Outsourcing is a business strategy that moves some of an organization’s functions, processes, activities and decision responsibility from within an organization to outside providers.
This is done through negotiating contract agreements with a vendor who takes on the responsibility for the production process, people management, quality, customer service and key asset management of the function.
The process can greatly reduce fixed overhead costs of an organization.
Why do organizations outsource?
Outsourcing allows organizations to focus on their core business and can create a competitive advantage by reducing operational costs.
The beauty of outsourcing is you can outsource an entire function or only a part of it.
As an example, you can outsource the network management oversight of an IT system but keep the end-user support in-house.
This can provide an organization with a good balance of on-site support for employees.
Organizations use outsourcing as a strategic initiative to improve customer service, quality and reduce costs.
Outsourcing can be a permanent or temporary arrangement to bridge the gap in staffing, to learn better quality techniques or improvement of faulty product design.
When looking for outsource opportunities, an organization should look at potential areas and each component within that area to determine if part or all of that function should be outsourced.
Different industries outsource different aspects of their businesses, but some common operational functions that get outsourced are:
Advantages of Outsourcing
There can be significant cost savings when a business function is outsourced. Employee compensation costs, office space expenses and other costs associated with providing a work space or manufacturing setup are eliminated and free up resources for other purposes.
Focus on Core Business
Outsourcing allows organization to focus on their expertise and core business. When organizations go outside their expertise, they get into business functions and processes that they may not be as knowledgeable about and could potentially take away from their main focus.
An example of this is when a grocery store decides to add a florist to their operation. If too much focus is put on that part of the business they lose focus of the core business which is grocery.
Improved quality can be achieved by using vendors with more expertise and more specialized processes.
An example of this would be contracting out a cleaning service. An outside service would have the resources for hiring, proper training and facility inspections that may not be available if the function were kept in-house.
The advantage of having a vendor contract is they are bound to certain levels of service and quality.
An example of this is if your IT function is outsourced and the technician calls in sick, it is the vendor’s responsibility to find someone to replace them and meet your support needs.
Outsourcing gives an organization exposure to vendor specialized systems. Specialization provides more efficiency that allows for a quicker turnaround time and higher levels of quality.
Disadvantages of Outsourcing
Outsourcing can expose an organization to potential risks and legal exposure.
As an example, if a car is recalled for faulty parts and that part was outsourced, the car manufacturer carries the burden of correcting the potentially damaged reputation of the car maker.
While the vendor would need to make good on the faulty product by contract, the manufacturer still has the black eye from the incident and carries the burden of correcting the negative public perception.
Unless a contract specifically identifies a measurable process for quality service reporting, there could be a poor service quality experience. Some contracts are written to intentionally leave service levels out to save on costs.
If a customer call center is outsourced to a country that speaks a different language, there may be levels of dissatisfaction for customers dealing with the language barriers of someone with a strong accent.
There can be negative perceptions with outsourcing and the sympathy of lost jobs. This needs to be managed with sensitivity and grace.
An outsourced employee may not have the same understanding and passion for an organization as a regular employee. There is the potential that an outsourced employee will come in contact with customers and not be as knowledgeable of the organization, resulting in a negative customer experience.
Organized labor in the United States has very strong feelings about outsourcing to other countries that have a less standard of living and worse working conditions. This viewpoint can affect how the workforce responds to outsourcing and can affect their daily productivity.
Legal Compliance and Security
It is important that issues regarding legal compliance and security be addressed in formal documentation. Processes that are outsourced need to be managed to ensure there is diligence with legal compliance and system security.
An example of this is outsourcing the IT function and having an outsourced employees use their access to confidential customer data for their own gain.
Outsourcing commonly results in the need to reduce staffing levels. Unless it can be planned through attrition, layoffs are inevitable. This is difficult at best and if not managed appropriately, can have a negative impact on remaining employees.
Finally, when researching vendors for outsourcing be sure to think through your specific needs and get at least three Requests for Proposals (RFP) to ensure you are getting the best value for your dollar.
Does your organization outsource any of its functions?
