Outsourcing can be defined as delegating implementation of a specific process (giving ownership of the process) to the service provider and specifying in detail the effects which the customer intends to get, but no instructions on how to perform each task, leaving the initiative in this respect, the service provider.
Entrusting decision-making powers to the implementation of outsourced tasks is a condition of outsourcing, which was also underlined in the definition proposed by Maurice F. Greaver. According to him outsourcing involves transfer, in accordance with the provisions in the outsourcing agreement (contract), of repetitive tasks performed in organization, as well as employees, machinery, equipment, technology and other resources and decision-making powers necessary to perform that tasks.
Outsourcing and collaboration
Based on the concept presented by P. Bendor-Samuel, it should be pointed out a fundamental difference between outsourcing and other forms of cooperation with the service provider. It is associated primarily with the scope of the decision-making powers regarding the possibility of making changes to the terms of the outsourced tasks. In the case of outsourcing, ownership of outsourced tasks shall be transferred to the contractor and the customer specifies only the expectations concerning the performance of the service provider.
Other forms of cooperation with the service provider leaves decision-making powers in the company, and not only defines the expected effects, but also transmits the contractor instructions on ways of achieving the objectives. Such forms of cooperation with the service provider are normally associated with greater involvement of the management in control of the contractor, but it is much easier to change service provider than in situation when full ownership of processes is transferred.
The nature and objectives of the outsourcing process
Outsourcing is a strategic process, involving huge organizational change, having an impact on the functioning of many important processes occurring in company. There are following types of outsourcing: recovery outsourcing, adaptive outsourcing, developmental outsourcing.
Analysis of companies which have decided to outsource show that as a result there has been a reduction in costs for obtaining the service, improving its quality, change in level of employment, as well as increased flexibility.
Preparation of outsourcing activity - internal analysis
A crucial role in this analysis is played by identification of areas of key company's competences and secondary activities. Entrusting service providers individual tasks, as well as the entire processes should be considered. Each of the processes in the enterprise should be assessed considering eventuality of transferring it to external service provider.
One of the major assumptions in this stage of the analysis is to distinguish between processes and parts of processes, which are located in the customer's core business and should not be delegated to external bodies. It should also be noted that among the separate processes may also be those that do not fall within the scope of the core business, but the specifics of the business requires full supervision of their implementation. In addition to deciding whether the task or process should be transferred to service provider, managers could also consider creating new, dependent, service company, that could provide services to the extent required. Such dependent entity acting primarily on the basis of the resources provided by the parent company might also attract new customers and provide additional benefits. Cooperation with the unit, which is co-owned by the parent company, may be a way to preserve the full supervision of contracted processes.
Internal analysis should be taken by team of specialists representing organizational units performing activities in the area that will be entrusted to the service provider, as well as representatives of other organizational units, dependent on proper realization of outsourced tasks.
Letter of intent in outsourcing
Letter of intent to purchase is prepared after selection of best tender complying with the utmost demands of the company. It is signed by the both sides of future cooperation agreement. It reflects the will of the conclusion of the agreement by the customer and the service provider. The letter of intent should include, such elements as:
- determine the general assumptions relating to the conclusion of the agreement and subsequent cooperation,
- the actions to be taken in an effort to conclude an agreement,
- the previous action taken by the customer and the service provider in order to cooperate,
- proposed schedule of cooperation,
- the rules for the application of contractual penalties.
Despite the fact that these issues do not reflect the full range of information to be included in the body of the letter of intent, however, from the point of view of the purpose of letter of intent to purchase they shall be regarded as essential.
It involves stopping realization of specific function and transforming obligation to its performance to an independent provider on the basis of specified long-term agreement. In the case where the outsourced tasks were performed within organization, consequence of such a decision is the dismissal of all units related to the realization of this function.
Outsourcing in such form, requires however, the existence of a stable market for the services of independent service providers. Their offering should be also competitive both qualitatively as well as affordable in comparison with the same scope of activities carried out by the company.
Advantages of outsourcing agreements
Among the main advantages of this type of outsourcing are:
- the opportunity to choose the partner that will suit the company's requirements of quality and prices,
- implementation of the tasks by external entity and the limitation of liability for their implementation so that managers can focus on core business,
- access to knowledge and innovative solutions applied by the service provider"
- less uncertainty regarding the proper implementation of outsourced tasks,
- the possibility of cooperation with provider having better knowledge of the industry, who can generate appropriate logistical strategy characterized by the ability to adapt to individual customer expectations in the sector,
- more flexible organization by reducing the complexity of its structure.
