What is Outsourcing?
Outsourcing is a practice through which the execution of a particular service or the actual manufacturing or assembly of a certain product is entrusted to third party entities like contractual vendors and agencies. One can choose to outsource part of or the entire business to third party vendors. Generally, businesses keep a tight core team while outsourcing all or most of the other functions to third party vendors.
Why do businesses outsource?
Businesses are driven by several motivations and compulsions towards outsourcing. I have listed some of them below.
- Absence of in-house resources- Businesses often outsource projects due to the lack of proper talent in-house. For instance, an automobile manufacturing company wants a new website for its new range of products. It might so happen that the company might not have the requisite talent on its payroll to carry out the task, nor does it have the requisite confidence to hire the in-house talent required, due to the current team’s lack of knowledge of the specific domain. Hence, it is safer and easier to simply outsource the task to an expert. Advertising agencies are one of the earlier examples of outsourcing.
- Limited scope of work or tenure- This is to date the most common form of outsourcing. Often a company needs a certain project to be executed, for which hiring someone or a team fulltime in-house cannot be justified. In such a scenario, the company can look to outsource to either freelancers of vendors. For example, if the same automobile company we talked about is bringing out a limited edition car to celebrate its 25th anniversary, then would it create a whole new assembly line for those cars and hire workers to operate it? Of course not! That’s just a criminal waste of resources. So the company can seek out a vendor who will take on the project and deliver the order as per schedule.
- Absence of a good talent pool locally– Sometimes, your geographical location can be a hindrance to hiring good talent. This is especially true for smaller businesses located in the hinterlands, away from major population centers. At that point, the choice is between hiring someone who is less qualified or outsourcing it to an expert. It’s really a no-brainer. Of course not all jobs or functions can be outsourced. But those which can be are.
- Cost reduction- Rapid globalization has allowed the world to work together more closely. Businesses have accordingly sought to profit from this and sought vendors from developing economies to bring down costs significantly. A prime example of this has been the proliferation of manufacturing freelancers in China who produce everything from cars to mobile phones to pen drives.
- Scaling up operations rapidly– This is true mostly for services. Businesses which offer different services as their primary product need to be versatile and flexible, since they cater to a wide array of clients. For companies in this sector, it is almost impossible to maintain a steady workforce. Sudden demand of increase in resources cannot be met in developed economies since the talent market is largely saturated and good talent comes at a premium. In such a scenario, businesses look towards business outsourcing in India to quickly scale up their operations. Like China, India has made a name for itself, albeit in outsourcing services. Several vendors exist in India who already have highly qualified professionals on payroll who can immediately step in to execute the client’s project. Rapid and immediate hiring is also much easier in India since there is a bigger talent pool and lesser number of available current jobs.
- Employee lawsuits- Employee lawsuits are a major issue in certain developed economies. While employment laws are in place to safeguard the rights of workers, lawsuits are also misused quite frequently. Companies also like to have the option to scale down in answer to market realities in order to survive. Since outsourcing is more like a pay as you go service, with term contracts and safeguards in place to protect the clients, many businesses look to outsource to save them unnecessary legal hassles.
Outsourcing and Offshoring- Meaning and Differences
Outsourcing is often used interchangeably with offshoring. Broad realities support the usage. However, there are a few crucial differences.
- Outsourcing is the broad, all-encompassing term for contracting out manufacturing and services to third party vendors. This also includes outsourcing to offshore entities (offshore outsourcing) in places like China and India. Offshoring on the other hand does not mean offshore outsourcing only. Many companies have setup wholly owned subsidiaries in foreign countries and shifted part or a majority of their operations to these centers. This isn’t outsourcing, since no third party vendors are involved. It is simply the concerned business opening up an alternative center. A good example of this can be seen in Detroit itself, which famously lost a lot of jobs to offshoring. Japanese car manufacturers shifted their assembly plants from Japan to the US in the late 70’s and early 80’s due to restrictions on importing Japanese goods to the US. This practice is simply offshoring. Offshore outsourcing on the other hand is what many mobile manufacturers indulge in, contracting the work to Chinese third party manufacturers.
- Another basic difference between offshore outsourcing and simply offshoring is the presence of the concerned business in the local economy. Most offshore entities of western businesses base their centers abroad to tap into and serve those local markets as well. In a way, the business is expanding globally and offshoring is a way of getting a new market interested by bringing the product to the proverbial doorstep of potential consumers. Offshore outsourcing on the other hand is primarily concerned with reducing costs and catering to the existing talent pool. A lot of products and services that are outsourced to offshore entities are not even available in those countries.
- Last but not the least, offshoring generally means a transfer of technology, knowledge and work methodologies. Most offshore centers of American or Japanese companies are almost exact replicas of their parent centers. Employees in these offshore centers are likely to be trained by the company on its product and work culture and new technology, hitherto unavailable at the location, introduced to get the centre up and running. Offshore outsourcing has little to no transfer of technology from the client’s side. If anything, the opposite might be true, especially in terms of the knowledge flow. Again, the difference comes in the ultimate goal that a business is trying to achieve. Offshoring is an investment- long term with a business trying to provide a solution or product that did not exist in the market, while also benefiting from cheaper labor. Offshore outsourcing is more need based. The business is seeking what it does not have. That’s it. So it makes sense that whatever transfer of knowledge has to happen, will probably be in the reverse direction, especially in services. A lot of outsourcing services to India for instance are helping small and medium companies grow in several domains in markets where locally such resources are simply not available, even at a premium.
There obviously will be a few pitfalls to everything. Outsourcing is no exception. This is a topic which is raised in pretty much every political debate centering on jobs. Hence I won’t go into it much and point out three crucial pitfalls which one should guard against as a businessman or woman.
- Less control over project or product.
- Possibility of subcontracting and hence inferior quality
- Loss of support for a product amongst the local audiences who might be against the idea of offshore outsourcing.
To sum it up:
Outsourcing is a great tool and a great leveler in business. It allows smaller fish to thrive in the same waters as the big sharks. However, it is great as long as it is being used adroitly. It is strictly a means to an end. The moment the means become the end, you are in trouble.