Outsourcing

What Is Outsourcing?

Outsourcing refers to handling in-house tasks, projects, or operations by an external entity. It is a standard business practice that allows the company to focus its time and energy on its core competencies and primary activities.

The external entity is called the service provider or third-party provider and usually operates through a contract. They hold specialization in the task they undertake. 

It may also sometimes involve hiring independent and individual contractors and freelancers to carry out specialized tasks. Companies can even choose the country of their choice for sub-contracting purposes. 

Firms can choose to sub-contract services onshore, i.e., in their domestic country, or nearshore, i.e., to a neighboring country or country within the same time zone. The firm can also offshore, i.e., subcontract services to a distant land. 

This method has unlocked many possibilities, especially globally, where countries with an abundance of skilled & unskilled labor have benefitted a lot. In addition, multinational companies have leveraged the synergies of appointing another agency to carry out the task.

Countries like India, Bangladesh, Pakistan, and Indonesia are some countries where abundant labor has created a market for professional activities. 

Activities like accounting, HR, payroll, tech, manufacturing, and customer service are some significant areas of operations outsourced.

The concept of getting the work done by someone else materialized in the 20th century. As a result, businesses began to experiment with 'outside resourcing.' As globalization picked up its pace, this outside resourcing was now a widespread phenomenon in countries.

Before the Industrial Revolution and business enthusiasts called this a business strategy, merchants and traders had outsourced manufacturing to regions of cheap labor. 

Reasons for Outsourcing

The rationale behind outsourcing attracted many firms to explore the decision to gain a competitive advantage. While it has pros and cons, a calculated decision can help make a company's operations efficient and effective. 

Following are the few reasons one considers before deciding to outsource: 

Reduces In-House Cost

It is a way for a company/business to deploy its tasks outside the organization. This deployment may assist in lowering internal costs that could have developed if the processes were in-house. 

Many organizations consider the expected subcontracting cost and inward cost before developing core competencies with the developing competition to acquire market share.

Saves Training Costs 

Employing human resources is a cumbersome task associated with expensive training costs. In addition, specialized labor requires special training as well as high wages. 

The company may not always be in a position to train its staff. In this situation, a company opts for contracting specialized personnel to already trained individuals and saves on the training costs. 

Improves Productivity And Efficiency 

A business can spend more time on its core activities by subcontracting the additional duties of departments to an outside party. 

The company can allocate and redistribute resources and time by doing this. This improves the productivity and efficiency of core operations and production activities.

Sustainable Use Of Resources

Planning the distribution of resources that will be consumed internally and externally makes the management competent to make sustainable uses of resources. Contracting outside parties who are well-versed and experienced in managing can also help sustainability. 

Reduces Business Risks

If a business should ever experience issues because of natural disasters, technical challenges, or market fluctuation, operations subcontracted by an offshore entity can come in handy. 

The offshore partners can then continue to work on their projects as their exposure to risk remains limited and thus reduces the overall business risk.

Reduces The Need To Meet Compliance Requirements

A company operating in an industry that needs to comply with regulatory authorities often has trouble conforming to it. In this instance, specialized external organizations carry out regulatory work, which makes it easier for the company to comply with regulations.

Types Of Outsourcing

As businesses outsourced different areas of operations, differentiating between them became a general norm. While some cater to a specific task, others take up an entire supply chain process comprising multiple responsibilities. 

Let us look at the different types of practices adopted by firms/companies.

Professional

Accounting, legal, purchasing, and administrative assistance are a few examples of specialized services that form part of professional outsourcing. 

With access to high-quality resources, the business only pays for the services it takes up, considerably lowering overhead costs.

For example, A doctor can hire a professional services firm to handle the accounting work when operating a clinic.

He could also administer the tax filing services to the same firm and have a complete focus to work on his specialization services, i.e., diagnosing patients. 

IT

Most businesses use some technology in their day-to-day operations. However, sometimes firms outsource their technology needs to cut costs or when they don't have enough resources to do an in-house setup.

Subcontracting the informational technology needs of the company to a third-party entity is called IT Outsourcing. The third-party entity takes care of everything from software development to maintenance and support. 

For example, a small business uses cloud computing to sub-contact the storage of files. 

Manufacturer

As the name suggests, the company considers subcontracting manufacturing, mostly non-essential items, to a third party to get better deals on wage rates and other production costs. This helps the company stay competitive in the market and helps focus on its core competencies. 

For example, an automobile company uses sub-contracts to manufacture small equipment while trying to build an entire car. 

Process-Specific

A process-specific contractor is appointed when the firm subcontracts a specific process in operation to an external party. For example, businesses with multiple supply chain processes for a product or a service opt for this.

For example, a domestic company distributing its product pan-country can appoint an outsourcer to carry out its shipping and delivering services. It can also indulge in international shipping if the outsourcer gives that service.

