Outsourcing

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Outsourcing is subcontracting a process, such as product design or manufacturing, to a third-party company.

Outsourcing became part of the business lexicon during the 1980s.

The decision to outsource is often made in the interest of lowering firm costs, redirecting or conserving energy directed at the competencies of a particular business, or to make more efficient use of labor, capital, technology and resources.

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Overview

Outsourcing involves the transfer of the management and/or day-to-day execution of an entire business function to an external service provider. The client organization and the supplier enter into a contractual agreement that defines the transferred services. Under the agreement the supplier acquires the means of production in the form of a transfer of people, assets and other resources from the client. The client agrees to procure the services from the supplier for the term of the contract. Business segments typically outsourced include information technology, human resources, facilities and real estate management, and accounting. Many companies also outsource customer support and call center functions like telemarketing, customer services, market research, manufacturing and engineering.

Outsourcing and offshoring are used interchangeably in public discourse despite important technical differences. Outsourcing involves contracting with a supplier, which may or may not involve some degree of offshoring. Offshoring is the transfer of an organizational function to another country, regardless of whether the work is outsourced or stays within the same corporation.

With increasing globalization of outsourcing companies, the distinction between outsourcing and offshoring will become less clear over time. This is evident in the increasing presence of Indian outsourcing companies in the US and UK. The globalization of outsourcing operating models has resulted in new terms such as nearshoring and rightshoring that reflect the changing mix of locations. This is seen in the opening of offices and operations centers by Indian companies in the U.S. and UK..

Multisourcing refers to large (predominantly IT) outsourcing agreements. Multisourcing is a framework to enable different parts of the client business to be sourced from different suppliers. This requires a governance model that communicates strategy, clearly defines responsibility and has end-to-end integration.

Process of outsourcing

Deciding to outsource

The decision to outsource is taken at a strategic level and normally requires board approval. Outsourcing is the divestiture of a business function involving the transfer of people and the sale of assets to the supplier. The process begins with the client identifying what is to be outsourced and building a business case to justify the decision. Only once a high level business case has been established for the scope of services will a search begin to choose an outsourcing partner.

Supplier proposals

A Request for Proposal (RFP) is issued to the shortlist suppliers requesting a proposal and a price.

Supplier competition

A competition is held where the client marks and scores the supplier proposals. This may involve a number of face-to-face meetings to clarify the client requirements and the supplier response. The suppliers will be qualified out until only a few remain. This is known as down select in the industry. It is normal to go into the due diligence stage with two suppliers to maintain the competition. Following due diligence the suppliers submit a "best and final offer" (BAFO) for the client to make the final down select decision to one supplier. It is not unusual for two suppliers to go into competitive negotiations.

Negotiations

The negotiations take the original RFP, the supplier proposals, BAFO submissions and convert these into the contractual agreement between the client and the supplier. This stage finalizes the documentation and the final pricing structure.

Contract finalization

At the heart of every outsourcing deal is a contractual agreement that defines how the client and the supplier will work together. This is a legally binding document and is core to the governance of the relationship. There are three significant dates that each party signs up to the contract signature date, the effective date when the contract terms become active and a service commencement date when the supplier will take over the services.

Transition

The transition will begin from the effective date and normally run until four months after service commencement date. This is the process for the staff transfer and the take-on of services.

Transformation

The Transformation is the execution of a set of projects to implement the Service Level Agreement (SLA), to reduce the Total Cost of Ownership (TCO) or to implement new Services. Emphasis is on 'standardisation' and 'centralisation'.

Ongoing service delivery

This is the execution of the agreement and lasts for the term of the contract.

Termination or renewal

Near the end of the contract term a decision will be made to terminate or renew the contract. Termination may involve taking back services (insourcing) or the transfer of services to another supplier.

