Table of Contents
- Executive Summary
- Pros of Outsourcing
- Cost Savings
- Refocusing on Core Competency
- Specialised Expertise
- Added Value to the Organization
- Cons of Outsourcing
- Loss of Control, Continuity, and Cooperation
- Loss of Innovation, Creativity, and Flexibility
- Conclusion and Recommendation
Outsourcing is a contractual relationship in which an organisation hires a third party, usually an external vendor or contractor, to perform and manage one or more internal functions previously done in-house to maximise service, optimize expertise, minimize cost and maintain, if not improve, quality (Blouin and Brent 1999, 18). Outsourcing has become a major management activity in recent years (Bromage, 2000). Due to changing business environments organisation needs to adopt measures to lead to a better quality of services and greater flexibility in management. There are several reasons why many firms utilize outsourcing of their services, such as enhanced efficiency, cost reductions, increased flexibility and focus on core competencies. Outsourcing offers many advantages, albeit clearly with many caveats. The loss of skilled, expert staff is expected with outsourcing. Certain outsourcing risks include loss of innovation, ingenuity and versatility and loss of control, consistency, and cooperation.
Outsourcing allows the organization to reduce costs and concentrate on its core competences and to improve its activities. Although outsourcing is an attractive strategy bounded by appealing benefits, it also contains some significant risks. However, this risk associated with outsourcing can be controlled and minimized if executed effectively. The immediate challenge facing organizations is how to make an informed offshore outsourcing decision that maximizes the benefits while reducing the risks. An important way to achieve the aim is to ask into how decision-makers perceive and determine the factors that influence their decision to outsource offshore.
Outsourcing has become a major management activity in recent years (Bromage, 2000). One of the problems to outsource or not outsource is that managers constantly question themselves (Gunn, 2003). The degree of outsourcing, and its pros and cons, must be studied. The author posits that outsourcing is very beneficial to the growth of a company as it allows an organisation to reduce cost and to concentrate on its core competences and improve its activities.
What is Outsourcing
As for manufactured products, outsourcing is the process of shifting manufacturing to an outside supplier. Industries are sending the work to other domestic or offshore facilities. The outsourced operations can be viewed as new intermediate inputs or completed imports, changing the entire domestic output process (Robert and Gordon, 1999). The outsourcing firm can then experience a reduction in the amount of labour required to continue operation.
Outsourcing is a practice being used increasingly by organisations to combat the competitive forces within the global manufacturing sector. According to Michael Corbett, Firms extensively “use outsourcing every day to improve the products and services they provide customers…. More than 90 per cent of companies state it is an important part of their overall business strategy.” (Corbett, 2004: p. 3)
Pros of Outsourcing
Cost savings is the most important and most commonly cited reason for outsourcing. According to Burmahl (2001), cost savings are among the top right to outsource. Cost-savings calculations encompass fixed costs, which include capital and administrative overhead; variable costs, which include specific supplies, services, and labour cost for all personnel involved in the manufacture of a product or the provision of a service; and indirect costs for opportunities foregone, which occur knowledgeable organisational workers are not focused on core competencies because they are performing less productive tasks (Spitzer, 1996).
Outsourcing attains cost savings in several ways. First, long-term cost savings come from a reduction in operating and maintenance costs as well as avoidance of depreciation of equipment because the organisation can take advantage of the most current technology and the latest benchmarking trends in the industry without the required up-front capital investment (Lynch, 2002). Smaller institutions that cannot afford full-time expert technicians in-house can also save money by outsourcing hospital equipment maintenance (Burmahl, 2001).
Second, outsourcing reduces operating costs by converting fixed price associated with ownership or purchase of the latest technology into a variable cost, in which expenses are more comfortable to manipulate as the business environment changes (Wiley et al., 1998). Third, cost savings result from the reduction in salary and benefits costs. Employer costs for employee compensation (salary, benefit and insurance) have increased steadily. Finally, despite the oversight of in-house costs, such as administration, safety, education and training, human resources (salaries, fringe benefits, and institutional overhead) and management costs that can reduce the full impact of outsourcing’s cost-savings, studies show that overall operational costs are recovered within few years of outsourcing (Caspersen, 2000; Goolsby, 2002).
