Outsourcing with Pros and Cons - Research Paper Example

?Running Head: Outsourcing with Pros and Cons Outsourcing with Pros and Cons Table of Contents Executive Summary Outsourcing is acontractual relationship in which an organization hires a third party, usually an external vendor or contractor, to perform and manage one or more internal functions previously done in-house in order to maximize service, optimize expertise, minimize cost and maintain, if not improve, quality (Blouin and Brent 1999, 18). Outsourcing has become one of the most important management activities in recent years (Bromage, 2000). Due to changing business environments organization needs to adopt measures to lead to better quality of services and greater flexibility in management. There are several reasons why many firms utilize outsourcing of their services, such as enhanced efficiency, cost reductions, increased flexibility and focus on core competencies. Outsourcing offers many benefits, although clearly with many caveats. The loss of skilled, expert staff is expected with outsourcing. Other risks involved with outsourcing include: loss of innovation, creativity, and flexibility and loss of control, continuity, and cooperation. However, these risk associated with outsourcing can be controlled and minimized if executed effectively. The immediate challenge facing organizations is how to make an informed offshore outsourcing decision that maximizes the benefits while minimizing the risks. An effective way to achieve the goal is to inquire how decision-makers comprehend and evaluate the factors affecting their offshore outsourcing decision. Abstract Outsourcing allows organization to reduce cost and concentrate on its core competences and to improve its activities. Although, outsourcing is an attractive strategy bounded by appealing benefits but it also contains some significant risks. However, these risk associated with outsourcing can be controlled and minimized if executed effectively. The immediate challenge facing organizations is how to make an informed offshore outsourcing decision that maximizes the benefits while minimizing the risks. An effective way to achieve the goal is to inquire how decision-makers comprehend and evaluate the factors affecting their offshore outsourcing decision. Outsourcing with Pros and Cons Introduction Outsourcing has become one of the most important management activities in recent years (Bromage, 2000). To outsource or not to outsource is one of the questions managers are increasingly asking themselves (Gunn, 2003). It is necessary to examine the degree of outsourcing and its pros and cons. The author posits that outsourcing is very beneficial to the growth of a company as it allows organization to reduce cost and to concentrate on its core competences and improve its activities. Outsourcing Outsourcing, as it applies to manufactured goods, is the practice of moving production to an outside supplier. Companies send this work to other domestic facilities or offshore. The outsourced activities can be thought of as new intermediate inputs or completed imports, shifting the entire production function done at home (Robert and Gordon, 1999). The outsourcing firm can then experience a reduction in the amount of labor required to continue operation. Outsourcing is a practice being used increasingly by organizations in order to combat the competitive forces within the global manufacturing sector. According to Michael Corbett, Firms extensively “use outsourcing everyday to improve the products and services they provide customers…. More than 90 percent of companies state it is an important part of their overall business strategy.”(Corbett, 2004: p. 3) Pros of Outsourcing Cost Savings Cost savings is the most important and most commonly cited reason for outsourcing. According to Burmahl (2001) cost savings is among the top reason to outsource. Cost-savings calculations encompass fixed costs, which include capital and administrative overhead; variable costs, which include specific supplies, services, and labor cost for all personnel involved in the manufacture of a product or the provision of a service; and indirect costs for opportunities foregone, which occur organizational knowledgeable workers are not focused on core competencies because they are performing less productive tasks (Spitzer, 1996). Outsourcing attains cost savings in several ways. First, long-term cost savings come from reduction in operating and maintenance costs as well as avoidance of depreciation of equipment because the organization is able to take advantage of the most current technology and the latest benchmarking trends in the industry without the required up-front capital investment (Lynch, 2002). Smaller institutions that cannot afford expert full-time technicians in-house can also save money by outsourcing hospital equipment maintenance (Burmahl, 2001). Second, outsourcing reduces operating costs by converting fixed cost associated with ownership or purchase of the latest technology into variable cost, in which expenses are easier to