We now discuss some limitations of our study. First, the data are cross-sectional. This concern is somewhat minor in this study because we are studying how current operations strategy impacts current outsourcing plans, but it would be appealing to determine how a firm’s operations strategy relates to actual outsourcing performed. Second, the survey was not designed to have multiple indicators of a single construct, so the constructs had to be gleaned from the available questions and are sometimes multi-dimensional. While the constructs reasonably reflect the questions used as indicators, a study designed explicitly for this purpose would probably have used slightly different, more unidimensional indica- tors of the underlying constructs. Third, the overall R-squared of the model was 14.1%, quite low but not unreasonable in research studying such a complex dependent variable. In spite of the above limitations, we have provided further evidence that capabilities do
matter and obtained new evidence about which specific manufacturing strategy variables matter most in outsourcing decisions. There is ample opportunity for future research to investigate more and different aspects of firm-specific characteristics that drive a firm to have a plan to outsource.
3.6
Conclusion
By linking a firm’s operations strategy to its outsourcing strategy, this study makes sev- eral contributions to the academic literature. First, it adds further empirical evidence that firm-level attributes (capabilities and priorities) do matter in outsourcing decisions, lending support to the resource-based view as important in boundary decisions and re- inforcing that firm boundary research that neglects firm-specific capabilities is lacking. Second, it looks at specific operations-based competitive capabilities and priorities, as opposed to a single variable such as “production experience” (Leiblein and Miller, 2003), and measures the influence of these individual priorities and capabilities on a firm’s out- sourcing plans. Third, this study provides a first step in utilizing operations strategy concepts not just to predict plant or business performance, but also to predict the health of the production function within the firm.
From a practitioner perspective, this research is not prescriptive-it does not provide guidance as to the conditions under which outsourcing should be undertaken. However, we can make statements of interest to managers. First, for practicing operations man- agers, this study reiterates the importance of attaining and articulating leadership in cost
to avoid being outsourced-the “soft stuff” does not seem to have great influence to high level managers’ plans to outsource. For higher-level managers, we suggest that difficult- to-measure, longer term criteria should perhaps be given a larger weight in outsourcing decisions, as opposed to a focus on costs.
Chapter 4
Buyer Beware? Quality Risk in
Outsourcing
4.1
Introduction
Pan Pharmaceuticals was a large contract manufacturer in the Australian pharmaceuti- cals industry in early 2003. But, in mid-2003 a travel sickness pill it produced on contract resulted in 19 hospitalizations. Investigations of Pan’s operations revealed such serious violations as the fabrication of test results and the substitution of raw materials. In the end, 1650 export products were recalled (Nowak, 2003; Schmetzer, 2003). For the firms who outsourced production of those 1650 products to Pan Pharmaceuticals, outsourcing certainly posed a quality risk. Although outsourcing has been on the rise over the past decade, the extent to which the case of Pan Pharmaceuticals is an isolated event is un- known. More generally, this research aims to subject to empirical scrutiny the degree to which outsourcing production to a contract manufacturer poses a quality risk to the
buying firm relative to producing in-house.
The research question we ask is: “Do contract manufacturer’s plants pose a higher quality risk than internal plants, on average?” For semantic clarity in this dissertation essay, we operationally define the three main variables associated with this question. A
contract manufacturer’s plant is an establishment that manufactures finished or nearly
finished products to another company’s specifications. An internal plant is an establish- ment that manufactures products under the brand name and specifications of its own company. Quality Risk is the propensity for product shipped from a given establishment to fail to perform as intended, due to manufacturing-related issues.
To address our research question, we develop theoretical arguments and an empirical model to enable us to test hypotheses concerning the influence of contract manufacturing relative to maintaining production in-house, as well as ISO 9000 certification, on quality risk. We included ISO 9000 certification because many practitioners consider it a process- based factor in an outsourcing decision that should act to lower quality risk. To develop a valid measure of quality risk at the plant level, we employed a Delphi approach using a panel of experts and eleven years of Food and Drug Administration (FDA) inspection reports. Using a systematic approach, we developed a sample of contract manufacturers and internally owned plants. We apply our research in a sample of 154 plants in the over-the-counter (OTC) and pharmaceutical drug industry.
Evaluating the potential quality risk posed by outsourcing production to contract manufacturers is important to operations management. The practice of outsourcing pro-
duction to contract manufacturers is common in many industries (Tully, 1994), including the prescription drug, over-the-counter drug, and regulated cosmetic industries which we study here (VanArnum, 2000; Jeffries, 2003; Antonelli, 2005). In fact, the global phar- maceuticals outsourcing market is predicted to reach $53 billion by 2010 from $24 billion today (Anonymous, 2006). Given that off-quality drugs can be harmful to humans, it is important for firms to understand whether or not outsourcing to contract manufacturers poses an added quality risk. While manufacturing outsourcing continues to increase in many industries, the theoretical underpinnings of the quality risk implications of using contract manufacturers are lacking.
In this paper, we make several contributions to the academic literature and practice. First, we draw from the economic incentives and measurement literature, the supply chain literature, and the total quality management (TQM) literature to propose a theory on the effect of outsourcing on quality, as it pertains to contract manufacturing. Second, we create an innovative measure of plant-level quality risk from publicly available FDA inspection reports. We do this utilizing the Delphi process with a diverse panel of experts. Next, using our summary metric, we provide empirical support that the use of contract manufacturers poses a greater quality risk than producing in internal plants. We control for several potentially relevant variables in this analysis. Finally, counter to conventional wisdom, our empirical results show that ISO 9000 certification does not mitigate quality risk. This is relevant to outsourcing decision-makers because ISO 9000 is often used to signal low quality risk.
related literature and present our theoretical model. We discuss our database and mea- surement in Section 4.3. In Section 4.4, we present the results of an ordered logit regres- sion analysis of the data. In Section 4.5, we discuss limitations and future research, and give our theoretical and managerial conclusions.