'"F~~k~'~'§~I~I~~,§~~~m=:l~(ISS modules can

)I

Differentiale
nly be lransponcd by Space Shunle)

Products

This seetion provides an overview of aerospace products, dividcd inlo aviation and space rc1aled ones, as shown in Table 3. Examples are given in parcnthesis for eaeh case. Thcre are many different types ofaircraft include
Economic Characlcristics of Acrospacc Organiz3tions

'0

lion of airplancs since they represenl the [arges! revenue portion of the induslry. Major cus/omers of the aircraft industry inc1udc commcrcial airlincs, transport companics and

the military. Facilitics that produce jet cngincs and auxiliary parts cmploy processes that are similar 10 many othcr meta! casting, fabricating and finishing facilitics and proccsscs from a

widc range of othcr industries. Typical producls manufacturcd by these faeiHties includc: cngines. exhaust systems, motors, brakes, landing gear, wing assemblics, propellers, ete. The main customers for these induSlrics are [he cnlcrpriscs involvcd in [he asscmbly ofaircraft. The space vchiclc and missile industry includcs entcrprises that arc primarily cngagcd in thc rcsearch and manufacturing of the foltowing typical products: guided and ballistic missiles, space and military rockets, space vehicles, propulsion unils, cngines and airframe assemblics. Thc main eustomer for this indllstry is thc mililary; howcver, spaee vehieles are also used by eommercial cntilics for relcasing commllnicalion satellites. Table 3: Primary Acrospace Products ,hialion Sector • Airct'llfi wfo Engincs (Airbus A380. Boeing B 787. Conc:orde. elc.)

SplIcr Secl(lr Spaee Vehidcs w/o Engines (Ariane 5. Spaee Shuttle. H2-A rockei. eie.) Missilcs (I'alriol. drones. SS9. eIe.) Spaee Syslems (Inlemalion31 Spaee Slation. Galileo GI'S satelliles. MeteQS31 wealher satelIile.ete.)

Jet Engincs (Rolls-Royce Tren! 900. CFM-56.

V2500. ete.)

Propulsion Units (Space Shuttle Main Engine SSME, Vuleain 2. Solid Rocket Boosler SRB. etc.)

Auxiliary Parts (Ianding gear. brakes. on-board entertainment sySlem. eie.)

Au~iliary Parts (Ianding parachut~'S, navigation computers. cameras. eIe.)

InfrastnlC1Urc (Frankfurt airport. SkyChefs calering. Lufihansa Technik maintenance. eie.)

lnfraslmclure (KOllroU spaeeporl. Sanla Maria ground slalion. Colibri Iransport ship. eIe,)

2.2.4

Conlraclor Classiflcalion

Manufacmring and asscmbly of complctc llnits in thc acrospace industry typically involves a prime contraclor and scveralliers of subcontractors as shown in Table 4 (modified from: US Environmenlal PrOleclion Agency, 1998). Thc prime COnlraClor seils

Economic Characteristics of Aerospacc Organizalions completc units to customers, while subconlractors sell

lJ 10

the prime conlractor or olher

subcontractors (US Congrcss, 1995). The examplc given in the table is taken from the aviation industf)' for large aircraft. While lherc has nOl been any foreign content for key aircraft eomponents for early models, such as lhe 80cing 727 (US companies have produced nose fuselage, front fuselage, center wing box, aft fusclage, wing and empennage), forcign panners have dearly beeome imponant for produetion of ellrrent models, such as lhe 80eing 787 (US companies only produce pans of the nose fuselage, front fuselage and empennage). Also, prime eontractors for the 8787 model control the seleetion process ofsubcontraetors, in the same manner as has been done for early models by Boeing (MacPherson & Pritehard, 2007), Tablc 4: Classification of Aerospace COlllrnctors Ag~nts

Tasks

F.nm"l~

Prime Conlraetor

Design. develop, assemble andlor 1l1allUfaeture eomplete unils and seil to 100 costomer

Aircraft fmal asscmbly and scl1ing to the airline (aircrafl)

FirsHicr Subconlraelors

Provide major asscmbly andlor manufae· ture OfStelions ofairispacccraft WÜhOlll design or 8.S>embly of complele units

Wing asscmbly (aircraft pans)

Sccooo-tier Subcontractors

Make "arious Sllbasscmblies and scctions

Fucl pump for wing (aircraft p"ns)

Third·tier Subcontractors

Produce machincd componcuts and sub· asscmblics

Elcclric controillnit offuc1 pump (variely ofinduslries)

Founh.ticr SubcomraCIOrs

Specialize in the production ofpanicular componenls and proccsscs

ElCClronic COlllponents of c1cetric control unit (variely of industrics)

Fifth·tier Subcontraclors

Produce basic comlllodilics and/or raw materials

Ccramic for elcclronic COIllponel1ls ("ariety ofindustries)

2.2.5

Industry Size

Figure 3 illustrates the distribution ofmanufaeluring planls and lhe associaled revenues wilhin the US aerospaee induslry. [ ehoose lhe US aerospace industry as an exampte beeause lhe USA has the largest share, e.g., 55% in 1998 (National Seienee Board, 2002), of lhe world 's aerospaee market, with rcvenlles of S l61 billion in 2004 (Euromonitor International, 2005), These figures show that while lhe "aircraft pans" seelor of the US aerospaee indllstry is by far the largest in lenns of number of manllfaeruring

Economic Characlcristics of Acrospacc Organizations

12

plants (59%), the "aircraft" seclor generates thc most revenue (48%). Revenue produccd in 2004 was ncarly idcntical for thc military Sc<:IOT and thc civil sec/ar (Euromonitor

International, 2005). In Ihis sludy, a manufacturing plant is dcfincd as a single physical loeation where industrial operations are perfonncd. Thus, a company may have one or many manufacluring plants.

Figurc 3 indicatcs that thc aircraft-rclated ponion of the US acrospacc industl)' is much larger lhan thc US space vehicle and missile ponion. Thc aircmft ponion com-

priscs approximatcly 90% of thc manufacluring p[ants and about 80% of thc rcvcnucs for thc induSIT)' overall. Howcvcr, considcring thc smatl perccntagc of plants that are engaged in gUlded missile and spaee vehicle manufae{uring (2%), revenue is relativcly high (15%) for this segment ofthe industry. In general, there are few plants that are responsible for assembling final aerospaee products and thcir production rates are low, but the value of eaeh oftheir products greatly surpasses that of the supponing industries. Revenue (ln million $)

Manufacturlng Plants

"'

,.

"'.

1121

e,... . . S1U3

D

""oft

•

Space Prtl~"" UlIItI and Plrts

o

A1rord Plm.

E3 Ul

GlIlded l.Iußes and SpIee Vehlcles

•

Space VeNelD Equipmelll

Annill

aIId EngI.... Plm.

Figure 3: Number of Manufacturing Plants and Associaled Revenue for the US Aerospace duslry (US Depanmem of Commcrcc. 1995)

In~

Tablc 5 lists the plant sizc distribution ofthe aviation seetor, while Table 61ists the plant size distribution of the spaee seetor. The number of aviation plants is strongly dccreasing, whilc there are an inercasing number of cmployees per plant. By contrast, the number of space plants is slightly inereasing alongside an increasing number of employees per plant. Thus, aireraft, cngine and manufaeturing of associated parts gcnerally employs fewer pcople per plant than spaee vehicle, missile, propulsion lmd manufacturing of assodated pans. This is due to thc fact that, for cxample, a simple glider can be

II

Eeonomie Charaeteristies of Aerospaee Organiza[ions

produeed by a loeal team of live persons using a few inexpensive [ools, while a eomplex rocket ean only be produecd by thousands of employees in a plant cquipped with expensive tools. However, the number of employees in [he aircraft industT)' (abou[ 650 (00) still execcds Ihal ofthe spaee vehicle industries (abou[ 150000). Note that the aviation industT)' (1745 plants) is more than ten times largeT Ihan Ihe space induslT)' (140 planrs) in tenns of number of pla11ls. Table 5: Planl Size Distribulion ofUS Avialion Induslry (modified from: US Dcpar1menl of COlluncrcc, 1995) AlrCTllft Plants

Plant Slu Jnu. or emplo)'eesl

Aircraft Englnes Plants

Assodat~d

Parts

Total Plants

Plants

,-,

[no·1

W-I

Jnu·1

W·J

[no·1

Inu·1

33

112

26

<8,

W·l

60

10-49

42

23

13'

27

371

"33

50-249

27

16

'27

27

182

16

250-2499

32

18

63

78

7

"

" '00

8

"2

'" '" J7

"2

'00

"

"

1121

'00

1745

100

2500'"

Total

182

W·I J7 JI

'<J

"

HJ

2

Table 6: Plant Size Distribution ofUS Space Industry (modified from: US DCpar1IllCIll of COlluncrcc, 1995) Plant Sil.e

Space Vehic1es Plants

Parts Plants

Total Plants

Assodat~d

[%1

Inu.1

W·J

[no.1

W.l

[no.1

W.l

,

10

6

27

26

13

8

"

16

23

27

"

50·249

5

13

8

"

'4

19

18

30

JI

250·2499

" " J8

32

IS

36

J7

5

3

19

'"

41

"

",

17

32

60

100

'"

Jnu. ur cmploreesl

[no.1

19 1049

2500+

Total

2.2.6

Propulsion Uni's Plants

4

100

" " 26

"

100

Organizational Architecture

The aerospaee seetoT, partieularly the spaee seetoT, is weH known for ils high quali[y but also for i[s eostly business as eomparcd to other market seetoTS. In addition to neeessary eosts, "Business as Usual" eosls in [he aerospaee sector are eaused by exeessive spceifiea[ions, high bureaueraey levels, numerous design ehanges, extcnded sehedules, parallel

Economic Characlcristics of Acrospacc Organizations

14

work on idcntical lopics, poor aod mostly bclatcd communicalion and [00 many meetings. Kocllc (2003) and Gochlich and Rucäcr (2005) list strntcgics

(0

Tcducc "Business

as Usual"' costs in [he acrospacc SCClOr. Thcir stratcgics rclatcd 10 organizational issucs are disCllsscd in the following parngraph for the dcvelopmcnl, produclion and opcralional phases orthe industry. a) DC"elopl1lefll PlIase

Succcss for a buyeT (principal) of developing new acrospacc systems is slTongly relatcd [0 [he type of contract shc has with her supplicr (agent), the organizalional principlc of supplicr 10 sub-supplicrs and the techniquc ofprototypc. As for the type 0/ (;OII/rael, award fee and fixcd price eontraets are typieally used. Award fce contraets are based on schcdule milestones, technical performance and final eost. These eontraets provide the contractor with an award when he aehieves eost savings. This ineentive for the eontraclOr helps 10 decrease developmenr costs. On the other hand, in a fixed price contract the agent is paid aprice for performing a job based on the spceifieations that are proposcd by the prineipal. Thus, the agent puts in cost-reducing eITons up to the point whcre the marginal eost of eITon equals the marginal bcnefit. A fixed pricc contract is more suitable for the production phase, becausc in the development phase it may cause critical delays in project schedulcs duc 10 bureaucracy, such as occurs in lengthy negotiations aboul risk premiums for the agent. Detailed compensation arrangcmcnts are invcstigatcd by Crackcr and Rcynolds (1993). In panieular in thc case of cost uncenainty - typical of the development phase - Jensen and Stonecash

(2005) provide a comprehensive overview. Thc orgolli;miollal pril/ciple for dcvclopmcnt of a eomplcx program rcquircs a clearcut prime contractor and subcontractor relationship that inc1udcs wcll-defined responsibi1ities. Several panicipating parallel contractors are coordinatcd by the customer or an additional organization instcad ofa strong prime contraetor, which causcs high program costs. For example, reorganization of the responsibility for Spaee Shuttle opcrations to only one prime contractor reduced annual costs by 32% compared to the prior practice of awarding five contracts to five diITcrent contpanies working in parallel (Koclle, 2003). Koelle argucs that thcse eost rcductions are thc result of lcss manpowcr, fcwcr intcrfaces, fcwcr planncd and unplanncd parallcl activities, and fewer dclays. As for the lecJmique o/prototype, the so-cal1ed "rapid prototyping" and "stcp-hy-step teehniquc" are commonly uscd. Thc aviation industry and privatc investors favor thc

Economic Characteristics of Aerospacc Organizations

15

rapid prototyping tcchnique. Time-consuming and expensive delai1cd design and theoretieal analyses efforts are replaeed by early eonstruetion in order to verify the design. A physieal likeliness of the produet is ercatcd dircetly from a threc·dimcnsional model. The prototypes are aceurate in physical dimensions and shape, but do not allow for material properties testing (Slay ct a1., 1999). An example is Ihe Ameriean SR-71 aircraft, whieh took off only 30 months after Ihe eontraet had becn awarded. The step-by-step teehnique is favored by the spaee industry and govemments (an exemption is Russian spaee projects, which suecessfully realize rapid prototyping). A subsca1c lest vehicle is built if the real-size program eannot be fully funded or technologieal verification by a ful1-seale flight vchicle seems indispensable. An examplc is the Delta Clipper DC-X experimental vehicle devcloped by McDonnell Douglas or the Phoenix flight test demonstralordevelopcd by EADS Astrium. b) ProdIlCl;Ol/ Pllu.\·e

Different prodlletion methods, depending, among other faetors, on annual flight or launeh rates, respeetivcly, are pursued for eeonomie effieiencies. For a relatively high flight or launeh rate, a eontinuous prodlletion aetivity is maintained, whieh means sehedllied introduetion ofnew vehiclcs into the program typically oceurs in thc aviation scctor (e.g., daily produclion of a single aisle aircraft). For a relatively low flight or launch rate, all vehicles plus spares required should be produced in an optimally short time period (in batehes) and put into storage until necded, as is typieal ofthe spaee seetor (e.g., bateh production of live Spaee Shuttle orbiters). Prodlletion facilities are then eonverted and uscd for other projeets. Implementing eontinuous produetion in the space sector toO, might decrease produetion eosts (ineluding efforts at quality eontrol) tremendously. However, today"s markct demands do not yet justify producing aerospace systems in high quantity. For example, reeent, inereasing intercst mainly in spaee tourism, but also in spaee-based solar power stations, moon or asteroids mining, and very fast delivery services may sllbstantially change eurrent dcmand-supply interactions (Goehlich, 2005). In this context, the kaming effect on one side and the forgclIing effecl on the other

side are introduecd briefly in the next two paragraphs. Despite widely eitcd examples of Icaming ellrves for aircraft prodlletion, the marginal eosts of prodllcing aireraft repre· sented by dircetlabor requircmenls do not always decrease (duc to kaming effects) and ean even inercase (due to forgeuing effeets) slightly over time, as shown in Figure 4.

Economic Characlcrislics of Acrospacc Organizations

16

Bcnkard (2004) introduces an empirieal dynamic oligopoly model orlhe commcrcial

aircraft industry that is proccsscd in thrce steps: (I) dcfinc a rcprcscntative model (lcaming curvcs, producl differentiation, emry costs, strategie intcractions, etc.); (2) cstimme primitives of (he model (slate variables for demand und supply, elc.); :md (3) run the model (compulc cquilibrium, comparc model rcsuhs with cxisting data, cvalualc

countcrfactual policics, dClcnninc accurncy, etc.). This model providcs a 1001 10 beller understand industry pricing, industry pcrfonnancc und optimal induslry policy. Thc novc1ty of this model is its capability to cndogcnously dClcnninc major charaClcristics,

such as cntry, exit, prices and quantitics in Markov Perfcct Equilibrium. A major result of this model is to explain empirically that a company has an incentive to continually price below static marginal costs instead ofexiting the market because ofan expectation for future succcss. Gncc an airline has dccidcd to buy from Produccr A, thc airlinc also has an incentive to buy again from thc same produccr. That is becausc airlincs prcfcr fleet commonality - also calle
1100 60

(A) 50 A"nual Output lunits/ycarl

(0)

Direct Labor Re<juirernem IIOOOhfllnitJ

90ll

(01

IA)

40

700 500

20

300

100

10

---'0

h--0

50

'00

'60

200

Curnulalivc Output [llnitsl

Figurc 4: Direct Labor Requirenx:nt und Annual Output fOT Lockhecd L IOll Aircraft Produc[ion (Bcnkard, 2000)

Economic Characteristics of Aerospacc Organizations

lJ

The Orl;aniz.1tional/c(ll"/Iing cjJect takes into aceount the diminishing effort that is requircd for manufaeture of fol1ow-on units under the same quality standards. Aireraft produetion is driven by strong leaming effccts (Wright, 1936). The leaming rate p, an indieator for leaming effeel, varies aeross eaeh plane type (Alchian, 1963) and depends on the number n ofunits built (Arend, 1987). This can be set, in the ease ofcontinuous production, ifno other data are available, to the fol1owing values (Goehlieh, 2002): p = 0,90 for n

= 2 to

100 unhs built, p

= 0,95

for n

= 101

to 1000 unilS buih, and p

= 1,00

for n > 1000 or n = I unilS built. Thus, p is diminishing with an increase in units built. Leaming primarily results from proeess improvements and same task repetition: eeonomists and engineers analyze the produetion process and make small ehanges that result in gradual productivity improvements. The use of new tcchnologies al10ws processes to require 1css manpower. Workers bceome more effieicnt at the tasks they perfonn through multiple repctilions. lt should be noted thai leaming comes al high eosts too. Same task repetilion is Ihe resuh of proeess improvemcnls and planning of Ihe eompany's organizational strueturc. New teehnologies must bc studied, verified in experiments and implemented. These aetivities rcquirc manpower resourees, expensive labor experiments and aequisilions. This means that a reduetion in direet labor reqlliremenlS is also the result of expendilllres (the program improvemem budget), whieh must be taken into accounl. lt ean be said that tOlal nccessary devclopment COSIS are divided into non-recurring eosts (before the start ofproduetion) and into rccurring costs (during produetion). Conscquemly, as Benkard (2004) claims, is "direet labor rcquircmems'· per unit the eorrcct parameter to asscss the leaming etfect? I suggest that the parameter would be better defined as "direet labor requircments plus program improvcment budget"' per unil in order 10 eorreetly model eoherenees (sec Thompson, 200 I). The organizationaljOlgcuillg ejJecl is Ihe hypothesis that a companies' slock of produetion experienee depreeiates over time (Argote, Beekman & Epp1c, 1990). This is eaused by the mmover and worker layotfs Ihat embody eompany experienees. One reason for deprcciation of experienee QCcurs in times of falling produetion rates beeause those times are aecompanicd by layotfs. Ouring subsequent increases in produclion, the eompany is often unab1c to aequirc the same workers that it fonnerly released and must rclain entircly new workcrs (Benkard, 2000). In loday's aerospacc business, whether industry or govemmcnl, it is eommon Ihat a Sllbstantial number of employees are hired as eontrnet workers in addition to the organization·s pennanent statf. The motivation for this is to easily dismiss employees in times wherc fewer laborers are needed. Another

Economic Characlcrislics of Acrospacc Organizations

18 inccntivc is

(0

cvadc (burcaucratic) rcquircmcnts. Duc 10 political und organi7.3tional

rcasons thai rcquirc maimcnancc of the balance of power allocations, euch division is siricily Iimitcd in its number of permanent stafT, but lcsscr regulation cxists cancerning thc number of contrac! workers allowcd. Organi7-<1tional fargelling is also c3uscd by shilling cmployccs 10 anOlhcr division or by thc nonnal rates of cmploycc turnovcr during pcriods ofconstall1 produclioll. It cun bc assumcd that with the incrcasing sizc aran

organization, the rorgcning effec! becomcs stronger because more rcquircments cxist und [he probabitity that cmployccs ure shiftcd 10 anothcr division whcrcin thcy eannot use their existing knowlcdgc is high. Il is very difticult to identify organizational forgetting, howevcr, bccausc data could bc consistcnt, with cither a 20% Icaming rate or a 25% lcaming rate with 5% forgclling (ßcnkard, 20(0).

c) Operution Phase [n the case of the Space Shuule. it has been planncd

{O

have a simple operation with a

high night rate, as shown in Figure 5 (Iert). The reality is that doing so rcquires a complcx operation, as shown in Figure 5 (right) for this transportation systcm wilh a low flight rate of a few launches per year, and total costs are approximatcly $0,5 billion per flighl. Why do cases Iike this (the Space Shuttle, for example) occur? Cases such as these can be explained by combining three negative (economic) faclors with the (technical) faetor that acrospace tcehnology is typically very ehallenging: a Irade-ofT dilemma, a business proposal dilemma and a budget cut dilemma.

Figure 5: Vision Versus Realily ofSpace Shullie Operation (NASA. 2000b)

Eeonomie Charaeteristies of Aerospaee Organizations

19

One of the most controversial topies is the Irade-off dilemma that exists between devclopment and operation eosts: if more eITort (in partieular in the fonn of monetary value) is invested in development, operation eosts decreasc and vice vcrsa. Simplified, deeision-makers can select between two program scenarios. Scenario A: low development eosts in the short-tenn (next 10 years) and high operation eosts in the long-tenn (10 to 40 years latcr). Scenario B: high development costs in the short-tenn (next 10 years) and low operation costs in the long-tenn (10 to 40 years later). Rational thinking decision-makers have an ineentive to ehoose Scenario A beeause the award system (eareer, salary, bonus, ete.) awards only short-tenn successes, but not long-tcnn suceesses. Next, the bllsiness proPO!;(I/ dilemma is discussed. To win a business proposal, an ineentive exists to estimate "[deal Cost," whieh assumes that evcrything goes as planned (standard industrial proposal) rcsulting in low cost assumptions: an asset whcn compeling for a eontract. Howcvcr, the history of rocketry teachcs diffcrently. In particillar, for the space sector, estimated concept life-cycle costs are typically only a fraction of aclual, rcalized space system costs. Technology ehallenges are more demanding than oftcn assumed and time passes more quickly Ihan planned. For example, the Spaee Shllllie orbiter development sehcdule was extended by 20"10, which rcsulted in inercased eosts of 22%, while the orbiter expcrienecd 25% mass growth during development, whieh resulted in lower payload perfonnanee (NASA, 2oo0a). Finally, lhe budget CUI dilemma is introduccd. During lhe tcnn of a program, budgel cuts commonly oecur due to political reorgani7.3.tion if govemmentally funded, or due to market shilling if privately funded. Typieally, a large number of aerospaee programs are governmenl funded and lhus, this topie is of major importanee. However, one of Ihc least wel1-undcrslood sources ofinstability is the polilical domain. Overnight, ncw polieics ean restrict the launeh of vchicles or can revise budgets lower, which can force dramatie change in projeet scope or even canccllation of aerospaee programs. For example, in 1997,32% of US defense programs experienccd budget rcductions by Congress, 53% experieneed budgct incrcascs and only 15% rcceived the budget they requested (Weigel & Hastings, 2(04). It can be eoncludcd that the probability thaI a budget will changc is mueh larger than lhe probability that il will remain on a nominal path. For an aerospace program to be robust, it must suceessfllily endure any ehanges that may oecllr during the course of devclopment and operation. Understanding the effeels of polilieal domain inslabilities in the fonn of unccrtain future annual budgels on acrospacc programs is, thercfore, of major importance.

