Outsourcing constitutes one of the fundamental sourcing strategies that organizations can adopt. Outsourcing entails an approach whereby certain business processes are undertaken by an external entity. Thus, outsourcing is based on a contractual relationship. The concept of outsourcing has gained remarkable significance over the past few decades. Traditionally, outsourcing was limited to peripheral organizational tasks. This trend is changing as evidenced by the high rate at which outsourcing is being integrated into diverse organizational activities.
Organizations perceive outsourcing as an essential strategy in their commitment to value addition. Some of the industries that have adopted the concept of outsourcing include aviation, manufacturing, and medical services. Firms in the oil and gas industry are also adopting the concept of outsourcing. Organizations’ motivation towards this strategy has been spurred by the need to attain competitiveness concerning high return on assets and better and quality service delivery. Secondly, the pressure to outsource has emanated from the need to adjust to the changing business environment. This goal is achievable via less commitment to in-house resources.
Despite the prominence of outsourcing in promoting business performance, most organizations have integrated the concept without formulating a well-thought-out strategy. Managing outsourcing can be time-consuming. Thus, organizational managers need to adopt an effective outsourcing policy. The policy should consider some elements, which include the identification of the firm from whom to outsource, the procurement process, and the nature of outsourcing contract to adopt coupled with how to sustain the outsourcing arrangement through effective management.
In the course of making the outsourcing decision, it is imperative for organizational managers to consider several elements, which include the benefits, risks, and the critical success factors. Failure to consider these elements might lead to poor implementation of the outsourcing strategy, hence limiting the likelihood of achieving the projected outcome.
Benefits of Outsourcing Strategy
Cost minimization comprises one of the main motivators in adopting the outsourcing strategy. However, the outsourcing decision should not be exclusively based on cost. On the contrary, organizational managers must evaluate the likely value that it will derive from outsourcing. Therefore, the probability that the concept of outsourcing will shift from solely being a matter of cost minimization to value addition is considerably high. Some of the value-added elements that organizations will focus on in their outsourcing process include growth in return on investment, developing best practices, achieving overall operational efficiency, and enhancing economies of scale.
1. Cost-saving
Cost minimization is one of the fundamental aspects that organizations consider in their strategic management practices. Outsourcing constitutes one of the strategies that firms are adopting to minimize the different components of cost, which include the fixed cost, variable cost, and cost of labor. However, in a bid to achieve cost minimization through outsourcing, organizational managers need to undertake an extensive cost analysis. Outsourcing is mainly applicable if the cost of undertaking a specific task in-house is higher than the cost of outsourcing.
2. Risk Sharing
Outsourcing is an effective risk management technique by minimizing, eliminating, and sharing risk. Under the outsourcing strategy, risk-sharing arises from the partnership relationship between the outsourcing firm [principle] and the outsourced firm [agent]. The two parties must work collaboratively, which leads to the emergence of mutual responsibilities and shared liabilities.
3. Refocusing on core competency
Due to outsourcing, an organization’s management team can build its core competency by seeking experts to undertake some of the tasks that a firm might not have the necessary capability to execute. Unlike the outsourcing firm, the outsourced consultants are self-contained, which means that they can effectively handle the task that seems challenging or non-core to an organization. Consequently, the organization’s top management team can refocus on the core organizational functions. Outsourcing adds value to an organization’s service delivery process. Subsequently, an organization’s ability to produce the desired value is increasing significantly.
4. Economy of scale
Outsourcing enables an organization to achieve economies of scale through cost reduction due to minimal errors, hence the need for repetition. The outsourced firm ensures that optimal overhead control measures are incorporated. The economy of scale is also achieved as an organization gains the best practices, hence reducing operational inefficiencies. Furthermore, outsourcing leads to growth in an organization’s market share.
5. Time-saving
Achieving high operational efficiency can contribute to an organization’s quest for a high competitive advantage. Organizations are motivated to outsource some activities by the need to save time in executing certain activities. Outsourcing fosters time-saving due to the expertise of the service provider. Subsequently, the human capital deficiencies that might limit a firm from undertaking the specific tasks are eliminated. Moreover, the need to undertake staff restructuring and employee training to achieve operational efficiency is eliminated. Saving time contributes to an organization’s overall performance as the top management focuses on executing the core business activities. Most organizations have not appreciated the importance of saving time in their quest to maximize productivity. Thus, the most cost-benefit analysis ignores time-saving as one of the variables in achieving the desired level of productivity.
