1. OUTSOURCING
Using FMEA
To Assess
Outsourcing Risk
by Cliff Welborn
normal and healthy part of the evolution in the
O
utsourcing has become a growing trend
among many U.S. companies.1 Two com- U.S. workforce.2 Lower costs are often the dri-
mon examples of the practice are out- ving factor, and there have been many success
sourcing IT jobs to India and outsourcing product stories of companies that enter this global supply
manufacturing to China. Some say the practice is a chain and realize significant cost savings.3, 4
However, outsourcing does not guarantee
business success. There is risk involved and not
In 50 Words all sides benefit from such arrangements.5
Or Less The advantages of outsourcing should be care-
fully weighed against risk and must go beyond
• Outsourcing has become common for many U.S. evaluating just price. So much more goes into
judging the business impact of an outsourcing
businesses, but assessing the risk involved in
decision. Without a systematic analysis technique
such arrangements hasn’t. to assess risk, much can go wrong: unexpected
cost, extended lead times, poor quality or other
• A modified version of failure mode effects negative performance variables.
analysis (FMEA) is one way businesses can Risk Assessment Basics
evaluate the risk of outsourcing options. Indeed, risk associated with outsourcing can
offset the often more publicized benefits.6
• Risk priority numbers can be calculated to rate Sometimes the risk doesn’t pay off. Some U.S.
companies have joined the outsourcing trend
any potential failures.
only to be disappointed in the overall net effect
QUALITY PROGRESS I AUGUST 2007 I 17

2. OUTSOURCING
on business operations and eventually returned FIGURE 1 FMEA Process Steps
jobs back to the United States.7, 8
Analyzing the risk associated with a supply chain Identify risk categories.
and outsourcing is a relatively new subject, and little
research has been done.9 But one thing is certain: Identify potential risks.
Documenting and analyzing risk is an essential ele-
Rate the opportunity, probability,
ment to continued learning and process improve-
and severity for each risk.
ment.10 It is critical to have an easily understood
method to identify and manage risk.11 Calculate the risk priority
Failure mode effects analysis (FMEA) is tool number (RPN) for each risk.
used to collect information related to risk manage-
ment decisions.12 There are documented procedures Analyze risks by RPN
to complete an FMEA and examples of its applica- using a Pareto distribution.
tion in various industries.13 A modified version of
the tool can be used to help evaluate the risk of Develop actions to mitigate
outsourcing options. risks with high RPN.
FMEA is a well documented, proven technique
Reassess risks with
commonly used to evaluate the risk for failures in
another cycle of failure mode
product and process designs.14 Every potential fail-
effect analysis (FMEA).
ure studied is evaluated in terms of likelihood and
severity.
A higher FMEA score indicates greater risk.
Common variables used to quantify risk are fre- quantity of parts associated with the defect, ability
quency of an activity associated with the defect, to detect the defect, probability of defect and sever-
ity of defect.
Other industry specific FMEAs
use other variables to quantify
risk. Rating scales of 1-5 and
TABLE 1 Outsourcing Risk Assessment 1-10 are often used to quantify
each variable. The 1-10 scale
Risk priority allows more precision in esti-
Risk Opportunity Probability Severity number
mates and typically creates
Cost more separation in scores
Unforeseen vendor selection cost 2 4 2 16 between risks. However, the 1-5
Unforeseen transition cost 2 4 2 16 scale makes it easier for a team
Unforeseen management cost 4 4 3 48 to agree on rating values.
Lead Time A risk priority number (RPN)
Delay in production start-up 2 4 4 32 is calculated for each potential
failure. A common RPN is the
Delay in manufacturing process 5 3 2 30
product of:
Delay in transportation of goods 4 2 2 16
Quality Probability of failure X
Minor cosmetic/finishing defect 5 4 1 20 detectability of failure X severity
Major cosmetic/finishing defect 5 2 2 20 of failure.
Component will not fit with mating The steps to complete a
5 2 4 40
parts—requiring rework
FMEA process are illustrated in
Structural defect—function failure 5 1 5 25 Figure 1.
18 I AUGUST 2007 I www.asq.org