20

Economic Characteristics of Aerospace Organizations

2.2.7

Performance

Measuring the perfonnance ofaerospace organizutions is a ehal1cnge, bccause there afe often many indicators and various viewpoints. Tab1c 7 shows the world's 1cading aernspaee eompanies ranked by revenue, a eommon perfonnanee indiealOr. As a result of their survey, Woo and Willard (1983) identify 14 distinet indicators to evaluate (strategie) perfonnanee: Return on Investment, Return on Sales, Growth in Revenue, Cash Flow/lnvestment, Market Share. Market Share Gain, Produet Quality Relative to Competitors, New Produet Aetivities Relative to Competitors, Dircet Cost Relative to Compctitors, Produet R&D, Proccss R&D, Variation in ROI, Pcrcentage Point Change in ROI and Pereentage Point Change in Cash Flow/lnvestmcnt. However, high perfonnanec is not always an organiza!ion's primary objeetivc. Most aerospace eompanies' military business comes from govcrnmcnt eontraets that do not provide incentives for operating cffieicntly. In addition, most military products are not pan ofa free market eeonomy due to the govemment's separation from the private seetor. Even if high pcrfonnanee is the primary objcetive, it may be limited by cxtcmul fuetors. Politieal restrietions ean make it impossible to seH businesses that lose money due to unemployment efTeets. Sharcholder reslrietions ean force eompanies to maintain duplielltive facilities or top management positions, as in the ease of EADS (Anselmo. 2005). Low perfonnanee ean bc eommonly due to learning cffcets; aviation eompanics priec thcir aircraft wcll bclow stlltic marginal eosts, which is inconsistcnt with stlltic profit maximizalion, but eOllsistent with dynamie profit maximizlltion (Benkard. 2004). Tablc 7: Acrospacc Companics Rankcd by Revenue (based on: Ansclmo, 2OOS) Rank

Name

2003 Revcnne Ibillion SI

,

EADS

43.3

3

United T«hnologics

37.0

4

Lockheed Martin

35.5

5

Northrop Grununan

29.9

6

Honcywcll International

25.6

7

Raythcon

20.2

8

Genemi Dynamics

19.2

9

BAE Systems

17.5

10

Bombardicr

15.7

Boeing

51.5

Economic Characteristics of Aerospacc Organizations

2J

2.3 Discussion For cach characteristic introduccd in this study, [ choose the key points (shown in the headline), whieh are, in my opinion, worthy of diseussion. 1 eompare these points to other industT)' scctors, trends taken from the literature amllor my own assessmenl. •

Mark{'t Slrueture: Few spaee organizations ha,'e significant markel power As learned from lhe eharaeteristie "Market Struelure," the space market is dominated by only a few space organizations. Here, market power is defined as the ability oforganizations to price above marginal cost.

•

Producls: Highi)' complex s)'stems As it ean be surmised from the "Products" charaeteristie. aerospaee products are highly eomplex and require significant engineering, manufaeturing and supply chain management eapabilities, as eonfirmed by A.T. Keamey (2003). For example, an airplane ean eomprise up to six million parts, whereas a car may eonsist of only some 7000 parts. Thus, life-eycle times in aerospace (sometimes more than 25 years) are dramalieally longer lhan for lhe automOlive industry (3-6 years).

•

Contractor C1assification: lIigh outsourcing ratio trend The characleristic ··Contractor Classification" indicates that there is alrend for outsoureing higher ratios and larger unilS. Larger sub-assernblies or systems eome inta the final airplane assembly line r:l\her than eomponents and smaller sub-assemblies that require sehcduling and inventory management, as has been done in past. This significanlly reduees the overall final assembly time and materials management, as stated by Slansky (2005).

•

Industry Siz{': High national seeurity demands ereale a large military market share As shown in lhe eharaeteristie '"[ndUSIT)' Size" seetion, the military"s share of the aerospace industry is aboUl half of the total seetor's revenue. Thus, the aerospaee business is driven not only by eeonomic aspcets, bUl also strongly by national seeurity demands. Therefore, aerospaee is a highly potitieizcd sector (McGuire, 2006). For example, the US government is eurrently operating under a restrietive launeh

22

Economic Characlcrislics of Acrospacc Organizations poliey; the Amcrican space transportution poliey of 1994 rcquircs US govcrnmcnt payloads 10 fiy on US-launchcd vchiclcs (111C Whilc Hüuse, 2006). As a rcsuh,

similar kcy lcchnologics havc been dcvclopcd individually, wherein cach count!)' maintains

ilS 0\\10

research budget, but with similar objeclivcs. Thc rcsult i5 an ovcr-

supply of more or 1css similar national rockets on the Olle hand und limitcd demand

duc 10 a stagnant salcllitc marke!, on the other hand.

•

Organizational Architecture: Highi)' necessar)' eITorls are parti)' compensated by strang govcrnmcnt rinancial support Thc characlcristic "Organi7..ational ArchilCClurc" shows that dcvc1oping, producing ilnd operating aerospacc products is quite trieky. For cxumple, thc aerospace scclor is marked in the lilerature by very high fixed COSIS in lhe fonn of planl and research COSIS (McGuire, 2006), high financial risks (bela values lypically reach 1,8 for dercgulatcd commercial airlines (Mull ins, 1982», low profit margins (lowcr than 5% is Ihe mlc (Lynn, 1998» und very long payback periods (Shcrry & Sarsfield, 2002). In lhe pasl, governmenlS have played a leading role in the funding ofthe aerospace scctor's rcsearch und capital-intensivc infrastructurc (The Whitc Housc, 2000). 1 cxpect a continuation in government subsidi7.3tion of thc aerospace sector due to the low return on research investmcnts, on lhe one hand, and the govemmcnt's high in· terest in aerospace, on lhe Olher hand.

•

I'er(ormance: Challenging aSSl'Ssment of performance As mentioned in the characteriSlic "Performance" section, it is hard to assess perfonnance. Pcrfonnancc should not only bc cxpresscd in lenns of profilability, becausc profilability alone, as an indicator for perfonnance. would causc misalign. menl. An organi7.ation must also balance lhe compeling claims of its various Slakeholders, in addition 10 focusing on the welfare of stockholders, to ensurc their continuing cooperation, as argucd by Bamard (1938). For cxamp1c, most acrospacc prodUCI Iines are nOI profitable, Lc., manllfacturers rely on one or two hllgely succcssful products to posilively afTect lhcir portfolio (McGuire, 2006). However, withoUI its unprofilable prodllct lines, companies may not bc compelitive in the market, because, for example, airline cuslomers are typically attracted by a family aircraft concept.

Economic Characteristics of Aerospacc Organizations

2J

2.4 Rcsults The purpose ofthis study is to investigatc the eharaeteristics of aerospaee organizations, foeusing primarily on

""'0

seetors: aviation and spaee. The acrospacc scetor has many

llniquc chamctcristies when eompared with "nonnar' businesscs. Unique eharaeteristies identilied in this study are: high market power for some types of organizations, highly eomp1cx systems, high outsourcing ratio trends, large military market shares, strong govemmemallinancial suppon and ehallenging assessment of perfonnanee. Funher, this study ofTers the idea that the aviation and spaee sectors are, for many features (c.g., high quality standards, massive entry eosts, vcry low production rates, high strategie power and high degree of intemationalization) ncarly identical, while for other features (e.g., market structure, demand-supply internetions, unit size of production and impcrfect eompctilion) different. Other extreme sectors also ex ist, such as the oil rig sector, the World Wide Web

SC\:-

tor, the shipbuilding sector, and so on, that have uniqlle and panly similar eharneteris· tics to the acrospaec seetor. An investigation into those scctors is not within the scope of the prescnt study, bllt may bc a fruitful arca for future research.

3 Outsourcing Strategics in Europe, USA and Japan: A Casc of Space Organizations This chaptcr investigates the advantages of outsourcing versus venical integration in thrce gcol;raphical areas, In thc first scction, I brief1y rcview the literature on c1assie organi7.ational thcories conccming outsourcing. These thcories form the foundation for developing my three hypotheses, as found in seetion two. To verify the hypotheses, [ apply them to a case slUdy, as described in seetion three. Seetion four follows with a discussion that includes Ihe limitations of my study and offcrs a path for future research. The ehapter eoneludes with speelliation on the praetieal valllc of eeonomic theory in general, vis-a-vis space organizations' outsourcing dccisions.

3.1

Introduction

[n this research, I focus on spaee organizations in three geographic areas: Japan, Europe and the USA. Spaee organizations were originally set up as govemmental entities for exploration and for the commereial use of space, which can include research, devc1opment alld operation ofrockels and sate11ites, manncd missions, and so on. For Europe, [ inelude ESA (European Space Ageney), for the USA, I use NASA (National Aeronautics and Spaee Administration) and for Japan, I foeus on JAXA (Japan Aerospace Exploration Agency). Special attention is given to JAXA, as this organization is eurrently in the privatization process. It has been notcd that "The (Japanese) govemment is now fol1owing a policy of privatization of the space industry, for example JAXA is outsollrcing some of its maintenance activities to private companies and is trying also to increase revenues through its operations" (Polak & Bclmondo, 2006, p. 24). To understand this move, one needs to rccal1 some recent events. The optimistic eommercial satellite market environment ofthe [990s has prescntly led to an overeapacity in the launeh services industry. The projeeted future growth eonvinccd many launeh service providers to invest in new or upgraded launch vehicles, such as the Deha IV. Ariane 5 ECA and the H-llA (Hague, 2003), Some son ofrationalization, therefore, beeame neeessary in order to stabilize this industry in the eurrent market environment, especial1y sinee a brcak-even point in the eommercial satel1ite market is years away (Hague, 2003). This is one ofthe key aspeets

26

Outsourcing Strategies in Europe, USA and Japan: A Case of Spaee Organizations

related to why JAXA is in the process of outsoureing its eommercial launeher operations. [n addition, JAXA is also considcring cxpanding Japan's role in the commcreial launch scrvices world markct, fol1owing an imprcssive record of [2 out of 13 successful launches into orbit (Asahi Shinbun, [5 September 2007). In rccent deeades, outsoureing has beeome a major issue in the economic field of rc-

search. Companies have Ihe choice ofwhether to olltsource activities or integrate them venica[ly. In the case of olltsourcing activities, therc is a shlf! of production andlor services to other eompanies. The advantages or outsourcing result through several phenomcna (Brick[ey, Smith & Zimmerman, 2006): (1) Ncw and more flexib[c production tcchnologies allow suppliers to adapt easi[y to customer demands. This teehnieal devclopment leads to [css finnspecific assets. (2) Improvcd communication tcchno[ogies mOlke daily operations easier. As an example or this, one ean observe speedy invcntory ordering by suppliers through the use of computers. (3) lncreascd g[obalization has [cd to prcssurc on many finns to rcduce COStS and to inerease their cfficicncy. (4) Exeess capacilies cnable fimls to obtain discounts from supplicrs. This can bc caused by worldwide or geographical1y rcstrictcd reccssions. Anothcr phcnomenon in regards to govemmental organizations is the shonage of finanee. A eountry in high defieit might be more wil1ing to outsouree publie projeets to private eompanies. Evcll in eountrics likc Gemlany, one can sec these devclopmcnts. These

s~lVings

can be seen in the bus transpon industry, where in recem years more and

more bus lincs have cither been closed or switched ovcr to private eompanies. All of thesc phenomena ean be scen as reasons for foreing companics to undenake outsourcing. The three areas of investigation diffcr with rcspeet to their market basis. There is, at least in Anglo-Saxon eountries, an unspoken agreement that the maximi7.ation ofshareholder value is the most relevant objective (Rappapon, 1986). [n contrast, Japan and also Europc can be considered as quitc different from this Anglo-Saxon approach. Therefore, the interest of this rescarch lies in the differenecs found among all thrcc areas.

Outsourcing Strntegies in Europe, USA and Japan: A Case of Space Organizations

27

3.2 Thcorctical Approachcs for Outsourcing 3.2.1

General

[ cmploy lhrec thcorctical approachcs for outsourcing in spaee organizalions: Iransaction cost theory, agency theory and the human rcsouree-based view. I will show what spccific trade-ofT exiSls between venical integration and olltsollrdng, and fonnulate my own hypothcsis bascd on lhcory's prcdiction for spaec organizalion activity. FinaJly, [ vcrify lhis hypothesis for lhe space organi7.3tion easc study. 3.2.2

Transaciion Cost Theory

One ofthe widely aceepted eoneepts for measuring outsourcing is transaction eost theory, bascd on thc work of Coase (1937). Aeeording to Coasc, transaetions should bc organizcd within a company as long as the costs ofthese transacIions are lower lhan the transaction costs in the market. Transaction eosts include searehing, contrncling, conlro1Jing, rceontracting and thc risk of dclays for bOlh sidcs. On behalf of transaction cost theory, all panies use infonnation according 10 lheir advantages, which leads 10 a slrategie asymmetry. To make it simple: a seiler altempIs to hide negalive product characteriSlies and a buyer does not show his uppcr limit for purchasing a given produe\. This leads to cach pany invesling in infon113tion eosts, as bOlh are trying to rcceive more and bClter infonnation. A seiler mighl be intercsted in undenaking market research abom his customers' behavior. A buyer, on lhe other hand, mighl be intercstcd in lesling a prodUCl before buying it. [n thc litemlurc, there are several attempts to overcome these conlraeting difficultics (Akerlof, 1970). The transaction eost eoncept is the predominant theoretical explanation in management studies and basicaJly sets out to explain govemance choiees and ex-post eontraclual eosts (Williamson, 1975). This lheoretical eoneept is widely used for its analytieal rigor bm is also eriticized for overemphasizing ex-post contraetual innuenees and underemphasizing revenue erealion (White, 2000). In sum, transaction cost lheory suggests that outsoureing should be eonsidercd if activities: (I) do not rcqllire investments in speeifie assets that invite hold-up; (2) are not subject to a high degrce of environmental llncenainty; and (3) are those aetivities whieh the organization infrequently rclies upon (Aubert, Rivard & Patry, 1996; Masten, 1984). [n the fol1owing case of spaee organizations, this industry can be characterized by a

28

Outsourcing Strategies in Europe, USA and Japan: A Case of Space Organizations

high level of uncertainty (few satel1ite customers dictate world market demand), with vcry spccific asscts (1aunchcrs, launch operation facilitics, and so on), and who frequclllly rcly on those asscts (main part of rcvenue and public acecptancc comes from successfullaunches). This leads me to the first hypothesis, as stated below. Hypolhesis J: In aecordance with transaction cost theory, the oUlsourcing activities of

space organi7.ations would result in higher transaction costs than would vertical integration activities, especially when there is a high uncertainty environment, very specific asscts and high frcqucncy

IlSC.

Nevertheless, in the following case of space organizations, companies increasingly oulsource lhose activities lhat are in contradiction to the ccntral tcnets of transaction cast theory. This leads to the assumption that transaction cast theory has a minor influ· ence on organizational decisions comparcd to agency theory, the human resource-bascd view, and othcr theorics. Another explanation could bc lhal some eompanics or space organi7..ations might not be able to produce cenain products or use cenain lechnologies on their own. In this case, an oUlsourcing of its own activities might be Ilnavoidable. A flIrther reason is that reputation and repetition provide a strong incentive to the operator for providing excel1ent service. For example, a launch failurc caused by the operator may have irreparable damagc for its brand image (i.e., reputation) alld may lead to no funher orders being placed with the operator (i.e., repetition). 3.2.3

Principal-Agenl Theory

Another dominant conceptual framework is the agency concept. Tlle idea cf the agency eoncept goes back to Jensen and Meckling (1976), who describcd the relalionship bc· tween principals and agents. Principals rely on agents who carry out what the principals want them to do. The agent might be a CEO whose own intcrcsts are not automatical1y in line wilh thc interests of lhe principal (e.g., the sbareholder of lhe eompany). Worth mentioning are Holmstrom's various investigations in such models (e.g., Holmstrom, 1999). In order to attain cquilibrium, agency theory emphasizes the cost of misalignment betwccn principals and agcnts (Bcehl, BoiIon & Roell, 2003). Potential misalignment conflicts arise between a principal and an agent, thus causing cconomic costs (Jensen & Meekling, 1976).

Outsourcing Strategies in Europe, USA and Japan: A Case of Space Organizations

29

In sum, one main aspect of principal-agent theory defines a trade-ofT between the

costs for the principal of monitoring outsourccd activitics, such as parts, products and human rcsourccs, in order to achieve the main goal ofthe prineipal (i.e., a eost incrcase) and the benefit of less organizational effon duc to fewer interactions (i.e., a cost reduction). Space organi7..ations consist, in the following case, as the principal, whilc companies to which aetivities are outsourced are the agents. Due to relatively high failure rates, the operation ortaunchers is very risky, so outsourcing would be an advantage for the space organization. As effective quality standards and processes exist in the aerospace seetor, monitoring costs causcd by outsoureing would be moderate. This leads me to the sccond hypothesis, as stated below. Hypolhesis 2: Aecording to agency thcory, outsourcing aelivilics for spaee organiza-

tions would bc preferable over venical integration when Ihe eosts of misalignment con· mcts caused by outsourcing are lower than the costs of Ihe incentive provisions caused by vcrtical integration. This hypothesis is in corrclation with the following case of space organizations. lt requires relatively linie eITon to "monitor" a launeh operator compared to other services. Risk transfcrring 10 the launch operator is high facilitation for space organizations; delays, launch failures and succession failure investigations within the organization ean harm a large, c1umsy bureaueratic spaee organization mueh more than a small and elliciently structured private launch operator. Another factor is that agents in a company havc more ineenlive 10 work hard than in a govemmenl ageney because thcir effort has more influenee on their payoffs, e.g., salary, job guarantee, awards, and so on (Schmidt, 1996). Also, the soft budget constraints thcory explains this effect by the faet tl1tlt govemments are sometimes forced to subsidize a govemment entity when it performs ineffieiently, as while a bankruptey may not be a eredible threat to govemmental bureaucrats. il cenainly is to managers. 3.2.4

The '''uman Resource-based View

Anothcr theoretical explanation for outsourcing and vcrtical integration is the human resource-bascd view. Aecording to Ihe human resouree·bascd view, organizalions difTer in Iheir use ofhuman resourccs (Wemerfelt, 1984). Organizmions with superior human

30

Outsourcing Stratcgics in Europe, USA and Japan: A Case of Space Organizations

resources can establish competitive advantages that enable them to outperform their rivals (Peteraf, 1993). In sum, the human

resource~based

view reeommends keeping strategie and eompeti-

tive activities in-house, beeause the loss ofhuman resource knowledge eannot be eompensated by the incrcase in short-term financial advantages over the long run. This is an important aspeet, partieularly in the following ease involving spaee organizations, as these companies are more specialized. Therefore, in these organizations, human resources are often critical because they cannot easily be replicaled. This leads me to the third hypothesis, as stated bclow. HYPolhesis

3: The human resource-based view suggests that advantages accrue for

spaee organizations that effieielllly vertically integrale their activilies, becausc oulsourcing aetivities could lead to a loss ofhuman resource knowledge. Controversially, in all three investigated areas the respcctive spaee organizations oulsouree their strategie and eompctltive launeh aetivilies 10 a large exlenl, thus resuhing in

a major contradiction with the central tcncts of the human resource-bascd view. This leads to the assumption that the human resource-based view has only a minor influenee on organi7.3tional decisions compared

10

other theories in these cases. Another explana-

tion might be lhat if spaee organiwtions arc not able to provide their own human rcsources (i.e., speeiatists for imperative tasks arc unavailable), an olllsoureing of eertain spccific activities might bc unavoidable.

3.3 Case Study or Space Organizations 3.3.1

General

[n the following section, [ introduce the casc of space organiwtions from Europe, the USA and Japan to whieh r have applied the prcviously described theories. Rallking the world·s spaee agencies in terms of annual total eash budget size in fiseal year 2006, NASA has the largest budget with around $16 billion, followed by Europc's ESA with a budget of about 53,8 billion and the Japanese JAXA budget of abOllt 52,1 billion. The Chinese Spaee Ageney (CSA) has a budget of around SI ,3 billion, the Russian Spaee

Outsourcing Strategies in Europe, USA and Japan: A Case of Spaee Organizations

3I

Ageney (RSA) around 51,2 billion and the Indian Spaee Research Organi7.ation (lSRO) has around 5 1,2 billion. One intercsting aspeet eoneeming the Chinese and Indian spaee programs is thattheir budgets are growing rapidly, largely as a resull ofthe high growth rates of their domestie eeonomies. The opposite developmenl ean be seen in Russia, where the spaee program has reeently experieneed severe budget eonstraints. For the purpose of the speeifie investigmion in this slUdy, I will narrow the ease study to the threc big players in this field: Europe, the USA and Japan. Table 8 ilJustrates the spaee market struetures of Europe, the USA and Japan for eommereial launehcrs. The names ofthe organizations given in braekets are the major players, while minor players are not Jisted. The different life-eyde phases are explained in the following paragraphs. Table 8: Comparison of Spaee Market 5truetures for Commereial Launchers Ufc-cycle

Europe

USA

Japan

Basic Research! Concepl! Definition

Ü
Govcml11cm (NASA)

Govemmcl11 (JAXA)

De\"elOpl11enl! Production

Private (EADS)

Private (Bocing)

Private (IHI, MIII)

Private (Arianespace)

Private (Bocing Launch Services)

Operation sinee 1980

•

sinee 2001

~

G","",,,,,, (JAXA)

-""""

~

Private (H·IIA Launch Services) since 2007

Basic Research, Concepl and Definition I'hases: Typieally, spaee agencies are responsible for the basic research phase. Basic research indudes any fundamental research, which need nOI neeessarily be relatcd to a speeific rocket program, such as investigations on novel propcllants. Such studies are somctimes investigmcd over several decades. The coneept phase includes preparation of a eoneeptual design and a system analysis. These activities are sometimes delegatcd to a consulting company. Ouring the eoneept phase, system speeifieations, an assessment ofpolitieal restrietions and advanced development on high-risk items (e.g., rocket engines) are completed. The concept and definition phase can usually be accomplished within 5 years.

Outsourcing Stratcgics in Europe, USA and Japan: A Case of Space Organizations

32

•

Development and Produetion Phase: Typieally, private eompanies devc10p and produee the rocket. The developmem phase refers to the eomplete developme11l of the rocket, ineluding tesls on one or more prototypes and construetion of ground support if not yet existing from older rocket programs. This phase ean be aeeomplished within 4 to 6 years. Nonnally, prototype flights are used to transport seien· tifie satellites imo spaee. [f the test flights are sueeessful, the series produetion of that rocket starts.

