Thursday, February 16, 2012

Cost Minimization and Organizational Innovation

In the last blog we began understanding the relation between innovation and outsourcing. In this blog we move to discuss the first of the various factors that influence the outsourcing choice - Cost Minimization.

Cost minimization is one of the most common motivations towards cost minimization. Cost minimization is derived from economies of scale which help spread the large fixed across a larger customer base. It works best when the market has a large number of buyers and seller - indicating that there is high competition in the market. The market therefore would have a large pool to choose from for the vendor who would give them the product at the least cost and therefore benefit from outsourcing.

One would also need to think of a globalized context in the present context. The globalization in the present context enables the companies to source the product from a larger pool and also benefit from the lower cost of factors of production the not so developed locations of the world - This is how the IT Enabled services industry has developed. The large fixed cost that these companies incur is spread across the large number of clients that these companies serve.

Let us take the example of Bharat Forge and understand this better - 

Bharat forge is an Indian company focused on forging - it is the second largest in the world. It has made significant investments in fully automating the forging processes and has instituted an IT enabled knowledge management system to capture and leverage the intellectual capabilities of its engineers and brought about improvements in the forging process that enabled it produce superior products at competitive prices.

The above example also indicates an additional advantage that a company that invests in cost minimization through specialization - by aggregating the demand of multiple customers - the company also begins to innovate. By doing a relatively narrow set of tasks, the company would be in a better position to figure out superior ways of performing the task and hence are able to innovate greater than a generalist organization. 

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