The Pros and Cons of Outsourcing

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The term outsourcing is often seen as a slick and modern management technique in business circles. Yet in other groups, outsourcing work overseas or just to an outside company down the street is viewed as the first form of cost cutting by corporations to meet their bottom line. Regardless of which side of the divide you may be on, outsourcing is one of those things that gets a lot of attention and is seen as a solution for many things. But there is no one-size-fits-all approach to sending work outside. I will endeavor to discuss a few of the tradeoffs here.

What Is Outsourcing?

If you look it up in the dictionary you will find the definition of outsource reads ‘to send away work to be done by people outside the company.’ The outsourcing company ends up paying for the activity it sends to the other party, instead of sustaining those resources and costs internally. One of the most widely recognized form of outsourcing are call centers. You know, calling your credit card company and talking to someone 8,000 kilometers away. Understandably, outsourcing conjures up a great deal of debate – over jobs, over frustrated customers, and over the need to reduce costs.

The Benefits of Outsourcing

Regardless of the debates, outsourcing is a way of the business world. To this end, the underlying principle that makes outsourcing a successful business strategy is the optimization of the skills and resources of both parties, that join to make the relationships mutually beneficial.

Here are some of the benefits brought about by outsourcing:

Cost Reduction – Let’s start with the easy one that comes to everyone’s mind. Outsourcing is an effective way to control cost. Larger companies with high overhead rates are prime examples of this, since they can offload production or service activities to smaller, lower overhead outfits. Or, perhaps the outside company has optimized a given process that allow them to produce piece parts at a lower unit cost. When the outsourced work goes to a low cost economy, the benefit of cost reduction are the most favorable.

Cost Avoidance – In a similar manner, while many managers see cost reduction as the main driver behind outsourcing, many business leaders fail to see outsourcing as a means of cost avoidance. Outsourcing can be extremely beneficial when it comes to certain tasks or activities that require either special equipment or unique skill sets. If the firm were to bring such things under its own roof, they would represent costs, such as increased fixed cost or added labor. Other costs incurred may include expenses related to inventory and stocking. Thus, outsourcing can be a way companies can avoid purchasing special machine or equipment, or hiring and training specialized people, particularly for short term needs.

Controlling Staff Size – People represent a cost to a company: salary, benefits, training, computers, etc. Adding people therefore adds cost. No company wants to earn a reputation for hiring employees only to let them go six months later when the demand has subsided in order to reduce costs. For these reasons, many companies are understandably leery about hiring. In many cases, companies will willingly choose to endure short term stress and shift work around in order to avoid the addition of staff. In such instances, when there is a temporary need for increased staffing as is often with seasonal business, outsourcing work or services can help companies get through peak times with relatively low risk.

Speed Advantage – Every company has its own processes and ways it goes about its business. But as a general rule, consider the cruise ship analogy: larger companies tend to be slower in its pace of business. And by contrast, smaller companies and business tend to be faster and more nimble. Because of this, there are advantages to outsourcing in terms of speed and efficiency. While internal resources may be capable of a given task or activity, they may not be able to respond quickly enough to fulfill a need. Outsourcing may prove to provide the benefit of time.

Focus on Core Expertise – Classic business strategy suggests that businesses are successful because of their core expertise. A shoe manufacturing company, for example, may not be the best at producing the leather used in the products, but may excel at assembling the shoes into their final form. Does it mean this company can’t produce the leather for its products? No. But as more and more operations and internal processes are brought in, it increases supporting operations, costs, and can rob valuable resources from the activity the firm does best. Outsourcing the production of the leather may actually prove advantageous in this case, in order to allow the firm can focus energy on optimizing and improving the shoe assembly process.

The Drawbacks of Outsourcing

Cost and speed advantages can often be found in an outsourcing arrangement, but the limitations of the arrangement may prove to be harmful to the business. Let’s examine some of the drawback of sending work to another party.

Losing Control – So again, we’ll start with an easy one. When you send work or processing outside, as is the case with outsourcing, you lose control of the activity. The outsourcing company cannot control the detailed activities, timing or sequencing as it could when it retains the work. In some sense, while the outsourcing company is the customer, it is somewhat powerless once the work or processing is offloaded. In high pressure or time sensitive situations, therefore, outsourcing can introduce an element of risk.

