Outsourcing in Regulated Industries

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Corporations outsource business activities to external partners for a variety of reasons – cost, flexibility, time to market, and core competence. Both manufacturing and services industries outsource extensively.

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While outsourcing certainly imparts competitive advantage to the corporation, outsourcing has downsides too:

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Several factors influence the process of outsourcing. Some key factors are:

  • Core vs. Non-core activities
  • Ability of partners (capacity, maturity, cost effectiveness, etc.)
  • Build vs. Buy policy of the organisation
  • Management capacity and organisation design to extend oversight outside of the organisation
  • Geography (source critical components from local suppliers, non-critical from distant markets)
  • Intensity of regulatory compliances

Each factor is important in its own right. We will delve deeper into the last dimension, the intensity of regulatory compliances.

Industries are governed by compliances depending on their criticality to human life or national security. Life Sciences, Defence, Aerospace are governed by high intensity of compliances because any deviation or flexibility tends to directly impact life, either of an astronaut, patient or soldier. As against this, consider the cement industry. As long as the quality of the end product is maintained, few regulatory pressures apply.

Since any analysis is incomplete without a 2×2 matrix, here we present one of our own:

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It shows the spread of industries across Outsourcing (X-axis) and Regulation (Y-axis). Below we analyse these four quadrants and assess each for process execution.

Low Regulation, Low Outsourcing

These industries tend to be monolithic in nature – a single large cement plant, or a motion picture studio in Hollywood. Low Regulation for these industries does not mean No Regulation. Cement industry is obviously regulated by regulations such as OSHA for safety, and the motion picture industry in the US is self-regulated by Motion Picture Association of America (MPAA).

With little outsourcing, the managements of corporations belonging to these industries have significant control over their operations, which helps maintain quantitative output levels at defined quality levels.

High Regulation, Low Outsourcing

Industries such Health Services belong to this category. With high regulation, these organisations establish rigorous process controls in their internal operations to ensure complete adherence to the regulatory requirements. Five important regulations followed by the healthcare industry are HIPAA, The HITECH Act, MACRA, Medical Necessity, and Chain of Custody Act.

Over years, organisations develop expertise in managing operations in compliance with regulations. With the advent of digital technologies, many processes have transitioned to non-paper methods, but retain equivalence to paper-based methods. For example, use of digital signatures instead of ink signatures on paper documents.

Low Regulation, High Outsourcing

These are industries such as apparel, electronics, printing & publishing where there is significant outsourcing to external partners. However, the products may typically have low impact on life, and thus the regulations are relatively low. Some exceptions do exist – radiation levels of mobile devices are strictly governed by the Federal Communications Commission (FCC). Or restrictions on use of child labour in apparel manufacturing.

These industries have organised themselves to execute at scale with several partners and ensure quality products at a competitive cost structure. Since there may be multitude of partners available and switching costs are low, organisations also find it easy to switch their suppliers relatively easily.

Operations in these industries are controlled by the partners, and the customer (outsourcing company) may have little control over their actual ground execution. Which is also why the customers may invest in frequent audits of the facilities to ensure operations are executed based on agreed upon Standard Operating Procedures (SOPs).

At the end of the day though, the supplier/partner is free to execute based on their own internal policies, and except the biggest customer (e.g. Walmart), hands-off is the approach typically adopted.

High Regulation, High Outsourcing

Defence, Aerospace, and Life Sciences are some examples of industries with high levels of outsourcing and regulation. The outsourcing party (Sponsor) remains legally responsible for production delivered by their suppliers. This requires the sponsor to undertake significant due diligence during on-boarding phase, as well as during the subsequent operations phase.

Switching costs are high, and not typically a reasonable option to follow. Following guidelines of Good Manufacturing Practices (GMP) requires special expertise, not easily available. Cost of deviation is high, which is life itself.

And so the partnership between supplier and sponsor has to be based on trust, with transparency, control and compliance built in. The two entities should execute essentially as a single workflow, or what we term as cross-enterprise workflow. Information related to execution problems, quality, or timelines should be immediately shared across the parties.

This scenario of “High Regulation, High Outsourcing” thus belongs to a new paradigm of multi-enterprise collaboration, resulting in ecosystems. This is the topic of our next article. Stay tuned!

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