•

Operation Phase: For early eommereial spaee flights, space ageneies were responsib1c for the operation and marketing of launehers. Later on, some spaee ageneies olllsoureed those tasks 10 launeh service eompanies. In Europe, the world's first launeh service eompany was ereated in 1980, and the USA followed in 2001. Japan is currently in the process of privatizing Ihe operation of launchers.

3.3.2

Europe

The major players for the commercial launeher sector in Europe are ESA for research, EADS for development and produetion, and Arianespace for operation. u) GOI·emmellfal Key Leaders (Research)

The European Spaee Ageney (ESA), established in 1975, consists of 17 member states. The ESA falls roughly within Ihe gCQgraphieal scope of the European Union (EU); however, Swit7.erland and Norway are also member Slates and there is strong eooperation with Callada. A long-tenn goal for the ESA is to attraet all EU states to beeome members by 2014 (ESA, 2006). The ESA has a staffofabolll 1900 employees with an annual budget of about 53,8 billion in 2006. The three largest contriblllors are Franee (about 30%), Gennany (aboul 25%) and ftaly (about 15%).

b) Pr;l"ute Key Leuder!J· (De,·elopl1lelll & Produclio/l) EADS was fonned by its member eompanies in July 2000, becoming the world's second largest aerospacc company after Bocing. One of its divisions, Astrium, with its subsidiary EADS Astrium Transportation, is a prime eontraetor for the Ariane 5 launcheT. This eompany developcd the Ariane launeher family, and is responsib1c for the delivery to Arianespace of a comp1cle and completc1y tested launcher whi1c managing all contraets assoeiated with its manufaeturers. Member states, Ihrough the ESA, fund the de-

Outsourcing Strategies in Europe, USA and Japan: A Case of Spaee Organizations

33

vclopment costs for the Ariane launehers and the associated tcchnology. The eompany has faeilities in Franee (Les Murcaux near Paris and Aquitaine near Bordeaux) and Gennany (Bremen). [n 2006, the spaee division had a workforce of abollt 11 000 em· ployees and eonsolidated revenucs of S4,4 billion, representing 12% of EADS' total revcnucs (EADS, 2007). c) Pril'flte XeJ' Leader..' (Operation)

Arianespace is a commcrcial launch service operator, holding more than 50% of the world market for satellites destined for Geostationary Transfer Orbit (GTO). Created as the first eommercial spaee transportation eompany in 1980, Arianespace has signed eontraets for 280 satellite payloads. Abollt 270 employees work for this company. Arianespaee has 23 shareholders including the French space ageney CNES with 34% and EADS with 30%, while aH of the Europcan eompanies panieipate in the eonstruction of the Ariane launehers (Arianespace, 2007). Although it operatcs as a private finn, Arianespaee reeeivcs considerable, although indircct, support from the European Spaee Ageney, which purehases Arianespaee's launeh services. 3.3.3

USA

The major players for the eommereial launeher sector in the USA are NASA for re· search, Bocing for development and production, and Boeing Launeh Services for operation. a) GOI·emmelltal Key Leadt'fl' (Re.\·earc1,)

The National Aeronamies and Spaee Administration (NASA) is the agency responsible for the nation's publie spaee program. [t had a budget of around $16 billion in 2006. NASA eonducts its work in four prineiple organizations, eallcd mission direetorates: aeronalllics, exploration systems, seienee operations and spaee operations. The Spaee Operations Mission Directorale provides eritical cnabling technologies for much of NASA through the Space Shuttlc, the International Space Station and flight support (NASA, 2006).

34

Outsoureing Strategies in Europe, USA and Japan: A Case of Space Organizations

b) Pril'ofc Kc)' Lcodcn.' (DCI'clopl1lellt & Prodlfctiflll)

Boeing opcrates in four prineipal segments: Commercial Airplanes, Military Aireraft and Missile Systems, as wel1 as in Spaee & Communieations, and also in the so-eallcd Boeing Capital Corporation, Space & Communieations operations, with its Network & Spaee Systems Division, principally focuses on research, development and the produetion of space systems, missile defense systems, satellites, launch vehicles and rocket engines, and also the Spaee Shuttle and International Spaee Station (ISS) programs (Boeing, 2008), In 2006, the Network & Space Systems Division's revenues were $[2 billion, represcnting 20% of Boeing's total revenues (Soeing, 2007b). Boeing has devc10ped and cominues to produce the Deha launeher family. The eompallY has eustomcrs in more than 90 countrics arollnd the world and is onc o(the largest US exponers in tenns ofsales. Recently, Bocing stancd to shift its core business away from commercial aircraft manufacturillg toward space vehiclcs, commullications, tcchnical services and de(ense applications (MacPherson & Pritchard, 2002). c) Pril'ote Ke)' Leaders (Operation)

Boeing Launeh Services (BLS), which is based in Huntington Beach, USA, is an or· ganization that combines strategic planning, business development and sales for commerciallaunch scrvice cllstomers. [t is a wholly owned subsidiary of Bocing and is pan of Boeing's Imegrated Defense Systems. BLS markets the Sca Launch and Deha IV launcher family (Bocing, 2008), 3.3.4

Japan

The major p[ayers for the eommereia[ space launch sector in Japan are JAXA for research, Ishikawajima Heavy Industries ([Hl) and Mitsubishi Heary Industries (MHI) for developmem and produetion, and H-llA Launeh Serviccs for operation launches. a) GOI'erl/melltol Ke}' Leader.\' (Re.\'carcll)

JAXA is the result of the merge between the National Space Dcvelopment Ageney of Japan (NASDA), (he National Aerospaee Laboratory of Japan (NAL), and the Institute of Spaee and Astrommtieul Scienee (1SAS) in 2003. JAXA wem through a drastie re· duction ofstafT, und more focus has sinee been put on the ISS program. JAXA now fot· lows a policy of privatizalion, which can be observed from various documented sourees,

Outsourcing Strategies in Europe, USA and Japan: A Case of Space Organizations

35

such as "Take steps toward tuming the space equipmcnt induslry and the spacc utilization scrvice industry into thc key industries of Japan;' as dcscribcd in JAXA's Vision 2025 (JAXA, 2005, p. 24). b) P,i1'ate Key Leaders (Del'e/opmelll & Prodltclion)

The key companies involvcd in thc developmcnt and production of commercial launchers in Japan are Mitsubishi Heavy Industries for liquid-fuelcd rockets (e.g., the main stage of H-lIA), IHI for the upper stages and sma]] engines, and Nissan for the solid fuclled rockets (e,g" strap-on boosters of H-IIA), Typically, these companies have inhouse R&D groups that co-dcvclop programs with JAXA, while privatcly financcd R&D programs arc almost non-existent in Japan (Polak & Belmondo, 2006). c) GOI'erumelllal1 Pril'afe Key Leaders (Operation)

H-IIA Launeh Services, as organized by Mitsubishi Heavy lndustries, is Japan's newly established launeh operator resuhing from the privatization process of H-liA launeh operations initiated in 2002. Thc H-liA No. 13 rocket, launched in September 2007, was the first H-IIA to be launched after JAXA's privatizution program (Asahi Shinbun, 15 September 2007). H-lIA Launch Services promotes the su1cs :md marketing of launch operations to govemmental and commercial customcrs all over the world. Funhennorc, it otTers supJXln services that are nonnal1y perfonned by the cllstomers themselves, inc1uding the prc-Iaunch operation and safety checks of spacecraft at Tanegashima Space Center, arrangement for launch·rclated insurance, rc+launch, back+up launch and finance (Mitsubishi Heavy Industries, 2007).

3.4 Discussion 3.4.1

General

The given case study has been examined using the thrcc separate theories discussed in previous sections, In the following section, this invcstigation will altempt to widen the point ofview through a discussion centered on the eohcrenccs, alternatives and limitations eoneeming the applied thcories.

36

Outsourcing Stratcgics in Europe, USA and Japan: A Case of Space Organizations

3.4.2

Understanding ofCohcrences

As I stated in Hypothesis I, the outsourcing activities ofthe Japanesc JAXA are hard to cxplain using transaction cost thcory. Also, thc human rcsourcc-bascd vicw, rcprcscntcd by Hypothesis 3, carries linie support. Only ageney thcory holds, represellted by Hypothesis 2, as it ean be applied to the privatization of the operational part of the JAXA space organization. As [ stated in Hypothesis 3, oUlsourcing is nonnally conneeted to a loss of knowledge, which is problematic in the area of human resourees. What ean be seen in spaee organi7.3tions is that several space organizations outsource specific production assets. However, the rcsearch part is n0n11ally eovercd by the space organi7.3tions themsclvcs. Therefore, space organizations seem to benefit from oUlsourcing eertain activities, while others are kept within the organization. Another factor is that the vertical integration of activities is mainly uscd in basic research scctors where it is not profitable to outsourcc aetivities. The aim of JAXA is to increase the eompctitiveness of Japanese commerciallaunch services. To do so, JAXA nceds to reducc eosts, incrcase rcliabiJity and improvc eustomer service. [n sum, [ argue timt, under the eurrcnt organizational architccturc (Le., where basic research, production and operating divisions are venieally integrated), the ability of this organi7.3tion to increase its commercial compctitiveness is significantly limited. Tbe reason for this is that an effieient organizational architeeture is different for abasie rcscarch division and an operation division: Whilc, for examp1c, in a basic research division the reward system needs to bc optimized to elicit innovations from seientisls, the rcward system in an operation division needs to bc optimizcd to motivale managers to create 1can processes and high quality standards. 3.4.3

Allernalh'c Thetlries

[ selected three theories out of a pool of alternatives because 1 expeet thm they are best suited for my investigation eentercd on oUlsourcing stralegies, whi1c also providing me with some signifieant rcsults within thc rcspectivc frameworks of transaction cost theory, agency theory and the human resouree-based view. I am aware that there are other theories or approaehes, e.g., the property rights theory, whieh posit that outsoureing stimulatcs cfficient bargaining powcr (sec Grossman & Hart, 1986). Also, rent-secking thcory as a coneept can bc discusscd in this area. Ae-

Outsourcing Strategies in Europe, USA and Japan: A Case of Space Organizations

37

cording to rent-seeking theory, vertical integration can stop socially destructive haggling ovcr appropriate quasi-rcnts (sec Williamson, 1985), but vertieal integration docs not eompletely eliminate contraeting problems (Klein, Crawford & Alehian, 1978). For instance, influence activities (giving someone authority means that this person will be lobbied) subsequently results in high costs (Milgrom & Roberts, 1988). Finally, adaptation thcory also exists, which stipulates that owning an asset allows the owner to deter· mine how the asset is eonscquently used (sec Williarnson, 1975). 3.4.4

Limitations

Generally, the weakness of these theories is that they make speeulative assumptiolls aoout human eognition and managerial discretion (Mahnke, 2001). Managers who need to decide on whether to vel1ically integrate or to outsouree tasks are usually faeed with a general lack of relevant infonnation. nlis fact strengthens the bounded rationality, wh ich means that human aetors involved in eomplex problem solving are Iimited in knowledge, skills and time (Cyen & March, 1963). lnstead, managers are driven by mealls of an experimental scareh to discover possibilities for improving the effieieney ofthe organization. Another weakness of these theories is their limitations of seope. Essentially. transac· tion eost theory is restrieted to the issue of the costs of writing complete contraets, while principal-agent theory narrowly focuses on the issue of moral ha7.3rd, and the human resouree-based view is limited to the simple issue of I inking resources to propcrty. Finally, it should be noted that Olltsourcing by eompanies and govemments has similar but not completcly identical objcctives. Typically, the company's motivation is based mainly on economical aspects. while the govemment's motivation might also be based on politieal aspeets. FUl1hennore, my definition of outsourcing is always con· nected to switching from govemmental activities to private cornpanies. Overall, this kind of outsourcing is much stronger than from one private to anOlher private company.

3.5 Rcsults [n Ihis chapter, I explore a number of reasons why the Japanese govemment's space organization, JAXA, recently intensified ils outsourcing aetivities 10 private companies.

38

Outsourcing Stratcgics in Europc, USA and Japan: A Case of Space Organizations

This process is shown to have occurrcd several years ago in the olher investigated areas: Europe and the USA. The directional trend of outsourcing activities in space organizalions, therefore, is most congruent with principal-agent thcory. In contrast, transaction cost theory and the human resouree-bascd vicw both fail to provide sumeicnt reasons 10 explain why JAXA should venically integrate its activities to bc more emcien\. ralher than outsoureing them to private companies. I also eoncludc that eeonomic thcories ean be used for a wide fjeld ofindustrial sectors, bul have limiled use with regard to lhe space seetor. One reason for this might bc that the characteristics of aerospacc organizations, and in panicular spaee organizalions, arc unique as compared 10 lhe overall eharacteristies of most other induslries, as shown in Chaptcr 2.

4 Dcvelopmentofa Make-or-Buy Decision-supporting Proccss The obj<x:tive ofthis ehapter is to analyze and support the makc-or-buy deeision. This is realizcd by the development ofa theory.based decision process. In this smdy,the proc· ess is applicd to aerospaee organi7..ations as a tool, but its transparency and modularization enablcs thc proccss to be applicd to any organization of intercs\. Thc chaptcr is stmclllred as folIows. In the next seetion, the make-or-buy continllum philosophy is introduced. In section two, the literallIre is qualitatively reviewcd by presenting the pros and cons conceming vertical integration and outsourcing. For illustration, the tool's propositions are sllpplemented with cxamples taken from the aerospace sector. Then, those pros and cons are quantitatively assessed and ranked by importance and probability. Next, the devcloped proccss is applied to four case studics. Finally, section three offers a discussion of scnsitivity analysis, eomparison with othcr studies and limitations.

4.1

Illtroduction

A company has many architcctural choices from which to produce its prodllets or scrvices (Figure 6). At one extreme, the product or selViee can be purchased from any supplier in the spot marke!. Allhe olher extreme, the company can produce the product or service intemally within a division. Between the extremes are various long-tenn eontracts, such as strategie alliances, franchise agreements, lease contracts, joint venlllres and supply contracts (Bricklcy, Smith & Zimmerman, 2006). Note that a certain overlap exists belween diffcrent types of long-Iernl contraets and typology can vary m some buycr-supplier relationships.

II spot

Outsourcing

r

Market Joint Venlllrc Strategic Alliance I Supply Contract Fmnehisc Agreement I Intcrnal Pro
I I

1

r

Lease Canlm<;!

Figurc 6: Illustration ofOrganiwtional ArchiteclUrcs

,----,1 Venical Integration

40

Dcvclopmcnt of a Make-or-Buy Dccision-supponing Proccss OUlsourcing is dcrivcd from the English language aod is a ncologism of the words

"outsidcr-rcsourcc-using," which mcans thaI the rcsponsibility for rcsourccs is shiftcd 10 third partics (Placzck & Szoltysck, 2006). [n the litCnllUrC, the term olltsourcing is widely understood to bc the process of moving an aClivity that was fonnerly finalized "complctcly inside" the organi7..ation 10 onc in which the activilY is finalizcd "complclcly outsidc"lhc organizatioll.

In Ihis study, howcvcr, Ihe tenns oUlsourcing aod vcnical integration are seen rclativcly, not absolulcly. Here, organiz3tional architcctures are proccsscd bctwecn (WO extremes: oUlsourcing means 10 move an aClivity "more outside" the company, while vertical intcgration mcans to move an activity "more insidc" thc eompany. For examp1c, a change from a joint venture to alease contract is defined herc as outsourcing because activitics arc re1ativc1y lcss vertieal1y intcgratcd in alease eontraet than in a joint venture. Long-term contracts are introduccd brief1y, as follows: •

Strategie Alliance: Alliances, or constcllations of bilateral agrecments among companies, are increasingly neccssary to successfully compcte in today's global marke!. Strategie alliances are bascd on the exchange of hostages (e.g., surcty bonds, exchange of debt or equity positions) and al10w the deve10pmcnt of long-term collaborative intentions that permit partners to mcet stratcgie goals (Lau, 1994; Mal1sson, 1995). Allianccs are difficuh to define because thcir struerural charactcristies are diverse. Jap:mese strategie allianees, e.g., opemte in networks ofrelationships between eompanies based on long-term mutuality, rather than on c1carly defined regulations or on inter-finn hicrarchical organizational structures (Gerlach, 1997), as commonly practiecd in Western counlries. Tactical alliances (e.g., code.sharing agreemcnts), which are loosc forms of eollaboration, and nomlally do nOI involve major rcsouree commitmcnts, are another form of strategie allianccs (Bennett, 1997).

•

Franchise Agreement: Aecording to Todeva and Knokc (2005), franchising means that a franchiser (the buyer) grants a fmnchisce (the supplier) the use of a brandname identity, but rctains contral over pricing, marketing and standardizcd service norms.

•

Lease Contract: Leasing implies that one company grants anOlher the right 10 usc patcntcd tcehnologics or processcs in return for royahies (Todeva & Knokc, 2005). In the literature (Millcr & Upton, 1976), leasing is distinguishcd bctwccn short- and

Devc10pment of a Make-or-Buy Deeision-supporting Process

4J

long-term leases. Short-term leases are for the shortest praetieable interval of time, e.g., three hours for rcnting a bieyc1e, one day for rcnting a ear or several years for renting spceializcd industrial eqllipmenl. Long-term !eascs are used for an extension over more than a single period, e.g., scveral years for rcnting a eopy maehine. •

Joint Venture: Joint vcntures involve two or morc organizations, eaeh of whieh shares in the deeision-making aetivities, sueh as markeling or research and devel· opment (R&D), ofthejointly owncd entity (Geringcr, 1988). Joim ventures with 5050 owncrship arc eommon.

•

Supply Cuntract: Suppliers ean be distinguished into four eategories (Kamath & Liker, 1994): (I) partner suppliers are jointly involved in speeifieation writing from the beginning ofthe projeet; (2) mature suppliers wait for rough speeifieations from the buyer beforc they begin work; (3) subordinatc supplicrs manufaeture based on detailed spccifieations given from the buyer; and (4) eomraetual sllppliers proposc standard parts that are uvailable through a eatalog.

4.2 Thc Proccss 4.2.1

General

The

make~or.buy

deeision.supporting proeess is stmeUlred as shown in Figure 7 and

eompriscs four submodules. The submodule "Settings" is illustruted in detuil in Figure 8. This module processes the input duta of strategie objeetivcs, organizutional characteristics, produet ehuraeteristies und enviromnental eharaeteristies. Thc module is based on u balaneed seoreeard philosophy, ofwhich detailed information ean be found in the discussion section ofthis study. The submodule "Integration Pros·' processes the main advantages of vertical integration from the point of view of the final assembler (Figure 9), while the submodule "Outsourcing Pros" processes those advantages of outsourcing as shown in Figure 10. The submodulc "Results" processes the output dara as shown in Figllre 11.

42

Dcvclopmcnt of a Make-or-Buy Dccision-supponing Proccss

SETIlNGS Submooulf

"TEeRA:'ON PROS

~ ~

Submod.l"

, OUTSOURCING PROS Submodule

RESULTS Submodult Figurc 7: Ovcrvicw ofthe Makc-or-Buy DC<:lsion-supporling f>roccss

SETIlNGS Sobmodult'

I

Slr.'~C

II

ObJKI1"e5

~I

lncrcasc ma.... et snarc

1"'''

Increase quaHly

f'0l

tncreasc stability

t:..:ncrcase short-Iernt

rw' lncrcasc ncx.bility I!!2lil

L:>CI()() lncrease conlrol

OrganiZllllloo Ch.nc1"r1slk.

Sct07 Organb:alion sizc

I

Produci Chanc"rIs'ln

• ~:;.cllO ProdUCI romplcxuy ~1I1 Assel spccilicity

r

n"lrnomenl

ell,rae'mll'"

Scl14 Tntensity of compctilion

llScto8 Technical "",periCIlCCl 1 f'109 Organ'1.3liona,skillsl

1

I

CbIUCIt'r1IIk:s

~115 M.arkCl demand uncer-l

E6

W~

~alilyofbusincss

h_

1

I

1 1

Cl12 Strategie lIu'nerabilitYl

~ScI13 Tcchnology uncenainl~

FiguI"C 8: Scnings Submodule

Vcnical integration and oUlsourcing propositions arc dividcd into control, stability and eoordination aspccts. Control aspcets arc those that hc1p the organization in tenns of case of monitoring, high transparcncy of processes, low opportunistic bchaviors and low burcaucracy. In the group ofstability aspects are those propositions that support the

Devdopment of a Make-or-Buy Deeision-supporting Process

4l

organi7-Ution 's existenee, sueh as high quality, high proteetion of sensitive infonnation, low risk and high fiexibility. Coordination aspccts eomprise propositions that inerease positive interaetions, such as high organizational synergies, low eosts and better strategy reali7-ution. The submodule "Results" presents the rcsults ofthis proeess in the fonn of deur graphics. The proccdure for developing this process is eompleted in three steps. Step I is a qualitative assessment of the propositions that eontribute to the make-or-buy decision. [n this step, all propositions found by literature review ure presentcd in the same fonnat und are briefiy diseussed. Step 2 ofTers a quantitative ussessmcnt of those propositions, using Likert sealing, pairwise eomparison and benefit estimution methods. Step 3 is an upplieation of the process 10 aerospacc organi7-utions for verificalion und insight. INTEGRATION PROS SDbmodDI~

I

11

Connol Asp«11

I I

Stabillt)' Aspec!s

r:.:.c

r

r:.:;Chicvc easy m?ni~~J RC
I"''' ~r

l"""

"''

00"

mprovc motivation by ncrsbil! efTe<;

I i n08

H"09

Avoidhightrading

Rcducc (ree-riller prob-~ en t 0

km

1b '

t

•r

Rcduce pooching Inereuse forcdosurc

,11

Rcducc compens:uionLelalcQ im:c:ntive 10 lease

nt2' Avoid expensive con-

~"OiO"lllgli COmpel'-' uvcnes.s OOSIS

I ~n20

I

Reduec hold-up prob-l t """ B'

~nlS' Rcduec eulrurc risk

I I

Avoid high seI-Up eosts~ Avol<)" O"iflku ty 10 sei ineclltivcs

.".

~ A,:oid phantom lirnb

t22' A"oid high transporta-l

AVOj<)"llrsl.mover~

V1lI1lage of $UJlJllier

18 ' ~:~doub1cmargin.

1 !,,,"

I

m~ove prlee cOOi'd-1 naI.lon

'nc~rdia.bmtyo(l ~nt7 -Redueetaxes

re<:elV!!!& an 10

Avoi
tt4"

Coonllnalion Aspec!s

-.

Figurc 9: Integration Pros Submodulc

"

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

44

OUTSOURCING PROS Submodul~

11

I

(:onllvl Asp«IS

r'''

AchIC~\~ 'ligh-powercd

~IU2' AVOIIl burcaucranc

diS!.

.

