Outsourcing

What is Outsourcing?

Outsourcing is a business practice in which services or job functions are farmed out to a third party. In information technology, an outsourcing initiative with a technology provider can involve a range of operations, from the entirety of the IT function to discrete, easily defined components, such as disaster recovery, network services, software development or QA testing. Companies may choose to outsource IT services onshore (within their own country), nearshore (to a neighboring country or one in the same time zone), or offshore (to a more distant country). Nearshore and offshore outsourcing have traditionally been pursued to save costs.

source: Daxx

Outsourcing was first recognized as a business strategy in 1989 and became an integral part of business economics throughout the 1990s. The practice of outsourcing is subject to considerable controversy in many countries. Those opposed argue that it has caused the loss of domestic jobs, particularly in the manufacturing sector. Supporters say it creates an incentive for businesses and companies to allocate resources where they are most effective, and that outsourcing helps maintain the nature of free-market economies on a global scale.

The Importance and Risk of Outsourcing

Outsourcing has been a feature of the IT landscape for at least three decades (Lacity et al. 2009). The most important reason for outsourcing is cost reduction (Blaskovich and Mintchik 2011; Lacity et al. 2009, 133), although other reasons include the need to improve process capability and business outcomes. Outsourcing brings risk to the enterprise from supplier credit risk; being locked in to a single vendor; loss of institutional knowledge; transfer of knowledge to the vendor; reduced internal controls; cultural differences between vendor and enterprise; and difficulty in managing business processes (Bahli and Rivard 2003; Lacity et al. 2009, 133). Outsourcing can also reduce risk by providing resources and capabilities that are beyond the financial and human resources of the enterprise. The level and type of outsourcing is also related to successful outcomes. High levels of outsourcing, for example, is associated with low success rates (Straub et al. 2008). As in many other areas of endeavor, the level of top management support is also associated with success (Iacovou and Nakatsu 2008) as is governance of programs and projects (Choudhury and Sabherwal 2003), and trust mechanisms in the outsourcing relationship (relational governance) (Langfield-Smith and Smith 2003; Poppo and Zenger 2002). The ability for outsourcing to affect enterprise IT capability has only been moderately researched. In the context of IT consulting, which can be seen as a light, human resources and strategic form of outsourcing, Nevo et al. (2007) shows that outsourcing positively impacts on overall capability when internal IT capability is weak.

Outsourcing Services

Business Process Outsourcing (BPO) is an overarching term for the outsourcing of a specific business process task, such as payroll. BPO is often divided into two categories: back-office BPO, which includes internal business functions such as billing or purchasing, and front-office BPO, which includes customer-related services such as marketing or tech support. Information technology outsourcing (ITO), therefore, is a subset of business process outsourcing.

While most business process outsourcing involves executing standardized processes for a company, knowledge process outsourcing (KPO) involves processes that demand advanced research and analytical, technical and decision-making skills such as pharmaceutical R&D or patent research.

IT outsourcing clearly falls under the domain of the CIO. However, CIOs often will be asked to be involved in — or even oversee — non-ITO business process and knowledge process outsourcing efforts as well. CIOs are tapped not only because they often have developed skills in outsourcing, but also because business and knowledge process work being outsourced often goes hand in hand with IT systems and support.

In Outsourcing and Offshoring, businesses often leverage global IT-enabled services (ITeS) to enhance efficiency and reduce costs. ITeS providers offer a range of services, from call center operations to back-office functions, demonstrating the value of integrating technology with traditional service offerings.

Different Outsourcing Categories

These days most freelancers or outsourcing providers will fall into one of the following categories, in regard to the services that they provide their clients. Some will even offer several of these:

• Inbound Customer Service
• Outbound Telemarketing
• Web Design & Development
• SEO and Online Marketing
• Back Office / Admin Support
• Virtual Assistant Services
• Accounting and HR Management
• Marketing & Sales Support

Simply put, outsourcing will give away some business tasks that can easily be managed by an independent entity, making life easier for business owners. And most of the time, as well as being able to pass on these tasks to someone more experienced than yourself (or your company), you will also save money, against hiring someone locally to do the same job – sometimes as much as 60%!

