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What is 'Outsourcing'

Outsourcing is the business practice of hiring a party outside a company to perform services and create goods that traditionally were performed in-house by the company's own employees and staff. Usually done as a cost-cutting measure, it can affect jobs ranging from customer support to manufacturing to the back office.

Outsourcing was first recognized as a business strategy in 1989 and became an integral part of international business economics throughout the 1990s.

The practice of outsourcing is subject to considerable controversy in many countries. Those opposed argue it has caused the loss of domestic jobs, particularly in the manufacturing sector. Supporters say it creates an incentive for businesses and companies to allocate resources where they are most effective, and that outsourcing helps maintain the nature of free market economies on a global scale.

 

BREAKING DOWN 'Outsourcing'

Businesses can reduce labor costs significantly by outsourcing certain tasks. They can also avoid expenses associated with overhead, equipment and technology. A manufacturer of personal computers might buy internal components for the machines from other makers, for example, to save on production costs. A law firm might store and back up its files using a cloud-computing service provider, thus giving it access to digital technically without investing large amounts of money to actually own the technology. When used properly, outsourcing is an effective strategy to reduce expenses, and can even provide a business with a competitive advantage over rivals.

In addition to cost savings, companies can employ an outsourcing strategy to better focus on core aspects of the business. Outsourcing non-core activities can improve efficiency and productivity because another entity performs these smaller tasks better than the firm itself. This strategy may also lead to faster turnaround times, increased competitiveness within an industry and the cutting of overall operational costs.

For example, a small company may decide to outsource bookkeeping duties to independent accounting firm, as doing so may be cheaper than retaining an in-house accountant. Or it may need a legal professional occasionally, but not full-time house counsel; so it hires an independent law firm, or keeps one on retainer.  But it happens in large organizations,too: Many corporations have eliminated their entire in-house customer service call centers, outsourcing that function to third party outfits located in lower cost locations. Other companies find outsourcing the functions of Human Resources departments such as payroll and health insurance, saves enormous amounts of time, effort and energy. As many as 16% of firms outsource some kind of task that deals directly with human resources.

Outsourcing Internationally

Businesses choosing to outsource internationally often benefit from differences in labor and production costs. Price dispersion in another country may entice a business to relocate some or all of its operations to the cheaper country in order to increase profitability and stay competitive within an industry. Other businesses seeking to obtain the same benefits may then decide to outsource or relocate as well, all the better to compete. Of course, this option becomes less attractive as different economies reach similar pricing. Globalization continues to increase in part as a direct result of increased outsourcing – though, of course, the cost benefits and competitive edge begins to shrink as economies and prices in different countries begin to converge.

Like domestic outsourcing, international outsourcing saves businesses money by allowing work to be completed on a contractual basis by non-employees, and in a location with cheaper labor or supplies. But it may also eliminate the barriers encountered by a business entering a new country to establish local market share. These businesses may need native speakers of a particular language or those familiar the indigenous culture or those with some sort of specialized expertise, in the local laws or safety regulations, for example. Hiring directly may not be justified, budget-wise, so outsourcing becomes an effective cost-control solution.

Statistics and Surveys

Companies typically save around 15% due to cost reductions brought about from outsourcing. A 2014 study from Datamark, Inc. claims one client saved 31% over one year when outsourcing one aspect of its business. Over three years, the cost savings rose to 33%.

Deloitte LLP's 2014 Global Outsourcing Survey interviewed respondents from over 22 industry sectors and 30 countries. The consulting firm found 69% of companies surveyed were more likely to outsource in some way due to cloud computing technology. Two-thirds of them wanted to outsource certain business processes. Up to 53% of survey respondents outsourced their IT functions in 2014, while 26% of firms that did not outsource anything at the time planned to do so sometime in the future.

Drawbacks to Outsourcing

Outsourcing also has several disadvantages. Signing contracts with other companies may take time and extra effort from a firm's legal team. Security threats occur if another party has access to a company's confidential information and then that party suffers a data breach. A lack of communication between the company and the outsourced provider may occur, which could delay the completion of projects.

There's little question that outsourcing has had a significant impact on the U.S. economy – though curiously a hard-to-define impact. Estimates of net jobs lost to outsourcing range from the hundreds of thousands to the millions, but even aggressive assumptions seem to suggest that it's less than 2% of the U.S. workforce.

Outsourcing customer service and support jobs to countries like India has become so common that it's become an advertising campaign topic for companies that want to stand out for their better (and presumably not outsourced) services. However, with some firms seeing savings of 50% or more for outsourced positions, it's clearly tempting for those under never-ending pressure to either match low-price competitors or shore up their own operating margins.

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