8

Sl.. bllll}' AJpens

I I

I fut04 ~chie\'e spreading of1

1

~t05 A \'Ol~lhlign cost 0 n II! UllllSfe

r',03' Avoid ~ost!y IlICen;~ pulO6 Dclcr markel cmry mouvlIllng em. p ~7

Ach;",,'c stable sei 0 c1iems

J

I

C ..... rdlnallon Asptds

1ft'11 0 Increase safes

I

rutil Reduce labOr oosts

1

~12 ~edllCe card""s activ;,,~

1 F 113 onncrcasccol'ICcnl::J eore Com~les

u108 Achic"c nigh Ilrogram I ~ Roouce levels ur manfkJIibilil ulO9 Increasc sharing or

_"0_

agement coordinalioo

1l:::llS"Avoid reduccd initia_ ,;, "- In lnves

gal,,·cNeI J EI16"AvclldllC Prt:SCIU Value ~lS

~117

RoollCe production

="

~118'Avoid

insufficient volume

~ 19

locrcasc bundling or _" .Iol

E,20 Achie"e !'"',

e~panding

==~

Gain access 10 1X'llefils

or

er's

'

uI22 Develop tccholesT stan-

""

~23' Avoid .rr~

liule leaming

~~t1raCI highet-quality

mss iaf

r'2' Achlcve a~ai~ Figure 10: Qutsourcing Pros Submodule

I ily

01 I

Devc10pment of a Make-or-Buy Deeision-supporting Process

45

RESULTS Submodul~

~esot SUb:~cril ofcach iel~llem

1t

s02 Su.b.bcneril ?fc~ch ] .a U$ted Iielllll lIem

~esOJ Mah-or-Buy ralio

1

Figurc 11: Rcsults Submodule

4,2.2

Qualitath'e Assessment

Each submodule and its associated items, or propositions, is organized in the same manner for simple review. The "Settings" and "Resuhs" submodulc items are listed bricfly, whi1c the "Integration Pros'· and "Outsourcing Pros'· submodule propositions are Iisted in detail, as spccified in the following text and shown by example in Figurc 12. For readcr-friendly usc, all information is preparcd in the same format. 1021' Amid

I'h~olO'"

limh pYio

Dc«:rirlion: LoSI inlcraelion cfli:cts "ilh oulsourecd aeli\'ilics (indtpcndenlly On lhcir eOTl.' or non-oorc: sialus) can diminis\1 lhc dTec\i"cncss ufille rcmaining acli"ilies (Mahnke. 2(01). ~: Airlin~'S

oUlSOur.-:ed lhe handling of passenger luggage al airports. E\'en

lhough airlincs lry 10 otTer lhe bcsl sen'iee for their firsl ebss pasSC1lgers. lhe passenger salisfaction ean he slrongly b1urrcd by dirty, damagcd, dclaycd or IOSI luggagc_ ~:

The organizalion can cnsurc: lhal its n:maining cmployccs inlCr1lCI c10scly

"ilh ils oulsourccd acli"ilics (Quinn & Hilrner.

199~).

Ahemali'·ely. Ihe organiza-

lion can handle lhe "Ioss" heller by finding and implemalling ahemali,"cs. if lhe proccss ofoutsourcing is slower.

Figurc 12: Examplc of a Venical Integration Proposition Header: The header is where J place the serial number and name of thc proposition. As for thc purpose of process development, I have reversed the propositions in such a way that the disadvantages of outsourcing become advantages of vertieal integralion and disadvantages of vertical integration beeome advantages of outsollrcing. Those re· versed propositions are markcd with an apostrophe ('). Description: The deseription bricfly introdllCeS the proposition, but mayaIso includc additional information. Ellam-

46

I.'!k:

Dcvclopmcllt of a Make-or-Buy Dccision-supponing Proccss FOT illustration, cach proposition is supplcmcntcd with an c:
aviatioll Of space seetor. Solution: Whcrc appropriatc, thc solution paragraph prcscnls

suggestions for alternative countcrmcasurcs, in addition 10 thc oUisourcing

Of

vcrtical

integration philosophy. lt bccomes neccssary to look at this fact \Ilhell trading outSOUTCiog for vcrtical integration. Howcvcr, il should bc mcntioncd that these countcrmcasurcs muy yicld high costs and rcalislically bc uscd to cenain imcnsilY ooly.

---------------- DcscripliOIl ofitems (md j)roposi/iol1s[rom here 10 page 72 ---------------a) SCII;/Igs SlIbmodllle (Strategie Objecli!'es)

•

SetOl Increase marke! share (financiul Key Performance Indicutor (KPI» Dcscription: Markct share indicates the percentage of sales in a given industry segment or sub-segment that are eaptured by the organizmion. This indiealOr has been widely uscd in the strategieally-oriented literaturc and is slrcssed by PIMS (1977), for instanee. Range: low

•

=0

less than 30";" share; high'" greater than 70"10 share

&t02 Inerease qualily (cuslomer Krl) Deseription: Quality indieates the level of flawlessness of an aetivity and, when high, has a positive effeet on cilstomer satisfaetion. Range: low

•

=0

faulty; high = flawless

$et03 Increase stubility (proeess Krl) Description: Stability indicates the desircd degrce of risk avoidance. For example, leasing entails low levels of financial rcsollrce eomrnitmcnt, while integration reduces risks of teehnology plagiarism. Range: low

=

risk neutral, organi7.ation is not afraid to take chances and be fully rc-

spollsible for any eosts; high = risk averse, organization seeks 10 avoid risk •

&t04 Inerease short-term profit (financial KPI) Deseription: Profit is abasie rneasilre ofthe profitabilily ofthe organization and relIeals the returns an organization can generate from creating and selling its produets. Higher profits rellcet grcater effieieney in tuming stock into ineome und larger

Devc10pment of a Make-or-Buy Deeision-supporting Process

4J

budgets available for reinvestment into the organi7.3tion for research und development, marketing und other investments (Razvi, 2007). Range: low = no profil; high = high profit •

SetOS Increase flexibilily (process KPI) Dcseription: Flcxibility indicates the desircd degrce of ability to adapt organizational strategy to ehanging market conditions. Range: low = adaptation not possible or very costly; medium = adaptation possible, but costly; high = easy adaptation

•

~l06

Inerease conlrol (process KPI)

Description: Control indicates the desircd dcgree of commund power by management over activities. Range: low = no contral; medium = partial contral; high = rull control b) Setti/lgs Silbmodule (Orgu/lizutio/lu/

•

~l07

Clluructeri~·tic.,)

Organization size (HR & innovation KPI)

Description: Size is an indicutor of the organizution's (human) resource availability. This indicator is most often interpreted as a souree of organizutional eosts (Shcpherd, 1972) bccause it is assumed to affeet pcrfonnanee negativc1y (Rumeh, 1982). Range: low

= a fcw hundred employees; medium = a few thousand employees; high

= Large Seale Enrerprise (LSE), over ten-thousand employees

•

Set08 Teehnical experience (HR & inno\'ation KPI) Dcseription: Experience rcfers to the extent to whieh employccs are involved and leam from similar prodllets (Koelle, 2003). Range: low = new team with no relevant product expcrience; medium = samc cxpcrienee with related produets; high = extensive expcriellce with similar prodllcts

•

~l09

Organizalional skills (HR & inno\'ation KPI)

Description: Skills are an indicator of employce knowledge to eoordinate projects and programs. Range: low '" no project management experience; high = extensive projeet management experience

48

Dcvclopmcnt of a Make-ar-Buy Dccision-supporting Proccss

c) Se(li"g~' SlIbl1lodule (Prod,ICI ChurQcteristics)

•

S('110 Product complexity (proccss KP) Dcscription: Complcxity rcfcrs 10 Ihe tcchnkal nature of !he producl.

Range: low '" simple uni!; medium"" conncction of simple systems; high"" canneelion aod interaction of advanccd systems

•

Selll Assel specificity (process KPI) Dcscription: Thc dcgrcc of spccificity for a ccrtain aClivilY is mcasuTcd by the differenee bClwccn {he cost ofthc assel and Ihe valuc of its sccand best lISC (William-

soll,1985). Range: low = reversible investment, C.g., capital cxpcndituTCs; high = irreversible investment, c.g., knowlcdgc acquisition

•

Set12 Strategie "ulnerability (process KP) Dcscription: The degrce of vulnerability of slrategie organizatlonal developmcnt is measured by thc amounl the aClivity conlribules 10, or cven represents, lhe organization"s corc compctcncics. Rangc: low = no relation to eore eompelenee; high = sensitive influenee on eore eompctcnees

•

Set 13 Technology uncertainly (financial KPI) Descriplion: This indicalor rcfcrs 10 the malurity levcl oftcchnology llscd. Rangc: low = variation of cxisting design wilh minor modifications; medium = ncw dcsign, bUI with cxisling eomponcnts; high = first gcncration system with advanecd statc·of-thc-at1 tcchnology

d) Setti"gs Slibmodille (Em"irof/lIIe"tul •

C"urucleristic~)

Set 14 Inll'nsil)' of compclilion (proccss KPI) Deseriplion: This indiealor rcfers to lhe numbcr of eompctilors in thc marke!. Range: low = no eompctitors, monopoly; medium = several eompetitors, oligopoly; high = many eompclitors, perfcet eompetition

Devc10pment of a Make-or-Buy Deeision-supporting Process •

49

&115 Market demand uneertainty (process Krl) Description: This indicator inc1udes unpredictable eustomer U1ilization, buying power, market seasons, standards, etc. Range: low = easy forccasting with no surprises; medium = ehallenging forceasting with some surprises; high = unforcseeable circumstanees

•

Set16

Qualit~·

ofbusincss c1imatc (HR & innovation Krl)

Description: The quality of a countl)"s business cHmate is measurcd by the Business Environment Risk Index (BERI). BERI data is eommereially available from Business Environment Risk Intelligenee (2005). This data incllldes the fol1owing eriteria with associated weights in braekets (Hollensen, 2007): poHtieal stability (12%), economic groWlh (10%), curreney convertibility (10%), labor productivity (8%), short-tenn credit (8%), long-tenn loans (8%), attitude lowards the foreign investor (6%), nalionalization (6%), monetary inflation (6%), balance of payments (6%), enforceability of eontraets (6%), bureaueratie delays (4%), eommunicution infrastructure (4%), local management (4%) and services (2%). Estimating the values of these eriteria leads to a sufficiently aeeurate indieator value for the purposes of this study. Range: low

= unacceptable,

very high risk; high

= superior

conditions, favomble

environment for investors, advanced cconomy e) Verticulllllf'grulioll Pros SlIbmodule (Colllrol Aspecl.~)

•

InOI Achie\'e easy monitoring of employee's effort Description: An advantage ofin-house production is the ability to monitor employee efforts comparcd to outsollrcing, where the partner's aetivities nonnally take plaee in a legally distinct setting and generally geographically distinct location (Grossman & Hc1pman, 2004). Thereforc, the likelihood of integration inereases with the diffi-

euhy of monitoring pcrf0n11anee (Anderson & Sehmitt1cin, 1984). This argument holds for behavior monitoring. For outeome monitoring, vertical integration is not mandatory to uchieve bcnefits in comparison with outsourcing, Examplc: In the aerospaee industry, eaeh task is delailcd und dcscribed in the fonn ofa eontract, independently ofwhether or not the task is performed ül-hollse or outsourced. Therefore, the potential for this argument is moderate.

50 •

Development of a Make-or-Buy Decision-supporting Process In02 Improve motivation b)' ownership effect Description: Ownership motivates the most prodlletive investment decisions, e.g., house owners take better eare oftheir living aceommodations than renters (Smith & Wakeman, 1985). Example: Typieally, as in many industry sectors, aerospaee engineers have the op· portllnity to patent-register thek ideas and coneepts. They typically show high motivation to push their ideas forward, as incentives, such as monetary compensation, appreciation and

sclf~rcalization,

are eonerete for "ownership ideas:' The challenge

for managers is to set ineentives in such a way that engineers apply balaneed effort distribution to all their tasks. See investigations on multitasks by Holmstrom and Milgrom (199 [) for details. •

In03' A\'oid high trading costs Description: Trading eosts inc1ude ongoing eosts for eontrol and eoordination, such as ordering, scheduling, monitoring progress and eontraet enforcement, in the case of outsourcing. As the frequency of transactions increase, vertical integration becomes more bcneficial comparcd to oUlsourcing to keeping trading eosts low (Wil. liamson, 1985). The time :md effort neeessary tO manage partnerships (ex-post) is generated by this typical kind oftransaetion eost perpctrator. Example: Bocing's rc1ationship with its sllppliers has been ehanging in recent years, as the eompany foellses on euning cOStS and strcamlining production. Boeing has bcen rcducing the number of its suppliers and asking the remaining suppliers to produee larger assemblies, rather than individual parts (Wilhelm, 200 I). Solution: Close geographical proximity bctwccn buyer and supplier plants facilitates coordination and eommunieation.

•

In04' Reduce free-rider problem Dcscription: Companies have problems motivating indepcndently owned (Le., outsollrced) retailers in a distribution system to invest in sufficient reSOllrces to maintain a brand name. Retailcrs have ineentives to save eosts by shirking on advertising and hiring

less~skillcrl

labor. All panies reecive the benefits from eost rcdlletions,

hut bear only pan of the deeline in sales, beeause these deelines are shared with other units. In the case of outsourcing, shirking is easier than in the case of vel1ical integration, due to diffieulties in observing effort levels and service quality.

Devc10pment of a Make-or-Buy Deeision-supporting Process

51

Example: Many airlines belong to an alliance, wherein they benelit from high passenger demand as a result of alliance branding prestige. If an airhne in this group offers a lesser service compared to othcr airHncs, it can save on costs, bllt still benelit from alliance branding. Solution: Imposing minimum quality, skill and advertising requirements, and controlling them frcqucntly may reduce free·rider inccntives, bllt is also very costly. •

In05' A\'oid "Buy-in" hazard Description: Buying-in refcrs to the practice (in the ease of outsourcing) of attempting to obtain a contraet award by otTering a price less than anlicipated costs wilh Ihe cxpectation of: (I) incrcasing thc contract pricc during Ihc pcriod of performance Ihrough, e.g., change orders or (2) rcceiving futurc follow-on contracIs at prices high enough to recover any losses from the original buy-in eontmc! (Defense Federal Acquisition Regulalion Supplement, 2006). Example: Minimum crediblc COSI means Ihat same cast items are neglecled (Koclle, 2003). In panicular, in Ihe case of Ihe space sector, these ilems inc1ude: premature loss chargc cost, mission abort surchargc cost, ecrtifieation cost, financing cost, product improvement cast, administration eosl and fces, Unrealistic eosl assumptions allow thc supplicr to otTcr an unfairly compelitive contract. Solution: If possible, Ihe buyer should retain litle of the specialized assets and loan Ihem 10 his supplier. This is also called quasi-vertical integration. üpportunism by the supplicr can thcn bc countercd by transfcrring asscts to more cooperativc supplicrs (Monteverde & Teece, 1982a). Another possibility is Ihal Ihe buyer obtains, from the supplier, a binding price commitment ex-ante by employing multi-year procurcmcnts or priee options for addilional quantilies (Defensc Federal Acquisition Regulation Supplement, 2006).

•

In06' Reduee eompensation-related incentive 10 lease Description: Compcnsution plans can create ineentivcs 10 lease; e.g., a manager whose bonus depcnds on Ihe return on invested capilal will lease rather Ihan purchase assets, [f products "must" be produced in-hüuse, this proposition has no impact, because managers do not have Ihe option to lease.

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

52

Examplc: In thc acrospacc seetor, Ihis may happen for small producls, such as leasing 10015, hut it mayaIso happen fOT largc activitics, such nS leasing a camptetc pro-

duelion plant. Solution: A solution is 10 include thc capitatized value orleast payments in invcsted capiral ca1culations (Srnith & Watts, 1982),

1> Verlicul/1I1egrulio/1 Pm.\' SlIbmod"le (Stuhility A.\pecl.\) •

1007 Reduce risk concerning quality Dcscriplion: Contracting tnny bc impcrfccI (i.c., irnpcrfcct contraeI)

ir same

attrib-

utes of the input are not verifiablc by third panies. FOT cxample, in somc cases, thc quality ofan input can bc obscrvcd by collabornting partners, hut cannot bc vcrificd by a court oflaw. Ifa eontraet that stipulates a given priee for an agreed quantity is signcd, a supplier eould lower its eosts by rcducing quality. The final goods pro· dueer would be obligcd 10 buy lhe inferior produets Wilholll rccourse (Grossman & Helpman, 2002). Another disadvantage in this field is the diffieulty for the buyer to monitor the complete produclion life-cycle from lhe supplicr: while an employer has control rights over an employee, e.g., conceming lhe manner in which the work is pcrfonned, a buyer docs not have those righls over an independent supplieT. In Ihis ease, juSt the outeome of the work ean bc eontrollcd (Masten, 1988). If maintaining the quality of apart is eritieal for the overall sueeess of the final produet, it is useful to produee the part in-house. Akerlof (1970) first noted the adverse seleetion problem (somelimes referred 10 as the lemon problem) thaI arises from the inabilily of buyers to differentiate bctween the quality of eertain produets. The most cited example is the uscd ear industry, in whieh the seiler operates at a eomparative advantage as Olhers in the market eannot tell if he is selling a ul emon" (i.e., poor quality ear). Consequently, there is risk involved in purchasing these goods and, while at Ihe produeCs low priee, buyers are willing to take this risk and traders who seil quality cars are nOI willing to scll at such a low prices. This proposition is important to situations in which quulity is critical for sueeess. Example: Buying a poor quality ear is rclativcly less fatal than buying a poor quality aircraft or rocket. Thereforc, efforts to avoid adversc seleclion effeets from the huyer and govemment are much more important for the aerospace sector lhan for any othcr SeeloT.

Oevc1opment of a Make-or-Buy Oeeision-supporting Process

53

Solution: This problem ean be avoided if the buyer eomp1ctes transactions with those suppliers that have established reputations for quality or from thosc that ofTcr warra11lies for their products. The buyer shoilld oillsource first for Icss critical components und later on OUIsource for more critical ones after she has gained more el'perienee with the potential supplier (Quinn & Hilmer, 1995). Quality unecrtainty el'ante can be redueed by liecnsing and/or ecrtifiemion praetiees (Akcrlof, 1970). For el'ample, certifications, such as a high sehool diploma or I"'h.O., indieate the auainment of eertain levels of profieieney. •

In08 IncreaSt reliability of receil'ing an input Ocscription: Companics somctimcs face a short supply of particular inputs. Motivation for non-market procllremcnt cnsures the supply of important inputs. Example: In the aerospaee industry, buyers have generally well-working, reliable supply ehannels, so this advantagc is of minor interest. However, Boeing is an el'eeption, as the eompany recently reschcduled the first test fHght for its B787 as it wrestled with software problems and a shortage ofbolts.

•

In09 Reduce poaching Oescription: roaehing means the misuse of infonnation or expertise that is given in trust for the aecomplishment of a spccifie purpose, now uscd for the gain of the recipient of the infonnation and to the detrintent ofthe giver (Klein, Crawford & AIchian, 1978). 1t is easier 10 eontrol proprietary infonnation when dealing with internal employees than with sllppliers. However, outsourcing often rcquires providing slIpplicrs with valuable knowlcdge-asscts, c.g., the organization's production processcs, which may then be Icaked to eompctitors. [n partieular, this is a dclicate problem when suppliers are dealing with several eompcting buycrs. While el'act imitations are hard to detennine, leaking knowledge may lead to innovative substitution based on a eombination of leaked know1cdge of the giver and eomplementary knowledge of the recipient (Sehumpeter, 1989). Malerba and Orsenigo (1995) distingllish between the Schumpeter I technologieal pattern and the Sehumpeter 11 technologieal pattern: Schumpctcr I tcchnologies are short-lived and quick to be replaeed by new teehnologies, resulting in minor imitation risk. Sehumpeter [I technologies are long-lived and new teehnologies complement them, or are based on thern, resulting in high imitation risk. Companies should retain core com-

Dcvclopmcnt of a Make-ar-Buy Dccision-supporting Proccss

54

pclcncics within {he organi7.lllion, nOI anly 10 prCVcn! olher companics from dcvc1-

oping similar capabililics, hut also to cnhanee lhe dcvclopmcnt of eore campeteneies (Prahalad & Harne!, (990).

Exarnple: Each tcchnology transfcrred 10 China's plnnls mllst bc ccnilied with 3 China Compulsory Ccrtificalion (CCC). This ccrtification rcvcals sensitive da!a that

cnables plagiarism (Shindc, 2007). Mitsubishi Henvy lnduslrics lcamcd how 10 operate alauneher from JAXA, which outsouTced this aClivity 10 Ihern. Olher organiza-

lions oow havc an inleTCS! in suhcontracting with Mitsubishi 10 bencfit from its launcheT operations expertise. [n particular, in lhe space seetor, organizations or eOllntries are very sensitive as to whether proprietary infonnation is available for compctitors or to othcr nations, duc to national security. Solution: Sehllmpcter 11 tcchnologies are typically onc source of a eompany's eompctitive advantage. Thus, imitation risk might bc rcdueed by only outsollreing aetivities related to Schumpeter 1 technologies and/or, by fragmcnting Schumpeter I[ technologics know-how to scvcral supplicrs so that thc infonnation givcn to cach of thc rccipicnts a[one is usc1ess.

•

InlO Increase foreclosure Dcscription: Forcc1osllrc occurs when prneliccs arc adoptcd, such as vcrtieal intcgrntion, that rcduce compclitive buyers' access to supp[iers (Lc., upstream foreclosure) or competitive seilers' aecess to buyers (Le., downstream forcclosurc) (Hart et al., [990). Examplc:

[n

the aerospace indllstry, thc probability of applying forec1osure is low,

because competitor reactions will eausc negative efTccts in the long run (e.g., the compctitor will build up his own aluminum supply chain, which may compcte with thc forcc1oscd production plant) that outwcigh thc achicvcd bcnefits in thc short run. •

In 11' Avoid high competith'eness costs

Dcscription: Compctitiveness costs are, among others, internal costs that resuh from poor and unstable supplier quality (Richardson, [993). The time and eITort neeessary to manage partnerships (ex-post) is gcncrntcd by this typical kind oflrnnsaction cast perpetrator.

