The Risks Associated with Outsourcing - Essay Example

The Risks Associated with Outsourcing Introduction – what is outsourcing Internationalization, globalization, corporate restructuring, changing market trends, layoffs and downsizing have led to fundamental changes at the work place. This has given rise to the concept of outsourcing. Outsourcing refers to relocation of jobs and services irrespective of the provider’s location and happens when a firm contracts a business function with an outside supplier (Sourirajan, 2004). The term ‘offshoring’ refers to relocation of jobs and production to a foreign country (Garner, 2004) while Olsen (2006) looks at it as contracting out business activities to foreign providers. Offshoring refers to the location of the work while outsourcing refers to who does the work. A company may offshore without outsourcing if the jobs are relocated to its captive unit or its own office in another country (Scott, Ticoll & Murti, 2005). Thus, in general terms outsourcing refers to a buyer contracting with an outside supplier for services. Various factors are responsible for this but both the buyer and the supplier are subject to risks in different fields. Risks Risks faced by client organization Outsourcing as a cost effective strategy has shown positive results but significant risks have to be recognized and managed. Since the company relies on some other company for its functions, they have to be managed properly otherwise it could adversely affect the customers and their operations (O’Keeffe & Vanlandingham, n.d.). As far as the buyer is concerned, delays by the supplier can affect customer satisfaction and performance level. In production units, this would mean maintaining higher levels of stocks to mitigate risks but then this involves higher working capital to be blocked. Secondly, the product or service quality may suffer in outsourcing. Hence it is important that the partners or the suppliers have to be assessed carefully before finalizing the deal. If the supplier does not have the capacity to carry out the work, or have the financial stability to service the contract, it poses a risk for the buyer (McKenna & Price, 2007) Suppliers may not be financially viable thus exposing the buyer to supply interruption risk. Loh and Venkatraman (1995) emphasize that the control issue is the major inhibitor. Firms are reluctant in shifting the locus of competencies towards the external suppliers. This would means that the decisions rights over the assets are vested in the vendors that might not share the same goals and objectives as the client organization. Loss in control can lead to lack of autonomy in decision-making, resource usage, or even security of information assets. Another risk that the client organization faces is the possibility of deliberate opportunistic behavior by the vendors. The supplier is likely to indulge in self-serving behavior before and after the contract (Loh & Venkatraman). The client organization also faces the risk of losing staff with critical business skills as Dow Chemicals. They used an innovative approach to create new outsourcing capabilities but in the process had difficulty in retaining skilled people to manage increasingly bigger and more complex IT-enabled business change projects and to implement systems integral to business performance (DiRomualdo & Gurbaxani, n.d.). Risks to both buyer and vendor The buyers normally have to transfer technical know how in outsourcing. The effectiveness of the knowledge transfer process is one of the critical success factors in the success of the outsourcing venture. Here the risks lie on both sides. The buyers may not share the complete knowledge with the suppliers which leaves a gap and which ultimately affects the final quality of work. On the buyer’s side, giving away total knowledge means transfer of intellectual property over which they are relinquishing their rights. The buyer’s have no control in the event the suppliers make use of this proprietary knowledge elsewhere. Business continuity risks may arise due to security breaches. There have been reports of unauthorized use of computer systems, leading to direct financial loss due to security breaches (Venkateswar, 2005). At the suppliers’ end viruses and worm attacks may cost the buyers heavily in terms of financial and reputation loss. There has also been increase in digital risk activity. Network security breach like data theft can take place which means unauthorized use of sensitive data. Risks faced by the supplier Risks to the supplier may arise are when the expectation are not clearly laid down by the buyer in the agreement. Secondly, even if the conditions are clearly laid down, over a period of time the business environment or the needs of the buyer may change which radically affects his interest (Goolsby & Whitlow (2004). Lack of communication may affect the buyer-supplier relationship. The scope of the contract, costs and service levels involved have to be accurately identified. Risks posed by the macro-environment The macro economic environment also poses risks to both parties. Changes in government policies, business environment and foreign exchange regulations could affect the contract adversely. Pricing in technology services is a critical issue and carries risks due to changes and fluctuations in foreign exchange market. The pricing schedule for vendors is usually specified in advance for the duration of the contract or negotiated each year (DiRomualdo & Gurbaxani, n.d.). Business conditions keep changing, technological advancements are ongoing, and hence pre-determining pricing may turn out to be detrimental to the interests of both parties. The vendors may lose in the contract as the Indian software vendors are currently facing due to the Indian rupee becoming stronger against the US dollars. At the same time, the clients may also be losers if the prices of services fall over a period of time. Hence the client must follow a highly competitive vendor selection process. Conclusion Thus, even though the benefits in outsourcing offer temptations to the client organization, the risks too have to be considered before signing the contract. Both parties face risk although the client organization is more at risk than the vendor. The skills and competencies of the vendor are critical in the success of the alliance. The client has to transfer not just the technical know-how to the supplier but also communicate the larger goals and objectives so that the vendor’s approach is in alignment with the company objectives. In fact, unless both the parties work in unison, risks would be on both sides. (Total word count – 1038). Reference: DiRomualdo, A., & Gurbaxani, V., (n.d.). Strategic Intent for IT Outsourcing, 10 Feb 2008 Garner, C. A., (2004), Offshoring in the service sector: Economic Impact and Policy Issues, 10 Feb 2008 Goolsby, K., & Whitlow, F. K., (2004), What Causes Outsourcing Failures? 31 Jan 2008 Loh, L., & Venkatraman, N., (1995), AN EMPIRICAL STUDY OF INFORMATION TECHNOLOGY OUTSOURCING: BENEFITS, RISKS, AND PERFORMANCE IMPLICATIONS, 10 Feb 2008 McKenna, S., & Price, R., (2007), Is outsourcing too risky? 31 Jan 2008 O’Keeffe, P., & Vanlandingham, S., (n.d.), MANAGING THE RISKS OF OUTSOURCING:A SURVEY OF CURRENT PRACTICES AND THEIR EFFECTIVENESS, 31 Jan 2008 Olsen, K. B., (2006), Productivity Impacts of Offshoring and Outsourcing: A Review, OECD Directorate for Science, Technology and Industry (STI), 10 Feb 2008 Scott, R., Ticol, D., & Murti, M., (2006), A Fine Balance, The Buying and Selling of Canada, PricewaterhouseCoopers, 10 Feb 2008 Sourirajan, S., (2004), GLOBALIZATION and OFFSHORE OUTSOURCING A Tale of Two Realities, Venkateswar, N. J., (2005), Mitigating Operational Risk in Outsourcing, 31 Jan 2008 Read More