Most companies nowadays use outsourcing for at least one of their business areas. The reason is obvious. It saves time, money, and effort. What is outsourcing, exactly? What types of outsourcing are there? Do the costs of outsourcing outweigh its benefits? Let's find out.
Meaning of outsourcing
Outsourcing is the practice of hiring a third party to perform business operations that are formerly done by the company’s in-house staff.
The main objective of outsourcing is to reduce labour costs and give your main staff more time to handle core business activities. Outsourcing activities can be carried out in various departments, including customer support, human resource, accounting, production or marketing.
Benefits of outsourcing
There are two major reasons for outsourcing:
Outsourcing: Cost savings
When companies choose to outsource, it often comes with a cost advantage. They can pay few wages for the workforce or reduce costs of overhead, equipment, and technology. Either way, the costs for performing the tasks are much cheaper than doing it in-house; and the company can save a lot of money to spend elsewhere in their organization.
We often see outsourcing carried out by multinational firms.
Apple hires a cheap labour workforce in countries such as China, the Philippines, Thailand, Malaysia, and Vietnam to make and assemble components of the iPhones.
Outsourcing: Focus on core activities
Cost-saving is not the only reason for outsourcing. Companies also outsource to focus more on other core aspects of their business. This will lead to more income opportunities and innovation. In other cases, outsourcing is a way for companies to free themselves of burdensome tasks they’re not good at.
A shoe production company may not have experience building an e-commerce store or running an online marketing campaign. In which case, they can hire a marketing agency to complete the tasks and reap the benefits. The main idea is to focus on what the company does best while shifting the rest to the external parties.
Types of outsourcing
Depending on the location of outsourced parties, outsourcing is split into three categories:
Outsourcing: Onshoring
Onshoring means outsourcing work from a third-party provider within your own country.
The main advantage of this approach is the local teams who are readily accessible and have a common background with your business in terms of language, time zone, or ways of work. This gives you more control over how the work is carried out and make timely adjustments should problems arise. In addition, the setup can be done quickly without much hassle on your side.
One disadvantage though is the high costs of employment. For example, if your company operates in the USA or Western Europe, you may need to pay more for the local staff than when hiring people from developing countries where the living cost is cheaper.
Outsourcing: Offshoring
Offshoring means outsourcing work from a third-party provider abroad.
In contrast to onshoring, the biggest advantage of this offshoring is the low costs. By shipping production to countries that have a lower minimum wage, companies can pay fewer wages and increase their profit margins.
The major drawbacks of offshoring are limited communication between the employer and employees, poor-quality products due to lack of facilities, and cultural conflicts.
Outsourcing: Nearshoring
Nearshoring means outsourcing from neighbouring regions or countries.
Nearshoring is an option that can limit the cons of offshoring (cultural differences, low skills) while capitalizing on the benefits of onshoring (similarity in the background, communication, higher accessibility) to maximize the value of outsourcing.
Examples of outsourcing
A good example of outsourcing is banks that outsource a third-party provider to validate customer ID. This not only helps them to save time and effort on non-core activities but also expands the service to many locations. Customers also benefit from a quicker process without having to visit the bank physically.
Google is a gigantic technology company whose business not only includes search engines but also extends to providing hardware and software solutions.
To improve efficiency, they outsource non-core activities such as administration and IT work. For instance, a lot of development work, email support, and phone support is carried out by staff all over the world.
The good point of Google’s outsourcing strategy is that they manage to blend external partners into the in-house operations to provide a seamless experience for the customers.
Disadvantages of outsourcing
Five most common disadvantages of outsourcing include:
Outsourcing: Contract complications
A lot of time and effort is exerted to create contracts with third-party providers. Companies also have to invest in building relationships and establishing communication systems with these partners. This may incur a lot of expenses and reduce the cost advantage of the original outsourcing plan.
Outsourcing: Communication inefficiencies
Another challenge arises from the difficulty to contact third-party companies at different time zones. This may result in a slow reaction to emergency situations and take a toll on the company’s performance. It is also hard for companies to get their in-house team to collaborate and work efficiently with overseas partners due to language and cultural barriers.
Outsourcing: Potential loss of control
Companies may lose control over certain aspects of their business. For example, they may be in charge of customer service taken over by virtual assistants from abroad. This is often the case with call centres where employees are often undertrained or lack professional tools to complete the job. Also, it proves difficult for businesses to train the external workforce rather than their internal team
Outsourcing: Security risks
There’s also the risk of security in which companies lose important data while exchanging with their third-party providers, or the providers might misuse, mishandle or accidentally expose the sensitive information.
Outsourcing: Ethical issues
Many outsourcing companies are criticized for the exploitation of cheap labour overseas. One example is in the fashion industry where fast fashion brands typically reallocate their production to workers in third-world countries like India, Bangladesh, Nepal. Most garment workers suffer from long hours and horrible working conditions with very little pay.
Insourcing vs outsourcing
The choice between outsourcing and keeping the production in-house often can give the company’s manager a lot of headaches. A common solution is to weigh the cons and pros of in-housing and outsourcing against the company’s objectives:
Quality: companies should complete the task on their own if it’s easier to manage quality and adjust problems that arise. On the other hand, if the third-party provider is equipped with better equipment and experience, it might be better to outsource.
Cost: small businesses may not have enough funds to hire a third-party company to handle their operations. However, a multinational company can benefit greatly by outsourcing staff worldwide.
Speed: internal teams respond faster than external teams, which is an advantage of “doing it in-house”. That said, in non-core business activities, outsourcing may result in faster customer response and task completion.
Flexibility: In-house team may be limited by the capacity to respond quickly whereas third-party providers may have a larger capacity to fulfil customer demands. If this is the case, outsourcing can be huge leverage.
Outsourcing - Key takeaways
- Outsourcing means hiring a third-party provider to perform business operations that are formerly done by the company’s in-house staff.
- The main objectives of outsourcing are to save costs and resources for handling unspecialized tasks.
- There are three types of outsourcing: onshoring, offshore, and nearshoring depending on the location of the outsourced company.
- While outsourcing holds many benefits, there are some disadvantages such as contract and relationship complications, communication, lack of control, security risks, and ethical issues.
- To choose between insourcing and outsourcing, companies need to consider factors regarding cost, quality, speed, and flexibility.
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