Devc10pment of a Make-or-Buy Deeision-supponing Process

55

Example: Typieally, aerospaee subsystems are tcsted from the final assembler before they are assembled, even though thcse subsystems have ulready been tested by the supplier. Solution: Suppliers ure rcquircd to eomply with the Boeing Quality Management System, ablend of ISO 9001 :2000 and aerospaee quality standards. In doing so, Bocing inspeetors do nOlneed to inspeet all parts before they are asscmbled. [fBocing ean be assured that a supplier has a good internal process and maintains quality standards, then as long as the inspeetors are able to wateh the proeess, they do not have to spend so much time watching the pans. (Destefani, 2004) •

In12' Avoid expensh'e conlraels Description: Complete contracts are expensive because they must specify exactly what is expected of each party under all possible contingencies, and require negotiation and enforeement (Hart, 1995). Teehnologieal uneertainty, remote dates for eontract pcrformance and creativity are variables that incrcasc the cost of drafting complete contracts (sec: Inl3' Reducc hold-up problem). But even in those situations whcrein all relevant variables can be cleurly spccitied in a contraet, the threat of produetion dclays during litigation may be an elTeetive bargaining deviee for the supplier (Klein, Crawford & Alehian, (978). Any contract is thcreforc still subjcct to post-eontraetual opportunistie behavior. This reSlllts in a loss of emdeney. For example, the bllyer may deeide to hold standby faeilities that are other.vise not worthwhile, as argued by Klein, Crawford and Alchiun (1978). In this context, it should be nOled that the use of eoncurrent sOllrcing (Le., sirnultaneollsly making and buying the same good) can be used as a sanctioning device (Parmigiani, 2007) since it enables the buyer to more easily switeh from outsourcing to venieal integration, if necessary. Example: Boeing's approach is to slowly ramp up the amount of work given to a new supplier (Destefani, 2(04). This ean build trust over time. Solution: Ineomplete contraets ean be used wherein details are omittcd und leO opcn for furore renegOliation. However, furore renegotiation motlvates sub-optimal investment, bccause it leaves unclear, e.g., how gains from investments are distributed among the panies. For these and other rcasons, the degree ofthe eontraet's ineompleteness should be bascd on the trade-olT betweell the costs of implementing more

Dcvclopmcnt of a Make-or-Buy Dccision-supponing Proccss

56

complcte agreements :lnd the bcncfits thaI arisc from a rcduction in opportunistic bchaviors 10 rcdistributc the contractual surplus (Cracker & Rcynolds, 1993).

Thc aimcd dcgrcc of complclcncss/incomplctcness is panicularly importa11l 10 sc· lecting the approprimc contrnc! type in dClcrmining compensation. The most complete type is the Finn-Fixcd Pricc contracl (FFP), whcrcin pricc is ncgotialcd ex-

anle. Thc most flexible type is the Fixcd-Pricc [nccntivc Successivc targets contract (FP1S), whercin nonbinding target prices are pcriodical1y negolialcd ex-posl (Federal Acquisilion Regulation, 2005). As the complcxity of a technologiea! system in-

crcascs, contracts are more ineomp1cte :md thereby pose grcatcr contractual hazards (Grossman & Hart, [986). Thus, vertical integration is more beneficia[ than vertical outsourcing. In this vein, Arrow ([ 969) calls attention to nonns of socia[ behavior. He obscrvcs that it is usdul for individuals to trust eaeh othcr's word, bcrause in thc absence of trust, it is vel)' eostly to arrnnge for sanetions, guarantces, ete., as dcscribed above. •

1013' Reduee hold-up problem Description: Hart (1995) shows that thc absence of ex-ante contraets creates a potential ho[d-up problem. Production typically requires investment in asscts. Finnspecific assets are those assets that are more valuablc in their current use than in their next best altemative use (Klein, Crawford & A1chian, [978). In this way, onee a supplier specializes in ils produetion for a particular final goOO, these inputs have no valuc to other eompanies - it is not possib1c to switch to another buyer without additional investment COSIS. This argument suggeSIS that the likelihood of outsoureing decreases with the specificity of the assc!. In addition, thc likc1ihood of outsourcing decreases thc more the environmental situation is unccrtain, because it is impossible 10 spcrify what actions each party should perfonn under all possible future contingencies. Buyers can thrcaten to rcfusc dc1ivcl)' of components un[css thc supp[ier's price is [owercd (i.c., hold-up betwecn complillies). Thus, thc supplicr is in a rclativcly wcak bargaining position ex-post Ilegotiation. Under such a threat, thc supplier will rationally underinvest in specifie asscts (i.c., undcrinvestment) (Holmstrom, 1999). Ovcrinvestmcnt can also occur whcn influence activitics are involvcd (Lafontaine & Slade, 2007). For cxamplc. ifthe govcmment subsidizes a company, overinvcstment is Iikc1y to occur. Buyers can also be in a weak bargaining position ex-post ncgotia-

Development of a Make-or-Buy Deeision-supporting Process

57

tion. High switehing eosts may lock the assembler into dependenee upon a supplier and thercby expose that assembler to opportunistie rc-eontraeting, or to the loss of transaetion-specifie expertise and skills (Monteverde & Teece, 1982b). If (aeeidentaHy) a key eomponent has been outsollrced, the buyer loses strategie flexibility, e.g., to introduce a new produet when he wants, rather than when the supplier permits (Quinn & Hilmer, 1995). Even if a non-key eomponcnt has bcen outsollreed, the buyer may lose control over a supplier, e.g., when the buyer does not have cnough market power relative to the seIler. Aecording to Duchi (1981), the hazard of opportunism from suppliers is absent in the less integrated Japanese industry. This is callsed, among other things, by the fact that the reImionship between the final assembler and the supplier is one of whole coopcration in Japan. Example: Onee an airline deeides to buy from Producer A, the airline also has an incentive to bllY again from the same produccr in order to mailllain the family eoneept (same cockpits result in no additional costs for pHots to tmin, same subsystems result in inexpcnsive maintenance, ete.). Therefore, the producer also has a strong incentive to offer a complete family coneept to the airline; even if Olle aircraft typc's marginal costs for production are higher than the priee quoted. In the ease of the aerospace sector, buyers have few (if any) alternative suppliers ex-post, owing to the extensive lead-time und eosts rcquired for development and produetion ofaerospaee systems. As a eonsequcnce, buyers ure in a wcak bargaining position, because they cannot switeh to an alternative supplier in the shon-term. Solution: Alternatives, besides venieal integration, are long-term supply eontraets, cxclusivc sclling rights, rights to vcto expansion, etc. Contraets that specify bargaining powcr distriblllion between the panners can overeome the underinvestment problem. For example, giving all power to the investing pany avoids llnderinvestment. However, this eomes at the cost of writing or enforeing the contraet. Another practieed option (similar to avoiding the "buy.in" hazard) is thatthe bllyer owns key pans ofthe eqllipment. In this way, the seiler needs to manufaclllrc the goods for the buyer. If a eonfliet oecurs, the buyer ean simply rcmove his cquipmem, forcing the scller to stop produetion (Quinn & Hilmer, 1995). Increased bargaining power by creating contracts with more than one panner is a common alternative as weIl. Heide und John (1988) suggest that the supplier shollld make olTsening investments thut create exit bafTiers for the buyer, e.g., create an identity in eonnection with the bllycr's prodllCt ("Intel inside" stickers on laptop computers, for example), establish

Dcvclopmcnt of a Make-ar-Buy Dccision-supponing Proccss

58

personal rclationships with the buycr's cmployccs (workshops, training groups, cvcnts) and add funher valuc 10 the product (bcforc-during-aftcr service).

•

1014' A\'oid first-mo\'cr advantage ofsupplier Dcscription: Thc spccifications of ncwly dcsigncd acrospacc subsystems arc often

unknown ex-anle. COllscqucntly, prc-produclion heurist!c dcvelopmcnt generales supplicr's production and design know1cdgc. Thus, a supplicr working on prc-

production dcvc10pmcllt gains a firsl-movcr advantage, becausc of the knowlcdgc acquircd during dcvclopmcnl (Montcvcrdc & Teecc, 1982b). In panicular, whcn the company sccks technologieal or qualilY leadership positions, vcnical integration is appropriate (HaITigan, 1984). Example: About 35% of Boeing's 787 "Dreamliners'" major systems are produced in Japan. This ean bceome a strategie threat to Boeing (Le., lhe buyer), who globally outsourees (e.g., to Japan), according to Goldstein's (2002) thrce-stage process for thc developing domestie aviation sector. These thrcc stages include: (I) the foreign country starts with co-produetion agrcements; (2) a viable set of subcontractors develop in the foreign eountry; and (3) the foreign country's industl)' is capablc ofputting all subsystcms togethcr and becoming a final assemblcr of completc aircraft. Perhaps inexplieable is the fact that eUTTent US poliey is framed with rcspeet tO national security issues, rnlher than economic concems, regarding global olllsourcing. For instance, contracts valued over $5 million (only) must be screcncd to ensurc that sensitive technologies arc not delivered tO potentially hostilc nations (Pritchard, 2(01). Solution: In contrnst to Boeing, Airbus only subcontracts intemationally for the subsystcms of its oldcr models, while subsystcms for its ncwer models are produced in Europe (Smith, 2001; Pritchard, 2001). By doing so, one can assume that Airbus avoids the opportunity for foreign countrics to develop statc-of-the-art subcontractors that onc day may gain compctencc to produce and assemblc novel aircraft at lowcr costs than Airbus. •

In15' Reduce cultural risk Deseription: Differences in regulatory traditions, euslOmers and heliefs about man· agement, economic dellclopmcnt, political infrastructure and memberships in eeonomic blocks may increase thc riskincss of foreign expansion (Pcnnings, 1994).

Devc10pment of a Make-or-Buy Deeision-supporting Process

59

Cultural risk rc1ated to eonfidentiality of eritieal infonnation and loss of eontrol is espccially important when accounting functions are outsourecd (Manabat, 2003). Thus, it can be assurned that domestic oUlsoureing is more likely to succecd than foreign olltsourcing. However, Lafontaine and Slade (2007) discover that the predietion from basic ageney theory, that inereased risk makes integration more likely, is not supported by empirical studies. Thcy explain this discrepancy with the fact that, in some situations, agents have more infonnation about loeal market eonditions. Example: The eosts, from manufaeturing to management, in Japanese eompanies have alrcady been estimated at the stage of planning and design. Thc priee that a eustomer is wi1ling to pay for a produet is first estimated and serves as the basis for ea1culating priees ofeomponent parts, ranging from design to sales (Chen, 2(04). In eontrast, the typieal method in the USA and Europe is 10 design first, and then estimate eost based on aseries of standard eosts, such as labor eost, materials cost and manufaeturing eost. Eaeh item is ea1culated and is then totaled by the aecountant. If the cost is too high, design will be modified and ca1culatcd again. These different approaehes may eause misunderslandings and dclays in international eooperation. Solution: Opening centers in multiple countries helps to minimize single loeation risks. g) Verlicullfllegrutioll Pros Slibmodule (Coordinutioll Aspects)

•

In16lmpro\'t' price coordination Deseription: II may be optimal from a eompany-wide standpoint to seI priees for produets and services whcrein somc units suslain losses. Independcnt unils eare only about their own profits. Howcver, if the eompany owns its units, it ean eoordinate prices :md service eosts. In particular, finns with refercnce to nelwork industries

fC-

quire extensive coordination (CarIton & Klamer, 1983). Example: In order to offer passengers proper transfer connections, airlines must operute short-distance nights (from spoke to hub and from hub to spoke) at a loss (Le., seat load faetor is low) to ensure Ihat their long-distanec nights (from hub to hub) are fully booked. Because long-distanee flighls have the potential for higher profits; the loss in short-distance flights is compcnsated by the profit gained from the airline's long-distancc flights.

60 •

Development of a Make-or-Buy Decision-supporting Process Inl7

Reduceta.~es

Description: Assuming that profits at different stages of produetion are differently taxed, total taxes can be reduced by shifting profits to low-tax activities. One way to realize this is whcn low-tax units charge highcr transfer priccs to high-tax units. However, this type of activity is limited by tax aUihorilies (Scholes et al., 2005). Further tax advantages arise from different treatments of gains and losses: tax is paid to the govemment when income is generntcd, but lhe govemment does not bill the company whcn losses occur. Therefore, based on analysis by Majd and Myers (1987), a vertically integrated company pays less in taxes than its businesses would pay separatcly. Exarnplc: In thc case of acrospacc organizations, tax reductions are a modernte advantage. The portfolio of large aerospaee organizations, such as Bocing, EADS or Lockheed Martin, lypically includes airernft, launchers and satellites for both eomrnereial and military purposes. As history shows, while a eompany's comrnercial airernft division may be profitable, its military.launcher division may suslain losses, or vice versa. •

In18' A\'oid double marginalizalion Description: Double marginalization QCcurs when there are successive stages of a non-integrntcd monopoly (Spengler, 1950). As a resuh, cach monopolist applies margins to raisc priccs abovc marginal costs. In contrast, a vertically intcgrated monopolist applies only one margin (Le., single marginalization). Example: There exist many monopolics and/or oligopolies in the aerospace sector. However duc to the eornp1cxily of aerospace producls, it is difficuh to create a vertically intcgralcd monopolist.

•

In19' A\'oid high sel-up costs Description: It is eostly

10

search for a suitable input supplier (while a spccializcd

component producer must lind a potential linal goods producer), with costs incurred such as; bargaining costs, dccision-costs and supplicr devclopmcnt costs for training and technology transfer (Richardson, 1993). Time and effon arc necessary to the manage pannerships (ex-ante) generated by this typical kind oftransaction cost perpctrator.

Devdopment of a Make-or-Buy Deeision-supporting Process

6J

Example: NASA sponsors tournaments to determine whieh supplier will obtain the contract for thc development of a new launchcr; coordination of thcse tournaments is very costly. Solmion: Increasing the contract period with suppliers reduces the frcquency of search aetivities. •

In20' A,'oid difficult}' to set ineentives Deseription: A eompany must try 10 provide its partners with incentives 10 produce inputs to its specificalions, and in the quantity that it demands. In the case ofajoim venture, the challenge is to set incentives in such a way that the person who makes the final deeision acts in the best interests ofthe joinl venture as a wholc, as opposcd to any one ofits individual members (Rowan, 2004). Example: Airbus plans to assemble A)20 jets in China under a 51%-owned joint venture with a consortium of local, state-owned companies. According to Airbus China Presidcnt Laurcnce Barron, this trealy will strcngthen Airbus' ties with the Chinese government. Ir will also mnke the relationship rcciprocal by sharing aircraß-making knowlcdge. (Ng, 2007) Solution: Long-term goals make contract negotiations easier, bccause the strategie palhway oftwo partics is more similar in thc long run, than operational drivcn taetical dccisions are in the short run.

•

In21' Avoid phantom limb pain Description: Lost interaction effects with outsourccd nctivities (independently on their core or non-core status) can diminish the effectiveness ofthe rcmaining activities (Mahnke, 2001). Example: Airlincs Oll!source the handling of passcnger luggage

aI

airports. Even

though airlines try to offer the best service für their first dass passengers, passenger satisfaction can suffer as a rcsult of dirty, damagcd, dclaycd or lost luggage. Solution: An organization can ensure thai its rcmaining cmployecs intcrnct closely with its outsourced aClivities (Quinn & Hilmer, 1995). Allernately, the organization can handle "losses" better by finding and implementing alternatives, if the process ofolltsourcing is slower.

62 •

Development of a Make-or-Buy Decision-supporting Process In22' Avoid high lransportation cost Deseription: By primarily outsourcing, the distanee betwecll the buyer and supplier is greater than ifthe aetivity is vertieally integrated. This results in highcr fucl eonsumption eost, higher airport or port fees, higher environmcntal penalties and longer rcaetion time for solving production troubles or supply shortfalls. Example: Aeeording to Airbus China President Laurenee Barron, it might eost more to build the A320s in China than al its plants in Europe because ofrcdueed aircraft pan transportation eosts from Europe and the longer industrial eyele in China (Ng, 2007). Solution: Motivating aerospaee suppliers to reside in elose proximilY to Ihe buyer's plants, as practieed by the automobile industry, in eoherenec with just-in-sequenee philosophy is one solution that avoids high transportation eost. Toyota's factorics in Japan and the USA are examples of large-seale integrators and suppliers that are 10eated near one another.

h) OUI,\'ollrcillG Pros Sflbmodu/e (Collfro/ A~pec's)

•

OulOI Achieve high-powere
Disadvanta~

geously, under such a Ihreat, the investing supplier will rational1y under-invest (Grout, 1984) in the rclalionship (sec: In 13' Reducc hold-up problem), Examplc: The buyer must also indirectly ineur same ofthe risk for Ihe supplier that is ineurred as a result of (too) expensive aerospace produets.

Devclopment of a Make-or-Buy Deeision-supporting Process •

63

OuI02' Avoid bureaueratic distorlions Description: In the easc of venieal integrntion, there are high eosts of prodlleing eomponents, because the company has many divisions to manage. This causes high govemanee eosts, duc to altenuated ineentives and burcaucratie distonions. Hayek (1945) argues tha! these costs arisc from the fact tha! knowledge is dispersed among several pcople in the organization. McAfee and McMi1Ian (1995) develop a model that rclays this claim. They find that produetion eosts incrcase in the 1cngth of a eompany"s hiernrchical strucrurc. Genernlly, pcople in organiza!ions devote energy to influeneing the organi7..ation's decisions to their advantage (Milgrom, 1988). More speeifieal1y, a cost of eommunication exists, beeausc people have incentive to exploit their infonnational advantages. This elTeet inereases eumulativcly as thc infonnation moves up the hierarchy. Thercfore, longer hierarchies have grcater informational inefficicncies: "'fhc larger any organization bceomes, the weaker is the eontrol over its aetions exereised by those at the top" (Downs, 1966, p. 109), rcsulting in diminishing relUrnHo-seale (i.e., Law ofDiminishing Control). According to Wil1iamson (1967), a manager trades olTwidcness for depth in undertaking any expansion ofhis rcsource units. He has more resourees under his eontrol, but the quality (scrial reproduetion loss) and the quantity (bounded eapacity constraint) of his infonnalion is lowercd and ean bc even more rcdueed if goals ditTer between hierarchieal levels. Wi1Iiamson's (1967) model shows that the optimal number of hiernrchical levels is bctween 4 and 7, assuming that the span of control is in nonnal ranges and that the organization employs between 1000 und 100 000 employees. Example: The aerospace industry is strongly alTected by this argument because of its historieal origin, wherein uerospaee organizations are strongly driven by a highpcrfonnanee-whmever-it-eosls philosophy, rnther than optimal organizational behavioT. Aerospace companies are also typically very large, intemationally oriented and inf1uenced by many stakeholders, so that it is very diffieult to eommunicate a c1ear "order:' Solmion: Mueh of the infonnation that top management needs for planning must come from bclow in the organi7..ational hicrarchy. A Japancse company's ability to utihze produelion information from lhe lowest level of organizalion is one of the sources of the eountry's eompetitiveness, aeeording to Aoki (1988). Levine and Tyson (1990) find that employee participation in decision-making improvcs eompany's

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

64

prodUClivily, becausc the information that workcrs huve, aod managers lack, about

the workplacc can bc uscd. Downs (1966) names Ihe following countcrmcasurcs for controlling lass: external data checks, rcdundancy, cfealion of ovcrlapping arcas of rcsponsibility, and rcorganization 10 keep the hiemrchy

•

Oul03' A\'oid

cosll~'

nato

incenlh'es for molh'ating emdent production

Dcscrintion: Companics must adop' costly inccntivcs and conlr01 systems 10 mOliV3tC interna! managers 10 cngage in cfficicnt production, othcrwisc, frcc-ridcr eITects will occur within vcrtical integration. Thcrc is a misalignmcn! of inccmivcs bCIWCClI

cClltral aod internal managers. Examplc: In Ihe acrospacc industry, cvcry task must be recordcd to mect strict aircraft licensing mies. Based on this, the free+ridcr effcct is ncarly prevented, thus, this argument is of minor interest. Solution: An atlempt may be made to invest in thc company culture, such as enhanced good will, teamwork and ethical understandings 10 address this concern. i) Omsollrcillg Pros Silbmodule (Srubility Aspect~)

•

OuI04 Achie\'e spreading or risk Description: Risk, while impossible to c1iminalc, can bc divcrsificd :md spread Ihroughout 01 corporalion. Bllrgers, Hill and Chan Kim (199]) argue that demand uneertainty motivates competitors to enter into strategie alliances in order to gain acccss to thc capabilities requircd to cope with such uneertainty. Burgcrs et oll. (199]) imply that poorly pcrfonning companies are more likely have an incentive 10 enter into al1iances Ihan emciemly operating enterprises. The reason for this is that poorly perfonning eompanies are likcly less able to dcal Wilh the adverse eonscquences ofuncertainties aml/or persistent competitivc banles. Example: One sourec for funding the A380 development comes from risk-sharing partners other than Airbus partners and their national govemments' funding, aeeording to Esty (2004). These risk-sharing partners agrced to bcar a eertain amount or the development eosts, whieh wOllld be rcpaid on a per plane basis, in exchangc for the right to beeome exc1usive suppliers for the A380 (Esty, 2004). Unfavorably for Airbus, might bc the commitment to acecpt thc risk-sharing partners as cxclusive suppliers, bccause exclusivc suppliers might have the incentive to bcnefit from this dcpendency (incrcasc prices, decrease quality, etc.) at thc expcnse of Airbus. Over-

Devc10pment of a Make-or-Buy Deeision-supporting Process

65

al1, the advantages of a low-risk funding program are assul11ed to outweigh the disadvantages of dependeney. •

OuI05 Avoid high cost of ownership Iransfer Deseription: \Vhen the useful life of a general (i.e., non-eompany specific) assct is significantly longer than the period over which a eompany expccts to llse the asset and when the eosts of ownership transfer are high, it may be advantageous to lease, rathcr than blly, thc asset (Smith & Wakcman, 1985). In particular, leasing reduccs the eosts for infonnation on qllality comparcd to purchasing (Flath, 1980). Example: An airline that leases an aircraft is less eoneemed aOOm its eondition than an airlinc that plans to buy the aircraft.

•

Oul06 Deter market entry Description: Selling up partncrships with potcntial eompctitor can dctcr their markct entl)'. Example: An incumbent airline may olTer a potential entrant airline to share expensive facilities, not for the purpose of eeonomies of seulc, bm to diseouragc the entrant from building its own faeility and entcring the market at a more eompetitive seale (Chen & Ross, 2000).

•

Oul07 Achie\'e stable seI of c1ienls Deseription: Random variation in demand for setvices from any one client ean bc eompensated for by a larger set of c1ients (Clemons & Hitt, 1997). Example: An uerospace organization typieally has u high incentivc to produce, not only for its countl)' of origin, but also to export its prodUCIS.

