Defining Outsourcing and Describing the Different Forms of Outsourcing - Essay Example

?Table of Contents Table of Contents 1.0.Background 2 2.0.Definition of outsourcing 3 3.0.Types of outsourcing 3 3 Think 180 outsourcing ification 4 3.2.Currie and Willcocks classification 5 3.3.Common classification 6 4.0.Reasons for outsourcing 7 4.1.The strategic reasons 7 4.2.The tactical reasons 9 V.0.Selecting what to outsource 9 6.0.Benefits of outsourcing 11 6.1.Benefits of outsourcing to companies 11 6.2.Benefits of outsourcing to America 13 7.0.Disadvantages of outsourcing 15 7.1.Disadvantages to companies 15 VII.2.Disadvantages to America 17 8.0.Conclusion 18 Works Cited 19 1.0. Background The world has become flat. An individual in any part of the world has access to all the tools, the information and the software necessary to apply knowledge whichever way they want. This flattening of the world has not only been beneficial to individuals but also to corporations. Companies today are neither restricted to the exploitations of only local resources, they can source for resources across borders nor are the resources sourced abroad as expensive as they used to be. This ability has been the keystone for outsourcing. The question here is how did the world get to be this way? Friedman (2) advances that the world became flat in three major phases: Globalization 1.0, Globalization 2.0 and Globalization 3.0. Globalization 1.0, from 1492 to 1800, was led by countries seeking resources and imperial conquest. The second phase between 1800 and 2000 was led by companies in search of bigger markets and labor was Globalization 2.0. And ultimately, the period that we are currently in, Globalization 3.0 is spearheaded by individuals and/or small groups globalizing. Globalization 3.0 therefore means that anyone who is smart enough can innovate wherever she is without the need to emigrate to the West – United States or Western Europe. The challenge though is that in these times, Globalization 3.0 times, when access to information and resources has become easier companies face stiffer competition. Organizations have no option but to seek ways to tap into the benefits they can obtain from these smart individuals or groups of individuals to improve their value propositions, efficiency and/or create new competitive advantages. That is why companies must think critically over the question on whether to outsource or not and what to outsource. This paper shall begin by defining outsourcing and then describing the different forms of outsourcing. Next it shall outline why organizations opt to outsource and how they select what to or not to outsource. The paper shall then dwell on the advantages and disadvantages of outsourcing from two perspectives: from the point of view of a company and from the point of view of our country, the United States of America. 2.0. Definition of outsourcing Outsourcing has been defined differently by different authors. Overby (1) defines it as the farming out of services to a third party and Lee (323) as the process of turning over part or all of an organization’s functions to external service provider(s). Everett (1) defines outsourcing is a leveraged business model that allows flexible use of the most appropriate resources for a particular project whereas Strassman (51) views it from a completely different angle and defines outsourcing as the distribution of labor and knowledge through specialization. Nevertheless, all these authors concur that outsourcing is deployed for purpose of gaining economic, technological and strategic benefits. Often, people confuse outsourcing with offshoring, which should not be the case. Offshoring, as we shall see in the other sections of this paper is a subset of outsourcing. 3.0. Types of outsourcing There are several types of outsourcing depending on the classification system used. Knowing the classification system and type of outsourcing vendor aides the organization in devising rules of engagement, deliverables and service level agreements. 3.1. Think 180 outsourcing classification The first form of classification system that we shall look at has been developed by a firm called Think180. This classification system uses two key differentiators: integration with business and recipients of service. The former looks at the level to which the outsourced function is integrated with company operations, and whether the vendor participates in the meetings and decisions of the business while the latter looks at the entity that receives the results of the outsourced function. This classification system categorizes outsourcing into four types: team partner, delivery partner, delivery vendor and facility vendor. This is depicted below: Figure 1: Think 180 outsourcing classification (Everett 3) Team partner is the most integrated with company functions and take part in company decision-making e.g. TQM business consultants. Facility vendor is the least integrated with company functions and their value is generally to reduce overheads e.g. an external web hosting company. A delivery partner augments internal capabilities, takes part in internal decision making but its output is delivered to external customers, suppliers and so on e.g. product sales trainer. Finally, the delivery vendor leverages other vendor operations for the company e.g. first level call center. 