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Cognitive bias and its impact on outsourcing

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Published: 3 Oct 2022

Cognitive biases can have a serious impact on supply chain management when it comes to outsourcing vendors. Krishnan Lakshminarayanan CQP MCQI, a Lead Auditor and Senior Manager at William Hare in India, examines some common examples and looks at how they can be avoided. 

Outsourcing strategy plays a critical role in the overall performance of an organisation’s success. Instead of struggling to establish all the required skill sets in house, organisations strategically choose outsourcing to utilise the expertise readily available, ultimately achieving a mutually beneficial business relationship. 

Across all industry sectors, outsourcing is flourishing mainly because it facilitates: 

  • value addition to products/services; 
  • tapping into a new/unexplored resource base and expertise; 
  • mitigating a risk posed to the organisation. 

The successful management of outsourcing depends heavily upon how an organisation handles its relationship with its vendors. This in turn depends on how decisions are taken around issues concerning the vendor. Mostly, these decisions are taken by different individuals at various levels of the hierarchy within the organisation. 

To understand how we take decisions in different situations, as an individual and as part of a larger group, let us consider ‘behavioural economics’. 

“Behavioural economics gives insights on human brain behaviour and its influence on the decision-making process. It reveals that there are several influences referred to as bias, or cognitive bias, which have a very strong influence on the human brain and, in turn, directly affect the decisions taken.”

Krishnan Lakshminarayanan CQP MCQI, a Lead Auditor and Senior Manager at William Hare

Behavioural economics gives insights on human brain behaviour and its influence on the decision-making process. It reveals that there are several influences referred to as bias, or cognitive bias, which have a very strong influence on the human brain and in turn directly affect the decisions taken. 
 
There are several such biases, and in this article, we will try to understand three examples in detail with the help of some assumed scenarios, with specific focus on the outsourcing process and vendor management. A table showing more biases can be found at the end of this article. 

Recency bias

Description: Much emphasis on the recent activity. 

Relevance to the outsourcing process: When a recently supplied product from a vendor fails, the organisation immediately decides to stop procurement from the vendor. 

Scenario 1: Equipment supplied by a vendor fails during testing, as part of commissioning trial run. Consequently, no further orders are placed with that vendor for four months. During this period, similar equipment was ordered from other vendors.  

Scenario 2: A director of an organisation visits a recently commissioned site. He notices that several stainless-steel fasteners are corroded. On his return, the director conveys this failure to the purchase team and they stop ordering from that vendor. 

Analysis: Both the above occurrences are classic examples of recency bias. Though there had been several successful supplies by the vendors, the most recent failure made the purchase team discontinue procurement. 

There is no detailed analysis of why those products failed; a root cause analysis should have been carried out. The outcome of that might have given insights to other major underlying problems, which may/may not have been relevant to the vendor services, for example, error in commissioning; unstable site conditions, and so on; or real issues of quality with the vendor. Only this type of analysis will reveal the root cause, and guide towards further action. 

Suggested actions:  

  • Failures should be thoroughly analysed by established methods. 
  • Vendor performance rating of the past few years can be circulated to the decision-making team. This ensures the purchasing team will not be influenced by the most recent issue, complaint or rejection.  

Recallability bias

Description of the bias: Past event that created a lasting impression. 

Relevance to the outsourcing process: An issue created by a vendor-supplied product, where the organisation’s customer penalised it heavily.  

Scenario 1: An organisation supplies a product to a process plant. A spare component supplied by a vendor fails, which resulted in total halt of a plant operation. End user heavily back-charged. 

Scenario 2: Performance guarantee parameters were not achieved and the customer debited a huge sum on the organisation through the revoking of the Performance Bank Guarantee – guarantees issued for the performance of an item supplied to a customer by a supplier. 

Analysis: Both incidents had a severe financial impact on the organisation. As a result of the occurrence, no further orders were issued to the vendor.   

Again, effective root cause analysis would have revealed the exact nature of the problem and causes of the same. Recallability bias has a strong influence on the purchasing team, which stopped further procurement.  