•

OuI08 Achieve high program nexibility Description: The buyer can convert the fixed cost ofpayroll to a variable cost using temporal)' stamnJ;. Thus, Ihe buyer can expand or shrink programs in a short period versus maintaining company cmployces. In this scenario. downsizing is possible without the disadvantageous publicity cntailcd by layotTs (Bcan, 2(03). Examp1e: Temporal)' staffing is typical in the aerospaec industl)' beeause the devc1opment phase for new aircrafl, rockcts, ctc., rcquires substantiallabor, whi1e thc period thercaftcr requires only moderate rcsources for product improvcmcnts, muintenanee, etc. In addition, passenger demand is eyclical, resulting in the fact thm air-

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

66

lioes lease an average of onc-third (Hcincmann, 2007) of thcir fleet

[0

adjust

10

changing market conditions. Currently, General E1celTic Commcrcial Aviation Services (GECAS) und the International Lease Financc Corpora/ion (ILFC) dominatc !he aircraft leasing service marke!. •

OuI09 Inereuse sharing of R&D costs Dcscrintion: Ncw producl innovations ure ortcn high-cost activitics und the rcquircd asscts ure bcyond the capabilitics of a single company. Thus, horizontal or vcrtical coopcration muy bc the ooly viablc mcans for improvcmcnl (Tcecc, 1992). In addition, collabof3tivc R&D reduccs needlcss duplic3tion of eITans, i.e., :lvoidancc of ncar-idcllticallcchnological paths (David, 1985). Example: Development ofthe International Spaee Station (ISS) may nOl be feasible for one country alone, from a financial and resource poinl ofview.

j) Omsollrcillg Pros Submodllfe (Coordillurioll

•

Aspecl~'J

QullO Increase sales Description: According to Frynas, MelJahi and Pigman (2006), global outsoull:ing has the advantage of collaboration and consultation with forcign industry and forcign policymakcrs. Conscquelltly, one of the goals of outsoureing is to secure a sale that would not take plaee in the absence of eompensatory provisions. In lhe IileratUIl: (Wessncr, 1999), this is called induSlrial ofTseI. Dircct offsets involve production sharing, lechnology transfer or worker training, whcll:as indircct ofTsets can include countcr Irades. Industrial offscts are cornmon in the aerospace market, where unit-selling prices are high and buyers are Slriclly regulaled by govemmenlS. Example: In 1974, Boeing conlracted with Mitsubishi in Japan to produce flaps for the B747, which resulled in major sales of B747s {o Japan (MacPherson & Pritchard, 2002).

•

Outll Reduee labor eosls Description: One of lhe basic incentivcs for outsourcing is

10

produce in regions

where labor eosts are lower than lhe horne region. Therc is also a trend toward outsoureing work 10 more low+cost service industries, such as lhose localed primarily in lndia. However, oUlsourcing in China, Thailand, Philippines, Russia, Bulgarin and Jamaica is also on lhe rise.

Devc10pment of a Make-or-Buy Deeision-supporting Process

6J

Example: Labor eosts are typieally at least 5()'l1o lower in the Asia-Paeifie region than in furore or the USA (MaePherson & Pritehard, 2002). Aeeording to the literarure, it is estimatcd that 3,3 million

white~eollar

jobs (equivalem to $136 billion in

wages) will shirt from the USA to low-eost eoumries by 2015 (Engardio, Bernstein & Kripalani, 2003).

•

Outl2 Reduce careless activities Description: Outsourcing is initiated to transfonn or rcduee sloppy aetivities (Rebitzer & Taylor, 1991). However, according to Mahnke (2001), when employees fear losing their jobs through oUlsoureing, they are strongly reluetant to share their knowlcdge with external vendors. Example: This argument is of less relevanee for the aerospaee sector, beeause OUlsourcing is beeoming the nonn.

•

Out 13 Inereuse coneentration on eore eompetenci{'s Deseription: Conecntration on eore eompcteneics means focusing owned rcsourccs on a set of eore eornpctencies, where the eompany sees a eritienl strategie need and where it has special capabilities of providing unique valuc to eustomers (Quinn, Doorley & Pnquelle, 1990). Quinn and Hilmer (1995) define eore eompeteney as folIows. (I) Sets of skills and knowledge, such as produet design, teehnology ereation or customer service, rather than traditional funetion, such as engineering, produetion or sales. (2) Flexible long-tenn architeetures that allow improving skil1s in areas that customers will continue to value over time. (3) A limited number of skill sets, typically less than three, because for a higher number of skill sets, a compuny might be unable to match the perfonnanee of its more focused eompetitors. (4) Areas where the eompany is able to dominate by pcrforming skil1s more effeetively than the competition. (5) Sets of skills that ure captured within the eompuny's system, rather than based on individuals whose dismissal might destroy eompany sueeesscs. Example: In order to incrcase the product palene, aerospaee organizations are foreed to reduce the depth of their produetion.

•

Out 14 Reduce le,·els or management coordination Deseription: Management ean focus more on the eompany's eore business, beeausc the time spent managing peripheral aetivities is rcdueed as a rcsult of oUlsourcing

Dcvclopmcnt of a Make-ar-Buy Dccision-supporting Proccss

68

(Quinn & Hilmcr, 1995). Thus, fewer levels of management coordinalion are

TC-

quircd, which rcsults in lowcr transaction costs Ihan ure incurroo in a more diversificd organization. Exarnple: JAXA recently outsouTccd its lUllnch operation division [0 Mitsubishi

Hcavy lndustrics in order to bc more compclitivc in thc international marke! for commcrcial1aunchcrs. •

Ou115' Avoid reduced initiative 10 in\'est Dcscription: One i05igh! from propcrty.righls lhcory is that a division's inccntivc [0 invest is rcduccd by thc fear of hold-up from its parent company, c.g., cXlracting

rcnlS in thc casc of vcrtical integration (i.c., hold-up within a company). Unfortunmcly, slopping one hold-up problem using a fonnal instrument typically creales another hold-up problem (Gibbons, 2005). Examp1c: This advantage is of minor interest to the aerospace seClor because the parent company's interests should not exploit ilS divisions, which would result in a weak competitive position. Solution: An atlcmpt to incrcasc thc inccntive to invest may occur by rcpctition, to show that the investment is ofbeneficial value. •

Outl6' A,·oid negalive Nel Present V.lllue projecls Description: Jensen (1986) predicts that a vertically integraled company invesls more in negative Net Present Value (NPV) projeets than its divisions would if operated separately. This can be explaincd by the fact that different lines of business have access to more free cash flow as part of a verticatly integrated company, lhan thcy otherwise would on lheir own. Example: This argument is of major intercst to lhe aerospace seClor because budgels are ollen allocaled to fascinaling projecls rather lhan to economically feasible projccts. Solution: An a1tcmpl to rcduce investmellls in cconomical1y unfcasible projccts may occur by establishing a commillee 10 evaluale, e.g., the NPV of each project.

•

OuI11 Redllce prodllclion costs Description: Over time, suppliers adopt technological advances that lower production cost without lowcring quality.

Devc10pment of a Make-or-Buy Deeision-supporting Process

69

Example: This argument is of high importanee to the aerospaee seetor beeause lhere is high ineenlive for acrospaee supplicrs to invest in niehe produets in order to beeome a pioneer in the induslry as weil as to produee at a low eost, so that other eompanics have less interest in entering the marke!. •

Oul18' Avoid insllffkient ,'oillme Description: It is typically difficult to generale sufficient volume to capitalize on returns-to-seale effeels in produetion. Returns-lo-sealc is the relationship betwcen output and a proportional variation of aJ1 inpUls, taken logether. Finns ean produee the optimal volume and seil the surplus in lhe open marker. Thus, this ehoice requires finns to enter a new market, whieh is not its primary line of business. An empirieal study eondueled by Berger and Dfek (1995) suggests that diversified organizations often perfonn poorly relalive 10 those that are more foeus oriented. Example: Thc typical (acrospaee) eompany has incrcasing returns-to-seale whcn output is low, followed by eonstant returns-to·seale as OUlpu! inereases, and deereas· ing returns-to-seale whcn OUlPUt is high, as demonstrated by Berndt, Friedlaendcr and Wang Chiang (1990). Solution: Howevcr, the proposition to avoid insuffieient volumc docs not hold for al1 types of eustomers that the eompany wishes to targer. Customers with higher incomes demand more differenliation or even eustomized and less standardized produets. Small eompanies ean satislY these demands beuer lhan large ones. These small eompanies typically produec only a very small volumc of proouets.

•

Out19 Achic\'e bundling of knowledgc Deseription: Bundling knowledge at one physieal plaee enables effieient use by partieipants (Clemons & Hin, 1997). Example: Airlines enjoy advanlages over alternative fonns ofsing1c-briefing offices before cach flight.

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Out20 Achicve expanding resources Deserintion: DUlsoureing ean aehieve an expansion of resources such that it redllees a eompany's developmenl phase - assuming ilS manpower resouree is eonstant - as multiple suppliers work simuhancously on individual eomponents of a system that are on the eritieal path (Quinn & Hilmer, 1995).

70

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss Examplc: Without immense lISC of supplicrs as rcsourccs, NASA would nOI havc hecn able 10 dcvclop Ihe Satum V rockel within one dccadc.

•

Oul2 J Gai" access to benelits or partner's assets Dcscriplion: A contractor with litt1c cxpcricncc in Ihe cQuntry whcrc Ihe projcct is localcd, bUl with spccializcd skills, should team up with one who has an cstablishcd organi7.3.tion, political Of othcr valuablc rclationship in Ihe country (Rowan, 2004). Sy doing so, Ihe contractor gains acccss 10 oew tcchnologics, rcsulting in improvcd pcrfonnancc, oew producl innovation (Rolhacnncl, Hilt & Jobc, 20(6) aod cuslOm· crs, resllhing in growlh in marke! power. Diversification ofnew business is applicable in the ease ofstrategic alliances. Example: An alliance wilh Airline B enables Airlinc A to obtain access to valuable mre slots at airports that were originally designmed for Airllne B. Thc structure of labor markcIS in Japan, in particular, whercin lifctime cmployment is commonly pracliccd, leads to a relatively homogencolls and slowly adjuslable labor force mixture, which is disadvanlageous to satisfying fast-changing markel trends. Therefore, Japancse companics are cncouraged to utilize supplicrs as efficient sources ofdispamte labor inputs (Smilka, 1991). This is one rcason why Japanese acrospace companies are less vertically integrated compared to Westcm companies.

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OutZZ De\'elop technical standards Description: Compclitors bcnefil from partial coopcmtion in rcferencc 10 defining standards. This is applicable, in particular, in the case ofstralegie allianccs or other fonllS ofhierarchieal, same-level eorporations. Example: Partncrs agrcc to only use a spccific plug for thcir aircmft modules to allow easy replacemcnt of cenain modules built by diffcrent companies.

•

Out23' A\'oid Iittle learning effects Description: Vertical integmtion leads to a high cost of producing componcnlS beeausc thc firm does nOI bcnelit from leaming that comes with speeializing in a single aClivity (Grossman & Helpman, 2002). Specialization greatly enhances Ihe stan· dard of Iiving of a soeielY. However, companies benefil from economies of seope, beeausc skills and rcsources can bc uscd in rclalcd markeIs. According 10 Nayyar (1993), bencfits from economics of scopc are available for relatcd, hut nOI for unrclated, diversificalions. Bellcfils from economies of scope for related products are

Devc10pment of a Make-or-Buy Deeision-supporting Process

7J

partly redueed by the negative effeet on demand beeause ofthe eapabililY to substitute a produet when the priee of another inereases. Example: In the

long~range

wide-body market segment, introduetion of Airbus'

A380 has a signifieanlly negalive effeet on the priee and sales of Boeing's B747, but an even greater adverse affeet on lhe Airbus' 1\330 and A340 (lrwin & Pavenik, 2004). However, Airbus' overall market share is assumed 10 inerease beeause

syn~

ergies that exis! in ownlng all Airbus family planes migh! induee airlines to switeh from Boeing planes to Airbus planes. This resuh highlights the fact thaI as companies expand their produel !ine over time, profit maximization bccomes more complicated as demand for a particular company's exisling models is sensitive to the price and chamcleristics of its new models. Solution: Companies must either spccialize in one activity or produee relatcd products to benefil from learning effects. •

OuI24 AUracl higher-qualit)' specialisis Description: Suppllers are able to attract higher-quailly specialists because its operational sea1c provides fulure earecr opportunities for more speeialized positions, than a less focused company can provide. Example: This argument is of 1css importance 10 the aerospaee scctor beeause buyers also offer many spccialized positions.

•

OuI25 Achieve avaiJability of belter spccialists Deserip!ion: External speeialists arc likely 10 bc belter spceialists (Domberger, 1998). However, Mahnke (2001) argues lhal if an activity has been poorly managed intemally, due to lack ofspeeialist knowlcdge, il is questionab1c thaI those managers are any belter at eommunicaling their needs to eXlemal providers. Example: This argument, 10 achieve availabililY of beller specialists, is one of the typieal ineentives for aerospaee organizations to hire spccialized eonsultants. However, Mahnke has many doublS on Ihe efficieney of this ehoiee, which should bc acknowledged.

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

72 k)

•

Re,mlt~·

SlIbmodllle

ResOI Sub-benefit of each setting item Dcscription: This ilcm shows the vcrtical integration and oUlsourcing sub-bencfits ofcach setting itcm, This rcsulr hclps 10 idcntify those setting ilcms that are slrongly

influCllccd by cither vcrtical integration or oUlsourcing.

•

Res02 Sub-benefit of each adjusted selting ilem Dcscription: This ilcm shows the vcrtical integration and oUlsourcing sub-bencfits of each adjustcd sClliog ilem. This rcsuh includes, in addition [0 ResOI, illf1ucncc

from: strategie objcclivcs, quasi-independent faclors, and weighting of strategie objtttivcs as weH as quasi-independent factors. •

Res03 Make-or-Buy ratio Dcscription: This item shows Ihe lotal benefit ofvertieal integration and outsoureing

as a fraetion. All eITorts have been taken to keep the graph simple.

------.--------- Descriplioll 0/items Gnd propositions /1'0111 page 46 10 here ---------.---.--

4.2.3 a)

Quantitath·e Assessment

Pre-us.\·essllle"t

For pre-assessment of approximatc1y 50 propositions eonceming outsourcing and vertieal integration deeisions two indiealors are used, namc1y "potential" and "probability:' The assessment of potential (What is the maximum positive, relative eITeet in tenns of short-tenn profit, marke! share, ete., to the organi7ll.tion, when this cireumstanee occurs?) is measured on a five·point Likert-type (ßabbie, 2000; Trochim, 2006) seale (+, ++, +++, ++++, +++-t+) whercin "+.. rcprcsents a very poor proposition and

"++t++.'

rcprcsents a very promising one. The assessment ofthe probabiliry (How often does this circumstanee occur?) is bascd on a five-point seale wherein "+" rcpresents aproposition thai very seldom oceurs, and "+++-t+" represents aproposition that oceurs very often. This pre-asscssment method ofpropositions based on potential and probability, in general, is sufficiently rcliable to preliminarily rank propositions. This ranking is helpful for accurate assessment, i.e., to spend rclatively more time on significant propositions than on those ones with low potential and low probability.

7J

Dcvc10pmcnl of a Makc-or-Buy Dccision-supporting Proccss

Tablc 9: Vertieallnlegralion Proposilions Scrlal No. lnOI

[ 11'02 <• In03' eE In04' 0

u

I .q :E ~

11'05'

Name

#

- --

Rcduce compensation·relalcd inccntiw tO lease Reduce risk conccming quality

'''''' '""9

Increase rcliability ofreceiving an input

InlO Inll'

Increase foredosure Avoid high eompetitivcncss eosts

In12'

A"oid expensive contraets

1013' 1014'

Reduce hold-up problem Avoid first-mover advantage of suppl;er

1015'

Rcduce euhure risk

#

Reduce poaching

Impro"e priel.' eoordination

In19'

A"oid double marginalization A,'oid high set-up eosts

---

~

A"oid difficulty to set incent;ves

U

In22'

A"oid high tranS(??fIation cost

•

~

#

#

#

Inll'

'""

''''''

InlO InlS' In21' tnt7 In20'

Inl8'

'''''''

#

-

~

,

-~

#

Potential

tnOS'

~

#

,

Avoid phantom limb pa;n

#

#

~

~

•

tn07 In))'

H

+

#

ln20' ln21"

-

#

~

~

~

Rcduce taxes

Inl4'

#

, , , ,

#

1016

#

H

+ +

, #

In06'

,

~ ~

A"oid "Buy·in" hv.ard

-

~

~

Rcduce free-ridcr problem

.g ~

8

,

Impro\"e motivation by o"'ncrship effc<:t A"oid high trading costs

ln07

[ lnl7 < 1018'

--

Potential I'robabil. Slgnlßc. Ranklng

Achie,"e easy moniloring ofcmployee's eITort

, , , , #

,• •

tnt6

Inor

'"" ,

'"""

1022' In02 In19'

#

--

~

ProbabililY

Figure 13: Potential-probability Matrix fOT Vcrtical Integration

7 16

5 6

" 12 ]

"

l6

",, 4 20

,

13

17 9 18

19

"15

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

74

Tab!e 10; Outsourcing Proposilions

g

OUIOI OUlO2'

Achic"c high-powcred inccnt;ves Avoid burcaucralic dislonions

U

OUIO)'

Avoid costly incclltives for mOlivalingcffic.

0

Out04 [ OutOS Out06 Out07 ;;; Out08 OUlO9

Achic"c spreading ofri.k Avoid high cost of Qwncrship transfer Detcr marke! enuy Achic\"C stabil.' -;Cl of clients Achie"e high progrnm nexibility J",rcasc sharing of R&D tOsts

OullO

lncrcasc sales

<

:Z S

~

Oulll Oult2 Oul13 Oul14 [ OullS' Oul16' ~ Oul17 .~ OullS' ~ Oul19 OUl20 OUl21 OUI22 OUl23' OUl24 OUl25

<:

,3

-"" -- -- -- -- -- - --- --

Potential I'robabil. Slgnlnc. l(anklng

Serlal No.

Reduce labor costs

#

I

+

#

+ +

16 20

++

13 2

#

10

.+

#

" "

+

..-

6

"

+

+

+

+

+

+

3 23 5 7 24

#

#

14

#

8

+

19

#

~

Rcducc levels ofmanagcmcnt coordinalion Avoid rel!l)(;ro initiative 10 im'est Avoid negative NCI Prcscnt Valuc projccis Rcducc produc\;on COSIS Avoid insuffic;cnl "olumc lncrcasc bundling ofknowlcdgc c~panding

#

#

Reduce carele•• aCl1vilies lncrcase concCI1tration on core compctencies

Achic"C

#

~

rcsourccs

Ga;n acccss 10 bcnefilS ofpanncrs assets Dcvetop Icchnical standards Avoid linlc Icarn;ng CffCClS AuracI h;ghcr·quahly spcciahS1S Achie"c availability ofbencr speeialisls

#

4

~

#

#

#

#

H

9 15

+

+ + + +

22 17 25 18

#

+ #

Table 9 and Table 10 show pre-assessmem rcsults for vertical integration and

O\lt~

sourcing. The ··significance" is genernted by multiplying the "potential"' by the '·probability" for eaeh proposition, For beller illustration, the symbol '.+'. is used instead of numbcrs, but calculation is bascd on numbcrs that arc roundcd-ofT. A more complcx algorithm 10 calclliate significance cOllld be llscd, blll wOllld not improvc the final process. Thercfore, r eoneentrate on the procedure for devclopin); this proeess, not on the mathcmaties, Figure 13 and Figure 14 show thc relatcd potcntial-probability matrix for venical inlegrntion and olllsourdng. Propositions that are in the signilicam scetor (marked in dark gray) ofthese matrices require special attention bccause they influence the make-or-buy decision more than the others.

75

Devc10pment of a Make-or-Buy Deeision-supporting Process

The philosophy ofthe potential-probability matrix is similar to the risk matrix. While thc risk matrix is an cffective tool used to guidc the user to avoiding risks of high probability and high consequenec (Alexander & Marshall, 2006), the potential-probability matrix illustrates the benefits ofhigh potential and high probability. rOlenli~1

-

-

~'''. QuIll

~

OUl17

011116'

OUl14

Ou12t

OuIIS'

~""

~.,

OUIOI

011123'

ÜIlIIO

0"103'

0u119

0u113

OuIOS

Oull0

~,

QUI07

~""

üu125 0u122

#

,

..

Qull2 0u115"

0,,,,,

•

#

--

~

f'~obabiliCy

Figurc 14: Potcnlial-probability Matrix forOutsourcing

For detailed assessment, a pair"\vise comparison (sec Grob, 1984) is used to support the subjcctive-bascd assessmcnt. This is a first approach method givcn unccrtainty in a situation, where detailed smdies are not yet been perfonned. The pairwise eomparison method is a powerful tool that allows the researcher to perfonn a fair and comprehensive transparent ranking of eriteria; it ullows ranking und ussessment of thc relative weight ofeaeh proposition to be detennined. However, results ofpairwise comparisons must be eheeked for plausibility. Therefore, the relative bcnefit on eaeh item of the "Seuings" submodu1c that is guincd from the propositions of the ·'Integration Pros" und "Outsoureing Pros" submodules are adjusted. All results for vertieal integration are ineorporated in the input mask of the ··Integration Pros" submodule, as shown in Table 11. Rcsults for outsourcing arc incorporatcd in the input mask of the ··Outsourcing Pros" submodu1c, as shown in Tab1c 12.

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

76

Table 11: Integration Pros Submodllie Strategie

Serial No.

Organizalion ChaneIer.

Objcd;,"C!i

En\·lronm. Charader.

PNlduel Charllcler.

Sum

,

•" ~

,""

.f'

!

<

'2

8

o

,

220

[001

,

5

5

,

0

2

o

,

5

o

2

,

0

0 0 , 0

[nO)'

In04' InOS' 1006'

In07

o o o o

• 'mJ9

~ InlO .q

In11'

In12'

,

0

55'

0

052

5

0

820 , 0 ,

o

0

2

0

,

2

0

2

0

,

5

5

, ,

8 5

o

0

,

0

5 ,

0 0 0

o

0

o

5

,

2 5

5

,

5

,

5

o o

o 2 ,

o , o

'""

~ "

, ,

InOI

1014'

5

0

,

5

5 ,

0 0

lolS'

o

0

500

,

2

!!J

1016

2

2

2 0

,

lol7

8 5

5

~

0 0

o ,

0 0 2 0 0

o

5

0

o

5

052

2

0

0

5

250 2

o o

0 0

1n22'

o o o o o

Su",

25

43

100 60

76

.2

]

In13'

In\8' 1019' 1020' 1021'

o

o o o 79

5 5

,

55

"•D"

,

o o 5 o o o

0

8

200

0

,

2

000

o

o

5 8

008 000 802

o

2

0 ,

o

0

o

000

o

8

0

8

000

8

,

8

8 8 8

000 2 5 0 0 8 2

8

"

8

48

o

62

2

500

5

24

8

508

70

8 8 8 5

o

000 580 200 058 000

8 5 8

o o o o

o o o o

o o o o

o o o

o o

o o

o o o o

8 2 2

2 ,

8 8

o

0

2

5 0 0

o o o o o o o o

o o o o o o o o 5 o o o o o

o

o o o o

, " 39

o

8

o o

m

33 54

12 47

57 6
" "13

2

o

0

0

o

19

2

5

5

805

8

2

0

o

5

5

5

2

o

o o

22

,

000 000 000

o

42

48

71

104

3J

82

84'

37

2

28

Note: Bcnefjllhal proposition "Inu" lias on ;tcm "Selyy"? Scale: 0

sr

no CffOXI: I·) -low efTccl: 4·6 - medium effccl: 7-9 - high effccl: 10 - 100"/0 elfcct

14 22

Dcvc10pmcnt of a Makc-or-Buy Dccision-supporting Proccss

7J

Tablc 12: OUlsourcing Pros SUblllodulc

Organ;zatiQo Chancln.

