Outsourcing, Its Importance, Pros and Cons | Free Essay Example

Outsourcing, Its Importance, Pros and Cons

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Topic: Business & Economics
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Introduction

Every business from baking to banking depends, to some degree, on others for producing its products and services. The process of acquiring products and services for running one’s business is called ‘outsourcing’ in the business world. Though, outsourcing is not a new phenomenon for the companies, but in recent years it has gained much momentum (Slack et al, 2012).

Now it is not restricted to an approach for reducing costs but has developed into a strategic management device with specific significance for businesses. Outsourcing refers to the “transfer of ownership of an organization’s business activities (processes or functions)-or the responsibility for the business outcomes flowing from these activities- to service provider” (Chamberland, 2003, Para 4).

Companies are now keen on outsourcing direct activities and indirect processes to service providers that is known as business process outsourcing (BPO). Whether it is the routine back-offices activities in the financial company or the payroll and the training and development activities in the Human Resource sector, outsourcing to expert companies is widespread in all areas (Slack et al, 2012).Until late 1990s information technology also used outsourcing to increase its operational productivities.

But the later years saw a prompt increase in business process outsourcing including fields such as manufacturing and designing etc. Now the focus is on the overall business benefits that aim at improving the company’s position in the market and also at increasing shareholder profits. In a recent IDC Canada survey, 90% of the Canadian executives alleged that they outsource in order to attain some change in business processes (Chamberland, 2003).

Normally, the facilities, technology and people are also transferred to the service provider and the service provider gives his services to the organization in turn. Organizations may outsource activities for problem solving and for strategic purposes as well. For example, if a company outsources some business process or activity to reduce the burden of its staff or to get the routine work done on time, it is a tactical arrangement.

“Tactical outsourcing arrangement can also be seen in a company that outsources its IT infrastructure in order to save operating costs” (Chamberland, 2003, para 5). A company that focuses on strategic outsourcing has different goals such as gaining competitive advantage, focusing primarily on the core activities that bring success, enhancing company’s market position and their share price escalation. Strategic outsourcing has to be flexible in its contractual form so that it is easier for the parties to realign their strategic intent for the benefit of the outsourcing organization (Chamberland, 2003).

Importance of Outsourcing to Organizations

The importance of outsourcing to organizations has been a subject of debate over the years. The emerging new phase has witnessed immense international technological competitiveness giving way to the equalization of expertise at global level. Outsourcing has become very convenient in the fields of information and networking technology and many other fields. It has opened new avenues for the growth of organizations around the world. Outsourcing benefits the companies by pulling down labour costs and extending reach to different ideas.

Modern telecommunication and Internet has also contributed to the huge recognition of outsourcing. New dimensions of collaborations and innovative ways of doing business are established through broadband communications (Wolff, 2007).

Companies believe that outsourcing non- core activities can enhance the performance of their core activities. It is noticeable that outsourcing affects the operation’s performance considerably; however, companies look into several aspects while deciding about outsourcing an activity. Organizations may not outsource activities with potential long term strategic importance for them.

It is also logical for the organizations not to outsource an activity if they have expertise in it. Outsourcing is also avoided by the companies to keep their designs and developments in house. Companies may also avoid outsourcing if their performance is superior to the potential supplier or if not it has the potential to significantly improve its performance in near future (Slack et al, 2012).

Examples of Outsourcing Companies

Coca-Cola presents an apt example of linking outsourcing to business strategy. It got itself established as a popular soft drink company in the 1890s. However, it decided to outsource bottling of their soft drink to independent bottlers, keeping in mind the limitations of capital, time and proficiency in bottling. In spite of the fact that bottling could bring competitive advantage to the company, it was outsourced because the company had other major concerns at that point of time.

“Outsourcing the non-core business activity of bottling its soft drink helped in focusing on the core objective of maintaining quality control and keeping its brand with increased market share” (Tahmincioglu, 2006, para 2). In the following years, the company attained its chief business objective of expanding its market far and wide with maintaining its brand. Later, in 1979 Coca-Cola bought many of its bottling partners because of their inefficiency in coping up with the increased competition in bottling sector. Now, company’s main concern was to develop its potential in bottling its products so it could beat its competitors.

Organizations have different perspectives concerning the importance of outsourcing. Carol Frank, an entrepreneur feels that outsourcing brings down the cost of production and hence, is advantageous for her company. She needed some overseas manufacturer for her Dallas Company’s birdcages. Her objective was to gain competitive advantage by outsourcing them at cheaper prices. She started with a Mexican manufacturer who turned out to be too slow. However, she ended up in finding a Malaysian company. Frank knows that it is difficult to make the manufacturer realize the significance of the birdcage as more than a mere piece of furniture, however, she can bear this as she is getting it 60% cheaper.