Disadvantages of outsourcing agreements
Objective assessment of this type of outsourcing, requires an indication of its main disadvantages:
- limited possibility of supervision of performed tasks,
- difficulties in strategic planning,
- the risk of conflict in places with bordering responsibilities,
- little impact on prices of transferred services,
- the possibility of loss of know-how and strong position among cooperating partners due to a too narrowly defined range of key competences,
- dismissal of staff when outsourcing is a form of restructuring of the company.
Outsourcing vs offshoring
Outsourcing by offshoring is a process, which consists of the production or services in the territory of another country. Offshoring can be carried out through internal action, namely by creating an entity that is dependent financially or through outsourcing, or commissioning service to the foreign contractor.
Impact on the development of offshoring was developing of the information technology, increased global competition and the liberalization of rules on international trade in services. Processes that are offshored are the most common IT services and business services. This is often referred to as BPO (business process outsourcing). BPO usually deal with the following functions: finance and accounting, legal services, customer services, administration, market research.
Benefits of outsourcing and offshoring
The main benefits of offshore services are in lower labor costs or access to greater resources of intellectual capital.
New form of offshoring, which is developing very dynamically in recent years, is offshoring of business processes based on knowledge. This type of activity is aimed, not on reducing costs but on creating high added value.
Precursor to the use of offshoring of business processes was a General Electric company, which already in 1990 started to create parent companies doing various business services. The company currently has approximately 30 units based on offshoring, which provide services in areas such as IT, customer service, human resources management, accounting, logistics. The most spectacular GE offshoring investment in recent years was the opening of the center of research & development in Bangalore, India. It is the world's second-largest unit of this type, which employs about 3,000 scientists.
- Business process outsourcing
- Outsourcing of marketing
- Transformational outsourcing
- Strategic outsourcing
Examples of Outsourcing
- Business Process Outsourcing (BPO): This is when a company contracts out a specific function or process, such as customer service, payroll, or IT support. The company then pays a third party to manage and execute the task.
- Manufacturing Outsourcing: This is when a company contracts out the production of specific goods or components to a third party. The company will typically provide specifications and quality requirements, but the third party is responsible for the actual production.
- Information Technology Outsourcing (ITO): This is when a company contracts out their IT needs to a third party. This can include software development, security services, database management, and other technical services.
- Human Resources Outsourcing (HRO): This is when a company contracts out specific human resources tasks to a third party. This can include payroll, benefits management, performance management, and recruiting.
- Logistics Outsourcing: This is when a company contracts out their logistics needs to a third party. This can include freight transportation, warehousing, and inventory management.
Outsourcing is not only limited to delegating the implementation of a specific process, but there are also several other approaches related to it. These include:
- Offshoring – relocating certain parts of a company’s operations, such as customer support, software development, or data entry, to a foreign location to reduce operational costs.
- Contracting – obtaining services from a third-party organization or individual for a fee and usually for a specific period of time.
- Insourcing – using internal resources of the organization to perform a certain task or process that is usually outsourced.
- Co-sourcing – combining the use of external and internal resources to achieve specific business goals.
- Near-shoring – relocating certain parts of a company's operations to a foreign country that is geographically close to the home country.
In summary, outsourcing is a popular approach to obtaining services from an external source, but there are several other related approaches that companies can use to reduce costs and improve efficiency. These approaches include offshoring, contracting, and insourcing, as well as co-sourcing and near-shoring.
- Chongvilaivan, A., Hur, J., & Riyanto, Y. E. (2009). Outsourcing types, relative wages, and the demand for skilled workers: New evidence from US manufacturing. Economic Inquiry, 47(1), 18-33.
- Greaver Jr M.F., (1999), Strategic Outsourcing. A Structured Approach to Outsourcing Decisions and Initiatives, AMACOM, New York.
- Grossman, G. M., & Helpman, E. (2005). Outsourcing in a global economy. The Review of Economic Studies, 72(1), 135-159.
- Grossman, G. M., & Rossi-Hansberg, E. (2006). The rise of offshoring: it’s not wine for cloth anymore. The new economic geography: effects and policy implications, 59-102.
- Lake, R. B. (1984). Letter of Intent: A Comparative Examination under English, US, French and West German Law. Geo. Wash. J. Int'l L. & Econ., 18, 331.
- Lynch, G. G., & Steinberg, M. I. (1978). Legitimacy of Defensive Tactics in Tender Offers. Cornell L. Rev., 64, 901.
- Outsourcing: Winning the Benefis, Reading the Rewards, (1997), Shreeveport Management Consultancy.
- Quinn, J. B. (1999). Strategic outsourcing: leveraging knowledge capabilities. MIT Sloan Management Review, 40(4), 9.
- Shared Services and Outsourcing (SSO) Hub Potential Analysis, (2005), A Frost & Sullivan Study, November.