3.2. Currie and Willcocks classification The other classification system proposed by Currie and Willcocks (122) also depends on two differentiators: the duration of contract and the level of risk shared. There are four categories that result from this: selective outsourcing, total outsourcing, insourcing and joint venture/strategic alliance sourcing. Currie and Willcocks referred to provision of IT services in explaining each of these categories. This paper follows a similar approach. Total outsourcing refers to where the company outsources its entire IT service while selective outsourcing refers to where it outsources a portion of the IT services and uses its internal IT division to supply the remaining portion. Selective outsourcing has two major advantages. First, it reduces risk by reducing dependence on the vendor and then it gives the company flexibility to use multiple vendors. On the other hand, total outsourcing has three major advantages. To begin with the vendor is charged with buying assets thus client benefits from cash generation. Secondly, client is faced with lower vendor management costs because she deals with a single vendor. Thirdly, due to the large size of the contract client benefits from larger economies of scale. The challenge though is that the success of these contracts is largely dependent on having long and intimate partnership with the vendor (Currie and Willcocks 126). Insourcing refers to when the company opts to retaining an in-house service section and insource technical capability in order to reduce risks and interdependency between it and the outsourcing vendor. Some of the reasons for this strategy are vendors’ failure to meet business objectives and /or consistent poor service, and client’s desire to have greater control over the future direction of its IT/outsourced function(s) (Overby, “Goodbye Outsourcing, Hello Insourcing: A Trend Rises” Para 4). Strategic alliances sourcing can be described as cooperative efforts in which two or more separate organizations, while maintaining their own corporate identities, join forces to share reciprocal inputs. The underlying principle here is that of mutual sharing of risks and rewards. The company may opt to implement this strategy with either an existing supplier or form it with a new supplier to whom it can outsource. Strategic alliances give the client company access to those managerial and technical skills that it lacks in-house but that the vendor has, as well as to influence the strategy and planning processes of the supplier (Currie and Willcocks 124). 3.3. Common classification The third classification system that we shall look at in this paper is that which we shall refer to as the “commonly-used” outsourcing classification system. This classification is based on the type of service that is being outsourced and it has three variants: technology services outsourcing, business process outsourcing and knowledge process outsourcing. Technological innovations are causing disruptive change in most industries. The rapid change in technological landscape makes it difficult for most companies to keep up. However, the need to keep up is even greater considering that these new technologies could be game changers for the industry. Investing on a whole new set of human capital and resources to monitor these technologies is not only an onerous task but is also costly for most organizations. It is therefore much easier to outsource these services from a third-party firm that has specialized on this field. This is what is referred to as technology services outsourcing. Business process outsourcing (BPO) is the most popular form of outsourcing. It involves outsourcing non-core functions such as human relations, public relations, accounting and so on to a third-party company. BPO has been the face of outsourcing since 1995, at the advent of the Internet boom. BPO can be further subcategorized into two: front office processes such as customer relationship management and back office processes such as payroll and order fulfillment services. Knowledge process outsourcing (KPO) is the most sophisticated of these three levels of outsourcing. KPO involve high level activities such as advanced research, technical and decision-making skills (Overby, “Outsourcing Definition and Solutions” 2). 4.0. Reasons for outsourcing Organizations outsource for several reasons that could be categorized into two: strategic reasons or tactical reasons. Below we shall give a list of the top five strategic reasons and similarly the top five tactical reasons. 4.1. The strategic reasons I. To support the company’s reengineering efforts. The world is increasingly being driven by customers, competition and change. These three challenges have necessitated companies to fundamental rethink and radically redesign their business processes to achieve dramatic improvements in the critical, contemporary measures of performance such as cost, quality, service and speed – a process referred to as business process reengineering (Muthu, Whitman, and Cheraghi). Outsourcing presents an organization with an avenue to immediately realize the anticipated benefits of reengineering by having an outside organization –one that is already reengineered to world-class standards perform those tasks that it can do more effectively than the client company. II. Gain access to world-class capabilities. Organizations that specialize in outsourcing invest heavily to ensure that they have top-of-the-class technologies, infrastructure, and human resources and so on. The client company can access these resources at a lower cost from the outsourcing vendor. III. Increase focus on core activities. Many businesses spend huge amounts of their resources on accomplishing non-core activities. With outsourcing the business can focus on developing its core competencies while being assured that the non-core work will be accomplished to a high standard by qualified vendors. IV. Redirect resources to more strategic activities. Since outsourcing enables the organization to “save” on resources from non-core activities, the organization will now have more resources to deploy to other previously under-resourced strategic activities. V. Share risk. Due to the rapidly changing technological environment, investing in resources such as IT has become high. By outsourcing IT activities, a company increases its dynamism towards today’s rapidly changing opportunities. 