6. Flexibility
Flexibility is a critical strategic factor and it is closely related to cost-saving. In the course of their operation, organizations must develop different types of flexibility, which include demand, resource, and operational flexibility. The potential for improved flexibility is measured by the organization’s ability to change its service delivery process to respond to the changing market conditions. The dynamic nature of the business environment requires organizations to respond to changing customer demands. Outsourcing remarkably improves an organization’s flexibility by reducing the amount of time that is required to complete a particular task.
Outsourcing enables organizations to achieve flexibility in different ways. First, the probability of dealing with a workload that would have proved challenging is increased remarkably by transferring such responsibility to the outsourced entity. Furthermore, an organization is not required to adjust its workforce structure, for example, by increasing the number of employees to undertake the task successfully. Increasing the size of human capital might increase the cost of operation because the person might not be adequately engaged during the low or unproductive periods.
7. Quality improvement
Service quality is a critical element in determining the repeat purchase behavior amongst customers. Organizational managers should not underestimate the importance of investing in effective quality planning, assurance, improvement, and control. If an organization perceives quality as a critical factor in attaining sustainable competitive advantage, outsourcing should be considered as a potential aspect to achieve continuous improvement. Organizations decision to adopt the outsourcing strategy should be based on the commitment to meeting specific client requirements and reaching high service level.
Challenges Associated with Outsourcing
Despite the benefits associated with outsourcing, organizational leaders must appreciate the existence of risks. The risk of outsourcing mainly emanates from the lack of a well-designed methodology that organizational managers can adopt in implementing the strategy. The outsourcing industry is characterized by diverse risk categories as evaluated herein.
1. Operational risk
Outsourcing entails transferring certain work processes to external clients based on a contractual agreement. However, such a strategy might hinder an organization’s operational efficiency. For example, the client might not develop an adequate understanding of the clients’ requirements. Moreover, failure to undertake an extensive analysis of the outsourced firm might lead to the selection of a poor service provider. Consequently, an organization might not achieve the desired outcome. Operational risk might also arise from the view that the outsourced firm might lose control of its function. Moreover, outsourcing at the operational level can easily lead to the development of dependencies that create unforeseen strategic vulnerabilities. This aspect underscores the importance of incorporating a systematic methodology that should serve as the guide in implementing the outsourcing strategy.
2. Strategic risks
Contracted service providers might develop opportunistic behavior. One of the core responsibilities of the outsourced firm is to offer consultancy services. However, to achieve this goal, the principal [the outsourcing firm] must provide the service provider with adequate information on its operational strategy. The outsourced firm might steal confidential information such as intellectual property rights, which might jeopardize the organization’s long-term competitiveness. This risk might arise from the existence of moral problems amongst the outsourced firm’s employees. Understaffing is another strategic risk associated with outsourcing. The service provider might double the cost of providing the service during the renewal of the contract after making sure that it is difficult for the outsourcing firm to pull out of the existing contractual relationship.
3. Composite risk
This type of risk arises in situations whereby an organization has continuously implemented the concept of outsourcing for a considerably long duration like 10 years. In such situations, the client company might not have developed the necessary operational capabilities to assist in sustaining its long-term competitiveness upon the expiry of the contract period. To manage composite risk, organizational leaders must focus on developing core competencies concerning the services being offered by the contracted firm. Conversely, strategic and operational risk can be managed by integrating effective preventative measures. One of the principal preventative measures that firms can adopt entails undertaking effective planning on the outsourcing initiative. For example, effective continuous accountability should be entrenched in planning the outsourcing function. However, most organizations are yet to appreciate the importance of accountability in the outsourcing process. Organizational managers should recognize that outsourcing certain operational activities do not include giving out the accountability role. On the contrary, the responsibility to ensure accountability should be a preserve of the outsourcing firm. Outsourcing might also be affected by a poor relationship between the firm and the service provider.