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In today’s global business competitive environment, business organizations must innovative and adapt new strategies to sustain revenue generation, value while remaining competitive. Organizations have embraced outsourcing principles and adopted them to help in expanding to new markets (Odu 19). Outsourcing has enabled US multinational corporations to reduce costs and compete effectively in the global market. While the proliferation of outsourcing has been beneficial to short term growth by taking advantages of; low wages, taxes and investment incentives in developing countries, it will significantly dissolve the competitive advantages the United States enjoys. The outsourcing approach changes the historical model of economies of scale, the resulting intangible and hidden trade costs of outsourcing shall have a heavy bearing on the US economy. The competitive advantage of high technology, support for startups will be gradually eroded, enabling developing countries to compete directly with the United States.
Economist view outsourcing as new form of international trade. Currently more commodities are traded than it was in the past, this can be either good or bad from differing perspectives. Most Americans hold the assumption that jobs, skills, money, and experienced are being shipped to foreign countries, and recipient countries are making financial, socio-economic and development progress while the U.S economy stagnates (Currie 47). This view has been strongly expressed leading up to the last two presidential elections, with candidates pledging to bring back “jobs”.
Consumers have been accustomed and aware to the fact that significant proportions of manufactured goods are produced abroad by corporations taking advantage of low production costs. A new trend catching is outsourcing services with India taking a huge chunk of call centers catering for the American consumer.
The notable divisions which companies outsource are customer support, human resources, accounting and manufacturing. This has not been limited to these divisions, skilled personnel in information technology, engineering, pharmaceutical and Research and Development are facing greater threats to losing workers abroad. No American worker or politician is keen on promoting outsourcing. For example, a software engineer at an Information Technology firm can embrace the thought of losing his/her job to an engineer in India, willing to take half of the pay. There is the prediction that by 2015, more than 3.3 million white-collar jobs and wages amounting to over US$136 billion shall be lost in the economy. In addition the economy will be affected by worker dissatisfaction combined with risks occurring as a result of outsourcing (Hira and Anil 63).
The resolution to outsource is most arrived at the interest of lowering firm’s operational costs, increasing competency, making efficient use global capital, labor, scarce resources, infrastructure and technology. Outsourcing differs from off shoring, it is relative to the firm restructuring and organization of labor within and between societies. Off shoring takes place when a segment of production process is moved off shore; sold or still under the control of a national firm.
Companies outsource tactically to reduce and control operational coasts, am most importantly increase profits. Access to low operation costs, college-educated workforce at a fraction of U.S national’s wages compels firms to take advantage of short-term outsourcing benefits. Partnership with other organization abroad provides U.S companies with access to new technology, tools and techniques that they may not posse, structured methodologies, procedures, documentation, and expanded skills offering competitive advantages. The partnership between Apple Inc. and Foxxcon Group provides a good example, in this arrangement Apple is freed up from manufacturing while taking advantage of Foxxcon capabilities. Outsourcing has been used successfully to achieve cost saving propelling companies to venture into foreign markets, these benefits however, do not offset the projected long-term impacts on United States industries and the economy.
Countries trade to achieve and maximize economies of scale in production. No single country can produce want it requires domestically. Each country specializes in producing goods or services at large scale to lower costs which formulate a comparative advantage in exports. This trade advantage allows it to import goods that have high production costs domestically.
Benefits of Outsourcing
Cost reduction is the key reason why a company might consider outsourcing. Tasks that are costly to be done in-house get outsourced to partners who can offer the services at lower prices. For example, if a firm requires urgently a specialized software engineer it will be much cheaper to outsource the service than training a staff member. The hired expert will accomplish the task faster, efficiently and cost effectively. Access to experts does not only lower long term costs but providers companies with opportunities to explore new possibilities and venture into diverse work specialization enabling them to prosper in this changing times.
Outsourcing presents firms with opportunities to enhance competitive strategies suited for the global market. By outsourcing product quality can be improved, lowering production costs which in turn are passed down to the consumer and increasing overall productivity of the business.
With outsourcing, firms enjoy increased operational flexibility presented in several ways. For one, a firm has access to a large workforce at its disposal relived of maintaining it on permanent basis. This means that a firm is able to benefit from contact personnel minus the stress of worrying about layoffs or idle workforce. This flexibility presents companies with freedom to adjust workforce capacity and production capacity according to changing requirements and market trends. Additionally, with outsourcing firms are equipped to handle unforeseen events like unanticipated delays, work errors or changes in management or production plans. More importantly, by being flexible firms can deliver on projects timely to the satisfaction of the clients (Ching 34).
