What Is Outsourcing?
Outsourcing is thepractice of hiring a party outside a company to perform services or create goods. In some cases, these were traditionally performed in-house by the company's own employees and staff. Outsourcing is a practice usually undertaken by companies as a cost-cutting measure or a strategic management tool. As such, it can affect a wide range of jobs, from customer support to manufacturing to the back office.
Outsourcing was increasingly used as a business strategy in the 1990s, when multinationals used third-parties for logistics and manufacturing functions, along with others. But due to its broader economic implications, 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 maintainthe nature offree-market economies in a highly connected world.
Key Takeaways
- Companies use outsourcing to cut labor costs, including salaries for their personnel, overhead, equipment, and technology.
- Outsourcing is also used by companies to focus on the core aspects of the business, spinning off the less critical operations to outside organizations.
- On the downside, communication between the company and outside providers can be challenging, and security threats may increase when multiple parties can access sensitive data.
- In some cases, companies will outsource as a means to move things around on the balance sheet.
- Outsourcing employees, such as with 1099 contract workers, can benefit the company when it comes to paying taxes.
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Understanding Outsourcing
When a company uses outsourcing, it enlists the help of outside organizations not affiliated with the company to complete certain tasks. The outside organizations typically set up different compensation structures with their employees than the ones used by the outsourcing company, enabling those organizations to complete the work for less money. This ultimately enables the company that chose to outsource to lower its labor costs through the combination of less pay and fewer benefits.
Businesses can also avoid expenses associated with overhead, equipment, and technology.
In addition to cost savings, companies can employ an outsourcing strategy to better focus on the core aspects of the business. Outsourcing non-core activities can improve efficiency and productivity because another entity performs these smaller tasks better than the firm itself. This strategy may also lead to faster turnaround times, increased competitiveness within an industry, and the cutting of overall operational costs.
Companies use outsourcing to cut labor costs and business expenses, but also to enable them to focus on the core aspects of the business.
Examples of Outsourcing
Outsourcing's biggest advantagesare time and cost savings. Amanufacturer of personal computers might buy internal components for its machines from other companies to save on production costs. A law firm might store and back up its files using a cloud-computing service provider, thus giving it access to digital technology without investing large amounts of money to actually own the technology.
A small company may decide to outsource bookkeeping duties to anaccounting firm, as doing so may be cheaper than retaining an in-house accountant.Other companies find outsourcing the functions of human resource departments, such as payroll and health insurance, to be beneficial.When used properly, outsourcing is an effective strategy to reduce expenses and can even provide a business with a competitive advantage over rivals.
What Are Some Criticisms of Outsourcing?
Outsourcing has disadvantages. For instance, signing contracts with other companies may take time and extra effort from a firm's legal team. In addition, security threats can occur when another party has access to a company's confidential information and that party suffers a data breach. Furthermore, a lack of communication between the company and the outsourced provider may occur, which could delay the completion of projects.
Beyond these factors, outsourcing has faced criticism due to the job precarity and lack of job promotion opportunities for contract workers. As mentioned above, contract workers often earn lower compensation than full-time workers and have fewer benefits, creating inequities in the workforce.
What Are the Benefits of Outsourcing Internationally?
Outsourcinginternationally can help companies benefit from the differences in labor and production costs among countries. Price dispersion in another country may entice a business to relocate some or all of its operations to the cheaper country in order to increase profitability and stay competitive within an industry. Many large corporations have eliminated their entire in-house customer service call centers, outsourcing that function to third-party outfits located in lower-cost locations.
In 2023, a Deloitte survey found that India, Poland, and Mexico were the top countries for outsourcing shared services. Meanwhile, outsourcing IT service desk functions was the top service exported in the information technology sector globally.
What Is Outsourcing?
First seen as a formal business strategy in 1989, outsourcing is the process of hiring third parties to conduct services that were typically performed by a company itself. Often, outsourcing is used so that a company can focus on its core operations. It is also used to cut costs on labor, among other costs. While privacy has been a recent area of controversy for outsourcing contractors, the practice has also drawn criticism for its impact on the labor market in domestic economies.
What Is an Example of Outsourcing?
Consider a bank that outsources its customer service operations. In this case, all customer-facing inquiries or complaints with concern to its online banking service are handled by a third party. While choosing to outsource some business operations is often a complex decision, the bank determined that it would prove to be the most effective allocation of capital, given consumer demand, the specialty of the third party, and cost-saving attributes.
What Are the Disadvantages of Outsourcing?
The disadvantages of outsourcing include communication difficulties, security threats where sensitive data is increasingly at stake, and additional legal duties. On a broader level, outsourcing may have the potential to disrupt a labor force. One often-cited example is the outsourcing done by the manufacturing industry in America, which has, to a large extent, moved production of its goods to other countries. In turn, higher-skilled manufacturing jobs, involving robotics or precision machines, have emerged at a greater scale.
The Bottom Line
While outsourcing can be advantageous to an organization that values time over money, some downsides can materialize if the organization needs to retain control. Outsourcing manufacturing of a simple item like clothing will carry much less risk than outsourcing something complex like rocket engineering or financial modeling. Businesses looking to outsource need to adequately compare the benefits and risks before moving forward.