Project

When companies need to evaluate different projects they can undertake, given the resource restraint, they can outsource the activities rather than do them in-house. It saves money, brings transparency, and gives access to niche talent that can be expensive if hired. 

For example, while considering investment avenues, a company needs to evaluate the return on investment. The company can subcontract this to a consulting company with better talent to assess the same based on the company's risk profile. 

Operational

Operational outsourcing refers to subcontracting operations-specific tasks to a third party specializing in carrying them out. For example, human resources, accounting, shipping, data analysis, and processing are everyday operations outsourced. 

Not only does the company salvage expenses, but it also makes the company efficient in its operations and reduces its workload. For example, a company appoints a third party to analyze customer data to serve its customers better and reduce its internal workload.

Advantages Of Outsourcing

Sub-contracting operations have helped firms achieve synergies but, simultaneously, have created distress for the organizations as exposure to certain risks has increased. 

As every coin has two sides to it, contracting operations have advantages and disadvantages, which companies evaluate to make sound decisions. Let us look at the benefits.

Increased Efficiency 

Subcontracting allows third-party vendors to take over the non-core activities of a business, making it easier to increase its focus on its core activities. 

A higher amount of time, effort, and other resources can increase the efficiency and effectiveness of the operation, which otherwise wouldn't have been possible.

For example, a company involved in providing event management services can get its accounting done by a third party to distribute more of its resources towards its core activity, i.e., event planning. 

Access to the Talent Pool 

When the company hires contractors from outside to carry out its internal work, it gives it access to new talent pools that provide qualitative output at lower costs. However, internally hiring new and creative talent pools is expensive and involves a lot of retention costs. 

For example, if a company wants to design a new office space or construction site, it can hire a construction agency to get better-fitted individuals for the job. It doesn't have to take upon the hiring process itself. 

Controlled Costs

The market offers a variety of vendors that provide specialized services. As a result, they offer competitive prices and, in doing so, help the company in controlling costs. 

The most flexible arrangement can be made as a pay-as-per-use service, saving significant investment costs required in infrastructure, staffing, and training. For example, various cloud storage providers provide services for their products on a usage basis. 

Greater Competitive Advantage

With changing market conditions, subcontracting allows the company to monitor cost levels and generate quality products and services for its end-users.

For example, if the tech environment changes for smartphones, manufacturers can contact up-to-age vendors for their support to keep up with the evolving market. 

Shared Risks

While operations are subcontracted, the outsourcer bears the risk for the parts of tasks it carries out. This sharing of risks makes the company exposed to lesser risk elements. 

For example, a company contracting another party to perform a project makes the other party susceptible to risks. So, in a way, both parties have shared risks. 

Disadvantages Of Outsourcing

While outsourcing has advantages, the other side paints a different picture. For example, involving a third party in internal business operations carries risks; however, weighing the cons helps the company make sound decisions. 

These are some of the disadvantages to consider before making a third-party contract

Company Loses Control

Contracting part of operations to a third party leads to a shift in managerial control, which makes the company redundant in its responsibilities. Losing control can also be in the form where both parties have confusion related to the objectives and goals of the project. 

Communicating one's specifications and expectations about a project mitigates the control risk. For example, if a company wanted the end goal of a project to be a report-based output and the outsourcer has come up with ppt base, it results in miscommunication of end goals and production. 

Involvement Of Hidden Costs

While failing to consider costs such as exchange rate conversion for domestic currency or inflation, management can estimate lesser costs than budgeted. 

Intangible costs such as backlash from domestic labor organizations or loss of security data can hamper one's brand and halt operations.

For example, a contract has specific terms and conditions that include payment of hidden costs, such as due to inflation; the company will pay x% of the amount.

Security Risks

When another party takes over a project or operations, the transfer of company data occurs, raising concerns about security risks. In addition, hackers, unethical sources, and competitors can use the data to hamper a company's image.

For example, subcontracting a company's IT needs contains the highest security risk. A company has to give up control over its internal data. A company can be at risk if the cloud software reveals customer data or crucial trade secrets. 

Reduction In Quality Control

The workers in an organization determine the quality of work as an output. Therefore, companies that are stringent in their quality control measures for their products and services may find it difficult to control the quality. 

For example, contracting to manufacture fast fashion clothes sometimes results in terrible quality products, which hamper the brand image of an organization. 

Untimely Shipment Of Deliverables

While employees work in different time zones, deploying cheap labor from developing countries can result in the untimely submission of deliverables. In a time-constraint project, this can hamper the efficiency of ongoing operations. 

For example, the time difference between India and the USA is 12 hours. Therefore, when done to employees residing in India, the delegation of work can hold up delays when time is a constraint. 

Researched and authored by Samridhi Singh | LinkedIn

Reviewed and Edited by Aditya Salunke I LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• First Mover Advantage
• Price Skimming
• Special Purpose Vehicle (SPV)
• Strategic Analysis
• Turnaround Recovery Strategies