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What is outsourcing?
Outsourcing is a strategic decision of a company to use an outside organization to perform work that is typically done within that company. This strict definition of the term covers only activities that were once internal to the company and includes only the process of moving the activity to the outside. Most companies involved in outsourcing, however, use a much broader definition. In this sense, the term can be defined as using a third party to service a particular product or using a technology provider to move into new delivery channels and markets. Outsourcing also includes managing the relationship between the buyer with its provider, or outsourcer, because nothing is more likely to lead to an unsuccessful venture than neglecting a partner (Lanz & Barr, 000, p.1).
Like traditional selection process, the outsourcing process includes all the steps of planning, selecting, and managing the service providers. In comparison with purchasing or contracting out, outsourcing, however, differs in the strategy that drives it. In general, it is a strategy that allows companies to focus their talent and resources on improving and expanding activities that generate revenue, minimizing the effort spent on maintaining the infrastructure that supports the core of the business while also exploiting the skills, technology of some suppliers to strengthen their core competency as well as maintain their non-core sector (Murray & Kotabe, 1, p.74; Leavy, 001, p.47).
Types of outsourcing
The range of arrangements between purchasers and service providers highlights a variety of outsourcing forms. Depend on the length of contracting time and the level of risk share, outsourcing arrangement can be classified into four types total outsourcing, selective outsourcing, strategic alliance sourcing and insourcing (Currie & Willcocks, 18, p.1).
Total outsourcing is when an organization chooses to contract out its service to a large single, preferred, trusted supplier. These contract usually last for five or ten years with the aim of nurturing partnership between the organization and that supplier. Total outsourcing enable the organization to concentrate on its core business activities, and remove the burden of having to manage and control what it considers to be a non-core service activity. However, total outsourcing carries with it the greatest interdependency between buyer and supplier and its success depends upon the development of a successful partnership between the two parties (Currie & Willcocks, 18, p.16).
The notion that a single vendor cannot possess world-class capabilities in all areas of business leads to the view that companies should embark on selective outsourcing to multiple vendors. Selective outsourcing, sometimes called transaction-based contracts, which are usually shorter, single contracts, with a supplier who compete with other suppliers for the business of the client (Kakabadse, A. & Kakabadse, N., 00, p.1). With this type of outsourcing, the interdependence of client and supplier is reduced to some extent as the client can flexibly switch from one supplier to another for the purpose of its business (Currie & Willcocks, 18, p.16).
Strategic alliance sourcing is entering into an alliance or a joint venture with a supplier on the basic of shared risks and rewards. It might be implemented by selecting an existing supplier or forming a new one to which service can be outsourced. By doing this way, the organization can be able to influence the strategy and planning processes of the supplier as well as access to particular managerial and technical skills, which it does not have in-house (Currie & Willcocks, 18, p.14). Strategic alliance sourcing might derive from the exposing of internal cost based activities to market forces, thereby turning them into separately managed profit centres, or have been viewed as a desired, alternative form of organization for the future (Chalos & Sung, in Kakabadse, A. & Kakabadse, N., 00, p.1).
Insourcing is a strategy in which an organization would like to reduce risks and interdependency between it and the supplier by retaining an in-house service section and insource technical capability in the form of contractors in accordance with the peaks and troughs of the service needed. Insourcing solves the problem that, in some cases, the in-house technical capability is equal to, if not greater than, that of supplier; therefore, outsourcing would not gain benefits such as accessing special skills or human resources. However, there is no guarantee that an in-house service section, with contractors being managed internally as permanent staff, will create more effective service operations (Currie & Willcocks, 18, p.17).
According to Murray and Kotabe (1, p.7), when classifying outsourcing in terms of locational and ownership aspects of service sourcing strategy, there are also four types of outsourcing internal versus external sourcing (ownership) and domestic versus global sourcing (location).
Why organizations outsource
Recently, increasingly rapid changes in all aspects of the environments, and in technology and international deregulation have challenged large corporations to compete on a global scale (Kanter, in Hendry, 15, p.14). To meet this competition the giants had to learn to dance, to be flexible themselves, and to "do more with less". Critically reviewing the sources of their value-added, many were beginning to contract out non-core functions and move towards to fast-moving, fashion-based industries (Hendry, 15, p.14). Hendry also states that the forces of competition were greater by the effects of the recent recession, and cost-cutting in all forms became today essential. Companies were forced to look much harder than ever before at their efficiency. And among measures like downsizing, delayering, internal markets or reengineering, outsourcing also remained a key element of the cost-cutting mix (Kakabadse, A. & Kakabadse, N., 00, p.1; Hendry, 15, p.14).
However, reducing costs is not a unique reason that companies begin outsourcing services (Lanz & Barr, 000, p.). Sound reason could include improving service quality and management, focusing more on the core competencies of the organization as there is a change or expected change in the company's markets. Gaining access to new technology and skills, reducing headcount, enhancing the organizations capability to develop new products and services, are identified as reasons for outsourcing. Shortening cycle times for market delivery, customer response is also a reason for contracting out (Leavy, 001, p.48; Lanz & Barr, 000, p.; Bailey, Masson & Raeside, 00, p.88).
