Outsourcing Definition, Pros & Cons

KEY TAKEAWAYS

• Outsourcing presents many opportunities for companies that want to lower costs and be more efficient. 
• It can be a strategic tool for growth and profitability. 

What is Outsourcing?

Outsourcing is when a company hires external parties to perform services or create goods. This allows the company to increase labor cost savings and improve efficiency. By handing off less critical duties to third parties, a company can focus on its core business functions. 

Companies approach outsourcing in many ways. Some companies outsource smaller projects to independent contractors like web designers or programmers. Others may outsource all their customer service operations to a large offshore service provider. 

In both cases, the primary goal is to boost efficiency and lower labor costs. For example, perhaps a company wants to break into a new overseas market. They may outsource their marketing needs to an agency based in that location. Since this third party will have expertise in marketing to the target demographic, they can operate faster and at a lower cost.

What Are the Different Types of Outsourcing?

When most people think of outsourcing, they think of exporting business activities to a country with a lower average wage. While this is often true, it doesn’t apply to every impending outsourcing decision.

Outsourcing is a general term that covers a variety of business arrangements. The three most common types of outsourcing are:

• Onshoring is relocating work to a lower-cost location within the same country.
• Offshoring is relocating work to third parties overseas.
• Nearshoring is relocating work to people in a nearby country or region.

Each type has a competitive advantage and disadvantages. For example, onshoring or nearshoring has the advantage of time zones. Since the time difference between the client company and outsourced provider aren’t extreme, business operations run without too many disruptions. It also reduces the chance that cultural differences or language barriers will impact efficiency. 

On the other hand, offshoring allows companies to take advantage of favorable economic conditions. Or, they can utilize manufacturing capabilities not found closer to home. 

Outsourcing Examples

Information technology services (IT) are some of the most common types of outsourced business processes. 

Most companies need qualified IT specialists to handle specific tasks. For example, they may handle database management or software programming. However, not every business can justify a dedicated IT department. Or the scope of the work may be too far outside the parameters of a company’s key activities. 

For example, even large banks or financial institutions may outsource their cybersecurity needs. And most e-commerce platforms work with external payment processors to handle transactions.

Here are some other examples of outsourcing:

• A small business using an accounting firm to handle its bookkeeping
• A multinational corporation delegating customer service to call centers around the world
• A computer company purchasing internal components from a third-party manufacturer
• A marketing firm using a human resources consultant to find their next CEO
• A bank working with third-party programmers for new mobile application development.

Pros of Outsourcing

Why do so many companies choose to outsource some of their business activities? 

Outsourcing presents several advantages for a company looking to boost its efficiency. These include:

• Lower Costs

It’s often cheaper to outsource a service than hire an employee to do that job full-time. It can reduce operational costs such as taxes, healthcare insurance, and other employee benefits.

• Access To Skills

Outsourcing is an approach to workforce development that allows businesses to access skill sets that are not readily available or financially feasible. For example, a small design firm might not have enough clients to justify a full time copywriter. So, they outsource their copywriting needs to a third-party marketing firm. 

• Higher Growth 

Onboarding full-time employees may be a better long-term option. However, the training process takes time. In contrast, outsourcing makes it easier and faster to scale by relying on third-party expertise. So businesses can outsource as many business objectives as needed to meet consumer demand until they can afford full-time employees. 

• Manufacturing Capability

Most companies don’t manufacture their own goods. Even if they do, they might still need extra parts from an external manufacturer. This can significantly reduce capital requirements, operating expenses, and production costs.

• Time Zone Requirements

Let’s say a software company has an enormous global user base. It wouldn’t make sense for them to handle all their customer support tasks from a single location. 

Instead, they could outsource these tasks to call centers located in multiple locations. That way, they could operate 24/7.

• Staffing Flexibility

A company’s needs may fluctuate throughout the year. Outsourcing allows a company to meet its staffing requirements according to demand. For example, a business could outsource their payroll tasks during tax season. That way, they won’t need to hire more employees for their accounting department.

• Risk Management

Employee turnover and unexpected events are risk factors that every business must consider. For example, a key employee might take an unexpected medical leave. In a situation like this, a company can bridge the gap by outsourcing that employee’s tasks for a limited time. 

Cons of Outsourcing

Despite the many advantages of outsourcing, it doesn’t always benefit every company. There are some potential drawbacks as well, which include: 

• Less Control

Outsourcing forces companies to give up control over various aspects of the workflow. This may result in a final product that doesn’t exactly meet expectations. Or it may lead to unexpected issues that end up costing more time and effort to address.

• Communication Issues

Third parties won’t have a deep knowledge of the outsourcing company’s work culture. Likewise, the outsourcing company may have unrealistic expectations for the contractors. Cultural barriers can compound this problem even more. 

• Security Threats

Outsourcing the handling of sensitive information increases the security risk for your organization. This data can be mishandled or misused. By the time security issues are discovered, it might be too late to prevent the consequences.

• Impact On The Economy

Outsourcing can have unintended consequences on the economy and labor force in general. For instance, it’s one reason why many American manufacturers moved overseas. 

Summary

Outsourcing presents many opportunities for companies that want to lower costs and be more efficient. It can be a strategic tool for growth and profitability.