Outsourcing and Offshoring
Outsourcing and Offshoring
Outsourcing refers to a firm's practice of paying another firm to perform a function or produce a product that could be done or made in-house by the paying firm. It usually involves more information exchange, coordination, and trust than a mere vendor relationship, since a certain amount of management control is transferred to the supplier. Products and services can be outsourced domestically or to a foreign company. Outsourcing is increasingly associated with firms located overseas, where salaries are markedly lower.
Business process outsourcing, or BPO, is the most common type of outsourcing, occurring when businesses outsource a part of their process to another company, with the goal of cutting costs and improving efficiency. Payroll, accounting, and customer service outsourcing are all examples of BPO. There are two classifications of BPOs: front office and back office. Front office BPO refers to outsourcing parts of the process that include customers or visible parts of the company, such as tech support or customer service. Back office BPO refers to activities that are not as visible and that do not come in contact with the customer directly (such as billing supply purchasing and other accounting services).
Outsourcing and offshoring began in the 1960s and 1970s with the transfer of physical manufacturing processes to lower-cost areas. For example, some U.S. companies shifted production to factories in Mexico that were part of a maquiladora system. Offshoring of physical products then moved to other low-cost locations such as China, India, the Philippines, and Eastern Europe. Despite increased transportation, dock, duty, and broker costs and loss of supply-chain speed, firms found that a 30 to 50 percent reduction in labor costs more than compensated for these increases.
The information technology revolution has made location much less important since inputs and outputs can be transmitted digitally. This has facilitated the offshoring of many white-collar functions. For example, the computer manufacturer Dell has outsourced its technical support for residential customers. When customers dial the number for technical support they are connected with technicians in India. With the costs of establishing sufficient bandwidth, compatible software connections, and video hookups decreasing rapidly, more employers may embrace the opportunity to replace employees located in the United States with lower-cost workers overseas.
Some analysts foresee a new global division of labor emerging. They propose that the West will focus on the highest levels of product creation, the part that entails artistry, creativity, and empathy with the customer, and the jobs involving turning these concepts into actual products and services will be sent overseas. However, outsourcing is also used for the process of innovation. Some American firms feel that their current spending on research and development is not yielding a sufficient return, so they are turning to “original design manufacturers” (ODMs). These ODMs completely design products that are then sold to firms such as Dell, Motorola, and Philips, who tweak them to their own specifications and label them with their own brand names.
TYPES OF OUTSOURCING
Although all types of outsourcing share similar characteristics already discussed, there are many different types of outsourcing recognized in the business world. Marc Schniederjans, in his 2008 book, Outsourcing and Insourcing in an International Context, gives an excellent list of the most common types of outsourcing, which include:
- Offshore Outsourcing. This refers to outsourcing to a firm located in another country. It does not mean that a company opens a branch in a different country—which is actually a form of insourcing, since the business is closer in proximity—but merely that another company enters the supply chain in an international relationship.
- Nearshore Outsourcing. This is a type of offshore outsourcing, but occurs when a company outsources to a nation that is nearby. For instance, America outsources many operations to Mexico, a neighboring country. Nearshore outsourcing reduces transportation and often communication costs.
- Transitional Outsourcing. This type of outsourcing allows a business to concentrate on a particular part of the business system, while outsourcing older or more traditional models. A company may outsource certain outdated technologies while working to develop a new replacement technology within the organization. Other companies may want to give up a business system entirely to free resources they can use to specialize.
- Co-sourcing. Co-sourcing involves paying the providing firm based on their performance, usually in reaching a goal. Companies collaborate on setting expectations and fulfilling them, and the provider is compensated when expectations are met.
- Spin-Offs. Spin-offs occur when a company splits and a separate organization is established. Tasks are switched to this new organization.
- Backsourcing. Also known as an insourcing activity, backsourcing occurs when a company is displeased with their outsourcing provider, and moves the outsourced tasks back to the original organization. This could involve breaches in the contract, ineptitude, or falling profits, but backsourcing usually means that negative aspects of the relationship caused the company to undo their outsourcing endeavor.
- Business Process Outsourcing (BPO). Already mentioned, this type of outsourcing is rising in popularity as companies move particular departments or systems to other firms who can carry them out more efficiently.
- Business Transformation Outsourcing (BTO). This process relegates business activities to another firm so that the company can focus on reinventing itself, create a new business model, or enter a different industry. An outside firm is hired to carry on the necessary systems of the old business while the company explores a new field or another way of conducting business within its industry.
- Value-added Outsourcing. This is when a company gains competitive advantage by outsourcing tasks the providing firm can do better or with more efficiency.
- Netsourcing. This involves partnering with another company for online interactions, such as renting a Web site or collaborating to create a new program for the company. Some outsource the maintenance of their intranet to other firms.
- Shared Outsourcing. This occurs when a provider works on the same outsourced task for multiple companies, such as handling customer service for several similar companies, or working on the same piece of computer code for more than one tech firm.