But Brenda Lynn (Fairfield, Conn.) does not get her knitwear manufactured outside the U.S. in order to maintain a competitive advantage attached with the quality and desirability of her designs. She feels that it is easier to beat the trends by turning new designs quickly and oversee production by staying stateside.

The case is different for Derek Lam, New-York based entrepreneur who gets 90% of his manufacturing done in Soncino, Italy. “He does so not to save capital but to utilize the traditional craftsmanship of Italy along with high-tech methods to produce dresses beautifully and speedily” (Tahmincioglu, 2006, para 3). However, he feels that complexities like currency fluctuations, regular travelling and linguistic challenges do occur in this process (Tahmincioglu, 2006).

Not only the entrepreneurs, but military is also outsourcing support from the private military companies. The U.S. military is outsourcing 20% to 30% of military support services in Iraq. Kellogg Brown & Root (KBR) has become a vital part of American military projecting its strength at global level (Bianco and Forest, 2003).

Pros and Cons of Outsourcing

Outsourcing has become very convenient with the use of modern telecommunications and Internet; however, firms face severe disapproval for outsourcing certain processes. Trade unions point out that outsourcing companies do the jobs at reduced salaries and reduced working conditions. They claim that flexibility is achieved at the cost of job security.

Outsourcing is considered to be cost effective and it does prove to be cost effective in long-term processes, however, in the initial phase when both the sides learn to get used to the new arrangement demands more investment.( Slack et al, 2012).Ron Hira of Rochester Institute of Technology considers it to be dangerous and disruptive. “He believes the disruptions and the dangers are being underplayed by the promoters of outsourcing-from universities to swarms of companies that facilitate hook-ups between outsourcers and outsources” (Wolff, 2007, p.3). The debate over the pros and cons of outsourcing is dominant in different areas of business.

Security

The promoters of outsourcing security claim that the IT staff can be utilised for more strategic matters if exempted from performing these security functions. Andre Gold, IT lead for risk management in ING, a Netherlands based global financial firm says, “such tasks as patch and vulnerability management and antivirus support are consuming a lot of staff time that might better be used, for instance, in strategic management operations for online business goals with partners and customers”(Messmer, 2008, p.28).

However, there persists a different point of view that presents the disadvantages of outsourcing security. Organizations are still hesitant in trusting an outsider company for performing their security functions such as updating security software or performing scans for them. The CISO at ICI (a global chemical manufacturer) accepts that outsourcing security services for vulnerability scanning and antimalware prevention has affected the performance of ICI definitely. However, he thinks that the outsourcer does not bear the responsibility for the failures and disappointments in business as he hardly realizes the impact of failures on the organizations. Similarly, Gossels, president of consultancy System Experts says,

“I’ve never seen large scale outsourcing work well. Security is a business enabler, and the decisions you make every day in your IT infrastructure impact the business. I don’t see how you can do that in an outsourcing way” (Messmer, 2008, p.28).

Similar views were revealed in a survey conducted on 479 security professional from different business sectors such as transportation, finance, telecom and government by Computer Security Institute (CSI). In the survey 61% of the respondents said that their organizations did not outsource any computer security activities. CSI found in its survey that the market for outsourcing security is limited to only a few functions that require specialized nature of work and the ability to segregate the task for access to key enterprise assets make outsourcing more appealing, it doesn’t appear that appetite for such outsourcing is growing overall” (Messmer, 2008, p.28).

Organizations like JP Morgan Chase are refraining from outsourcing security functions. According to the vice president IT risk management, Anish Bhimani, the organization is turning to less expensive ways of getting activities like firewall monitoring and vulnerability assessment in-house by means of procured tools. Mark Grimmelikhuijsen, who is serving as the senior security manager at Campbell Soup Company, believes that outsourcing security may result in further apprehensions regarding the liability of disputes and failures. There could be an intricacy of keeping a watch on the watcher.

Critics of outsourcing security worry that it could lead to a mechanized way of following the contract and ignoring implications. However, the advocates believe that the security experts can be engaged in more crucial matters while getting the regular tasks done (Messmer, 2008).

Tax Preparation

Outsourcing in the field of tax-preparation and financial services has become popular with the technological advancement of moving data conveniently.It is beneficial for the companies during busy season to handle the pressure efficiently with lesser staff. Fred Shapes, CPA, who is partner at Rosen, Seymour, Shapss, Martin (RSSM) &Co., New York finds tax offshoring helpful as it relieves the seasonal workload. “The firm outsourced about150 individual returns to India for 2003 and increased it to about 600 returns for 2004” (Shamis et al, 2005, p.58).