manipulate as the business environment changes (Wiley et al., 1998). Third, cost savings results from the reduction in salary and benefits costs. Employer costs for employee compensation (salary, benefit and insurance) have increased steadily. Finally, despite the oversight of in-house costs, such as administration, safety, education and training, human resources (salaries, fringe benefits, and institutional overhead) and management costs that can reduce the full impact of outsourcing's cost-savings, studies show that overall operational costs are recovered within few years of outsourcing (Caspersen, 2000; Goolsby, 2002). Flexibility In addition to cost savings, outsourcing has become more popular because it facilitates strategic flexibility, a concept that is closely linked to cost savings but also has additional added value to the organization. Organizations cite flexibility and adaptability as their main reasons for seeking outsourcing. Outsourcing provides flexibility in several ways. First and most closely related to cost saving, outsourcing provides the flexibility to meet the unpredictable workload demands in uncertain economic environments either by reducing the number of institutional personnel, by transferring the work to the outsourcing partner, or by importing outside staff to do in-­house work (Goolsby, 2003). The organization's mandatory costs of doing business include the costs of carrying a skeletal workforce even during slow or non-productive periods. Conversely, building an in­-house work force large enough to meet peak demand often means that some personnel sit idle during slow periods and/or that the firm incurs significant hiring and firing costs as it adjusts the level of employment to increases and decreases in output demand (Lankford and Parsa, 1999; Goolsby, 2003b). Furthermore, outsourcing permits the flexibility to reduce time and monetary commitments for compliance with administrative changes and employment laws. Business experts advocate that organizations narrow their focus to three core competencies and outsource all non-core functions (Keane, Marx and Ricci, 2001; Goolsby, 2002). One characteristic shared by firms that succeed in transforming with the changing global competition is a clear focus on core competencies (Herzlinger, 1998). Many employers have followed these pundits' advice on the use of employment intermediaries and rely more on alternative staffing arrangements, employing FTE workers only when there is an immediate and direct demand for their services (Polivka 1996). Moving away from the traditional employment models towards these more complex, strategic alternatives also means that the organization must keep abreast and comply with changing federal, state and local employment regulations. In spite of the substantially higher hourly salary for outsourced labor, outsourcing generates strategic advantages by eliminating the bureaucratic costs of doing business, the headaches of compliance with employment laws, and other administrative functions that normally demand a large portion of management's time and attention (Drucker, 2002) Firms engaging in outsourcing require less internal labor management than firms that do not support the strategic flexibility of transferring the responsibility for training, hiring and firing the staff to outside vendors (Schwalb, 1997). Read (2001: p. 8) summarize the relationship among unions, culture and flexibility: Outsourcers usually have more flexibility to hire and fire staff than [institutional employers] do internally. They are not constrained by union rules and internal corporate culture misgivings about using temps and laying off people. Organizations have the option to utilize their in-house employees for core-function tasks and outsource the non-core tasks, rather than to trying to shuffle positions within the organization in order to comply with all the changes in employment codes for employees and accommodate strategic organizational changes. Refocusing on Core Competency Outsourcing increases operational efficiency by employing the best people to do the job they know most about. Outsourcing adds efficiency because a consultant is self-contained and can do the job as much as two or three times faster than if done in-house (Peach, 1997). The expertise brought in can also free the in-house staff and organizational resources to focus on core functions. Outsourcing brings in best practices, focuses on performance levels and encourages cooperation between the organizational employers and vendors, effectively aligning existing organizational processes and efficiently maximizing the available resources and skills. Specialized Expertise Specialized expertise consistently ranks as one of the top reasons why both general business utilize outsourcing (Mullin, 2002). A 2002 H&HN survey of hospital executives revealed that 64 percent identified obtaining specialized expertise as the top reason for outsourcing (Burmahl, 2001). The steep learning curve, the competition between traditional employees and outsourcing vendors to recruit the best