Outsourcing

Outsourcing is “an agreement in which one company contracts-out a part of their existing internal activity to another company”. It involves the contracting out of a business process (e.g. payroll processing, claims processing) and operational, and/or non-core functions (e.g. manufacturing, facility management, call center support) to another party. The concept “outsourcing” came from the American Glossary ‘outside resourcing’ and it dates back to at least 1981. Outsourcing sometimes, though not always, involves transferring employees and assets from one firm to another. Outsourcing is also the practice of handing over control of public services to private enterprise.

Outsourcing includes both foreign and domestic contracting, and sometimes includes offshoring (relocating a business function to a distant country) or nearshoring (transferring a business process to a nearby country). Outsourcing is often confused with offshoring, however they can be distinguished: a company can outsource (work with a service provider) and not offshore to a distant country. For example, in 2003 Procter & Gamble outsourced their facilities’ management support, but it did not involve offshoring. Financial savings from lower international labor rates can provide a major motivation for outsourcing or offshoring. There can be tremendous savings from lower international labor rates when offshoring.

In contrast, insourcing entails bringing processes handled by third-party firms in-house, and is sometimes accomplished via vertical integration. However, a business can provide a contract service to another organization without necessarily insourcing that business process.

Two organizations may enter into a contractual agreement involving an exchange of services, expertise, and payments. Outsourcing is said to help firms to perform well in their core competencies, fuel innovation, and mitigate a shortage of skill or expertise in the areas where they want to outsource.

In the early 21st century, businesses increasingly outsourced to suppliers outside their own country, sometimes referred to as offshoring or offshore outsourcing. Several related terms have emerged to refer to various aspects of the complex relationship between economic organizations or networks, such as near-shoring, crowdsourcing, multi-sourcing, strategic alliances/strategic partnerships, strategic outsourcing., and vested outsourcing.

Outsourcing can offer greater budget flexibility and control. Outsourcing allows organizations to pay for the services and business functions they need, when they need them. It also reduces the need to hire and train specialized staff, brings in fresh engineering expertise, and can reduce capital, operating expenses, and risk.

“Do what you do best and outsource the rest” has become an internationally recognized business tagline first “coined and developed” in the 1990s by the “legendary management consultant” Peter Drucker. The slogan was primarily used to advocate outsourcing as a viable business strategy. It has been said that Mr. Drucker began explaining the concept of “Outsourcing” as early as 1989 in his Wall Street Journal article entitled “Sell the Mailroom.”

From Drucker’s perspective, a company should only seek to subcontract in those areas in which it demonstrated no special ability. The business strategy outlined by his slogan recommended that companies should take advantage of a specialist provider’s knowledge and economies of scale to improve performance and achieve the service needed.

In 2009 by way of recognition, Peter Drucker posthumously received a significant honor, when he was inducted into the Outsourcing Hall of Fame for his outstanding work in the field.

Reasons for outsourcing

Companies primarily outsource to reduce certain costs, which may include peripheral or “non-core” business expenses, high taxes, high energy costs, excessive government regulation or mandates, and production or labor costs. The incentive to outsource may be greater for U.S. companies due to unusually high corporate taxes and mandated benefits like social security, Medicare, and safety protection (OSHA regulations). At the same time, it appears U.S. companies do not outsource to reduce executive or managerial costs. For instance, executive pay in the United States in 2007 was more than 400 times more than average workers—a gap 20 times bigger than it was in 1965.

Digital outsourcing

Many think of outsourcing as it relates to manufacturing (e.g. the “made in China” label on the products you buy). However, outsourcing of white-collar work has grown rapidly since the early 21st century. The digital workforce of countries like India and China are only paid a fraction of what would be minimum wage in the US. On average, software engineers are getting paid between 250,000 and 1,500,000 rupees (US$4,000 to US$23,000) in India as opposed to $40,000-$100,000 in countries such as the US and Canada. Outsourcing has also expanded to include many different countries; Costa Rica has become a big source for outsourcing work as it offers the advantage of a highly educated labor force, a large bilingual population, stable democratic government, shares similar time zones with the United States, and it takes only a few hours to travel between Costa Rica and the US. Companies such as Intel, Procter & Gamble, HP, Gensler, Amazon and Bank of America have big operations in Costa Rica. In the recent years there has been an exponential growth in white collar work with service providers emerging in a wide range of activities, from banking and legal services to companies like Resourcesus US, a pioneer in outsourcing services for architecture firms in United States. Unlike outsourced manufacturing, outsourced white collar work, offers workers the flexibility to choose their working hours, and which companies to work for. With many individuals telecommuting from home, the companies that require this type of work do not need to allocate additional funds for setting up of office space, management salary, and employee benefits as these individuals are contracted workers.