What to outsource
The reasons why to outsource is certainly obvious; however, the most basic strategic choice is what to outsource (Leavy, 001, p.48). Recently, companies seem to favour extensive outsourcing. More and more companies are being advised to concentrate on core activities and outsource as much as possible the rest. This approach has so much popular that it is sometimes hard for us to imagine why high levels of integration ever made commercial or strategic sense.
For instance, back to the early 180s, the IT industry was dominated by a small number of manufacturers, like IBM and Digital, which controlled the key technologies in both hardware and software. These companies sold very high margin products directly to industrial and commercial customers. However, the situation, then, has changed dramatically. The IT industry has recorded rapid growth through the increasing convergence of computing and telecommunications, and has seen the emergence of a new mass-market segment following the arrival of the personal computer. This explosion resulted in the growing of the sub-supply sector, and gradually, contributed to the emergence of independent service providers in many non-core areas like construction, maintenance, and distribution. They are competitive in scales and reputation. As a result, todays industry leaders, like Dell and Cisco, now use extensive outsourcing. Cisco outsources most of its manufacturing and much of its product development. All of Dells software and non-assembly hardware are provided by outsiders. Dell has no plants for making microchips, printed circuit boards, keyboards or monitors. It takes orders directly from customers and uses third parties for distribution and servicing. Its value proposition is focused on the provision of quality, customisation and responsiveness at prices that competitors cannot match (Leavy, 001, p.48).
James Brian Quinn, an expert in management, (cited in Leavy, 001, p.48) states that extensive outsourcing is becoming more and more compelling, not just in the IT, but across the commercial spectrum. When properly developed, strategic outsourcing substantially lowers costs, risks and fixed investment while greatly expanding flexibility, innovative capabilities, and opportunities for creating higher value-added and shareholder returns.
In terms of what to outsource, Ventkatesan (in Leavy, 001, p.48) suggests that firms should concentrate on main components that are fundamental to product differentiation, and subcontract components that customers do not consider important. However, outsourcing, in this case, borders a too low level, which limits its potential.
On the other hand, Bask (001, p.478) recommends that a company can outsource all of its logistics services through one provider once having core capabilities such as marketing and selling to enhance the performance of the company. Those services could comprise of transportation, forwarding, warehousing, price ticketing and distribution to retail stores.
Contrarily, Quinn and Hilmer (quoted in Leavy, 001, p.48), are more adventurous when they advise that a firm should outsource any activity, except those where "it can achieve definable pre-eminence and provide unique value for customers", or for which it has a "critical strategic need". The most important thing is the opportunity to innovate, learn and create value with "best-in-class" suppliers.
Marketing has traditionally outsourced some of its functions to third parties like distribution and advertising, and today could be customers (Sheth, Sisodia & Sharma, 000, p.60). For example, a company may contract with an outside vendor to serve certain customers - a change the customers may not even be aware of. Fundamentally, the logic of customer outsourcing is to make unprofitable customers become profitable by making them a part of another company which has a more favourable cost structure (Sheth, Sisodia & Sharma, 000, p.60).
Benefits gain from outsourcing
Adopting outsourcing arrangements, companies could get four broad benefits from these strategies as follows
Specialization
Management must be focused on the areas which companies competitive advantages (Lanz & Barr, 000, p.). Having other suppliers in charge of supporting goods and services allows companies to concentrate on those activities in which they can establish distinctive core competence. By doing so, it allows companies for achieving economies of scale, thus producing goods or services more efficiently while improving quality through the application of specialist knowledge. In turn, the achievement of scale economies and quality improvement promotes the company's competitive advantage (Kakabadse, A. & Kakabadse, N., 000, p.10).
Speed
The rapid changes in the environment require organizations to be able to make and implement decisions quickly. The larger the infrastructure, the slower the company will change. Therefore, depending on the solution selected, an outsourcing solution can be up and run in a very short time (Lanz & Barr, 000, p.).
Flexibility
Enterprises that are to survive in competitive markets need to be able appropriately adjust their infrastructure scale and scope at low cost and a rapid rate (Hayek cited in Kakabadse, A. & Kakabadse, N., 000, p.10). It is apparent that small enterprises with their clients, cooperated by performance-related contracts, have the ability to adjust more quickly and cost effectively to changing conditions than large integrated corporations.
Every company has limits on the resources it can call upon, the constant challenge is to ensure that these limited resources are directed towards the most important activities. Outsourcing allows the organization to redirect its resources from non-essential activities towards those essential activities, generating greater rewards (Lanz & Barr, 000, p.; Kakabadse, A. & Kakabadse, N., 000, p.10).
Efficiency
Geography does not protect against cheaper products or services any more, because consumers can now shop globally (Lanz & Barr, 000, p.). Market competition usually leads to an environment of competitive pricing, thus forcing players to lower cost of goods and service delivery. In order to maintain a cost-driven competitive advantage, an efficient mechanism for reducing resource costs is outsourcing (Williamson, in Kakabadse, A. & Kakabadse, N., 000, p.110). However, outsourcing only brings in efficiency where competition itself is an effective driver of price.
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