In addition to cost savings, outsourcing has become more popular because it facilitates strategic flexibility. This concept is closely linked to cost savings but also has additional added value to the organisation. Organisations cite flexibility and adaptability as their main reasons for seeking outsourcing. Outsourcing provides flexibility in several ways. First and most closely related to cost-saving, outsourcing offers the flexibility to meet the unpredictable workload demands in uncertain economic environments either by reducing the number of institutional personnel, by transferring the work to the outsourcing partner, or by importing outside staff to do in-house work (Goolsby, 2003).
The organisation’s mandatory costs of doing business include the costs of carrying a skeletal workforce even during slow or non-productive periods. Conversely, building an in-house workforce large enough to meet peak demand often means that some personnel sit idle during slow periods or that the firm incurs significant hiring and firing costs as it adjusts the level of employment to increases and decreases in output demand (Lankford and Parsa, 1999; Goolsby, 2003b).
Furthermore, outsourcing permits the flexibility to reduce time and monetary commitments for compliance with administrative changes and employment laws. Business experts advocate that organisations narrow their focus to three core competencies and outsource all non-core functions (Keane, Marx and Ricci, 2001; Goolsby, 2002). One characteristic shared by firms that succeed in transforming with the changing global competition is a clear focus on core competencies (Herzlinger, 1998). Many employers have followed these pundits’ advice on the use of employment intermediaries and rely more on alternative staffing arrangements, employing FTE workers only when there is an immediate and direct demand for their services (Polivka 1996). Moving away from the traditional employment models towards these more complex, strategic alternatives also means that the organisation must keep abreast and comply with changing federal, state and local employment regulations. Despite the substantially higher hourly salary for outsourced labour, outsourcing generates strategic advantages by eliminating the bureaucratic costs of doing business, the headaches of compliance with employment laws, and other administrative functions that generally demand a large portion of management’s time and attention (Drucker, 2002)
Firms engaging in outsourcing require less internal labour management than firms that do not support the strategic flexibility of transferring the responsibility for training, hiring and firing the staff to outside vendors (Schwalb, 1997). Read (2001: p. 8) summarise the relationship among unions, culture and flexibility:
Outsourcers usually have more flexibility to hire, and fire staff than [institutional employers] do internally. They are not constrained by union rules and internal corporate culture misgivings about using temps and laying off people.
Organisations have the option to utilise their in-house employees for core-function tasks and outsource the non-core functions, rather than to trying to shuffle positions within the organisation to comply with all the changes in employment codes for employees and accommodate strategic organisational changes.
Refocusing on Core Competency
Outsourcing increases operational efficiency by employing the best people to do the job they know most about. Outsourcing adds capability because a consultant is self-contained and can do the job as much as two or three times faster than if done in-house (Peach, 1997). The expertise brought in can also free the in-house staff and organisational resources to focus on core functions. Outsourcing brings in best practices, focuses on performance levels and encourages cooperation between the corporate employers and vendors, effectively aligning existing regulatory processes and efficiently maximising the available resources and skills.
Specialised expertise consistently ranks as one of the top reasons why both general businesses utilise outsourcing (Mullin, 2002). A 2002 H&HN survey of hospital executives revealed that 64 per cent identified obtaining specialised expertise as the top reason for outsourcing (Burmahl, 2001). The steep learning curve, the competition between traditional employees and outsourcing vendors to recruit the best in the business, and the rapid pace of changing technology have produced not only a shortage of knowledgeable employees but also a war on talent (Williams, 1998; Nyberg, 2002). According to Wiley & Coe (1998), outsourced expertise helps organisations to reach optimal productivity by filling hard-to-fill staff positions.