There are no complexities in the functioning. He says,” We get a 48-hour turnaround. But– like anything else, you have to monitor and manage the process” (Shamis et al, 2005, p.58). Besides this, it lowers the labour cost and allows the companies to handle more work. However, modifying business processes result in some unpremeditated results such as liability for the accuracy of work, security of client’s information and impact of outsourcing on the company’s professional image in the market (Shamis et al, 2005).

Retail Business

Outsourcing is a widespread phenomenon in retail business. It is used by many retailers as a tool that works as a supplement facilitating their internal resources. The experiences of the retailers at Chain Store Age’s Managing the Store- Development Process discussion reveal the trend that generally the in-house staff and outsourced workers collaborate in the store development process. However, they feel that it is important to manage the outsourced section for the success of the project.

For example, Linens’ n Things, Zale Corp. and REI perform the significant activities like store’s design and merchandising in- house and outsource the left over work.According to Jane Rappleyea, VP, at Linens’ n Things in store planning &construction the fixture drawings are done in-house and serve as a basis for the overall construction documents. The construction documents are outsourced to the architect and engineering firms based around the country gaining benefit of the local expertise. On the other hand firms like Tandy Corp., who operate Radio Shack believe that quick turnaround time is the basic requirement in the designing and production of drawings that can be achieved fast and if done in-house.

This is so because; in-house environment can regulate every feature of the process, from planning to excellence. However, sealing drawings in all the states is not possible to do in-house for every corporation. For example, CompUSA is capable of doing all its documents activities in-house but in California, it needs to outsource because they are not so knowledgeable of seismic procedures out there, according to the VP, store planning, Jim Paddock. Hence, it is not always possible to perform all documentation work in-house. Sometimes specialized requirement may occur that are beyond the capabilities of the organization and demand outsourcing.

It is commonly recognized that outsourcing is beneficial in retail business as it allows high level proficiency and new talent to reach everywhere. It also enables chains with inadequate resources to experience state- of- the-art technology (The pros and cons, 2002).

Mark Ambrose, director of store design& planning, Ross Stores, Newark Calif tells the advantages and disadvantages of outsourcing. The good thing is that outsourcing is not included in overhead costs and can be discontinued when the production reduces speed. However, getting them back when the production accelerates is difficult as they might be engaged with other firms by now. Hence, the retailer has to outsource newer faces and invest in their training again.

According to Ambrose, training is inevitable for every new worker, in-house or outsourced, who is involved in the production. It is commonly believed among retailers that in spite of being a cost effective tool for handling the ups and downs during the production process, outsourcing brings certain disadvantages too. These may include unavailability of the same outsource, repeated investment on their training,

vendor complacency: It is another disadvantage that retailers face while outsourcing. It is difficult to maintain the quality and services over a long period of time (The pros and cons, 2002, p.9B).

Research and Development

Outsourcing in the field of Research and Development in America is a cause of concern for many who believe that falling prospects of jobs may result in a drop in the quality and quantity of the labour pool in America and ultimately exhaust its innovation capacity. This could raise America’s competitive future at stake (Wolff, 2007). Hira (2005) senses the need for new policies that preserve and boost American competence in the field of science and technology. He worries that America’s innovativetalent may considerablybeaffected by outsourcing R&D with so many options available overseas like India and China grabbing high level R&D work for lower costs (cited in Wolff, 2007).

Gilmont from University of Pennsylvania’s Wharton and Engineering Schools, supports the idea of outsourcing R&D as he believes that corporations need innovation and it cannot be attained from one’s own laboratories. Innovation can come from anywhere. He asserts, “Everyone I have spoken to knows that they need to add innovation to their total package tools and that it’s going to come from another source” (Wolff, 2007, p.4).

Audit Functions

Audit activities, too, are outsourced to support the internal audit departments. Non-core IT audit activities can bring various benefits to the internal audit departments such as providing more time to systems development and crucial projects. Expert technicians can perform the audit functions in a specialized manner. Hence, outsourcing saves company’s capital by saving its time and effort. With reduced operating cost and training cost, outsourcing proves to be advantageous for the audit department. Hence, getting certain functions done by an efficient external service provider on time contributes to the performance of the department or organization.