Strategie Objfftive.

Serial No.

Enviroom. Charaeler.

!'ruduel Chanctc...

SOß]

,•

•<" ,;1

,

]

00101

" 00102'

8

o

o

o

5

o

0

2

2

8

5

2

o

2

o

8

o

5

0

8

,

,

0

00105

2

,

2

8

OUI06 .~ OUI07

5 2 ,

0 0 0

6

,

o 7

Oolor

.. OUI04

i

-<

~

00108

''''''' 00110 00111

o

OUI13

6

OUI14

Ou116"

_~ OUI17 ::.: Ou118"

]

o

OUI12

~ OU115"

~

o

0

o ,

8

o

0

2

0

o o

0

o

0

o

0

8

0

8

8

o o

2

0

0 8

0

8

o

8

005

2

0

0 0

o o

o o

0

o

0

o o o

o

008

5

o

2

5

3

7

000

7

o

0

o

o

o o

0 0

0

0 0

0 8

5

0

2 8

'0

3

0

7

o

0

5

2

7

3

7

9

3 3 0

5

6

3 8

2 5 0 2 0 0

7

o 0

,

o o

o

o

,

0 0

,

8 5

o

9

5 3

,

5

5

5

3

o

0 0 7

J

7 4

3

2

9

7

,

6

o

3

2

4

o o

4

2

<m05

o

3

2

Sum

62

42

78

o

o

139 59

NOle: Bcnefil lhat proposition

"·Oul.~X··

0 0 0

5 0 0

2

8

0

5 4

2

0

5

5

o o

0

8

5

0

085

5

6 8

m

0

5 5

o

Seale: 0

5

5

OUI20

Out22 Out2r OUl24

2

8

o o

5

o

000

5 8

Outl9

<mO'

0

5

o o 8 o

o

0

0

0

0

0

o

0 8 5 2

7

3

10

5

8

5

o

o o

5

o

0 0 002 o 0 0

0 0

0 0 0

0 0

o o

0 2 0

000

7

8

8

2

5

6

J

5

2

4

0

,

2

o

o

o o o o

8 o 5 5 0 o o 008 6 o o 5 0

o 6

o

o

o o o

o o

o o o o

o

0

o o o o

33

36

5

8

5

o o o

8

5

8 5 ,

5 0 2

o

0

o

o o o

22

32

" "

40 46

J6

15

3

38

0

65

0

52 31

6

0

28

o

0

16

0

2J

, ,

0 5

22

3

0 3 0 0

o

o

2

005

5

o o

5 0

005

5

5

0

o

15

78

50

53

56

64

" "

0

004

44

9

o o

" " 39

30

19

0

26

35

869

has on ilem "Selyy"!

nQ effoxl: 1·3 m 10w effccl: 4·6 - medium effcct; 7-9 - high effoxl: 10 - 100"/0 effccl

Dcvclopmcnt of a Make-or-Buy Dccision-supponing Proccss

78

Figurc 15 illustrates [he sub-bcncfits Ihal ycrtical integration und outsourcing promisc 10 cach setting itcm. As can bc seen, many setting itcms significantly bencfit if ue· tivitics ure vcnical1y intcgralcd. These includc: "Sct06 [ncrease control," "ScII2 Strategie vulncrnbility (high)" und "Set 16 Quality of business climalC (Iow)." The following setting itcms significantly bcnclit ir aClivitics are outsoufccd: "SctOI [ncrease marke!

share," "Sct04 [ncrease

shon~lcrm

profil;' "Set 14 lntcnsity of compclilion (high)" und

"Set [5 Marke! dcmand unccnainty (high):'

1I1l;k>lbldil.l%11

SctOl 1",= rmrI:<.'\ silan:

Iillbl
Sct02lro:=quaIiy

p

SclO3lro:=stabiJiy SclO4 11"0:= ,hort-tenn profi

SclMlro:r=lbillilly

C

SclO6 I""""", cmtro\ SclO7

p

]

_00

"

,

sill: (hiY'l

S
Selll

~

sp..'Cifdy(highj

S
5~

,,,~lfy(high)

S
, , , ,• " '" " " " • " OUl>wrrl"l:

~c(bw)

SclO9 Q-ganiz:llmaJ.
C [

~-ml

SclO8Tocmhl

'_00

S
OlrbOllITi"l:

Figure 15: Intcgration arld Outsourcing Sub-bcncfil for Each SClling Item (ResOl Outpul Mask)

4.3 Application of Proccss 4.3.1

General

To verilY and use this process, the fol1owing four casc slUdies arc applicd: (A) Copy machine llsage (as a rcfcrence); (B) Aircraft final asscmbly production; (e) Satellite rockct launch opcration; and (0) Spacc tourism rockct dcvclopmcnl. In thc following, each case study is brief1y introduced and then applied

[0

the process.

Devc10prnent of a Make-or-Buy Deeision-supporting Process 4.3.2

79

Case Sludies

For al1 eases, ] exarnine the rnake-or-buy deeision frorn the buyer's poinl of view. The buyer is typieally a large aerospacc organizution dUlt aims tO implemcnt its activitics efficiently by detcnnining the appropriate Icvel of olllsourcinglinlegration. Each casc is assessed separalely. •

(A)

Cop~'

machine usage (as a reference): The targcl is to copy office letters. On

average, aboul ten office workers share a copy machine. Those copy machines are multi-use machines, meaning they are also used for printing, faxing and scanning doeumcnts. If onc machinc is out of ordcr, it is easy 10 use anothcr machine in a nearby location unti] the original is fixcd. CUfTemly, a large supply market for copy maehines is available in any size, color, quality, etc. This case is the reference. History has shown that copy machines are rypically leascd to cornpanies. Copy rnachines are produccd by spccialized organizutions. Thcrcfore, it would be very surprising for an aerospace company to develop and build its own eopy machinejust to copy daily office documents. •

(8) Aircrart final assembly produclion: The targct is the final asscmbly of the

aircraft, which means assernbly of subsystems, such as wings, stabilizers, engines, fusc1age, cabin intcriors, ete., all for one main system - the aircraft. Today, only a few competitors have the expertise to assemble final aireraft. [n the furure, emerging competitors will arise. Shon lead-limes, low costs and higlt quality are key requirements for a successful final assembly line. •

(C) Salellite rockel launch operation: Note that this case is already discussed in

Chaptcr 3. Hcre, ] apply the process, rather than isolatcd theorics, to the case. The target is to operate commercial rockets to satisfy nationally-owned satellite launches as weil as providing overcapaciry for the global satellite marke!. Competition bctween rocket operators is high. Low prices, high l1exibility, complete custorner services and high suecess rates are the key points used to gain new eustomers and maintain existing ones. The launcher that is cUfTently used, an HII-A rocket, is based on proven technology. However, operating costs need to be reduced in order to remain eompetitive.

Development of a Make-or-Buy Decision-supporting Process

80

•

(D) Space tourism rocket de\'elopment: Thc larget is 10 dcvc10p a smalJ suborbital rocket with a capacity ofup 10 live passengers. This rocke! should bc semi-reusable and penni I wcekly flights. Eaeh flight should initially bc sold for $200 000 (in 2008 dollars). The rocket should bc in operation in 2015. Demand for such a flighl is uneertain, as spaee tourism is a new market domain, and only market surveys are yet available to detennine dcmand. Teehnology is available as shown by the suceessful test flights ofScaled Composite SpaceShipOne in 2004, but the eertilication process for passengcr flights is a ehallcnge with rcgard to safety and environmental coneems. Market compctition is rclatively low because only Scaled Composites has the proven neeessary expertise to realize devc10pment of a suborbital rocke\.

4.3.3

Resldls

With the case studies in mind, [ apply the make+or-buy decision<supporting process in the following live phases, as shown in Figure 16. For this, I develop a tool entitled ·'MoB-Taol;· as shown in Figurc 17.

Ph.s, I

....nl

-=

-

Definc Mission Statement

Definc Strategie Objecti\'cs and Independent Faetors

- ~ ~«

Phu,J

Definc W"';ghting QfFactOr$

liiI

Ph.se <4

Check Plausibility oflntegration Pros and Outsourcing Pros Submodules

Go/'

Ph.se !'i

Obtain Results

~

Figurc 16: Applicalion oflhe Make-or-Buy Dedsion-supponing Process

Dcvc10pmcnt of a Makc-or-Buy Dccision-supporting Proccss

SI

~-TooI

"'--...,.. "

. . . _ . , . _ A. GeoWIdIo

li

1-.,- _-_ - r--"- --_.600.___. ---_ _._-. -. \'_1"

..n..... _ .. _ . . ..n................ ..n....... ..-.

lI.

."P'-<".

......... . .-- .popII"' _•__0'_ :

",,- _

,~..,.-

n

.~

Bo. . . . .fi-o

'''''0

-......

..._ _ (J_r.

...

'" ........... (Ibd):

...

.......

~

..

______

~'-"'If...-

•

WC_ _ _ _ (....r - l

- -

(Dls,:...._""k.. "".........

... _

""_~._.....,.

• 1 i I

I, I, I, )C...,. _ _ ..... .......... --.."""""'"'" .. ., ,, )SpO<._-.......... . . , • . '.)-_""6-_ (oom..-o)

T... _ _

-

•

,-

(pooI;ooloil;fy, _ _• ...,..,.._.........,.•

........ ........-

r..oon._~

~

...-,Oy,

.... ~P<""Io«"""

-~

~.

- • ! ! ! ! ••• t l J ~ • ! i

• I 1 i tI f f f ,I f ,, I l • •I 1 , I .• I I I , , , I J I l 1 J ,I, - I r I I ! j,

) (')_10. .., .." . _ ........._

.. _

...,Io. "-00;...;-

.." ' - _. . . """" ....... 'loooillodio ....

ll<1p

_w.

,--

--.-. ....)_ .. ""r.....

S
....

{B) .......... - . . . _ . . - , ._ ...-(Cl_",,"'

,,,., _ _"'....,...n.. ......... --.. _

-

~._

-

'1o\>:1'_ ....."'_ .... _ld ...'~lI».. fi'...." ........ ~ ..

"'_0I......,'iIy.

0

_ · . _ ~ _ . , , _

-_.. _ _ _ _ _ ,.,-.. _ _...

.-,"'_01.......... ' "'_01 .......... 1 "'_01.........' "'_0I.....,'iIy.

-

i

J

~

I, .,, •

i

.. ..

<

• •

I, I I I ! , j, , j, .j , I, • • ,, .. •• ,, ,• , ., ,, ,, ,•• ,, ,,, •• •• •• .• • •• • .•

.. .. .. 0

0

..

.. .. 0

..

"'-~ 'O~....,,1>oP>

CIooI""P>f ......._ ... _ ........,_.-.,..- _

....... _ ... _.n.m....-'......-._;{__.-....-.... ~, ........,... ~

N"'-bip _ _ _....

.....,n.. ... _ _

-~

FlgUrc 17: EXlr3cI from thc MoB-Tool

~.

~.

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

82

Befafe dcfining the organi7.ation 's strategie objcctivcs, it is ncccssary 10 clc3rly dcfinc a mission statement,

3S

shown by cxamp1c in Tab1c 13. Thc mission statement is assumcd

cqual for all four case smdics. Tablc 13: SCllings Submodule (Input Mask 1J3) Cas~

Sludy

Mis~ion

(A) Copy maclline

Slal<:m<:"t

"I'l"{lvidc SOCiCly with ,uper;or serospace produas lhat improw [he qual;!y

(8) Aircraft

oflif<:. satisfy CUS10mc. nee<Js. and providc c"'pto)'<:cs with advanCCIllCnl

(e) Satellit<:

opponunitics at>d investors with a SUl'Crior rate ofrctum."

(0) SP.1CC lQuris111

b) Phase 1: Defille Strutegie Objeclil'l!s' und Independent Faclors NCXI, strategie ob]ec!ivcs, using the mission statement as a guidc (profitability, market share, quality, cost, flexibility, dcpendabilily, innovation, ete.), are defincd as shown in Table 14 für eaeh ease study. In addition, quasi-independent factors, such as organiza+ tion, product and environmental charaeteristics are also classified in this table. Table 14: Seuings Submodule (Input Mask 213) Strategie

Cue Slud"

F;n,·ironm. CharadH.

Produel Charader.

Organi7,ation Charadcr.

Obj«li\'e~

,•

•E ,•"

2

(A) Copy maehinc

,

o

(ßl Aircrnft

10

7

7

(Cl Satctl;te

10

10

7

" 7

7 5

"

(D) SP.1CC tourism

10

10

2

1

5

5

8

"

Scalc: 0 ~ vcry low; I 3 ~ tow; 4-6 - medium; 7-9

8 8

8 ~

10

10

2

2

5

7

7

4

6

10

10

9

8

6

6

high; 10 - vcry high

1

10

2

5

1

8

,

9 8

1 ,

5 5

2

9

2

\0

6

Devc10pment of a Make-or-Buy Deeision-supporting Process

83

c) Phase 3: Defitle Weigh'ing u[ Fflctors [t is ehal1cnging to define the weighting ofeaeh independent faetor rmd the relationship between strategie objcetivcs and independent faetors as a who1c. Equal weighting is assumed for all case studies (6,25%, each summing up to 1()()%), as shown in Table 15. Table 15: SeHings Submodu1c (Input Mask 313) Slral..-gic ObjNlh'es

Case Sludy

Organi/.lllion Charafler.

ProdUfl Charafler.

En\·ironm. Charafler.

,• •~

,,,, •

(A) Copy

mach;ne

6.25 6.25 6.25 6.25 6.H 6.25 6.H 6.25 6.25 b,25 6.25 6,2S 6.25 6,25 6.2S 6.25

~Ai~

~6.25W~6.25WWWW6.25b~W6.25W6.25W

(e) Salellite

b.25 6.25 6.25 6.2S 6,25 6.25 6.H b.25 6.25 6,25 b.25 6.25 6,25 6,25 6.2S b.25

(0) Spate tour;sm

b.25 6.25 6.25 6.2S 6,25 6,25 6.H 6,25 6.25 6.25 6.25 6,25 6.25 6,25 6.25 b.25

Nme: Each row sums 1(> 100%. Value. are g;"cn in percentage (0/0).

d) Plluse 4: Check Plullsibiliry o[[wegru/ioll Pros ulld Omsoltrcillg Pros Sllbmodules As prcviously noted, this is a make-or-buy decision-supporting process that is applied to the aerospaee sector. Thus, ussessment is done to ereate "[ntegration Pros" und "Outsoureing Pros"' submodules, as shown in Tablc 11 and Tablc 12 from the acrospaee seetor point of view. If no beller values arc available, it may be possible to use this aerospace-specifie data for non-acrospace sectors, but rcsults should be analyzed carcful1y. [n applying this proccss 10 acrospace or non-acrospacc scetors, refcr to Tablc 1[ und Tablc 12.

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

84

e) Phase 5: Ob/ai" Re.~I/II~·

Vcrtical integration aod oUlsourcing sub-bcncfirs of cach adjuslcd sClling itcm for the fOUT case studics are showll in Figurc 18 10 Figurc 21. .!lok< ll
• 1l<·<~H

p

I

SdO I 10<1''''. mark
eJ

Sd02 ]nc..-< qu.liy

Set03 I""'. ... ''''biIO:y Set04 10""..,... ,bon'lenn p,ur. SedlS J"",.... o..d,;t;ry 5..06 [OCre:l" COIItroI

Set07 Orpnizalion ,tu (high)

P

~

p , , • ,, "

1o,,,,,.tt1011

Toch"".,

<>;pc
SelIO I"r<>duo' ."",pb"y (hillhl

Setl.

As~

SelI2

s,,,'ogic 'l.lnermilily (high)

.podTdy(bigh)

S.II) Tochnobgy

C-

;

SeIO~

SeI09 ürganiul....... killl (Iow)

OIIb... r
e :J

, , 1".. ~ ..11...

""""""''Y (high)

Setl ~ lo'rn,iy of .""'petilion (high) SeIl S Mark'" dcmand uncmoi"y (high)

, , • , , , , ,

SelI6 Ou-I«y ur bu,D:s. 010"". ('
0."..«1""

Figurc 18: Sub-bcnefit for Case Study "(A) Copy Machinc" (Rcs02 Output Mask)

.Oeka Ikndil (.)

lilF .&"'",

setOl b>•• m>rk.. ,,,,,,,

5<102 ,"" ..... qualily Set03

1",,~•• tabiIf:y

Set04 locrn>< .oo'Henn prof. SdO~

1""r<3
Set06 I""",... <",,'roI Sd07 Orpni1,alion.'" (h~l Sd08 Trchnbl "'....;.,n<,. (10",) SeI09 Orpnizalional 'kill< (10",) SelIO Produ<;, cornpbily (hishJ

c:::

-=

SeIl ,

p

e :J

0u" .... 1.~

(h;ghJ

SelI3 Trchoobgy un<,."u,'Y (hishJ SelI4 In,cm;ily ofcompclili.>n (hiJhJ SeIl ~ M..-k« drn\and u"""".i1'Y (hish)

, , , • ,, , , , , • , , , , , " '.'I'Ii'''''''' Inl<~"~""

As~.pr< ",,"y

SelI2 S,,,'<'gic ,'uMabilily (high)

5",,6

Qua~ ofbu.......

c....,. (10"')

O."....11IlI

FiguTC 19: Sub-bcnclit for Casc Study "(8) Aircrall" (ResOl QUlpUt Mask)

85

Dcvc10pmcnt of a Makc-or-Buy Dccision-supporting Proccss

.u<~.~"
•

S
~".fIH

S..021", ..,...qualiIy S
P

SeIM I", ..,.,. ,hort·,..,.., pmfl SelOS I",r-. tkxill.y 5«06lnc ..""<",,'rol Sel07 Organization ,i:.« (high) Sel08T..,IIeical <Xf"'I"""".(kow)

P

:J

~ C-

, , , ........IOi..

5«09 Organi.
~

SeIlf compeo'lion (high) SeIl S

, , , , , , , , , , , " 0u"...«1.1'" ""'1'.011.. " o.m..."I.g

~b.l:...

drnland u""",.,,,in,y (high)

SelI6 Quality or b,.. ilen clitn.,,, (kow)

Figur<: 20: Sub-bcncfil for Cssc Study "(C) Satellilc" (Rcs02 Output Mask)

1iI1l<~.ll
.1l«,IiIH

5<10 I Increa>< mark'" ,hat< 5<102 I"" ....< qu."y

p

[

5<103 I"" ....< ,,,,lPiIiy Sed).ll"" ..... ,hort-I""" profI SetOS I""",..< tkd,iIily

c::

SeI061nc""". <"",mI 5<107 OIpoization 'i>< (high) 5<10~

P

::J

Teeh.;''' OXp
Sot09 Qrx>nizat.,... ,kiDs (Iow) SelIO Proo.x, c","p~_,ily (high) SeIl I All"" >p«iflbilily (hi:8/J)

~ b

SelI3 Teehn<Jl<>gy u"""""',y (high)

:::J

, , , • ,, , , , , , , , , , " " 0.'''.'''"1 '""g.arIoa

OU......... g

SetI<> Inl"",ily or"ompolilion (high) SeIl S Mark.. d<-rrwwl une"".i"y (high) 5"'16 Quolily<>fbo<, dm.." (Iow)

l·"l,arI...

Figur<: 21: Sub-benefil for Case Sluuy "(D) Space Tourisl1\" (Res02 OUlPUI Mask)

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

86

Thc "Bencfit" bar chan rcprcSCllts absolute valucs. Minimal valucs 3fe zero
whclhcr vcrtical integration or oUlsourcing is prcdominanl, \lenkal integration valucs are subtracted from the rcspcclive outsourcing values in the "Deha BcnefiC bar chan. Bascd on these (absolute) sub-bcncfits, Figurc 22 shows [he (relative) makc-or-buy

ratio for the four eases. Thc bar chan rcprcscnts the ratio of "curnulatcd oUlsourcing bencfiC

10

"cumulatcd venica! integration benefit," minus one for each case. The ''Test

integration" bar cxists [0 lest the 1001 againsl
(A)Copy rmehine uuge (as n,:fe~ncc) (B)Ain:rafllinal assclTtly produclion

(C) Salcllitc rockCI Iaunch opcralion

p p

(0) Space lourism rockct dc\"clopm.::nl

I C Eknc1it Ralio [-]

Tesl in 0.20

0.15

More Illtegration

0,10

0,05

0.00

0,05

0,10

0,15

0,20

More OulSourcing

Figurc 22: OUlsourcingltnlegration TOlal Bcncfit Ratio (Rcs03 OUlPUI Mask) For case study "'(A) Copy machine," as expccted, the tool indicatcs that outsourcing of copy machinc usage promises very high bcnefils, while venical integration promises very low bcnefilS; the intuitive answer is the same, as it would be an unlikely use of resources for an aerospace eompany to devclop and build its own office copy machines. For case study "(8) Aircraft;' thcre is no accordanec bctwecn lhe tool and instinctual recommendation in the case of aireraft assembly; Ihe 1001 showed a small preference for outsourcing, while, intuitivcly, the risk of rcvealing know-how to outside producers

oevc1opment of a Make-or-Buy oeeision-supporting Process

8J

would lead one to suggest integrating this aetivity. For easc study "(e) Satellitc," the tool shows a tendcney toward reeommcnding outsoureing the operation of roekets, rather than integraling it. The case srudy from Chapter 2 led to the same result. For case study "(0) Space lOurism;· the results show that there is a significant benefit to outsoureing the devc10pment of aspace tourism roekeL This also makes intuitive sense, bccause thc daily operations attendant necessary to make ncaHenn profits would not blend weil with the fUlUristic ereativity (and far-tenn profit) that such a program requircs. Rcsu1ls ofCase A, C and 0 reflect expcetations, while Case B docs noL Reasons for this might inc1ude: (I) expcctations are incorrect and it is aetually better to outsouree an airerufi's final assembly produetion; (2) the process eharaeteristies are based on ineorreet assumptions; ami/or (3) important infonnation from the case study is not includcd in the input mask. An empirical validation in the fonn of expert interviews might hc1p to more elearly identify these reasons.