The requirement for specialised equipment and licensing makes outsourcing an attractive alternative in areas such as landscaping, ground maintenance, hazardous waste disposal, and pest control (Burmahl, 2001). These areas demand compliance with complex regulations such as the 1976 Resource Conservation and Recovery Act, which defines hazard chemical and procedures for handling and disposal as enforced by the Environmental Protection Agency (Smith, 2001). A repeat survey in 2000 shows that the numbers remained consistently high with 78 and 80 per cent of those responding reporting that they currently outsource pest control and waste disposal, respectively (Burmahl, 2001). Also, vendors’ best practices on hazardous waste disposal limit an organisation’s liability for correctly categorising, storing, transporting, and disposing of dangerous waste (Smith, 2001).
The extensive investment in both expert labour and resources makes a function ideal for outsourcing (Houlton, 2002). There are other values added to the organisation from bringing in outside expertise. Some organisations are squeezed for expert personnel and decide to outsource based on a talent shortage. Other organisations have skilled staffs but would rather have them function at a higher task level or would rather off-load the hassle of bureaucratic compliance and the policing of increased infrastructure to the experts in the field (Abraham and Taylor, 1996; Cope, 2002).
Experts argue that handing over sophisticated technologies to companies with the know-how is both economical and efficient, improving organisational services by eliminating the risk and time involved in developing that knowledge in-house (Williams, 1998).
Added Value to the Organization
Outsourcing adds organisational value that can be less obvious and difficult to quantify, but strategically equal to or more important than cost-savings (Ahmed, 2001). Even though cost-savings is the primary driver for outsourcing, operational decisions based solely on cost rarely produce the optimal organisational value. The real value in a business outcome is achieved when a business process improvement in one area also strategically impacts the business goals in one or more other regions. Increasingly, many companies realise that their best strategic partner is not necessarily the one that offers them the lowest cost since the most significant value could either be from renovating an operating modality or transforming an industry’s focus (Craumer, 2002). Future outsourcing trends will shift from a focus on cost savings to value creation which manifests in different modalities such as increasing overall operational efficiency, incorporating best practices, increasing ROI, and taking advantages of economy of scale and scope (Janssen, 2002; Swarts, 2002).
Cons of Outsourcing
Successful strategic outsourcing relationships are complicated. Outsourcing offers many advantages, albeit clearly with many caveats. The loss of skilled, expert staff is expected with outsourcing. Although a critical strategic reason for outsourcing is to reduce personnel costs, many policy experts question the demoralising effect that outsourcing arrangements can have on the remaining institutional staff (Huber 2002). Certain outsourcing risks include loss of innovation, ingenuity and versatility and loss of control, consistency, and cooperation.
Outsourcing potentially impairs the confidence of the organisational workforce because the employees who are not replaced may still experience difficulties with culture fit, job security, and degradation in their interaction with third-party vendors. Many workers who are about to be replaced have complained that the most humiliating aspect of outsourcing is being forced to provide on-the-job training for the very same people who will replace them (Bulkeley, 2004; Solomon and Kranhold, 2005). Doig et al. (2001, 26) write “outsourcing involves massive changes to a business … changes involving trade-offs and organisational trauma.” With outsourcing becoming more pervasive in organisational strategies, the morale of the workforce cannot be overlooked because employees who feel strong support from management are more likely to work together to achieve the organisational goals as well as to remain with the organisation in times of uncertainty (Jackson et al., 1998).