However, outsourcing IT auditors brings complexities too. There has to be an appropriate check and management of the outsourced projects to determine their relevance and cost effectiveness. Outsourcing IT related audit function sometimes threatens the internal IT staff about their job continuation. It is also observed that the service provider is unable to provide proper attention to internal audit’s needs if handling many clients at a time. Besides, there are various hidden costs such as travel expenses, capital required for legal activities and start-ups.Other possible disadvantages include inadequate understanding of the scope of the project, miscommunication, not maintaining the brand quality and slowed down services (Pyzik, 2012).

Outsourcing may worry companies with the disadvantages discussed above, but Bhagwati et al (2004) suggest that it is important to understand its usefulness as a trade phenomenon having almost same qualitative effects as that of the conventional trade in goods. According to them it is necessary to recognize raised complexity that results from induced weakening in trade and the displacement of workers from certain sectors, however, they believe that outsourcing is not going to affect employment in countries like the U.S. having potential of creating high value jobs over time (Bhagwati et al, 2004).

Recommendations

It is generally believed that companies should not outsource their core activities that are crucial for their success. However, it is important for the companies to clearly distinguish between their core activities and non-core activities in order to use outsourcing effectively for the benefit of the organization. Further, it is more important to distinguish activities as core or strategic activities (Chamberland, 2003).

Chamberland suggests that strategic outsourcing has to be more than a typical customer-supplier relationship. For obtaining maximum benefit from the strategic outsourcing, it is important to build “a structure that approaches a partnership- like arrangement –where the organization that is outsourcing and the service provider see each other as equals engaged in a common enterprise-tends to allow the service provider to deliver greater value during the course of arrangement (Chamberland, 2003).

Rappleyea, of Linens’ n Things, believes that it is important to manage outsourcing in the same manner as the internal resources are managed in order to control their services and quality. The outsourced relationship will produce good results if we put in good efforts in maintaining it. He says, “You have to look at the company as an extension of your internal-resources construction.” (The pros and cons 2002, p.9B).

President of Westwood Contractors, Fort Worth, Texas, Robert Benda, recommends that the client- retailer should provide leadership for the smooth continuing of the relationship and think about the mutual benefit. He reveals that the longest lasting relationships for them have been those “where the client leader on the team has exhibited a balanced interest between their vendor’s well-being and success and the company’s objectives” (The pros and cons, 2002, p.10B).

In the realm of project management in retail business, it is wise to hire people with like mind. Rappleyea of Linens’ n Things suggests that there should be no discrepancy between the outsourced and the internal project managers. He says that, “You should treat them as if they are part of your staff, sharing information and keeping them on top of what’s happening. If you treat them as stepchild or as an afterthought, that’s when you are going to have problems. They need to be in the loop on everything” (The pros and cons, 2002, p.10B).

Audit executives need to practically and strategically decide while outsourcing IT activities for themselves for successfully meeting the audit plan. There has to be an appropriate check and management of the outsourced projects to determine their relevance and cost effectiveness. These measures can help in dealing with the complexities that come up with outsourcing IT audit functions (Pyzik, 2012).

Companies should keep in mind that outsourcing should not be taken as a substitute for the internal capabilities and should not hamper their internal strengths. It is important for the business people to keep their knowledge updated regarding the latest developments in their businesses and constantly changing market demands. Moreover, companies should review their in house business activities systematically for strategic decision making (Chamberland, 2003).

References

Bhagwati, J., Panangariya, A. & Srinivasan, T.N., 2004, ‘The muddles over outsourcing’, Journal of Economic Perspectives, vol. 18, no. 4, pp.93-114, Web.

Bianco, A. & Forest, S.A., 2003, ‘Outsourcing’, Business Week, Web.

Chamberland, D. Is it core or strategic? Outsourcing as a strategic management tool, 2003, Web.

Messmer, E. 2006, ‘Outsourcing security presents pros and cons’, Network World, vol. 25, no. 12, pp. 1-28, Web.

Pyzik, K. 2012, ‘The pros and cons of outsourcing’, IT Audit, Web.

Tahmincioglu, E. 2006, ‘Here or there’, Business Week, Web.

The pros and cons, 2002, Web.

Wolff, M.F. Engineers, Academics, 2007, ‘Policymakers argue offshoring pros and cons’, Research Technology Management, Web.

Shamis, G.S., Green, C. M., Sorensen, S.M. & Kyle, D.L., 2005, ‘Outsourcing, offshoring, nearshoring: What to do?’ Journal of Accountancy, pp. 57-61, Web.

Slack, N., Brandon-Jones, A., Johnston, R., Betts, A. 2012, Operations and process management, Pearson, London, UK.