What is Outsourcing?

The term outsourcing refers to the general business practice through which firms cut costs by transferring a portion or an entire organizational function to an external agency located either domestically or abroad rather than performing it internally.

Outsourcing is the use of external agency to perform the business activity more cost-effectively and efficiently in the given time frame.

Outsourcing can be defined as the transfer to an external agency or service provider the operation and day-to-day management of a business process, which can be done keeping in mind productivity, cost effectiveness and system efficiency.

The external agency is called vendor, while the company that contracts with another company to provide services that might otherwise be performed by its in-house employees is called resourcer.

Vendors are experts in their jobs and in addition they have domain knowledge of the customer’s industry.

They are either standalone outfits, i.e., experts in one particular activity or integrators having expertise in multiple functional areas. The integrators have the capabilities to integrate them as per the customer’s needs.

The concept of outsourcing started with Ross Perot when he founded Electronic Data Systems in 1962. EDS would tell a prospective client,

“You are familiar with designing, manufacturing and selling furniture, but we’re familiar with managing information technology. We can sell you the information technology you need, and you pay us monthly for the service with a minimum commitment of two to ten years.”

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Outsourcing allows firms to focus on other business issues while having some processes handled by outside experts. In this case, a firm may decide to tactically outsource its bookkeeping function to an external accounting firm, as it may be more cost effective to do so than managing it internally with in-house accountants.

General Electric, for example, has outsourced about 900 different business processes to India and as a result saves nearly $350 million annually (The Boston Consulting Group and University of Pennsylvania, The Wharton School, 2007). Thus, a firm’s decision to outsource falls within the class of ‘make’ or ‘buy’ decisions (Walker and Weber, 1984).

The vendor company that handles the outsourced work is usually streamlined and often has world-class capabilities and access to new technology that a firm can’t afford to buy on its own. Also, if a firm is looking for expansion, outsourcing is a cost-effective way to start laying down foundations in other countries.

Information technology is one of the primary outsourced job functions today. Everything from in-house servers being relocated to server firms around the globe to internal help support desk, programming, analysis and database management is outsourced to third parties.

In a business firm with IT enablement, information technology outsourcing may include a transfer of responsibility for management of data centres and networks (LAN, WAN, and telecommunications) to a third party. Human resources is becoming another sought-after outsourceable function for all kinds of businesses.

Other areas of outsourcing are Sales, Documentation, Utility, Financials, Insurance, Logistics, Secretarial Services, Consulting, Healthcare, Manufacturing, News and Media.

Benefits of Outsourcing

There are some definite advantages to outsourcing.

  • Contract work is often cheaper—especially if opted for off-shore development. Here, people are hired only for specific tasks.
  • Outsourcing creates shareholder value by reducing costs and commitments to fixed and working capital.
  • Outsourcing helps a firm focus on its core business, helping to create a competitive advantage within its industry.
  • Many of the companies that provide outsourcing services are able to do the same work for considerably less money, as they have the expertise to complete the job in the shortest possible time.

Other advantages include access to best-of-class capabilities and accelerating the benefits of reengineering. Another advantage outsourcing gives firms is a chance to get the best job possible from the vendors it hires. However, if the work is done in-house, there may be company ties which are hard to break.

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Drawbacks of Outsourcing

There are some disadvantages of outsourcing as well, particularly in marketing outsourcing.

  1. One is that outsourcing often eliminates direct communication between a firm and its clients. This prevents the firm form building strong relationships with their customers, and often leads to dissatisfaction on one or both sides.
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  3. There is the danger of not being able control some aspects of the business, as outsourcing may lead to delayed communications and project implementation.
  4. The sensitive information is more vulnerable, and the firm may become very dependent upon its outsource providers, which could led to problems in the event of the outsourcing service provider backing out of the contract suddenly.

Thus, while outsourcing may prove beneficial on many counts, it also has many drawbacks. It is important that each individual company accurately assesses its need to determine if outsourcing is a viable option.