3. Outsourcing options can be FIGURE 2 Example of Pareto Distribution of Risks in Outsourcing
evaluated in much the same
manner as product and pro- 50
cess defects. Risks are evaluat-
ed in terms of opportunity, 40
probability and severity, and
can be grouped into intuitive Risk priority number
30
categories.
The opportunity score for a
risk is the frequency at which 20
that activity happens. Using
the 1-5 scale, an activity that is 10
a one-time event or seldom
takes place has an opportunity
0
score of 1. If the activity is a
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The severity score indicates
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the level of impact if the risk
materializes. A risk with a low Risk
severity score causes a mini-
mal impact on operations
when it happens, while a risk
with a high severity score creates a significant instance, when RadioShack builds a new store or
impact to operations. The impact might be in terms remodels an existing one, RSSF consolidates the
of cost, lead time, loss of intellectual property, required construction materials from various ven-
quality to the customer or other relevant cate- dors into one shipment. This procurement configu-
gories. ration reduces complexity and shipping costs for
The RPN for a risk is calculated as the product of: RadioShack.
The supply of major store display fixtures is typ-
Opportunity score X probability score ically awarded on a yearly contract basis. Through
X severity score. a request for proposal (RFP) process, vendors sub-
mit bids to supply a fixture for a calendar year.
Once the RPN is calculated for each risk, the Historically, RSSF used domestic manufacturers to
risks are analyzed using a Pareto distribution. supply all major furniture and fixtures, including
Actions are then taken to mitigate risks, and the items such as wall systems, gondolas and shelves
process can be performed again to evaluate resid- to display products.
ual risk. Recently, RadioShack changed its fixture design
direction from primarily wood based products to
RadioShack Example metal based fixtures. When this design change was
RadioShack Store Fixtures (RSSF), a division of implemented, potential vendors in Asia were con-
RadioShack Corp., procures and distributes furni- sidered in the RFP process. Initial estimates indi-
ture and fixtures to RadioShack retail store loca- cated that Asian vendors offered a significant cost
tions. RSSF serves as a consolidation warehouse for savings compared with domestic vendors, espe-
items purchased from many different vendors. For cially those vendors that provided metal fixtures.
QUALITY PROGRESS I AUGUST 2007 I 19

4. OUTSOURCING
RadioShack decided to award the business to an Ratings and Scores
Asian manufacturer. In the third step, the team evaluated each risk
Although the quoted purchase price from the using the 1-5 rating system and the variables of
selected vendor was significantly lower than other opportunity, probability and severity. The 1-5 rat-
domestic or offshore vendors, there was a concern ing was determined by consensus following group
about the risk of entering into a long-term relation- discussion. Although this rating technique might
not represent the utmost in analytical accuracy, it is
a quick, easy and commonly used technique that
provides a quantitative measurement to a qualita-
tive concept.
Outsourcing options can be For example, the risk of a delay in the manufac-
turing process was given an opportunity score of
evaluated in much the same 5. Since manufacturing is a recurring activity, the
chance of a delay at this stage is recurring. The
manner as product and opportunity score of 5 indicates that there were
many instances when this risk could materialize.
process defects. Risks are The probability score for a delay in manufactur-
ing process risk is 3. This is the team’s evaluation
evaluated in terms of of the chance that there would actually be a delay
in manufacturing. This evaluation was also based
opportunity, probability on the team’s understanding of the vendor’s man-
ufacturing capabilities and performance history.
and severity, and can be The final variable scored was severity. A delay in
manufacturing was evaluated to have a severity
grouped into intuitive score of 2. The score indicates the overall impact to
RadioShack if the delay materializes. The score also
categories. suggests that the impact would not be greatly sig-
nificant to the overall performance of the company.
As described in Figure 1, the fourth step in the
FMEA development was to calculate the RPN value
ship with a relatively unknown vendor not based in for each risk. This was a simple multiplication of:
the United States. The outsourcing risk assessment
procedure illustrated in Table 1 was used to evalu- Opportunity score X probability score
ate the risks of this relationship. A cross functional X severity score.
team consisting of representatives from design,
global sourcing, operations and quality assurance In the fifth step of the FMEA development, the
was established to perform the FMEA. The out- risks were sorted in descending order based on their
sourcing risk assessment chart in Table 1 was used RPN score and graphed as a Pareto distribution, as
to collect the relevant FMEA data. shown in Figure 2 (p. 19). This representation of the
The first step of the FMEA development process risks was used to prioritize risk mitigation efforts.
was to identify risk categories. Through group dis- In this example, the risk with the highest RPN
cussion, the general categories were established as score was “unforeseen management costs.” It had a
cost, lead time and quality. RPN of 48. “Unforeseen management costs” repre-
In the second step of the FMEA development, sented the risk associated with incurring additional
the team brainstormed and generated a detailed cost to conduct business with a vendor from anoth-
list of potential risks. The detailed risks were er country. The management team was concerned
grouped under the risk categories established in about the communication barrier and its ability to
step one. efficiently convey business transactions.
20 I AUGUST 2007 I www.asq.org

5. The risk with the next highest RPN was “com- REFERENCES
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in a smooth supply chain relationship. Without ing Management Journal, Vol. 16, No. 4, pp. 28-35.
the FMEA based outsourcing risk assessment 12. Anand Pillay and Jin Wang, “Modified Failure Mode
tool, unforeseen problems might have impacted and Effects Analysis Using Approximate Reasoning,” Reli-
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From Theory to Execution, ASQ Quality Press, 1995.
Future of the Analysis Tool 14. G.Q. Huang, J. Shi and K.L. Mak, “Failure Mode Effect
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Decision makers considering outsourcing Manufacturing Technology, Vol. 16, 2000, pp. 603-608.
options should use the FMEA based outsourcing
risk assessment technique. The technique is easily
implemented and understood. CLIFF WELBORN is an assistant
Further research should be undertaken to veri- professor at Middle Tennessee State
fy the risk assessment results with actual short- University in Murfreesboro. He earned
comings and failures of various outsourcing a doctorate in industrial engineering
options. This can be done through a comprehen- from the University of Texas at
sive study of companies undertaking outsourcing Arlington.
programs.
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