Proponents of outsourcing point out that by doing so firms can free up capital funds and limited time to focus on core business activities. Ancillary jobs can be performed by contacted firms or individuals. Firms especially in manufacturing are able to access latest production technologies and equipment without purchasing or maintaining them. Good outsourcing relationship presents firms with unmatched opportunities to access a network of business partners. For example, electronic assembling firms in China partner with more than two electronic manufactures, firms sharing one assembler can benefit from the supply chain such as sourcing from a chip maker or glass display maker.
The United States has a comparative advantage in industries that require highly skilled labor and capital investment. The highly skilled workforce with a strong knowledge base gives the U.S edge in the global economy. No other country has a high turnover rate of business startups as compared with the U.S. Corporations by shifting some of these jobs overseas to benefit from reduced costs distribute knowledge and facilitate spillovers. Economies such as India or China, receive spillover benefits from influx of knowledge enabling them to advance their economies. A direct result is that competitiveness of U.S technology is placed at risk as its competitive edge advantage is lost from the U.S control (Mascarenhas 53). Additionally, the U.S must compete directly with emerging economies in highly specialized areas that it has enjoyed greater monopoly. Aerospace manufactures that now outsource subassemblies are at risk in the long term of creating competitors. These partners now building components may one day build whole jets largely due to technology, trainings and contacts provided by U.S firms. U.S aerospace firms do not have guarantees that their intellectual properties shall be protected.
Manufacturing is vital to a nation, it fosters a strong domestic economy, generates employment sustaining family wages and salaries, resulting in decent standard of living for the working class. Manufacturing firms large and small are bastions of state and local economies, supplying jobs and tax revenues to finance essential public services. Manufacturing creates economic activity spillovers in other sectors that supply intermediate goods and services. It also stimulates creation of numerous high-end job services such engineers and programmers in software technology within local economies. Additionally it drives economic productivity, innovation and engine of overall economic growth.
Manufacturing of semiconductors, the basis of modern electronic devices, prominently add value to the U.S economy proving high-value-added production, high-wage jobs, efficiency and productivity gains, and wage growth. Notwithstanding this, the United States is losing capacity and leadership in production of semiconductors. William J. Spencer (Emeritus of International Sematech chair), summarizes the leadership concerns by suggesting that a blend of market forces and foreign policies is creating powerful incentives to reallocate new chip fabrication overseas. If the trend persists, U.S leadership in chip design and manufacturing will erode with unpleasant consequences. Productivity growth will slump down severely impacting the economy spilling over to military security and might. These warnings have been raised by the National Security Agency and independent institutes.
The semiconductor business demonstrates the problems arising from outsourcing key industrial sectors critical for preservation of critical national security requirements. Natural disasters in South East Asia were chip production is being outsourced; possess a fundamental threat to electronics supply chain. For example the 1999 earthquake measuring 7.6 on the Richter scale that struck Taiwan shut down factories in Hsinchu industrial district disrupting the supply of wafers. Additionally, offshore sourcing and production of chip presents a potential threat to classified information embedded in chip designs. It greatly increases the possibility of unfriendly governments or non-state actors embedding Trojan horses, worms or malware in foreign manufactured chips to be used in military or intelligence applications.
As other nations execute strategic industrial policies to build up their technological capacities and strong, modern manufacturing base, U.S. policies continue to encourage U.S. manufacturers to shift their operations offshore. A comprehensive strategy aimed at reversing the decline in the nation’s manufacturing base will be sufficient for safeguarding and revitalizing the industrial base in the coming decades in face of looming competitive global commerce.
Another long term affect that poses much greater in addition to knowledge spillovers is the lack of local talent available to be utilized in the economy. College enrollment for courses leading to high skilled jobs as suffered a setback due to uncertainties associated with outsourcing of these jobs. In addition, the U.S economy is at risk of losing its attractiveness to skilled immigrants.
Outsourcing disrupts education evident with the college students shunning to pursue high-tech fields and opting for business oriented courses. Students are concerned that by pursuing these course coupled with instability in the labor market they face risks of losing out due to outsourcing. Studies show the proportion of graduates planning to major in computer science or engineering is now 70% below its peak in the early 1980s (Santos 87). With companies shipping IT operations to countries such as India and China, these countries are capitalizing by investing heavily in education and training to continue to attract, retain best talents, and maintain competitive edge in the global IT industry.
The increasing deficit in trade posse’s long term effects on the growth of the U.S economy. The U.S economy consumes more than it produces. This deficit cannot be scaled down if economic activities continue to be exported overseas. Goods and services produced and provided by U.S firms are being imported back to the U.S worsening the deficit situation. Outsourcing also diminishes the purchasing power of workers and shrinks their presence in the consumer market.
