The Pros and Cons of Outsourcing

October 13, 2014 Business Process, Business Strategy, Productivity, Supply Chain Management

The Benefits of Outsourcing Must Outweigh The Drawbacks

Whenever we hear someone mention the term outsourcing, we usually have an immediate reaction to that single word. First, we might say that outsourcing work is a modern and effective management technique that has many applications and offers countless benefits. Or, we may say that outsourcing work – either overseas or just to an outside company down the street – is yet another form of cost cutting by corporations to meet their bottom line. While the topic of outsourcing may be polarizing, in reality, it can be an effective solution for many business challenges. However, it must equally be said that whether you are a small business or large corporation, there is no one-size-fits-all approach to sending work outside. Whether you build houses, manufacture medical devices, or own a florist shop, any benefits we gain by outsourcing part of our operation comes with a lengthy list of challenges. Our job, as managers and business leaders, is to decide if the benefits of outsourcing are worth the challenges and risks. Let’s take a closer look at some of the tradeoffs of outsourcing to help you decide if it is right for your organization.

What Is Outsourcing?

If you look it up in the dictionary you will find that the definition of outsource reads ‘to send away work to be done by people outside the company.’ In short, the outsourcing company hires someone else to do work, instead of doing it internally. A traditional and widely recognized form of outsourcing are call centers. We have all experienced it: you dial-up your credit card company and ask someone who is 8,000 kilometers away to help you remedy a charge you made at your local pharmacy. In fairness, hiring someone to paint your house is another example of outsourcing (in theory, you could do it yourself). Regardless of the business model, there are both benefits and drawbacks to any outsourcing arrangement.

The Benefits of Outsourcing

The underlying principle behind outsourcing is that it optimizes skills and resources. Resource optimization, as we know, is one of the most fundamental aspects of running a success business. Thus, when done correctly, outsourcing can be a successful business strategy. To elaborate on this in details, here are some of the specific benefits that outsourcing can provide:

1. Cost Reduction

Let’s start with the first thing 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 save money by offloading production or services to smaller outfits with lower overhead costs. Or, sometimes external companies have optimized a special processes that allow them to produce product at a lower unit cost than you can. And, of course, outsourcing work to a low-cost economy can also be favorable since it takes advantage of lower labor rates (which is the reason why you often speak to someone very far away when you call up your credit card company).

2. Cost Avoidance

In a similar manner, while many managers see cost reduction as the main driver behind outsourcing, many business leaders forget to see outsourcing as a means of cost avoidance. Outsourcing can be extremely beneficial when certain tasks or activities require either special equipment or unique skill sets. To illustrate this point, consider dry-cleaning your clothes. Why do we bring our suits and expensive dresses to be dry-cleaned? Why don’t we just buy a machine to do it at home? The answer is that the machines are expensive and require specialized knowledge to use. Oh, and they take up space, so we may need to buy a bigger home which adds additional cost. Though a simple example, it goes to show how outsourcing can be a good way for companies to avoid purchasing special equipment, or hiring and training specialized people, particularly for short-term needs

3. Managing Staff Size

People represent a major expense to a company, and no company wants to earn a reputation for hiring employees only to let them go six months later when the need for labor has subsided. As a result, many companies willingly choose to endure short-term stress and to shift priorities around in order to avoid adding staff. But, when there is truly a need for a temporary increase in staffing (which is often the case with seasonal business, for instance), outsourcing that work is a very effective way to get through peak times with relatively low risk.

4. Speed Advantage

Every company has its own processes and approach to running its business. But as a general rule, larger companies tend to be slower in their pace of business. Smaller companies, by contrast, are usually faster and more nimble. While internal resources may be capable of a given task, they may simply be too consumed by daily activities which in turn dilute their focus. Thus, outsourcing work may offer tremendous speed advantages to larger organizations.

5. Driving a Focus on Core Expertise

Businesses are ultimately successful because of their unique core expertise. A shoe manufacturing company, for example, may excel at assembling shoes into their final form but may not be the best at producing the leather used in their products. Does it mean this company can’t produce the leather for its shoes? No. But the added operations and processes required to do so can rob valuable resources from those activities the firm does best. Outsourcing things you do not do well is a great way to maintain focus on what you do best.

The Downside of Outsourcing

The cost and speed advantages of outsourcing are obvious, but the limitations of the arrangement may prove to be more harmful to the business than it is worth. Let’s examine some of the drawbacks of sending work to another party.

1. Losing Control

So again, we’ll start with an easy one. When you send work or processing outside, you lose sight of things like detailed timing, sequencing, and sometimes quality. It’s a matter of control. By outsourcing work, you are inherently giving up a level of ownership and become dependent on someone else. Sometimes this is acceptable. However, in high-pressure or time-sensitive situations, outsourcing can introduce an element of risk.

2. Loss of Intellectual Property

In some cases, outsourcing may result in the loss of sensitive company data and intellectual property. Non-Disclosure Agreements (NDAs) are the legal means of protecting against this, but once a product or process is sent outside, the information is in the hands of another party no matter what. While intent does not need to be malicious, sharing information with an outside firm may not be in your best interest.

3. Defective Quality

While audits and supply chain management processes are established to protect your company from a supplier’s quality defects, there is no guarantee that an outsourced process or activity is immune from error. So, while paying an outside firm to do a job frees up internal resources, it also puts you at the mercy of that company’s quality control processes and standards. Sure, quality issues can occur internally; but equally, you can divert resources and energy quickly to address serious problems. Managing another company through such a situation, however, is far more complicated.

4. Ramp-Up Time

In many situations, outsourcing work comes with a learning curve. In some hurried situations, outsourcing may not offer a benefit because of the amount of time required to get the outside firm up to speed. Keep in mind that ramp-up time often includes the general learning curve, as well as the time it can take to provide electronic data, processes, standards and other administrative information required to perform the work. Unless there is a pre-existing arrangement, a quick turn-around on work may simply not be worth the effort.

5. Loss of Learning and Knowledge Growth

Imagine you hire an outside firm to evaluate your customers’ purchase history in order to identify the best day of the week to offer a sale. The outside company specializes in this and is able to do this very well. However, if you were to do the analysis yourself, you may identify other valuable trends about your customers that you would never otherwise learn. When of strategic importance, outsourcing work can result in a missed learning opportunity.

6. Hidden Cost of Oversight and Coordination

Call it what it is: outsourcing is a logistical hurdle. To outsource anything takes time and effort on your part. It is important to look at all costs associated with outsourcing an activity, not just the savings. Outsourcing often includes hidden costs such as legal expenses, travel expenses, shipping charges, transactional fees, and the labor required to actually send the work outside. While these hidden costs not be a major factor in your decision to outsource something, they may make a potential outsourcing deal less attractive.

Outsourcing: Advantageous When Done Right

Overall, outsourcing is a great strategy to help your business remain strong and financially healthy. Though there are many benefits to outsourcing, the risks and drawbacks need to be carefully considered to ensure you will gain the benefit you seek. Before jumping into an outsourcing arrangement with two feet, take a look at the situation and make sure it is the right thing for you to do.