Reasons for outsourcing

Organizations that outsource are seeking to realize benefits or address the following issues:

• Cost savings. The lowering of the overall cost of the service to the business. This will involve reducing the scope, defining quality levels, re-pricing, re-negotiation, cost re-structuring. Access to lower cost economies through offshoring called "labor arbitrage" generated by the wage gap between industrialized and developing nations.
• Cost restructuring. Operating leverage is a measure that compares fixed costs to variable costs. Outsourcing changes the balance of this ratio by offering a move from fixed to variable cost and also by making variable costs more predictable.
• Improve quality. Achieve a step change in quality through contracting out the service with a new Service Level Agreement.
• Knowledge. Access to intellectual property and wider experience and knowledge.
• Contract. Services will be provided to a legally binding contract with financial penalties and legal redress. This is not the case with internal services.
• Operational expertise. Access to operational best practice that would be too difficult or time consuming to develop in-house.
• Staffing issues. Access to a larger talent pool and a sustainable source of skills.
• Capacity management. An improved method of capacity management of services and technology where the risk in providing the excess capacity is borne by the supplier.
• Catalyst for change. An organization can use an outsourcing agreement as a catalyst for major step change that can not be achieved alone. The outsourcer becomes a Change agent in the process.
• Reduce time to market. The acceleration of the development or production of a product through the additional capability brought by the supplier.
• Commodification. The trend of standardizing business processes, IT Services and application services enabling businesses to intelligently buy at the right price. Allows a wide range of businesses access to services previously only available to large corporations.
• Risk management. An approach to risk management for some types of risks is to partner with an outsourcer who is better able to provide the mitigation.
• Time zone. A sequential task can be done during normal day shift in different time zones - to make it seamlessly available 24x7. Same/similar can be done on a longer term between earth's hemispheres of summer/winter.

Criticisms of outsourcing

Public opinion

There is strong public opinion regarding outsourcing (especially when combined with offshoring) that outsourcing damages a local labor market. Outsourcing is the transfer of the delivery of services which affects both jobs and individuals. It is difficult to dispute that outsourcing has a detrimental effect on individuals who face job disruption and employment insecurity; however, its supporters believe that outsourcing should bring down prices, providing greater economic benefit to all. There are legal protections in the European Union regulations called the Transfer of Undertakings (Protection of Employment) that protects individual rights. Labor laws in the United States are not as protective as those in the European Union. A study has attempted to show that public controversies about outsourcing in the U.S. have much more to do with class and ethnic tensions within the U.S. itself, than with actual impacts of outsourcing.

Against shareholder views

For a publicly listed company it is the responsibility of the board to run the business for the shareholders. This means taking into consideration the views of the shareholders. Shareholders may be interested in return on investment and/or social responsibility. The board may decide that outsourcing is an appropriate strategy for the business. Shareholders have a responsibility to make their views known to the board of directors if they are against outsourcing.

Failure to realize business value

The main business criticism of outsourcing is that it fails to realize the business value that the outsourcer promised the client.

Language skills

In the area of call centers end-user-experience is deemed to be of lower quality when a service is outsourced. This is exacerbated when outsourcing is combined with off-shoring to regions where the first language and culture are different. The questionable quality is particularly evident when call centers that service the public are outsourced and offshored.

There are a number of the public who find the linguistics features such as accents, word use and phraseology different which may make call center agents difficult to understand. The visual clues that are present in face-to-face encounters are missing from the call center interactions and this also may lead to misunderstandings and difficulties.

Social responsibility

Some argue that the outsourcing of jobs (particularly off-shore) exploits the lower paid workers. A contrary view is that more people are employed and benefit from paid work.

Quality of service

Quality of service is measured through a service level agreement (SLA) in the outsourcing contract. In poorly defined contracts there is no measure of quality or SLA defined. Even when an SLA exists it may not be to the same level as previously enjoyed. This may be due to the process of implementing proper objective measurement and reporting which is being done for the first time. It may also be lower quality through design to match the lower price.

