Outsourcing Definition & Meaning (Pros, Cons, 5 Examples)

Outsourcing is where a company hires an external firm to conduct certain aspects of its business. In other words, one business hires another to operate part of ... SkiptocontentHomeMicroeconomicsOutsourcingDefinitionWhatisOutsourcingOutsourcingExamplesAdvantagesofOutsourcingDisadvantagesofOutsourcingOutsourcingDefinitionAdvantages,Disadvantages,andExamplesWRITTENBYPAULBOYCE|Updated30January2022WhatisOutsourcingWhatisoutsourcing?Outsourcingiswhereacompanyhiresanexternalfirmtoconductcertainaspectsofitsbusiness.Inotherwords,onebusinesshiresanothertooperatepartofitsoperations.Forexample,AppleoutsourcesthemajorityofitsproductiontoFoxconnwhichassemblesmanyofitsproductssuchastheiPhone.Outsourcingitselfisanefficientcost-cuttingmeasurethatbusinessesusetohelpincreaseefficiencyandprofitability.Inaway,itcanbeseenasthedivisionoflaborbetweenbusinesses.Thebusinessthatisoutsourcingislefttofocusonwhatitismostefficientat,whilstathirdpartyconductstherest.LookingatApple,outsourcinghasbeenahugesuccess.Thecompanyfocusesondevelopingnewsoftwareanddesigns,whilstitoutsourcesmostofitscomponentstothirdparties.KeyPointsOutsourcingiswhereaspecificpartofthebusinessisconductedbyathirdparty.Firmsprimarilyoutsourceinordertolowercostsandfocusonitscorecompetencies.Outsourcingisgenerallyadvantageous,butcangowrongifabadpartneringcompanyischosen.Outsourcingstartedtogaintractioninthebusinesscommunityinthe1990sandtookoffalongsideglobaltrade.Astradebarrierscamedown,itbecameeasierandcheapertooutsourceproductiontolowcostbusinessesabroad.However,thishasnotcomewithoutitsramifications.Manyopponentscitethelossofdomesticjobs,particularlyinmanufacturing,whichhavebeenoutsourcedtoforeignentities.Ontopofthat,servicesthathavebeenoutsourcedcanleadtoalowerquality–largelybecausetheyarenotinthecompany’sfullcontrol.Bycontrast,outsourcingitselfisseenasanefficientallocationofresources.Tasksaredonebyspecialistcompaniesthataremoreefficientinthatrole.Forexample,aminingcompanyisunlikelytohavethelevelofexpertisetorunandadministerapensionscheme,sothefirmunderstandablyoutsourcesthisinstead.Foraminingcompany,wastingpreciousresourcesonanadministrativejobsuchaspensionsjustdoesn’tmakesenseforit.reportthisadOutsourcingExamplesAdministrationManycompanieshaveoutsourcedadministrativetaskssuchasinvoicing,databaseadministration,andthird-partycommunications.Thesearerelativelysimpletasks,sooftengetoutsourcedtodevelopingnationssuchasthePhilippinesandIndia.AppleAppleoutsourcestheproductionofitsiPhonestohundredsofseparatefirms–includingFoxconnthatmanufacturesthefinalphone.Aspartofthesupplychain,AppleoutsourcesmultiplecomponentsfromSamsungsuchastheflashdriveandthemobileDRAM.ThismethodofdoingbusinessworksforApple.Insteadoffocusingonthedevelopmentofnewcomponents,itcanoutsourcethesewhilstitfocusesonitscorecompetencies.CallCentersAsignificantnumberofcallcentershavebeenmovedtodevelopingnationssuchasIndia,Indonesia,andthePhilippines.Thismaybeforgeneralqueries,ortechnicalcallsregardingissuessuchasabroken-downlaptop.Followingtheinitialboominthe1990sand2000s,theoutsourcingofcallcentersabroadwasmetbycustomerswhowereunhappywiththequalityofservicetheywerereceiving.TheEnglishlanguageinsomeoftheoutsouringcountrieswasnottothesamestandard,whichcreatedacommunicationhurdleforcustomers.Inturn,itledtomanycompaniesbringingbackcallcentersandoutsourcethemlocallyinstead–althoughatahighercost.ITThereareanumberofsophisticatedsoftwareoptionsthatitwouldbewastefulforanindividualcompanytodesign.Forexample,arestaurantmaywantanappthatallowscustomerstoorderdirectlyfromtheirtable.Mostrestaurantmanagerswouldn’tknowwhereorhowtostartdevelopinganapp.Instead,itisfarmoreefficienttooutsourcethistoanindependentfirmthatdoesthisworkdayin,dayout.Manyfirmsnowusethirdpartiestosourcetheirsoftwareneedsthatinturncanhelpincreasethefirm’sproductivity.Notonlydomanycompaniesoutsourcesoftware,butalsotechnicalsupport.Forinstance,ifyouhaveanissuewithyourlaptop,manyoftheplacesyoucallareoutsourced.Microsoftisafamousexample,wherebyitoutsourcestocompaniessuchasTataandWipro.PensionsPensionshavebecomeincreasinglycomplexasregulationsconstantlychange.ThemarketitselfhasalsodevelopedfromarelativelysimpleDBschemewhichissolelypayablebythecompany,towardsaDCschemewhichreliesonemployeeandemployercontributions.Inturn,thereisamixtureofschemeswithdifferentfeaturesandschemerules.Thecomplexityofthemarkethasledmanybigfirmstooutsourcetheirpensionadministrationtothirdparties.Inturn,theydealwithcommunicationwiththemembersanddetailssurroundingtransfersandinvestmentoptions.OutsourcingAdvantagesandDisadvantagesAdvantagesofOutsourcing1.ConstantServiceByoutsourcingproduction,particularlyabroad,thefirmisabletooperateona24-hourbasis.Forafirmthatneedsacontactcenteropentocustomersallday,thiscanbeseenasacrucialadvantage.Customersmayneedassistanceduringthenight,sohavingsomeoneonhandtohelpisimportantifitwantstomaintainahighlevelofservice.2.ExpertiseOutsourcingfirmstendtodealwithmorethanonebusinessatatime.Thesefirmsrunoperationsdayin,dayout,workingontheirspecificpartoftheprocess.Aswiththedivisionoflabour,theyareabletoreallyfocusonandenhancetheircapabilities.Forexample,securityfirmsaremuchbetterequippedtotrainandsourcequalifiedpersonnel,asopposedtothelocalsupermarket.Thisisbecausethesecurityfirmwillalreadyhaveprocessesandstructuresinplace–suchastrainingpersonelandmanuals.3.FocusonCoreCompetenciesAsthefirmdoesn’thavetofocuson100differentcomponentswithinthebusiness–itisabletofocusonfactorsthatseparateitfromthecompetition.Forexample,Nikefocusesondesigning,developing,andmarketingitsproduct,butoutsourcestheactualmanufacturingprocess.Similarly,firmsrequiredepartmentsthathavenothingtodowiththeircorecompotencies.ThinkoffinanceorIT.Foraclothingstore,thesearedepartmentsthataren’tnecessarilypartofitscorecompetencieswhichissourcingqualityclothes.Instead,itoutsourcesthoseareaswhereithaslittleexpertisein–whichwouldrequiresignificantlevelsofinvestmentandtime.4.IncreasedCapabilitiesByoutsourcing,afirmnotonlybenefitsfromitspartners’expertise,butalsothewealthofresourcesithasavailable.Forexample,whenAppleoutsourcesitsproductiontoFoxconn,ithasaccesstofactoriesacrossEurope,America,andthroughoutAsia.That’snotonlythefactorybutitsprocessenhancementandthemachineryitusestoo.AcompanylikeApplecanaffordtobuythesefacilitiesitself,butforfirmswithlimitedcapital,itcanbeasignificantadvantageasitallowsthemaccesstoequipmenttheywouldotherwisebeunabletoafford.5.LowCostsWhenabusinessoutsourcesitsproduction,theotherfirmwillhavemanyothercustomerssosignificantlybenefitsfromeconomiesofscaleinthatfield.Forinstance,UKbasedLloydsBankagreedonaseven-yeardealwithIBMtooutsourcetheirIT.LloydsBankitselfdoesnotfunctioninthetechnologysector,soitsscaleislimitedtoitsownbusiness.Bycontrast,IBMservestheglobalcommunity,withover$77billioninsales.Atthesametime,outsourcingtothirdpartiesincountriessuchasIndiaandChinacansavesignificantamountsduetolowerlabourcosts.Thefirmalsobenefitsasitisabletosetupinthosemarketsrelativelyeasilythroughoutsourcingwithalocalsupplier.DisadvantagesofOutsourcing1.LossofControlWhenoutsourcing,thefirmessentiallylosescontroloverwhatisbeingproducedanditsquality.Howcanitensurethatthe1,000unitsitreceivesareofthehighestquality?Atthesametime,thefirmisatthemercyofitsoutsourcingpartner.Ifakeypartofthebusinessisoutsourced,thefirmhaslittlenegotiatingpowertomove–largelyduetothesignificantimpactamovemayhave.LargerfirmslikeNikeandApplemayhavegreaterpowerovertheiroutsourcingpartners,butsmallerfirmsmayfinditmoredifficult.Thisisparticularlytruewhenthefirmistryingtooutsourcenewproductsfromtheirpartner.Theymaywantthepartnertodevelopanewproduct,butduetotheirsize,areunableto.2.LowerQualityByextensionoflossofcontrol,thereisthepotentialforalowerqualityoutput.Asthefirmhasnodirectcontroloverwhatgoodsorservicesarebeingproduced,theymaysufferfromasub-parstandard.Whilsttheymaybeabletonegotiatewiththeiroutsourcedpartner,itmaybedifficultforthemtoadjusttothefirm’srequirements.3.PersonnelDifficultiesFirmsmayoutsourcetopartnersoutsidethecountry,orevenindifferentregionsofthesamecountry.Whatcanresultarelanguageandculturalbarriers.Somefirmsmayhavearelaxedandlaidbackculture–whichmaynotbeconducivetoafirmthatisverystrictanddemanding.Thismaybecultural,orstructuraltothebusiness,butcancreatesignificantfrictionbetweenfirmsthatcanimpactonthefinalproduct.4.PublicOpinionOutsourcingisgenerallyviewedunfavourablybythepublicasitisperceivedthatjobsarebeinglostabroad.Infact,thiswasoneofthemaindriversthatwonDonaldTrumpthepresidencyin2016.Subsequently,firmsthatengageinoutsourcing,particularlyabroad,havestartedtodevelopabadreputation.Partofthepublicopinionbattleisthefactthatfirmsareoutsourcingabroadthetakeadvantageofcheaplabour.Atthesametime,firmshavegonetoofar,notingtheNikesweatshopscandalin2013,wherechildlabourwasused.5.SecurityRisksWhenoutsourcingkeyaspectsofthebusinessabroad,thereisapotentialrisktointellectualpropertyrightsandotheraspectsofsecurity.Atthemoment,Chinapresentsarealandcrediblethreattothefirm’sintellectualpropertyrightsandwidersecurity.Infact,researchbyCNBCfoundthatChinesefirmsstolefrom1in3UScompanies.6.SlowerTurnaroundTimesWhenoutsourcing,thepartnerfirmwillhavemanyotherclientstoservice.Soalthoughafastturnaroundtimeiscrucial,itisalsoimportantfortheotherclients.Thiscanleadtoincreasedpressureonthepartnerfirmtomeetstricterdeadlineswhichitisunabletodo,duetoothercommitments.Ifitdoesnothavesufficientcapacity,itislikelytoleadtoslowturnaroundtimes.GeneralFAQsonOutsourcingWhatisoutsourcing?Outsourcingiswhereonefirmhiresanotherfirmtoconductpartofitsbusiness.Forexample,AppleoutsourcestheproductionofitsiPhonetofirmssuchasFoxconn.Isoutsourcinggoodorbad?Outsourcingcanhelpcompaniesreducecostssignificantlyandfreesupresourcestoallowthemtofocusontheircoreoperations.However,poorqualityoutsourcingpartnerscouldprovideabadserviceanddamagethefirmsoverallreputation.Whydocompaniesoutsource?Thetwomainreasonsforoutsourcingisfirstlytoreducecosts,andsecondly,toallowittofocusonitscoreoperations.Whatareexamplesofoutsourcing?Examplesofoutsourcinginclude:callcenters,manufacturing,IT,pensions,andfinance,amongmanymore.FurtherReadingComplementaryGoodsDefinition-AComplementarygoodisaproductorservicethataddsvaluetoanother.Inotherwords,twogoodsthatthe……ComplementaryGoodsDefinitionReadMore»WhatistheGiniCoefficient-Simplyput,theGinicoefficientisastatisticalmeasureusedtocalculateinequalitywithinanation.Originallythoughtofby……WhatistheGiniCoefficientReadMore»FixedCostDefinition-Afixedcostisacostthatabusinessmustpaywhetheritproducesoneproductoramillion.The……FixedCostDefinitionReadMore»Postnavigation←PreviousPostNextPost→reportthisadxx