4.2. The tactical reasons I. To control operating costs. The most cited tactical reason for outsourcing is to control / lower operating costs. Access to a vendor’s lower cost structure is one of the most compelling short-term benefits of outsourcing. II. Increase availability of capital funds. Outsourcing non-core activities removes the need to make capital investments in these non-core activities. This naturally translates to having more capital funds available for core activities. III. To secure resources not available internally especially over the short-term. Companies that are trying out new markets or product offerings may not need to make huge investments over untested waters. Outsourcing enables firms to acquire the lacking resources over the short term to test the market before the firm finds the need to fully invest. IV. One time applications. Instances may arise when a business needs to make a one-time huge investment because of reasons beyond its control. Outsourcing offers firms a means to meet this one time need without the need to permanently make an investment. V. Generate a cash infusion. In some cases, when a company is outsourcing it may agree to sell some of its previously owned resources to the vendor as part of the outsourcing agreement. Sale of these assets result in cash infusion for the client company, V.0. Selecting what to outsource Following from the above and many other reasons why firms seek to outsource it is not surprising that companies today are endeavoring to extensively outsource. The convergence of globalization, the Internet and core competence philosophy have aggravated this push by businesses to big but lean. In fact, it is difficult for us to fathom the relevance, strategic or commercial, of the pre-2000 high levels of integration encouraged in businesses. The success of mega-corporations through extensive outsourcing e.g. Dell, make it difficult for businesses to select what to outsource and what not to outsource. However, the question of what to outsource remains critical regardless of whether the outsourced function is the most menial and non-core task. The fact is that it still constitutes part of the organization and an organization is only as strong as its weakest link. The following five areas are a good place for organizations to start from when deciding what to outsource. I. Core competencies. Prahalad and Hamel (5) warn companies not to be carried away by their business units or core products, but instead seek to understand their core competencies. The company needs to identify which process are core to its success now and in the future. These competencies are not static but change over time as the company’s competitive position and value propositions change. If a process is outside of the core list, outsourcing may be looked at as an option. II. Financial implications. One of the key drivers for outsourcing is to control or lower cost. The organization must be fully aware of the implications of outsourcing on its cash analysis. III. Expertise. The company must evaluate the capability and financial stability of the outsourcing company (Nygaard Para 6). This is looked at with the aim of leveraging the vendor’s expertise to increase the client company’s customer value proposition. IV. Teamwork and complexity. The impacts of outsourcing on the effectiveness of the team as well as the level of complexity that shall be introduced into the supply chain are factors for the organization to think about as well (Nygaard 7). If outsourcing makes decision-making an unnecessarily lengthy process then it needs to be relooked at to affirm whether it is worth pursuing or not. V. Space. For businesses that are contemplating expansion either locally or to new markets/ regions this decision requires additional capital. Rather than using their cash up-front to expand these companies may opt to outsource instead and utilize the vendor’s resources while they assess the new market/region. 6.0. Benefits of outsourcing 6.1. Benefits of outsourcing to companies I. Focus on core activities. As companies grow so too do their non-core, back office activities. Often this simultaneous growth of non-core activities demands a considerable share of company resources (staff, finances and infrastructure). However, the more successful an organization is, the more it needs to invest in its core competencies to sustain its competitive advantages. Outsourcing enables firms to invest more on the core activities that made them successful in the first place while non-core activities are taken care of by vendors with expertise in those particular activities. II. Controlling or lowering costs. Depending on the scope of one’s business, sometimes it may not make economic sense to say have a fulltime dedicated IT department in for example a clothing retail shop because the personnel may to as fully engaged as they should be. Having such a department, key as it may be, may unnecessarily increase the costs of the company. In instances such as this it is better to outsource the service so that the company adopts a pay-per-use model while it is guaranteed of quality service. III. Better operational control. As businesses grow so too do the need for better control of the increased human resource, client base, production plant, order processing and so on. Often, depending on the nature and scope of the business, it lacks capacity to adequately handle particular functions. It is better for the organization to seek firms that have expertise and better management capabilities in those particular functions so as to bring them under control. IV. Internal staff development. Some projects that are outsourced need to be done on-site for example a company-wide