4.4 Discussion 4.4.1

General

The following seclion attempts to widen the srudy's point ofvicw through a discussion eentercd on: (I) the choice ofitems for the "Setting" submodu1c; (2) the sensitivity of propositions of the "Integration Pros" and "Outsourcing Pros" submodu1c; (3) a tradeofTbetween informal and fomml statements; (4) a eomparison betwccn processes and/or models from other authors to my developed make-or-buy dccision-supporting process; and (5) limitations conceming the introduced process. 4.4.2

Choice of Items for "Settings" Submodule

The balaneed scoreeard philosophy is uscd to create the "Selling" submodulc. The balanced seorccard, introduced by Kaplan and Norton (1992), is a widely used strategie business perf0n11anee mcasurcment system. This method seeks 10 rcport on 1cading indieators of an organization's hea1lh, rather than referring to traditional accounting measures alone. These leading indicators are ealled Key Performance Indicators (KPI) bccause they are critical to the successfill execution of an organization 's stratcgy. Bascd

Dcvclopmcnt of a Make-ar-Buy Dccision-supporting Proccss

88

on [he strategie goals of an organiz3tion, target valucs for KrIs arc set. KPls cnablc an organization 10 measurc and monitor its pcrfonnancc on a strategie and opcrational

level. Thc goal is 10 cstablish a common KPI languagc that spans all arcas of an cntcr· prise.

Typically, KPls afe uscd in a post-aote contC/(1 10 cvaluatc an organizalion's past per[annanee. Krauth Cl al. (2(05) rcason that KPls should bc utilizcd in the planning phase

as wcH, 'hus ex-ame. I follow this approach for the makc-or-buy dccision-supponing proccss. A kcy attribute oflhis proccss is its support for idcntifying causal1inkagcs bc-

tween components orlhe business that fulfill the stratcgy (i.c., 10 dctcnninc the bencfit share of each proposition that contributes to either venieal integration or oll1sourcing). Ofien the balanced scorecard is broken down into a financial, customer, process and an HR & innovation perspcctive. This procedurc aims to avoid the c1assic problems of measurement, such as (Van Aken & Coleman, 2002) use of too many metries, use of exclusively eost metries, use of only shon-tenn focused metries and use of metries that drive the wrong behaviors. The ehoiee of KPls is organization-speeifie and depends upon its goals. An organization's goals change over time (Allio, 2006). In a stan-up high leehnology company, for example, managers foeus on reliability. In the growth stage, managers eoneentrate on market share. In mature industries, managers focus on production costs and/or capacity utilization. In an aging industry, managers primarily focus on cash flow. I select those KPls for the make.or·buy decision thatl reeommend for use by a rypieally mamre aerospace organization. Due to the modularity of this process, it can bc extended easily to additional KPls and/or existing KPls can be tenninated. In addition, my proposed weighting (I assume equal weighting) of each KPI is easily ehangeable. 4.4.3

Sensilivit}' Analysis

I perfonn sensitivity analysis 10 make the process propcnies more transparent; helping to identil'y critieal elements and interpret estimation results. Saltelli, Tarantola, Campolongo and Ratto (2004) define sensitivity analysis as the study of how the uncenainty in the output of a model (numericalor otherwise) can be apponioned to different SOUfCes ofuncertainty in lhe model input. Eaeh input faetor is perntrbed, in turn, whilc keeping all mher input factors fixed at their nominal value (i.e., the "One·faelOr·al-aTime" approach), to detennine its influenee on the result: e.g., the elfeet on the makeor-buy result for a very low and a vcry high value of item "Set04 Illerease shon-tcnn

89

Devc10pment of a Make-or-Buy Deeision-supporting Process

profit." [ assume that a sensitivity analysis based on the "Onc-faetor-at-a-Time" approach dclivers sufficicntly significant rcsulls for a linear, equation-based process, as developcd in this study.

__ SetOI I...,,..a,,,, n""kt ,h,,,,, - - Set02 I...,rease qualily SetID I...,rea.., 'Illbility

"

___ SetM 1"""'3$0 'hort·'enn prof. __ SetOS I...,rea""

l\:~l:>iily

--- Set06 I...,rea,e 0"""01 - - Set07

"

Fm. sitc (1\Wl)

Se,OS Teomi:ol e,per.,...,e (Iow)

-

, - Set09 Orll"n",,'i:;Jnalsk;n, (Iow) SetlO PTOd"", <~_,i1ytlQgh) Set I1

A".' ,peoudy (high)

Set 12 Slratogi: 'ur.erability (higll) _

Se, 13 Tctln:>!ol!Y _<""ny (high)

____ Set14 1r4C....ly of 0'"'"fIC'1'" (high) --- SetlS Morkcl de,rorod _el13in1y (l\VIl Set 16 Quolily of l:u\.ilc•• olilroto (Iow)

FiguTC 23: Resuh ofScnsilivilY Analysis I use the data set ofthe case study "(0) Space tourism rocket development" for sensitivity analysis. The rcsult is shown in Figurc 23. All values ure within thc acceptable range and no anomalies are found. "SetOI lncrease market share;' "Set061ncrease eon· trol" and "Setl6 Quality of business cHmme (Iow)'" sensitivities are higher than +1-10% when strategic objectives and independent factors are varied +1-20";". Thus, spC(;ial attention should be paid when these values are set. 4.4.4

Informal Venus Formal SlatemenlS

Some readers may prefer or expcet formal statements to informalones. I choose to use informal statements for two rcasolls. First, characteristics of aerospace organizations are unique compared to the overall characteristics of most other industries as shown in Chapter 2. For this reason, rnany economic theories should be modificd to apply to the special cases of3crospace organizations (Gochlich & Bebenroth, 2008). Dculing with those theories from a qualitative

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

90

vicw (i.c., using informal statements) ralhcr Ihan a quantitative vicw (i.c., Ilsing formal statements), makcs il casicr 10 dClcnninc the potential und wcakncsscs of invcstigatcd theories, itcms und propositions. Sccond, my motivation und attempt is to generale an overnll makc-or-buy decision-

supporting proccss for acrospacc organizations toward undcr:standing the commonalitics, distinclions und interactions oflhe (nonnally isolalcd watchcd) makc.oT+buy thcories und known rccommendalions. Furthermore, [ um motivutcd [0 provide a combined accüunt of the costs, risks aod bencfits of oUlsourcing vcrsus vcrtical integration, Ta accomplish (his, J discavcr that the top-down approach of using infonnal statements is superior to the bonom-up approach of using fonnal statements: simulating the complex architecture of aerospace organizations by only fonnal statements would cause a disaster duc to the overwhelmingly unmanageable number of cquations it would create. Use of infon11al statements pennits the necessary dis!anee rcquircd for the "banlefield of theories" and allows me to uneover imponant cohercnees. This is in accordance with Gibbons (2005, p. 236), who states that ··finns have invcntcd far more ways to work together than organizational eeonomics has so far expresscd (not to mention evaluatcd)" combined with Krugman's (1995, p. 54) waminß for ··sensible ideas that could not be effectively fonnalized [and] fonnalizable ideas that seem to have missed the point:· Funher consideration can be found in Baker, Gibbons and Murphy (2004).

4.4.5

Comparison Wilh Olher Sludies

Many amhors investigate business cases for omsourcing. Duc to very different assump· tions in these studies, an exact comparison is not possible atthis time. However, a preliminary comparison is allempted in order to enlarge the basis of discussion for makeor·buy decision models and/or processcs. Several models are drawn in the economic literallIre to distinguish between activities that can be outsourced and those that should be made in-hause by the buyer based on multiple criteria. Some ofthe models soned by year of publication are listed below: •

The Tulloek (1980) modcl, based on rent-secking, al10ws one to detennine the transaction costs of omsourcing, bm docs not produce a trade-off bctween outsoure· ing and venieal integration.

Devc10pment of a Make-or-Buy Deeision-supporting Process •

9J

The Venkatesan (1992) model indicates that there are either eore produets that should be strictly produeed in house or non-eore produets that should bc strietly produccd with the help ofsuppliers. The weakness ofthis model is its neglect ofthe intemlcdiate types of produets (from eore to non-eore) and thus, the eOTTesponding reeommendations.

•

The Quinn and Hilmer (1995) model is based on the dimensions "degree ofstrategic vulnerability" and "potential for competitive advantage." This model covers three eonditions of make-or-buy (in-hause produetion, partnership and buy-ofT-the-shelt). The amhors only analyze some possibilities out of a total of nine.

•

The Olsen and Ellram (1997) model specializes in the partnership condition and distinguishes betwcen strategie produets (important, but diffieult to manage), bottleneck produets (not impoJ1ant and diffieuh to manage) and Icvcragc produets (important and easy to manage). ln-house production and buy-ofT-the-shelf are not considered.

•

The Clemons and Hitt (1997) model is based on the coneept of a "keepcr.'· An activity should be eonsidercd "a keeper" if its loss, should it occur, would entail high costs or even destroy the company. Clemons and Hitt argue that the traditional characterization of ·'core" is of little use in assessing what can bc outsourced, [nstead they propose the fonnation of the fol1owing four groups: (I) Strategie Competenee: an activity that represcnts a kecper and a competence that should not be olltsourced. (2) Strategic [ncompetence: an activity that represents a keeper, but is poorly perfomled internally should not be outsollreed. Outsollreing would initial1y ofTer benefits, but the potentiallosses of oUlsourcing will dominate any short-tenn gains. Instead, these incompetence activities should bc improved. (3) Non-stT3tegic Competence: an activity that represents a non-keeper, but is a company's competence and can be oUlsourced or become a business unil. (4) Non-strategie incompetence: an activity that rcprcsents a non-keeper und an incompetence that should be outsourced. Outsourcing otTers opportunities for performance improvemenl with moderate risks.

•

The Levin and Tadelis (2005) model distinguishes betwcen vurious contract fonns that range from employment, and thus veJ1ical integration, to olltsollrcing types. This mode1's feature is to investigate the make-or-buy decision from the point of contracts.

Dcvclopmcnt of a Make-or-Buy Dccision-supporting Proccss

92

In an cnhanccmcnt 10 cxisling models, thc proccss dcvelopcd in thc prescol sludy

covers thc cnlirc spcctrum of makc-or-buy dccisions (thc continuum from in-hüuse 10 buy-off-lhc-shclf). This mcans that cxisling models are isolatcd, as they da not take into consideration [he parameters dcvelopcd by one anothcr. Thc strengths orlhis developcd

proccss are

[0

support thc dccision-makcrs witb holistic TCcommcndations. It focuscs on

improvcmcnt 10 cxplain aod prcdict organizmional archilccmrc from an ccanamic-

emdeney pcrspective. Tbc process allows one 10 dClcnnine whm organizalional (aod supplicr) archilCClurc is best suitcd 10 a specificd activity. Thc ccanamic environment is held filled for analyzing alternative structurcs individually, and finally eompared to one another. 4.4.6

Limitations

Extant make-or-buy related studies are quite voluminous. Thus, eomplete implementation of this Iitera!ure into the make-or-buy decision-suppol1ing proeess is bcyond the seope of the presenl study. Rather, [ limit my diseussions and investigations on those studies tImt 1 found to have signifieant influenee on make-or-buy decisions, espccially for managers. However, [ find that many extant sludies suffcr from measurement problems, such as folIows: •

Some factors, such as motivational, cultural and social factors are hard to handle, bUl may strongly influenee decisions.

•

Several studies examine only one faetor thai is predicted to affect the make-or-buy dccision, holding other faclOrs constant, whereas it is ofteu a combination of such factors that should bc assesscd (Lafontaine & Slade, 2(07).

•

While it is easy to detennlne extemal transaction costs (bu)'er to supplier) but dirncult to idcntify internal Iransaction costs (dcpartment to dcpartmcnt), many resulrs oftrade-ofTstudies are unjustified, biased in favor ofvertieal integration. However, Ihose eompanies who condllel extensive oUlsoureing may have 100 many sllppliers. This wOllld be more coslly 10 manage than less emCienl in-house operations, as argued by 81axill and Hout (1991).

•

Companies from differenl cOllntries generally apply divergent suceess eriteria bc· eause ofunique cultures (Van & Zeng, 1999). [n addilion, each cllhllre has specific cultural codes, e.g., the lruSI-based cooperative nonns of Japanese sociely encourage

Devc10pment of a Make-or-Buy Deeision-supporting Process

9J

high eollaboration rates among eompanies (Todeva & Knoke, 2005). Thus, assessing international scenarios is espeeially eomplicated beeause results are biascd by different cultural environments. •

Aehallenge exists whether to llse objeetive outeome indieators (e.g., finaneial gains, number of innovations, revenue), subjeetive indicators (e.g., partner satisfaction with the eollaboration, eustomer service, corporate identity) or both, in order to fllily assess the performance of organizmions.

•

In the ease of the make-or-buy deeision-supporting process, some of the propositions overlap eaeh other partly or one proposition may be a sub-proposition of another (e.g., proposition "Out I I Redllee labor eosts'· is to a great extem a sllbproposition of proposition ··OuI17 Reduee produetion eosts"). Avoiding this fact would result in garbling of the modules. Inslead, double eounting of similar advantages is avoided in the presclll srudy by earefully assigning vallIes to eaeh proposition (e.g., the benetlt value of proposition "Oul17 Reduce production costs" exc111des the bencfit of low labor eosts, as this itcm is represented by proposition "Out I I Redllee labor eosts"). Thus, the precision ofpropositions is limited. Yet, lassurne that a preponderanee of

indication, gathcred across plentiful studies of diverse industrics, time periods and geographie regions using different approaches, yields convineing evidence as 10 the validity ofthe imrodueed rnake-or.buy decision-supporling proeess.

4,5

Rcsults

Thc purposc ofthis ehapter is to investigate make-or-buy deeisions. The primary output is the development ofa process us weil as its application to four ease studies. The process provides a tool, based on theories, empirieal data und syslemutie means that is designed tO support managers in generaling make-or-buy deeisions of greater aecuracy and transparcncy than is curremly available. Although strategie motives for organizations to engage either in verlieal integration or in outsoureing vary aeeording to the senin!; (organization-spccifie eharaeteristics, product characleristics, multiple environmental fuetors, ete.), it is possible to obscrve significant results.

Dcvclopmcnt of a Make-ar-Buy Dccision-supporting Proccss

94

Thc prcscnt findings havc important managerial implicalions. First, rcsuhs confinn

that milke-ar-buy dccisions afe important contributors 10 control, stability aod coordina-

lion aspccis ofbusincss dccisions. Sccond, one can sec thaI cffcctivc make-ar-buy dccision expertise is criticallO an organization's succcss. Third, the process shows thm $Catlcring the main question (i.c., Ihe make-ar-buy dccision) iota many suh-qucslions (i.c.•

the 16 items and 47 proposilions), hclps 10 generale a transparent aod stmlcgy-oricnted sollL1ion. Thc nex! step, hut bcyond the scope ofthe preseot study, is an empiriea! validation (he tao) in the foml or interviews with acrospacc cxpcrts, cconomists and politicians.

or

5 Conclusion This chaptcr summarizcs the rcsults of thc thrce studics discusscd in Chapters 2, 3 and 4. Dctailed discussions and specific rcsuhs can be found in thc discussion and rcsuhs sections of each main chapter. Here, 1 highlight the key outcomes of this research series: •

In Chapter 2, the characlCristics of aerospace organizalions are shown as llnique compared 10 those of mOSI other industries. High markct powcr for most types of acrospace organizations, highly complex systems, high olltsourcing ratio trends, large milital)' market shares, strong govemment financial support and challenging assessmenl of performance are all unique characlcristics. This part of the study also shows that thc avialioll and space sectors share many fcarures (e.g., high qllalily standards, massive entl)' cosls, vel)' low pro· duction rates, high stralegic power and high degree of inlemationalization) that are ncarly idcnlical, whi1c other features (e.g., markel slructurc, demand-supply intcractions, unit size of produetion and impcrfeet competition) are different. I conc1ude in Chapler 2 that other extreme sectors, such as the oil rig sector. the World Wide Web scctor and the shipbllilding sector, have some llniqlle and some similar characleristies to Ihe aerospace SCcloT. An illvesligation into those sectors is not in the scopc ofthe prcsent study but may be a fl1.litful area for future research.

•

Chapter 3 eSlablishes thaI many cronomic theories should bc modified if applied to the eases of aerospaee organizations. Thus, one should study Ihe make-or-buy recommendations from consultams with caUlion as their rcsults arc typically bascd on general assumptions and convcntional cconomic thoories, not those specific to the aerospace sectoT. [ demonstrate in my research on space organizations the reasons Ihal the Japanese govemment's aclivilies in Ihis industry have shirted loward using privale companies, a shirt Ihal has also been visible in bolh Europe and the USA in recent years. As an example, 1 show that the aim ofthe Japanese space organization JAXA is 10 increasc the eompclitivcncss of Japanesc commcreiallaunch scrvices but, to do Ihis, JAXA ncrds to rcduce eosls, inercase rdiabilily, and improve cuSlomcr scrvicc. Under the current organizational architcrture (Le., where basic research, production

96

Conclusion aod operating divisions afe vcrtically intcgrnlcd), the ability of this organization 10 incrcasc its commcrcial compctitivcncss is significantly limitcd. Howcvcr, the dcvclopmcnt loward oUlsourcing launch operation aClivitics cannot bc cxplaincd by ci!her transaction COS11hcory or the human resourcc-bascd view, bUl is coogment with the agcncy !heory.

\Villl (ml/sac/ion

COSI

,"eOly, outsourcing would rcsull in highcr transaction

costs Ihan wDuld vertical integration aClivitics, especially when thc environment is unccrtain, und asscts are spccific aod hcavily uscd. In the hl/Illan resolll"ce-based

l'iew, advantages accruc when activitics are cfficicntly vcrtically intcgratcd becausc oUlsourcing deplclcs human reSüuree knowlcdgc. Thus, JAXA's olllsourcing is morc in aeeord Wilh agenc)' IheOJY, where oUlsoureing aelivities for space organizations arc preferab1c ovcr vcrtical intcgration whcn thc costs of misalignmcnt connicts caused by olllsourcing are 10wer than thc costs of thc ineentives from vertieal integralion. Thcrcfore, thc dircetional trend of outsourcing activilies in spacc organizations is most congment with

principal~agent

theory; transaction cost theory and the human

reSOllree-bascd view bath fail to provide suffident reasons to explain why JAXA should vertically integrate ils aClivilies 10 bc more effident, ralher Ihan olllsourcing Ihem 10 privale companies. I conclude in Chapter 3 that conventional, broad-based economie thcorics have only limited appliealion 10 lhe spaee seclor - and possibly Ihe aviation sector as weil. To corroboralc this eonclusion, othcr similar spacc and/or avialion-spceific casc studies should bc lested using thcse Ihrce theories. Funher, the exlcnl to whieh each of Ihese Iheories may have proportionale or disproportionalc innuence on Ihe Iheorelieal resuhs is a diffielllt lask and a ehallenge for future research. •

Chapter 4 develops a loollhal faeililales

make~or-buy

dccisions for managers work-

ing in Ihe aerospace seclOr. Abolli 50 proposilions ofmake-or-buy decisions, mostly gained from sceondary analysis, are eoliceted and ranked. Thcn Ihose propositions are systematieally conneclcd 10 6 slralegie objectives, 3 organizalional eharaclerislics. 4 producl characleriSlies and 3 environmental eharaelcriSlies. Thc resulting tool is applicd to four case studies taken from the acrospaec scclor: (A) Copy maehinc IIsagc (as a rcferenee), (8) Airerafl final assembly produelion,

Conc1usion

9J

(C) Satellite rocket launch operation and (0) Space tourism rocket dcvelopment. [n

three of the four cases, thc make-or-buy decision rccommcndcd by the tool mirrorcd instincrual, cxpcricnce-bascd conc1usions. Case (A): As expccted, the tool indicates that oUlsourcing of copy machine usage promises very high benefits, while venical integration promiscs very low benefits; the intuitive answer is the same, as it would bc an unlikely usc of resources for an aerospaee company to develop and build its own office copy machines. Case (8): There is no accordanee between the tool and instinctual reeommendation in the case of aireraft assembly; the tool showed a small preference for outsoureing, while, intuitively, the risk of revealing know-how to outside producers would lead one to suggest integrating this activity. Case (C): Thc tool shows a tendency toward reeommending outsourcing thc operation of rockets, ralher than imegrating it. The case study (rom Chapter 2 led to the same result. Casc (0): Thc results show thaI thcre is a signifieanl benefit 10 outsoureing the developmcnt ofa spaee lourism rocket. This also makes intuitive sense, beeause the daily operations attendant to making near-tenn profit would not blend weil with the futuristic ereativity (and far-tenn profit) that such a program rcquires. [ eonc1ude in Chapter 4 that the main outcome of this st\ldy is the development of a make-or-bllY dccision-supponing process. A structurcd application proccdure makes this process attractive to any manager who necds a simple and transparem tool to support makc-or-buy decisions. Dividing the make-or-buy question into many sub-qucstions bascd on, in this case, [6 objcetives und characteristics, hclps decision-makers generate a transparent and strategy-oriented solution with fair at· tention to all important eonsiderations. Sy contrast, the less struetured inlllitive approach allows the dceision-makcr to weigh only a few argumentslpropositions simultaneously - rypically Ihose which have CllITent subjeetivc irnponance for the deeider, e.g., bad ncws aboUl Dollar/Euro CUITency trends, which would favor an outsourcing deeision or bad news about risk of revealing know-how, whieh would favor an integration decision as in Case (B). Thc ncxt stcp, wh ich is bcyond the scope ofthe presem study, is an empitical validation ofthe tool in the fonn ofinterviews with aerospace experts, cconomists and politieians.

Conclusion

98

As closing thought, from these thrcc sludics, I havc concludcd Ihal cconomic motivational goals, political hurd1cs 3nd tcchnicaJ challenges should bc more c10scly mcrgcd in

the carly phascs ofslralcgic dccision-making for any ncw, large-scale program in acfOspace organizalions. By dOlog so, decision-makers cao adapt the organizational architccturc of acrospacc organi7.3lions 10 the nceds of 3ny planncd big prograrn, rcsulting in an imponam aspcci of cfficicncy improvcmcnts.

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About the Author [)r. De Roben A. Gochlich was bom in Ilcrlin. Gcnnany. in 1975. I-Ie stlldied Acrospacc Engineering at Ihe TcchniC<11 Universily ßcrlin from 1996 to 2000 and n.'eeived his docloral dcgrcc in Engineering in 2003. Hc has done research stays and consulting in the fields of jet engines. rcusable lullnch vehic1es and space tOllrism at the Israel Instilllle of Technology (I-Iaifa. Israel), al the UnivcrsilY of Washington (Seaule. USA). at Ihe National Aerospace Laboratory (Tokyo. Japan) and at EADS Space (KOllroll Spaccport. Frcllch Glliarm). Robcrt A. Goehlich ereatcd and lcctured Ihe lI'orld·s first "Spacc Tourism·· Mastcr"s and Ph.D. courscs as a visiling professor al Kcio University (Yokohama, Japan) from 2003 to 2005. He was also in\'olvt.:d in JAXA·s Future Space Transponation Systcm Tcam conccming cost oplimizution and in NASA's "Moon. Mars und beyond·· vision conceming "Ecollomic Dc\'clopmcnt of Spacc" projccL Sincc 2006 hc has led vurious projcels at a leuding aerospuce complmy. In 2008. hc rceciv<.:d his docloral dcgrcc in Economics at thc Ellropcan Busincss School (Ocslrich-Winkcl. Gcrmuny).