History of Outsourcing

20th Century
Following the adding of management layers in the 1950s and 1960s to support expansion for the sake of economy of scale, corporations found that agility and added profits could be obtained by focusing on core strengths; the 1970s and 1980s were the beginnings of what later was named outsourcing. Kodak's 1989 "outsourcing most of its information technology systems" was followed by others during the 1990s. In 2013, the International Association of Outsourcing Professionals gave recognition to Electronic Data Systems Corporation's Morton H. Meyerson who, in 1967, proposed the business model that eventually became known as outsourcing.

IT-enabled services offshore outsourcing
Growth of offshoring of IT-enabled services, although not universally accepted, both to subsidiaries and to outside companies (offshore outsourcing) is linked to the availability of large amounts of reliable and affordable communication infrastructure following the telecommunication and Internet expansion of the late 1990s. Services making use of low-cost countries included

• back-office and administrative functions, such as finance and accounting, HR, and legal
• call centers and other customer-facing departments, such as marketing and sales services
• IT infrastructure and application development
• knowledge services, including engineering support, product design, research and development, and analytics.

Early 21st Century
In the early 21st century, businesses increasingly outsourced to suppliers outside their own country, sometimes referred to as offshoring or offshore outsourcing. Other options subsequently emerged: nearshoring, crowdsourcing, multisourcing, strategic alliances/strategic partnerships, strategic outsourcing.

From Drucker's perspective, a company should only seek to subcontract in those areas in which it demonstrated no special ability. The business strategy outlined by his slogan recommended that companies should take advantage of a specialist provider's knowledge and economies of scale to improve performance and achieve the service needed.

In 2009, by way of recognition, Peter Drucker posthumously received a significant honor when he was inducted into the Outsourcing Hall of Fame for his outstanding work in the field.

Limitations due to growth
Inflation, high domestic interest rates, and economic growth pushed India's IT salaries 10 - 15%, making some jobs relatively "too" expensive, compared to other offshoring destinations. Areas for advancing within the value chain included research and development, equity analysis, tax-return processing, radiological analysis, and medical transcription.

Offshore Alternatives
Japanese companies outsourced to China, particularly to formerly Japanese-occupied cities. German companies have outsourced to Eastern European countries with German-language affiliation, such as Poland and Romania. French companies outsource to North Africa for similar reasons.

For Australian IT companies, Indonesia is one of the major choice of offshoring destination. Near-shore location, common time zone and adequate IT work force are the reasons for offshoring IT services to Indonesia.

Growth of white-collar outsourcing
Although offshoring initially focused on manufacturing, white-collar offshoring/outsourcing has grown rapidly since the early 21st century. The digital workforce of countries like India and China are only paid a fraction of what would be minimum wage in the US. On average, software engineers are getting paid between 250,000 and 1,500,000 rupees (US$4,000 to US$23,000) in India as opposed to $40,000–$100,000 in countries such as the US and Canada. Closer to the US, Costa Rica has become a big source for the advantages of a highly educated labor force, a large bilingual population, stable democratic government, and similar time zones with the United States. It takes only a few hours to travel between Costa Rica and the US. Companies such as Intel, Procter & Gamble, HP, Gensler, Amazon and Bank of America have big operations in Costa Rica.

Unlike outsourced manufacturing, outsourced white collar workers can choose their working hours, and for which companies to work. Clients benefit from telecommuting, reduced office space, management salary, and employee benefits as these individuals are contracted workers. However, ending a government outsourcing arrangement has its difficulties too.

Reasons for outsourcing
While U.S. companies do not outsource to reduce high top level executive or managerial costs, they primarily outsource to reduce peripheral and "non-core" business expenses. Further reasons are higher taxes, high energy costs, and excessive government regulation or mandates.

Mandated benefits like social security, Medicare, and safety protection (OSHA regulations) are also motivators. By contrast, executive pay in the United States in 2007, which could exceed 400 times more than average workers — a gap 20 times bigger than it was in 1965 is not a factor.

Other reasons include reducing and controlling operating costs, improving company focus, gaining access to world-class capabilities, tax credits, freeing internal resources for other purposes, streamlining or increasing efficiency for time-consuming functions, and maximizing use of external resources. For small businesses, contracting/subcontracting/"outsourcing" might be done to improve work-life balance.

Why Companies Outsource

The simplest way to put it is that companies outsource because it reduces their overhead to produce a product, thus increasing their profit margins. It’s purely a business decision.