in the business, and the rapid pace of changing technology have produced not only a shortage of knowledgeable employees but also a war on talent (Williams, 1998; Nyberg, 2002). According to Wiley & Coe (1998) outsourced expertise helps organizations to reach optimal productivity by filling hard-to-fill staff positions. The requirement for special equipment and licensing makes outsourcing an attractive alternative in areas such as landscaping, ground maintenance, hazardous waste disposal, and pest control (Burmahl, 2001). These areas demand compliance with complex regulations such as the 1976 Resource Conservation and Recovery Act, which defines hazard chemical and procedures for handling and disposal as enforced by the Environmental Protection Agency (Smith, 2001). A repeat survey in 2000 shows that the numbers remained consistently high with 78 and 80 percent of those responding reporting that they currently outsource pest control and waste disposal, respectively (Burmahl, 2001). In addition, vendors' best practices on hazardous waste disposal limit an organization's liability for properly categorizing, storing, transporting, and disposing hazardous waste (Smith, 2001). The extensive investment in both expert labor and resources makes a function ideal for outsourcing (Houlton, 2002). There are other values added to the organization from bringing in outside expertise. Some organizations are squeezed for expert personnel and decide to outsource based on a talent shortage. Other organizations have skilled staffs but would rather have them function at a higher task level or would rather off-load the hassle of bureaucratic compliance and the policing of increased infrastructure to the experts in the field (Abraham and Taylor, 1996; Cope, 2002). Experts argue that handing over complex technologies to companies with the know-how is both economical and efficient, improving organizational services by eliminating the risk and time involved in developing that knowledge in-house (Williams, 1998). Added Value to the Organization Outsourcing adds organizational value that can be less obvious and difficult to quantify, but strategically equal to or more important than cost-savings (Ahmed, 2001). Even though cost-savings is the primary driver for outsourcing, operational decisions based solely on cost rarely produce the optimal organizational value. Real value in a business outcome is achieved when a business process improvement in one area also strategically impacts the business goals in one or more other areas. Increasingly, many companies are realizing that their best strategic partner is not necessarily the one that offers them the lowest cost since the greatest value could either be from renovating an operating modality or transforming an industry's focus (Craumer, 2002). Future outsourcing trends will shift from a focus on cost savings to value creation which manifests in different modalities such as increasing overall operational efficiency, incorporating best practices, increasing ROI, and taking advantages of economy of scale and scope (Janssen, 2002; Swarts, 2002). Cons of Outsourcing Successful strategic outsourcing relationships are complex. Outsourcing offers many benefits, although clearly with many caveats. The loss of skilled, expert staff is expected with outsourcing. Although a key strategic reason for outsourcing is to reduce personnel costs many policy experts question the demoralizing effect that outsourcing arrangements can have on the remaining institutional staff (Huber 2002). Other risk involved with outsourcing include: Loss of Innovation, Creativity, and Flexibility and Loss of Control, Continuity, and Cooperation. Morale Outsourcing potentially impairs the morale of the organizational workforce because the employees who are not replaced may still experience difficulties with culture fit, job security, and degradation in their interaction with third-party vendors. Many workers who are about to be replaced have complained that the most humiliating aspect of outsourcing is being forced to provide on-the-job training for the very same people who will replace them (Bulkeley, 2004; Solomon and Kranhold, 2005). Doig et al. (2001, 26) writes “outsourcing involves massive changes to a business ... changes involving trade-offs and organizational trauma.” With outsourcing becoming more pervasive in organizational strategies, the morale of the workforce cannot be overlooked because employees who feel strong support from management are more likely to work together to achieve the organizational goals as well as to remain with the organization in times of uncertainty (Jackson et al., 1998). Loss of Control, Continuity, and Cooperation In addition to reducing staff morale, outsourcing also complicates an organization's ability to monitor cooperation, control the outsourced function, and affect continuity of service, specifically continuity of care in healthcare settings. These concerns are especially true for organizations that have adopted an outsourcing model where their entire existing assets are sold to the