There are a number of stakeholders who are affected and there is no single view of quality. The CEO may view the lower quality acceptable to meet the business needs at the right price. The retained management team may view quality as slipping compared to what they previously achieved. The end consumer of the service may also receive a change in service that is within agreed SLAs but is still perceived as inadequate. The supplier may view quality in purely meeting the defined SLAs regardless of perception or ability to do better.

Quality in terms of end-user-experience is best measured through customer satisfaction questionnaires which are professionally designed to capture an unbiased view of quality. Surveys can be one of research. This allows quality to be tracked over time and also for corrective action to be identified and taken.

Staff turnover

The staff turnover of employee who originally transferred to the outsourcer is a concern for many companies. Turnover is higher under an outsourcer and key company skills may be lost with retention outside of the control of the company.

In outsourcing offshore there is an issue of staff turnover in the outsourcer companies call centers. It is quite normal for such companies to replace its entire workforce each year in a call center. This inhibits the build-up of customer knowledge and keeps quality at a low level.

Company knowledge

Outsourcing could lead to communication problems with transferred employees. For example before transfer staff have access to broadcast company e-mail informing them of new products, procedures etc. Once in the outsourcing organization the same access may not be available. Also to reduce costs, some outsource employees may not have access to e-mail, but any information which is new is delivered in team meetings.

Qualifications of outsourcers

The outsourcer may replace staff with less qualified people or with people with different non-equivalent qualifications.

In the engineering discipline there has been a debate about the number of engineers being produced by the major economies of the United States, India and China. The argument centers around the definition of an engineering graduate and also disputed numbers. The closest comparable numbers of annual gradates of four-year degrees are United States (137,437) India (112,000) and China (351,537).

Work, labor, and economy

Productivity

Offshore outsourcing for the purpose of saving cost can often have a negative influence on the real productivity of a company. Rather than investing in technology to improve productivity, companies gain non-real productivity by hiring fewer people locally and outsourcing work to less productive facilities offshore that appear to be more productive simply because the workers are paid less. Sometimes, this can lead to strange contradictions where workers in a third world country using hand tools can appear to be more productive than a U.S. worker using advanced computer controlled machine tools, simply because their salary appears to be less in terms of U.S. dollars.

In contrast, increases in real productivity are the result of more productive tools or methods of operating that make it possible for a worker to do more work. Non-real productivity gains are the result of shifting work to lower paid workers, often without regards to real productivity. The net result of choosing non-real over real productivity gain is that the company falls behind and obsoletes itself overtime rather than making real investments in productivity.

Standpoint of labor

From the standpoint of labor within countries on the negative end of outsourcing this may represent a new threat, contributing to rampant worker insecurity, and reflective of the general process of globalization (see Krugman, Paul (2006). "Feeling No Pain." New York Times, March 6, 2006). While the "outsourcing" process may provide benefits to less developed countries or global society as a whole, in some form and to some degree - include rising wages or increasing standards of living - these benefits are not secure. Further, the term outsourcing is also used to describe a process by which an internal department, equipment as well as personnel, is sold to a service provider, who may retain the workforce on worse conditions or discharge them in the short term. The affected workers thus often feel they are being "sold down the river."

The U.S.

Outsourcing became a popular political issue in the United States during the 2004 U.S. presidential election. The political debate centered on outsourcing's consequences for the domestic U.S. workforce. Democratic U.S. presidential candidate John Kerry criticized U.S. firms that outsource jobs abroad or that incorporate overseas in tax havens to avoid paying their fair share of U.S. taxes during his 2004 campaign, calling such firms "Benedict Arnold corporations". Criticism of outsourcing, from the perspective of U.S. citizens, by-and-large, revolves around the costs associated with transferring control of the labor process to an external entity in another country. A Zogby International poll conducted in August 2004 found that 71% of American voters believed that “outsourcing jobs overseas” hurt the economy while another 62% believed that the U.S. government should impose some legislative action against companies that transfer domestic jobs overseas, possibly in the form of increased taxes on companies that outsource. One given rationale is the extremely high corporate income tax rate in the U.S. relative to other OECD nations , and the peculiar practice of taxing revenues earned outside of U.S. jurisdiction, a very uncommon practice. It is argued that lowering the corporate income tax and ending the double-taxation of foreign-derived revenue (taxed once in the nation where the revenue was raised, and once from the U.S.) will alleviate corporate outsourcing and make the U.S. more attractive to foreign companies. Sarbanes-Oxley has also been cited as a factor for corporate flight from U.S. jurisdiction.