Most outsourced jobs to developing countries are not replaceable and present difficulties returning them back. It also means that the few remaining positions, individuals willing to take them must accept wage cuts and reduced benefits that they would have received if these jobs were not outsourced (Bureau of Economic Analysis and Bureau of Labor Statistics). Outsourcing creates a population of underemployed and severely affects the middle class purchasing power.
Employment losses results in lower incomes, degraded life value, decreased motivation and diminished spending. Failure by consumers to spend puts a strain on the economy; if money is not ploughed back the economy struggles to grow (Schniederjans, Ashlyn and Dara 6). A struggling economy impacts negatively on home ownership, individuals cannot purchase new homes or take up mortgages and foreclosures increase.
Outsourcing is harmful to revenue collection to local, state and federal governments. Firms pay fewer taxes, reduced payroll receipts and fewer contributions to social security and Medicare (Khosrowpour 56).
If foreign outsourcing on balance raises economic well-being, policies aimed at arresting that activity would have a net economic cost. There are, however, other avenues for policy response that most economists think could be generally beneficial. One avenue is to work to expand overseas markets through further removal of foreign trade barriers against American exports. A second avenue would be to use policy to boost the benefits of trade by correcting deficiencies in the economy’s ability to create new products and processes that could become attractive exports.
A third avenue is to use economic policy to remove any unwarranted bias against the economy’s tradable goods sector caused by an elevation of the incentives toward foreign outsourcing that arise from the economic forces generating the trade deficit (Taylor and Akila 26). A fourth avenue would be to use policy to address the hardships and inequities arising from trade and foreign outsourcing by extending compensation and more effective tools for adjustment to those who are hurt by the disruptive effects of foreign outsourcing and other market forces.
Signs of Changing Trends
The U.S. Congress of recent has taken action to limit outsourcing and off shoring by adjusting the nation’s inter-national commerce policies, however, further measures must be done. The President has backed creation of more employment opportunities rallying for greater investments in infrastructure and moving rapidly towards clean energy driven economy. State like Ohio have implemented policies and passed laws limiting the flow of public funds to foreign firms. In addition, some corporations and entrepreneurs have begun to question the wisdom of outsourcing, deciding to set up new facilities in the United States, expand their operations within the country and establish firms taking advantage of American workforce skills, knowledge and capabilities. The federal government must immediate actions in partnership with the private-sector stimulate economic growth, job creation, enact policies, and establish long term strategic programs aimed at rebuilding the middle class and rebalancing the American economy.
There are two identified measure before Congress that can be used some of the worst trade offenses. The first recognizes the manipulation of the Chinese currency, undervalued approximately 40 percent with respect to the U.S. dollar. Thus, costing the U.S. economy more than 3 million jobs. The Chinese government continues to violate its international obligations with respect to championing and safeguarding workers’ rights, human rights, illegal subsidies, currency manipulation, and respect for intellectual property rights by its citizens. Congress has been urged to enact a comprehensive trade bill enabling the federal government with tools to address these challenges combined with strengthening trade laws and their enforcement.
The current tax regulations permits U.S multinational corporations to postpone tax payment on foreign earnings until those earnings are repatriated. These provisions encourage continued investment in foreign economies with low tax rates at the expense of creating jobs in the U.S economy, and further tilting trade deficit in favor of emerging economies. Comprehensive tax reforms reflecting the changing situations need be recommended and enacted. These regulations must be punitive to businesses or hinder foreign investments and expansion by U.S firms.
Outsourcing has transformed the ways in which nations interact. Corporations have fragmented their operations internationally in order to concentrate exclusively on their core competencies. Short-term benefits, such as cost savings were identified, however several intangible consequences and hidden costs were overlooked that will have an effect on the U.S. economy in the subsequent years ahead. There is still a lot we do not know about outsourcing, largely because the available data does not provide information needed to fully understand its magnitude, the reasons behind it, and the actual effects it has on the economy. However, there is still substantial information that can be examined to analyze the long-term consequences that will alter our economic status. The sudden increase in outsourcing highly skilled professional jobs may be suspending our position in the world as a lead economic power. Companies must realize that their strategic advantages will thrive based on maximizing their knowledge-base, which is achieved through employing highly educated U.S. workers.