Suggested Actions: Failures are to be analysed through established methods. Such major issues need to be discussed in the presence of stakeholders from different department. The discussion should be impartial. Forums such as a customer complaint review meeting, non-conformity review meeting, and so on, can be established. 

Status quo bias

Description of the bias: ‘Let’s not change anything now and make it more complicated.’ 

Relevance to the outsourcing process: Even if a vendor is not performing well, the organisation may decide not to change vendors as it is unsure of the new and unknown.  

Scenario: This is the most common bias faced in outsourcing, and there are many occurrences of such bias, with an organisation opting to ‘live with it’. 

Analysis: In these instances, an organisation continues to order from the same vendor whose performance is not as per requirement. This will make the vendor’s team more lethargic and their performance further deteriorates. 

Suggested actions: All the established processes/vendors should be subjected to a periodic review to identify possible improvements and suitability for continuation. All the points arising from this should be documented and presented to management to support decision-making. The leadership team should be open to suggestions for improvements.  

The following table gives a quick look at a few other cognitive biases, their impact on outsourcing and how to avoid such traps.  

Bias Details Impact on outsourcing How to avoid
1. Anchoring Too much emphasis on the numbers thrown to the organisation. Vendor ranking with numbers may influence our decision. Ranking process should be well established considering all influencing factors and views of all stakeholders.
2. Sunk cost Keep on investing on the activity which has already created a loss to our resource. An outsourced process is not yielding the expected result. But the organisation decides to keep continuing with the process, as it has already invested a lot on the process. All the established processes are to be subjected to a periodic review by experts to identify possible improvements, ways to sustain and suitability for continuing.
3. Over confidence Deciding based on over confidence. Vendor who has not performed well recently, but one of the heads of department has extra confidence on the vendor, and keeps supporting/promoting them. Strengthening the contractual terms. Ensuring the risk is known to all stakeholders. Making the decisions transparent and based on facts.
4. Group think Involving several members for a decision-making process and possibility of going towards a few inputs. When a top management person or other influential person says that the vendor has improved a lot, all others agree to that immediately without analysing. Leader should give independence to all participants. Make note of all suggestions. Ensure open dialogue.
5. Satisficing Our brain does not look for the perfect solution – it looks for the acceptable solution. The purchase team may slow down or stop the search for new vendors. Organisation shall have continual improvement as a mandatory process in all activities.
6. Confirmation Gathering confirming information and ignoring/avoiding disconfirming information. During a discussion on a vendor error, a few participants start talking for the vendor and few talk against the vendor. The organisation shall base the decision on more factual objective evidences.
7. Illusory correlation Jump to conclusions about relationship between two variables where no relationship actually exists. Vendor seems to be close to promoter’s family. Prevent assumptions.
8. Reasoning by analogy We assess a situation and then liken it to a similar situation that we have seen in the past. Temptation to such analogies seriously downplay differences and to focus on similarities. A vendor is good or bad; we decide based on the behaviour of a similar vendor in the past. Make a list of similarities. Make a list of differences. Make a list of known, unknown, presumptions. Then analyse and weigh the situation and decide.
9. Normalising deviance Deviation is taken for granted. Unexpected becomes expected and, in turn, expected becomes accepted. In a meeting to discuss a vendor’s error, few employees say – this vendor has supplied correctly several times. At times it happens. Leaders should ensure that such ‘comfortable’ answers should not be encouraged and there shall be proper analysis for failures.
10. Ambiguous threats Problem prevention is not given due recognition/ weight. Vendors fond of ‘crisis management’ are easily selected compared with vendors that are very systematic and ensure no crisis arises. Give weight to planning and execution as per plan, while vendor is being evaluated.

Conclusion

Though such biases influence all the decisions we take – professionally and personally – I have focused here on the impact of such biases on the outsourcing process. Being aware of such brain-behaviour patterns will surely help us all to make decisions professionally and based on facts. I hope this will trigger further thoughts for exploring similar impacts on other areas such as customer management, employee management, etc. Professionally managed vendors tend to become long-term supporters for the organisation, ensuring a strong vendor team for effective supply-chain management.

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