Policy solutions to outsourcing are also criticized.

Security

Before outsourcing an organization is responsible for the actions of all their staff and liable for their actions. When these same people are transferred to an outsourcer they may not change desk but their legal status has changed. They no-longer are directly employed or responsible to the organization. This causes legal, security and compliance issues that need to be addressed through the contract between the client and the suppliers. This is one of the most complex areas of outsourcing and requires a specialist third party adviser.

Fraud

Fraud is a specific security issue that is criminal activity whether it is by employees or the supplier staff. It can be argued that fraud is more likely when outsourcers are involved. In April 2005, a high-profile case involving the theft of $350,000 from four Citibank customers occurred when call center workers, acquired the passwords to customer accounts and transferred the money to their own accounts opened under fictitious names. Citibank did not find out about the problem until the American customers noticed discrepancies with their accounts and notified the bank..

See also

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• Application Management Outsourcing
• Business process outsourcing in India
• Business process outsourcing in the Philippines
• Business process outsourcing
• Comparative advantage
• Compromise agreement
• Co-sourcing
• Crowdsourcing
• Farmshoring
• Freelancing on the Internet
• Homeshoring
• Hot desking
• Hotelling
• Information technology consulting
• Insourcing
• Knowledge process outsourcing (KPO)

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• Engineering Process Outsourcing (EPO)
• Legal Process Outsourcing (LPO)/ Legal outsourcing
• List of management topics
• List of Outsourcing Companies
• Nearshoring
• Nomad worker
• Offshore software development
• Offshoring IT Services
• Offshoring
• Service Level Agreement
• Small office/home office
• Supply Chain Management
• Supply chain
• Telecentre
• Telecommuting
• Telecottage
• Vertical integration