Loss of Intellectual Property – Sending work outside may inadvertently leak sensitive company data and information outside. Non-Disclosure Agreements (NDAs) are a means of protecting against this, but once a product of process is sent outside for a given process or activity, the information is in the hands of another party. The outsourcing firm is at the mercy of the recipient’s training and data protection protocol.

Defective Quality – While audits and various supply chain processes help protect a company from poor quality by suppliers, like with all things, there is no guarantee that an outsourced process or activity is immune from error on the outside. By paying the outside firm to do the job, the outsourcing company is freeing up resources to do other work, but absorbs some level of risk. Should the supplier make mistakes or lose process control, the issues may not be caught until it’s too late.

Ramp Up Time – In many situations, outsourcing work comes with a learning curve. In time sensitive situations, outsourcing may not offer a benefit because the amount of time required to get the new player up to speed may be prohibitive. The ramp up time may not be limited to a learning curve, but may also include the time it takes to provide electronic data, processes, standards and other administrative information.

Loss of Knowledge Growth – Although it was mentioned as benefit, outsourcing to benefit from the expertise of another also limits the learning the outsourcing firm can gain itself of a given task or process. For example, if you outsource the evaluation of customer purchasing data to another party to identify the best day of the week to offer a sale, you may miss identifying other valuable trends and information.

Hidden Cost – Call it what it is: it takes time and effort on the part of the outsourcing firm to outsource the work. It’s important to look at all costs associated with outsourcing an activity, not just the savings. There may be legal expenses, transactional fees, and of course, there will likely be labor associated with sending the work outside. Hidden costs are not likely to be a major factor in outsourcing, but may make a potential outsourcing deal less attractive.

Thing to Consider When It Comes to Outsourcing

Even though outsourcing may come across as a great quick fix to keep a business thriving, it does require up front planning. Particularly when you have temporary, short term, or cyclic needs, if you think you will need help, it is best to plan for it so that you can be ready. If you need immediate help for the short term, it’s probably too late.

Here are some questions to ask yourself to help evaluate how and if outsourcing is a viable option for you:

Is significant effort required to get the other company ‘up to speed’ or to ensure the work is done correctly? If there is still considerable effort required on your part to outsource and get the job done, outsourcing may not be the best option. It will likely consume a great deal of time and energy on your part in order to get the other company up and running. For short term results, an outsourcing strategy is unlikely to success unless there is a pre-existing relationship and history with the other firm.

What other costs will you incur aside from the fee paid to the outside company? If transaction fees, or significant labor to outsource the activity, the financial benefit of outsourcing may be diminished. Though still viable, if outsourcing is being done purely for cost reasons, hidden costs may make sending work outside less attractive.

By outsourcing the activity, will you lose out on gaining some pertinent knowledge? Particularly when it comes to outsourcing a ‘back office’ type of service, you may run the risk of losing some information. For example, if you outsource some payroll activities to an outside firm, you may lose the opportunity to note trends or gaps in compensation of your work force. If you outsource a specific portion of software coding to make up for lack of resourcing, you may lose development of a particular skill that would result if you did it yourself.

Does the outsourced activity fall within your core competencies? If you are looking to outsource activities or processes that are close to you expertise, consider outsourcing those activities that are not. In many cases, the non-core activities are an extra draw on your organization, and you could benefit by having an expert perform those tasks.

Is the outsourced task critical to product quality or your company integrity? If the outsourced activity can impact the customer or product quality, be sure to establish reasonable audits or controls into the outsourcing arrangement that give you the opportunity to verify the work is being done to standard. This will help serve as a means of retaining some of the control that will be lost as compared to if you kept the activity internally.

Are employees constrained by administrative overload? If critical skill holders are bogged down by tasks or activities that take time away from their prime responsibilities, outsourcing can be a great way to bring efficiency to your business. Consolidating administrative tasks and offloading them can reduce the need to hire more highly skilled people.

Overall, outsourcing is a great strategy to help your business remain strong and financially healthy. But the drawbacks need to be considered to ensure you will gain the benefit you seek.

 

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