Loss of Control, Continuity, and Cooperation
In addition to reducing staff morale, outsourcing also complicates an organisation’s ability to monitor cooperation, control the outsourced function, and affect the continuity of service, precisely continuity of care in healthcare settings. These concerns are especially real for organisations that have adopted an outsourcing model where their entire existing assets are sold to the outsourcing provider who then improves the products or services before leasing them back to the organisation. In some cases, outsourcing connotes changes in every aspect of the operations of business-its people, processes, technologies, financial structure, and relationship with its customers, suppliers, and shareholders. Losing control in an outsourcing relationship manifests from the failure to understand the premises for seeking an outside vendor. “For reasons of politics or budget limitations, too often the outsourcing decision is taken without proper consideration of the effect of privatization on the core missions of an agency” ( Avery 2000, 330). At other times, buyers fail to reap the full benefit of the outsourcing relationship because they invest time and resources in locating the most compatible outsourcing vendor but then tend either to ignore the details or fail to compose SLAs with monetary penalties or cancellation options for the outsourcer that fails to meet promised performance objectives. Therefore, the potential loss of ownership and the limited ability to control and manage performance are severe concerns for organisations that outsource.
Loss of Innovation, Creativity, and Flexibility
The impediment of the capacity to innovate and the erosion of the competitive drive are always legitimate concerns in outsourcing relationships. At the beginning of the outsourcing trend, the boundaries between core and non-core functions and between in-house resources and outside providers were very distinct (Ahmed, 2001). However, rapidly changing technology, increasing competitive environments, and evolving work cultures have blurred the distinctions among these four factors. The failure to monitor the external environment constantly, to strategically adapt accordingly, and to determine whether an operation can be improved in-house before engaging in outsourcing results in the organisation giving away value and outsourcing a slice of activities (Schwarzwaelder 2001,4). Some critical questions that an organisation must answer before outsourcing a function are: What core competencies give the organisation a strategic advantage? Which services are not too essential in the core of our mission entrust to an outside vendor? Which might be outsourced? Is this a core competency that, if outsourced, could threaten the competitiveness of the business? What is the organisation’s mission, and what does it do best?
Because its strategic functions are central to an organisation’s strength and position in the marketplace, organisations should be very reluctant to outsource day-to-day operations to others. Still, they should be even more concerned not to entrust proprietary information to outsiders (Ahmed 2001, 22). One analyst cautions that when organisations are not careful and selective, they “leave themselves vulnerable to a market coupe by former partners when they outsource [and fail to] … distinguish ‘key’ activities from ‘strategic’ activities” (Craumer 2002, 5). For example, IBM mistakenly believed in the 1980s that its core competency is marketing rather than building operating systems and computer chips and outsourced the building of its computer operating system and processing chips to Microsoft and Intel, respectively. IBM’s miscalculation propelled Microsoft and Intel into a more prominent company in the computer industry and eventually led to its demise (Carey, 1995; Lankford and Parsa, 1999). An organisation that outsources strategic activities and functions at the very heart of its mission may lose its competitive advantage, driving force, vision for the future, and its ability to innovate by removing the source of creative energy from the organisation itself.
Inflexible arrangement and the lack of creativity are common contractual or service difficulties. Commitment to a fixed method manifests whenever there is a lack of a clear understanding of what is to be gained from outsourcing and a lack of the prerequisite in-house versus outsourcing comparative analysis. Organisations that plan for the long-term benefits of outsourcing avoid conflicts over creativity and flexibility. Explicitly, the long- term vision incorporates strategies “with Enterprise-level outcomes like improved ROI or greater shareholder returns … Usually, this means outsourcing with a focus on external results-like repositioning yourself in the market place or changing your value proposition to customers in some key way, versus using outsourcing to save 5 [per cent] on the cost of an internal administrative process” (Craumer 2002, 4).
Conclusion and Recommendation
Outsourcing allows the organisation to reduce cost and concentrate on its core competences and to improve its activities. Although outsourcing is an attractive strategy bounded by appealing benefits, it also contains some significant risks. The immediate challenge facing organisations is how to make an informed offshore outsourcing decision that maximises the benefits while minimising the risks. An important way to achieve the aim is to ask into how decision-makers perceive and determine the factors that influence their decision to outsource offshore.
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