IT infrastructure upgrade. During such projects the company’s internal staff gets the opportunity to work with the vendor experts. At the end of the project, the company’s staff ends up undergoing on-the-job skills upgrade or training. This indirectly builds the company’s internal capacity. V. Access to superior services. Smart use of offshoring can better the performance of even established corporations (Engardio, Arndt, and Foust Para 19). Some functions such as marketing and consumer analytics have become highly specialized to the extent that there are companies that can guarantee better service than the in-house departments. In such cases it is better and cheaper in the long run to hire an in-house director to manage / co-ordinate with the specialist outsourced firm than to seek to raise an internal department to that level of expertise. VI. Staffing flexibility. Outsourcing offers a workable solution to organizations that experience cyclical demands in particular operations. With outsourcing the firm is flexible to hire additional staff when the business-cycle peaks and to release them when the business-cycle dips. 6.2. Benefits of outsourcing to America When one hears the word outsourcing in the United States, the picture that comes to an American is shipping of US white-collar jobs off to low-wage developing countries. However several authors such as Wadhwa; Berke; Engardio, Arndt, and Foust argue that this may not be the case. They give evidence of outsourcing being beneficial to the American economy as well. Some of the benefits of outsourcing to America are discussed below. I. Online contracting. Whereas most Americans focus on the jobs offshore-outsourced by the big companies they forget than small businesses also outsource. Small companies lack the resources to hire full-time professionals and in the U.S. they have heavily exploited online contracting to meet their business needs. America has a very vibrant online freelance market where small businesses are able to obtain quality services from fellow American professionals at reasonable cost (Wadhwa Para 5). II. Need to locate production near consumption. America is one of the world’s largest consumer markets therefore it remains attractive for most global companies. the rising wage demands in India, and slowly China, in addition to the huge logistics and transportation costs is making more companies to begin considering locating their production plants near their huge markets – which includes America. In addition to locating production near consumption, foreign companies are attracted to the U.S. by other attributes of the American economy such as U.S. management style and technique, U.S. branding, or U.S. design knowledge (Berke Para 13). III. Increased scope to invest in new technologies and business opportunities. Farrell and Rosenfeld (8) state that for every dollar of cost that U.S. companies offshore-outsource, on average they save 0.58 cents. When such savings accrue from the volume of trade, U.S. companies are able to have more cash to invest in new technologies and business opportunities both at home and abroad. This results in more jobs, both at home and abroad, higher dividends to American shareholders and low prices with better quality for U.S. consumers. IV. Improved competitiveness. Outsourcing enables American companies to enhance their competitiveness by taking of distinctive skills regardless of which part of the world they are located. In this era of global competition, companies cannot pass up on any opportunities that promise to increase their competitiveness (Farrell and Rosenfeld 9). V. Increased market for transformational outsourcing. America has several companies that have specialized in transforming businesses from human resources, finance, or information technology departments. Corporations such as IBM services, Genpact and Accenture are big outsourcing specialists that can help an organisation redesigns all its processes, build new IT platforms and so on. They also have a global network of staff from the U.S. to Eastern Europe, to Asia who are familiar with the cultural contexts of global businesses (Engardio, Arndt, and Foust 9). 7.0. Disadvantages of outsourcing 7.1. Disadvantages to companies I. High security risks. Information is crucial for the success of any business. Naturally, this implies that each business has its own category of sensitive, private and/or secret information. Outsourcing exposes the company information to employees other than its own. This exposure obviously heightens information security and confidentiality risk. To minimize security risk exposure the company will need to perform two critical activities. Firstly, do a thorough vetting of the outsourcing company. Look at its past performance records, probably looking at records for the staff who will be seconded to your organization may also be prudent depending on the nature of the business. Secondly, include a penalty clause in the outsourcing contract to safeguard the company if an incident occurs. II. Loss of critical skills and competencies. When a service is outsourced, the customer loses his understanding of the service over time. In the duration of the outsourcing period, the vendor may continue to provide the company with superior services however, a large part of this new knowledge remains with the vendor and is not transferred to the client company. Worst case scenario is that, the client could remain aloof of technological breakthroughs in the outsourced function. To mitigate this company has to retain certain know-how and internal capacities in both technical and managerial areas so as to be able to handle the outsourcing relationship properly (Willcocks and Lacity 177). III. Likelihood of quality challenges. Like any other organization the vendor is keen on making a profit. The vendor