- Multisourcing. This involves a company choosing multiple firms to outsource tasks to, usually to improve quality and gain more flexibility in their outsourcing arrangements. Some companies only begin to multisource to ensure competitive bidding for their outsourcing contract; eventually, they choose one firm at a lower cost.
OUTSOURCING AND MULTISOURCING
How should a company begin to outsource? Most experts agree that the current outsourcing trend involves backing away from large contracts that have high costs and put a hefty amount of the company's production process in other hands. Instead, businesses are backing down, choosing lesser contracts with a variety of other firms, some local and some overseas, in a network-type of relationship, also known as multisourcing. Multisourcing allows businesses more flexibility, letting them solve production problems with greater ease and implement new techniques with less hassle.
What other considerations should companies make when deciding to multisource? Business writer Ephraim Schwartz outlines several important issues to consider in his 2008 article, “Outsourcing: Breaking Up is Hard to Do”:
- The more complicated outsourcing becomes, the more vendors will be present and the more issues that will need to be resolved, especially if a certain part of the company's process is divided up among several different outsourced tasks. Primary concerns will be communication and coordination. It is best to develop a successful integration plan before multisourcing.
- Bigger companies might be less willing to be multi-sourcing partners than outsourcing partners. Outsourcing with one sizable contract means that the company carrying out the tasks is guaranteed large payments for a fair amount of time. In multisourcing, companies must be willing to accept shorter contracts and less money. This means large outsourcing-ready firms will not be as likely to participate in the company's outsourcing efforts. Smaller firms may need to be found.
- Multisourcing, even more than outsourcing, needs talented project managers. Having skilled people on both sides is necessary, especially because of the coordination difficulties in multisourcing. Managers with the ability to field complaints, solve problems, and handle multiple communication efforts are necessary.
- Costs can come with multisourcing, Although savings is a primary objective when outsourcing, costs can creep up in other areas. The talented managers, large-scale communication efforts, multiple vendors, and multi-level training programs will all eat away at the savings outsourcing gives. Companies should carefully consider how much they will really save—and spend—on multisourcing.
BACKSOURCING AND CONTRACTS
When considering a move toward outsourcing business processes, a company should attempt to protect themselves against the possibility of backsourcing. Backsourcing occurs when a company, disappointed by the results from their provider firm, brings their processes back to the original organization and breaks off their partnership with the providing firm. A final act, backsourcing should be carried out only as a last resort, the end to a failed relationship. This is also known as insourcing, although insourcing typically refers to bringing processes closer to a company for a multitude of reasons, not only negative results.
Business author Addleshaw Goddard has devised a list of suggestions for companies who are considering back-sourcing, whether before or after their original outsourcing decision. This comprehensive list includes many of the key backsourcing issues, which should be mentioned:
- Companies should do what they can with their existing contract with the provider when deciding to backsource. Backsourcing requires paying very careful attention to the original contract and often creating a new agreement to help the process.
- Companies should take care of their own employees. Often organizations will find it necessary to send their employees to be a part of the outsourcing endeavor, for training and knowledge purposes. When backsourcing, companies should ensure they have provided for these employees prior to attempting the backsource. Will the employees still have jobs at their organization? Will they have the same jobs they had prior to outsourcing?
- In the time between outsourcing and backsourcing, the company may have lost the ability to perform the outsourced tasks, especially if they were complex. Companies should be sure they can still perform the necessary processes if they decide to backsource. Losing capability can severely cripple an organization's flexibility when dealing with negative outsourcing.
- When first creating the outsourcing contract, companies should be careful to include provisions in case of backsourcing. Flexibility is very important. Legally, companies need to have enough room to maneuver to a different provider or reassimilate processes in case of failure.
- Reviews help companies judge the performance of their outsourcing providers. Regular reviews should be conducted to ensure the provider is fulfilling the contract and producing satisfactory results. Many companies tie semi-annual reviews into the contract, so they can use the reviews as a basis for backsourcing if necessary.
- Companies may wish to hire third-party reviewers, to analyze the provider and their overall competence.
There are other types of measurement that companies can use to analyze their providers in an outsourcing relationship. Benchmarking measurements, which look at price and quality, can also judge the performance of out-source firms. Other company measurements can be applied to the outsourcing endeavor as well.
Outsourcing and offshoring have caused considerable controversy in the United States, as the country has lost jobs to foreign nations. Forrester Research predicts that 3.3 million white-collar jobs and $136 billion in wages will shift from the United States to lower-wage countries by the year 2015. Despite possible backlash, some feel that outsourcing and offshoring are beneficial to the United States. Nineteenth-century economist David Ricardo proposed that the nation losing jobs will eventually recover its economic loss by developing worldwide markets for its products and services. Outsourcing can also enable firms to spend more time and resources on their core competencies, leading to more innovative goods and services to be sold globally.
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