The term “strategic outsourcing” may sound like an oxymoron since the central dogma of outsourcing calls for companies to sequester strategic capabilities in-house and only source non-core activities from 3rd parties to drive efficiency.  The situation becomes more complex in a dynamic context since what may be deemed a core competency today may become peripheral tomorrow. One key strategic consideration in outsourcing is to recognize and anticipate the underlying industry structural trends (consumer, technology, macro-economic) that can sway a set of value chain capabilities from its current strategic role to a more peripheral role down the horizon.

The key benefits of outsourcing stem from 3rd party’s ability to pool cross-firm and even cross-sector volume and experience on a given set of capabilities to achieve economies of scale (e.g. 3PL warehousing for CPGs; credit assessment for credit card companies) and economies of scope (e.g. product bundling in contract sale force) without compromising competitive advantage.  However structural barriers can prevent capabilities from realizing cross-firm economies of scale and scope. For example, manufacturing in the food sector, early stage R&D in the pharma sector and sales force in the med device sector are capabilities facing structural barriers to realizing cross-firm economies of scale and scope. As such, a third party “capabilities supply market” never develops and companies must continue to pursue  in-house options on these “strategic” competencies.  Broadly, 4 key structural barriers can prevent an outsourcing option from materializing:

1. Process non-modularity: the ease of decomposing key activities and processes into modular sub-components for outsourcing. For example software testing is amenable to divide and conquer due to standardized, object oriented architecture. In contrast, early stage drug discovery is less modular since conducting biochemical experiments require tacit knowledge that varies from person to person and lab to lab.
2. Long capital payback: the capital investment intensity and risk required to install and establish 3rd party capacity. To illustrate, building microelectronics fabrication and assembly plants requires a large initial capital outlay that no one OEM was willing to commit to.  The subsequent pace and adoption of contract manufacturing for the global consumer electronics industry was catalyzed by significant  government subsidy and investment programs in the 60′s/70′s by Singapore and Taiwan as an economic growth platform.
3. Regional or fragmented consumer needs: A highly fragmented set of consumer needs or consumption pattern may limit the benefits from economies of scale and scope. For example, advertising in the used car sales industry enjoys modest economies of scale, compare to say marketing household consumer products, as most customers still search and shop for used cars using localized media.
4. IP appropriation risk: The ease by which differentiated assets or know-how can be protected through patents and other contractual IP mechanisms if they are exposed to 3^rd parties. For example, outsourcing i-Phone manufacturing has low appropriation risk due to a strong thicket of technology patents. Outsourcing sales force for med-device OEMs has strong appropriation concerns since key physician (customer) relationships with sales reps is much less amenable to IP securitization.

Executives faced with making  decisions on the future direction and investment thesis for the firm must assess and anticipate trends (e.g. disruptive technologies, regulatory policies, changing or new customer needs) along the above four structural drivers in determining the outsourcing vs. develop in-house equation. The future identity of the firm depends on it.