We live in a world where the same amount of work done in one country or city isn’t equally paid as if it were done elsewhere. Some can argue that the discrepancies in pay levels come from state and federal taxes, the country’s economic standpoint (measured in GDP per capita), and wage-setting institutions. Regardless, the basis of the decision is an economic one.

According to Brandon Gaille, 46% of companies have cited their top reason for outsourcing was to reduce operating costs, with 12% desiring to access world-class capabilities.
Here is a thorough breakdown of the reasons as to why people outsource:
1. Reduce or control costs — 44%
2. Gain access to IT resources unavailable internally — 34%
3. Free up internal resources — 31%
4. Improve business or customer focus — 28%
5. Accelerate company reorganization/transformation — 22%
6. Accelerate project — 15%
7. Gain access to management expertise unavailable internally — 15%
8. Reduce time to market — 9%

To Outsource or not to Outsource

Outsourcing only makes sense when the cost to buy goods or services from an outside vendor is much lower than the cost to deliver the service or manufacture the product in-house. However, many companies have discovered that cost is not the only consideration when evaluating outsourcing as a strategy.

While many overseas vendors can deliver lower-cost goods, they are not always at the same quality level. Some online retailers that have outsourced technical support to non-English-speaking countries have discovered their customers have difficulty communicating with the phone operators, creating dissatisfaction the retailers hadn’t anticipated. Consequently, some businesses are shifting work back to the U.S., despite the higher costs.

Requirements for Successful Outsourcing

Critical aspects of a successful outsourcing program include:

• Clear goals, visions, and plans
• Careful vendor selection
• Relationship management
• Properly structured subcontract and vendor agreements
• Open communication with stakeholders
• Executive support
• Careful attention to personnel issues
• Short-term financial justification

Of these, three aspects are particularly important for ensuring a successful outsourcing experience. Find more details on open communication, executive support, and relationship management below.

• Open Communication: Open, clear, and consistent communication is fundamental to the success of the program. Any changes that need to be made on the fly will be more successful if the contractor and company can clearly communicate about the changes. Stakeholders should also clearly understand their role in the process. Communication channels between all parties should remain open.
• Executive Support: Strategic objectives, such as outsourcing initiatives, must come from the top echelon of a company. Senior management must articulate the goals and objectives of the outsourcing initiative, and they must communicate how the process will benefit the organization. Ensuring the success of outsourcing initiatives does not stop when the ink has dried on the contract, so executive leadership must continue to be engaged as contract work continues.
• Relationship Management: Just as executives should remain engaged with the goals of outsourcing throughout the contract work, the person managing the contractors must continue to cultivate a good relationship with the contractors. This includes checking in on work, ensuring good morale, and addressing any issues that arise. Not only should there be a clearly defined escalation procedure, but senior management should meet at appropriate intervals to discuss the outsourcing relationship. Meetings also should be held at the operational level to address the working of the outsourcing contract in practice, to identify and resolve any problems that have been encountered, and to agree on changes to ensure continued satisfaction.

Advantages and Disadvantages of Outsourcing

Advantages
Outsourcing can free up cash, personnel, facilities and time resources. It can result in cost savings from lower labor costs, taxes, energy costs, and reductions in the cost of production.

• In addition to cost savings, companies may also employ outsourcing strategies in order to focus on core business competencies. This allows companies to devote more resources to what they do well, which can improve efficiency and increase competitiveness. Production can be streamlined and production times shortened while reducing operational costs.
• The noncore functions that a firm outsources will usually go to outside organizations for whom those functions are a core business competency, further benefiting the business through the improved management of those functions.
• A company also may benefit from outsourcing by avoiding government regulations or mandates, such as environmental regulations or safety regulations and requirements.

Disadvantages
While outsourcing has many advantages, it also presents some disadvantages.

• The relationship with the third party that takes on the outsourced functions must be managed. This includes negotiating and signing contracts, which requires time and the involvement of a company's legal counsel, as well as the day-to-day communication with and oversight of the outsourced work.
• Security also is an important factor in outsourcing. Many outsourcing relationships inevitably will involve the third party organization's access to sensitive business data, trade secrets, and other confidential information that is necessary to perform contracted functions.

There may be some negative public relations impacts for companies when outsourcing results in the loss of a large number of jobs for workers in their local communities.

See Also

• Knowledge Process Outsourcing
• Transition Methodology
• IT Services
• IT Strategy
• IT Governance
• Enterprise Architecture