Further reading

• Ganesh, S. 2007. "Outsourcing as Symptomatic: Class visibility and ethnic scapegoating in the US IT Sector." Journal of Communication Management. 11.1: 71-83.
• Tim R. Holcomb, Michael A. Hitt. 2007. "Toward a model of strategic outsourcing". Journal of Operations Management, volume 25, issue 2: pp. 464-481
• Thomas Kern, Leslie P. Willcocks: „The Relationship Advantage“ Oxford University Press 2002, ISBN 0199241929
• Thomas Kern, Leslie P. Willcocks, Mary C. Lacity: „Netsourcing “ Prentice Hall PTR 2002, ISBN 0130923559
• Peter Bendor-Samuel (author), Turning Lead Into Gold: The Demystification of Outsourcing (2000), ISBN 1-890009-87-3
• A.D. Bardhan and C. Kroll, The New Wave of Outsourcing (2003).
• Peter Brudenall (editor), Technology and Offshore Outsourcing Strategies (2005), ISBN 1-4039-4619-1
• Lou Dobbs, Exporting America Why Corporate Greed is Shipping American Jobs Overseas, 2004 ISBN 0-446-57744-8
• Christopher M. England, Outsourcing the American Dream, October 2001, Writer's Club Press, ISBN 0-595-20148-2
• Georg Erber, Aida Sayed-Ahmed, Offshore Outsourcing - A Global Shift in the Present IT Industry , in: Intereconomics, Volume 40, Number 2, March 2005, S. 100 - 112, [1]
• Gary Gereffi and Vivek Wadhwa, Framing the Engineering Outsourcing Debate: Placing the United States on a Level Playing Field with India and China (2006).
• Thomas L. Friedman, The World is Flat: A Brief History of the Twenty-First Century 2005 ISBN 0-374-29288-4
• Ron Hira and Anirl Hira, with forward by Lou Dobbs Outsourcing America, What's Behind our national crisis and how we can reclaim American Jobs 2005 ISBN 0-8144-0868-0
• Mark Kobayashi-Hillary. 2004. (2nd ed 2005) Outsourcing to India. ISBN 3-540-23943-X.
• Mark Kobayashi-Hillary, 'Building a Future with BRICs: The Next Decade for Offshoring' (Nov 2007). ISBN 978-3-540-46453-2.
• Mark Kobayashi-Hillary & Dr Richard Sykes, 'Global Services: Moving to a Level Playing Field' (May 2007). ISBN 978-1-902505-83-1.
• William Lazonick, Globalization of the ICT Labor Force, in: The Oxford Handbook on ICTs, eds. Claudio Ciborra, Robin Mansell, Danny Quah, Roger Solverstone, Oxford University Press, (forthcoming)
• Baziotopoulos A. Leonidas (2006), "Logistics Innovation and Transportation", Work-in-Progress Conference paper, EuroCHRIE Thessaloniki, 2006.
• Catherine Mann, Accelerating the Globalization of America: The Role for Information Technology, Institute for International Economics, Washington D.C., June 2006, [2], ISBN paper 0-88132-390-X
• Stephen Haag, Maeve Cummings, Donald J. McCubbrey, Alain Pinsonneault, Richard Donovan "Management Information Systems For The Information Age", 2006, McGraw-Hill Ryerson, ISBN 0-07-095569-7
• National Academy of Public Administration. (2006). "Off-Shoring: An Elusive Phenomenon". Report for the U.S. Congress and the Bureau of Economic Analysis: Washington.
• McDonald, SM and Jacobs, TJ (2005) Brand Name ‘India’: The Rise of Outsourcing, Int. J. Management Practice, Vol. 1, No. 2, pp.152-174.
• Toledo, Mario, Outsourcing and Offshoring: Companies immerged in a complex environment,, Institute of Technology and Innovation Management Project Work, Hamburg University of Technology.
• Peter Wiggers, Maritha de Boer-de Wit, and Henk Kok, "IT Performance Management", 2003, ISBN 0750659262

External links

Industry bodies

• The National Outsourcing Association The outsourcing trade association advocating best practice in the industry.
• Shared Services & Outsourcing Network

Journals and publications

• economist.com
• Outsource Magazine
• Business Trends Quarterly (BTQ) - Strategic Sourcing Section
• zdNET Outsourcing Toolkit

Articles

• Nearshore outsourcing is more cost efficient than offshore outsourcing - by H.J.M. Boersen, W.G. van Gils and M. Zantinge
• Free Trade Bulletin no. 10. Why We Have Nothing to Fear from Foreign Outsourcing
• Reasons Leading to the Ineffectiveness of Information Systems Outsourcing in Minimising Costs - by Petros Michaelides (2006)
• Chindia Sweeps the Sourcing Space - by Partha Iyengar and James Popkin (Q2 2007)
• At Mysore We are Running a US Law Firm by Shelley Singh (Economic Times)
• Fortune 500 firms driving LPO industry by Praveen Bose (Business Standard)
• U.S. corporates outsource legal work to India by Anjali Prayag (The Hindu Business Line)
• New York Firm Takes On India... "Very Nice!" by Heather Greenwood Davis (The Globe and Mail -- Lexpert Magazine)
• LPOs add more punch to India action by Sushmita Mohapatra & P P Thimmaya (The Economic Times)
• Now, for some LPO action by Sachin Malhan (The Hindu)
• Making a Decision to Outsource: Driving Factors

Videos

• Report: Many U.S. Parents Outsourcing Child Care Overseas
• Trade and the Future of American Workers
• Difference between Outsourcing and Worldsourcing