will therefore only be willing to offer service up to the letter of contract and nothing more. This means that should there be changes in the market that demand rapid response in the outsourced function, the vendor will slow down the client’s response unless client amends the contract. IV. Inability to adapt to new technologies. On paper many companies decide to outsource on the premise that they shall enjoy the best in technology from the vendor without the lead time that is customary for setting up the infrastructure in-house. In practice, though, if vendors do not find benefits in the adoption of new technologies, they could become reluctant to adopt them, in an attempt to make the service they offer as profitable as possible. To tackle this challenge, the client company should include a clause in the outsourcing contract that will direct the vendor to apply new technologies in the case there is technological evolution in future. V. Hidden costs. Barthelemy (61–66) summarised the hidden costs of outsourcing into four major areas. First of all, many an enterprise underestimates the expense associated with identifying and evaluating suitable vendors, selecting a finalist, and negotiating as well as drafting the contract. Secondly, it can take months before the vendor knows as much as the in-house department to proceed. Thirdly, there are costs related to vendor management such as monitoring whether the contractual obligations are adhered to, negotiating any contract changes required and so on. Fourthly, after the outsourcing period is over, the company incurs transition costs to resume its activities internally. VI. Loss of managerial controls. Outsourcing a function to a third-party essentially implies signing over management control and decision making for that function to the third-party. Given that the third-party is driven by different mission and objective from the client company, conflicts may arise. Unfortunately, the contract signed by client and vendor only covers the service level agreement and not management decisions. VII. Tied to financial well-being of vendor. When a company outsources it becomes dependent on the vendor to deliver on the outsourced function. This means that it is in the best interest of the client to see that the vendor is financially stable. If vendor for some reason goes bankrupt, the client will be in trouble. The likelihood of this to occur can be minimized through conducting a thorough vetting of potential vendors, their financial strength and how critical the function that they will be doing is to the client. VII.2. Disadvantages to America Outsourcing increases the threat by the emerging economies especially China to America’s competitiveness. This can be looked at in two ways. I. Friedman points out that misnomer that many Americans have been led to or lead themselves to believe that China, India, et al are racing them to the bottom whereas in actual sense they are racing the US to the top. These emerging economic powers have rich educational heritages, an ambitious youth and access to work experience from leading corporations that have outsourced to their countries. They also have access to a wide range of information over the Internet. Friedman (7) goes on to affirm that whereas American multinationals previously outsourced and offshored to minimize cost, they are now doing so because they are unable to find the talent they need locally so they source it abroad. II. Outsourcing has the potential to atrophy a company’s competitive advantage as it focuses less on development of competencies that it considers non-core now but that could be game-changers in future. Prahalad and Hamel (8) stated that outsourcing could provide a shortcut to a more competitive product but that it typically contributed little to build the people embodied skills that are needed to sustain product leadership especially for organizations that intend to remain competitive in the future. Nobel Laureate Paul Samuelson supported this argument when he stated that in certain circumstances practices that promote free trade such as offshore-outsourcing could erode the comparative advantages of rich countries and leave them worse off (Farrell and Rosenfeld 3). 8.0. Conclusion Americans do not need to be afraid of outsourcing. As described here it has got more benefits than detriments to not only the businesses but also to the country. The much touted job losses especially due to offshore-outsourcing has been refuted by several studies including (Engardio, Arndt, and Foust; Kirkegaard; Farrell and Rosenfeld). However, that is not to say that outsourcing does not have its downsides. From this discussion we have seen what organizations need to look out for when outsourcing and also how to minimize the disadvantages of outsourcing. The critical element in minimizing organizations from failing because of outsourcing lies in vendor vetting whereas the key element in minimizing the negative impact of outsourcing to the American economy is to utilize the savings accruing from outsourcing researching new technologies and creating more business opportunities both at home and abroad. Works Cited Barthelemy, Jerome. “The Hidden Cost of IT Outsourcing.” MIT Sloan Management Review 42.3 (2001): 60-69. Print. Berke, Jonathan. “Outsourcing--To America.” Forbes.com. 29 May 2008. Web. 6 Dec. 2011. Currie, W. L, and L. P Willcocks. “Analysing Four Types of IT Sourcing Decisions in the Context of Scale, Client/Supplier Interdependency and Risk Mitigation.” Information Systems Journal 8.2 (1998): 119 - 143. Print. Engardio, Pete, Michael Arndt, and Dean Foust. “The Future of Outsourcing.” Bloomberg Businessweek. 30 Jan. 2006. Web. 6 Dec. 2011. Everett, Jim. “Managing External Resources – Forms of Outsourcing.” May 1999. 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