outsourcing provider who then improves the products or services before leasing them back to the organization. In some cases, outsourcing connotes changes in every aspect of the operations of a business-its people, processes, technologies, financial structure, and relationship with its customers, suppliers, and shareholders. Losing control in an outsourcing relationship manifests from the failure to understand the premises for seeking an outside vendor. “All too often, the outsourcing decision is made, for reasons of ideology or resource constraints without giving careful consideration to the impact of privatization on the core missions of an agency” ( Avery 2000, 330). At other times, buyers fail to reap the full benefit of the outsourcing relationship because they invest time and resources in locating the most compatible outsourcing vendor but then tend either to ignore the details or fail to compose SLAs with monetary penalties or cancellation options for the outsourcer that fails to meet promised performance objectives. Therefore, the potential loss of ownership and the limited ability to control and manage performance are serious concerns for organizations that outsource. Loss of Innovation, Creativity, and Flexibility The impediment of the capacity to innovate and the erosion of the competitive drive are always legitimate concerns in outsourcing relationships. At the beginning of the outsourcing trend, the boundaries between core and non-core functions and between in-house resources and outside providers were very distinct (Ahmed, 2001). However, rapidly changing technology, increasing competitive environments, and evolving work cultures have blurred the distinctions among these four factors. The failure to monitor the external environment constantly, to strategically adapt accordingly, and to determine whether an operation can be improved in-house before engaging in outsourcing results in the organization giving away value and outsourcing a slice of operations (Schwarzwaelder 2001,4). Some important questions that an organization must answer before outsourcing a function are: What core competencies give the organization a strategic advantage? Which services are not too critical to the core of our mission entrust to an outside vendor? Which might be outsourced? Is this a core competency that, if outsourced, could threaten the competitiveness of the business? What is the organization's mission and what does it do best? Because its strategic functions are central to an organization's strength and position in the marketplace, organizations should be very reluctant to outsource day-to-day operations to others, but should be even more concerned not to entrust proprietary information to outsiders (Ahmed 2001, 22). One analyst cautions that when organizations are not careful and selective, they “leave themselves vulnerable to a market coupe by former partners when they outsource [and fail to] ... make a distinction between 'core' and 'strategic' activities” (Craumer 2002, 5). For example, IBM mistakenly believed in the 1980s that its core competency is marketing rather than building operating systems and computer chips and outsourced the building of its computer operating system and processing chips to Microsoft and Intel, respectively. IBM's miscalculation propelled Microsoft and Intel into a more prominent companies in the computer industry and eventually led to its demise (Carey, 1995; Lankford and Parsa, 1999). An organization that outsources strategic activities and functions at the very heart of its mission may lose its competitive advantage, driving force, vision for the future, and its ability to innovate by removing the source of creative energy from the organization itself. Inflexible arrangement and the lack of creativity are common contractual or service difficulties. Commitment to an inflexible arrangement manifests whenever there is a lack of a clear understanding of what is to be gained from outsourcing and a lack of the prerequisite in-house versus outsourcing comparative analysis. Organizations that plan for the long-term benefits of outsourcing avoid conflicts over creativity and flexibility. Specifically, the long- term vision incorporates strategies “with Enterprise-level outcomes like improved ROI or greater shareholder returns ... Usually this means outsourcing with a focus on external results-like repositioning yourself in the market place or changing your value proposition to customers in some key way, versus using outsourcing to save 5 [percent] on the cost of an internal administrative process” (Craumer 2002, 4). Conclusion and Recommendation Outsourcing allows organization to reduce cost and concentrate on its core competences and to improve its activities. Although, outsourcing is an attractive strategy bounded by appealing benefits but it also contains some significant risks. The immediate challenge facing organizations is how to make an informed offshore outsourcing decision that maximizes the benefits while minimizing the risks. 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