Outsourcing: Advantages and Disadvantages

Introduction & Overview

The dramatic changes that have occurred in the global business and economic environment in recent times have not just created great growth opportunities for western businesses, but also provided them with new avenues for improvement of efficiency, productivity and profitability (Cullen & Others, 2005). Astonishing technological advances, along with globalisation, the growth of instantaneous communication systems, the dismantling of physical and economic barriers between countries, economic liberalisation, the unrestricted movement of goods, people and capital, cheaper travel, and the development of low cost and good quality centres for production of goods and services, as well as markets, in transitional economies like those of China, India, Russia, Brazil and South Africa, have radically changed the business environment of western companies(Cullen & Others, 2005).

Changes in business and economic environments have been instrumental for the emergence of outsourcing, a business process for achieving improvements in organisational efficiencies, customer response and costs (Lamminmaki, 2003) (McIvor, 2008b). Whilst outsourcing has in recent years come into public focus in the UK and the USA because of the migration of jobs from these countries to outsourcing locations in lower cost production and service centres across Asia, it is also readily taking place within organisations operating within the same local and national boundaries (Lamminmaki, 2003). Accepted to be one of the most significant management concepts and practices to have emerged after the closing of the Second World War, outsourcing can be very broadly defined as “the process whereby activities traditionally carried out internally are contracted out to external providers” (Lamminmaki, 2003).

Outsourcing, even though it is now broadly identified with the offshore migration of facilities for production of goods and services, can actually come about through various forms of relationships between business firms like joint ventures, partnerships, franchises, and shared service arrangements, as well as virtual organisations, where a core of in-house executives are supported by external contractors (McIvor, 2008b) (Harland & Others, 2008). Despite outsourcing often being associated with downsizing, there is a clear distinction between the two processes; downsizing relates to doing the same activity with lesser people, whereas outsourcing relates to the alteration of organisational boundaries (Harland & Others, 2008).

Outsourcing provides a very strong avenue for organisations to improve their efficiencies, reduce their costs, improve their performance, enhance their customer relationships and improve their competitive advantage (McIvor, 2008b) (Harland & Others, 2008). The hotel industry is also engaging with outsourcing in various operational areas and the trend appears to be increasing with time (Harland & Others, 2008). However, outsourcing is essentially an extremely complex process, and whilst most firms engage in such activity to reduce their costs, cross industry surveys have repeatedly shown that a limited minority (above 20-25%) actually achieve significant cost reduction (Harland & Others, 2008). The complexity of the process, especially in offshore outsourcing, brings with it a range of difficult challenges that need to be overcome for organisations to actually benefit from its many advantages (Harland & Others, 2008).

Outsourcing: Advantages and Disadvantages

Most outsourcing decisions in modern business organisations are important and complex enough to be considered integral to broad organisational strategy (Doh, 2005). With outsourcing essentially referring to the contracting of functions that were or are traditionally executed in-house to specific external suppliers, outsourcing decisions are associated not just with cost savings, performance improvement and improved customer service and response, but also with a range of risks that can arise from the removal of specific functions from the internal organisational domain and their transfer to external suppliers (Trent & Monczka, 1998) (Doh, 2005). Even a simple and routine hospitality function like laundry can prove to be a source of concern if it is outsourced and the service providing organisation fails to meet its commitments. Whilst outsourcing of laundry can lead to saving of space, elimination of concerned machinery, and reduction of supervisory and operational manpower on the part of hotels, late deliveries of laundered items or damage to clothes during laundering can lead to customer inconvenience, dissatisfaction, loss of reputation and loss of repeat business.

Performance Improvement

Outsourcing decisions are closely related to broad organisational strategy, and can be taken for strategic improvement, (by way of reducing costs or increasing efficiencies), strategic business impact, (by way of enhancing performance), strategic exploitation of commercial opportunities, and strategic enhancement of scale (Trent & Monczka, 1998) (Doh, 2005).

The major reasons for outsourcing normally relate to (a) improvement of company focus, (b) gaining access to high class and international capabilities, (c) accelerating re-engineering benefits, (d) sharing risks, (e) freeing of manpower and other non-capital resources, (f) increasing availability of capital funds, (g) reducing operating expenditure, (h) obtaining infusions of cash (I) obtaining resources that are not internally available and (j) eliminating functions that are not easy to manage (De Boer & Others). Apart from such advantages, outsourcing offers managements avenues to avoid difficulties in speciality areas, which are external to their core operations (De Boer & Others, 2006). Such strategies empower managements with increased flexibility in the allocation of human resources, make commercial suppliers of outsourced services contractually bound to levels of costs and services that are not always possible in-house, free high quality in-house staff for interesting and important tasks, relieve managements from the distraction of controlling staff functions and help in improving quality (Neu & Brown, 2005) (De Boer & Others, 2006). As is evident, many of these benefits can lead to significant improvement in organisational performance, both from the angle of improvement in marketing and revenues, as well as from enhancement of operating efficiencies, improvement in performance and reduction of operating costs (De Boer & Others, 2006).

Risks and Challenges

Whilst outsourcing does provide a range of avenues for building competitive advantage, it is a complex and difficult process and outsourcing decisions inevitably lead to the generation of numerous challenges, some of which are routine and others unique and case specific (Moses & Hlstro, 2008) (De Boer & Others, 2006). It is a fallacy to think for instance that outsourcing can always lead to significant cost savings (De Boer & Others, 2006). Cost savings occur, as revealed by different surveys, in not more than 20% of outsourcing initiatives (De Boer & Others, 2006). Practically 50% of organisations who engage in outsourcing however do manage to break even, even whilst a significant proportion of firms end up spending more money after implementing outsourcing strategies (De Boer & Others, 2006).

Outsourcing also opens organisations to a range of risks (De Boer & Others, 2006). Any outsourcing decision leads to the ceding of operational control over some areas of business activity to the service provider (Moses & Hlstro, 2008) (De Boer & Others, 2006). Such loss of control can lead to difficulties with operations and affect responses with clients, if actions at the end of the service providers go wrong (Moses & Hlstro, 2008) (De Boer & Others, 2006). Most outsourcing agreements suffer from irreversibility because such contracts are usually followed by the extinguishing of existing facilities and disbanding of the workforce required for carrying out the in-house functions (Moses & Hlstro, 2008) (De Boer & Others, 2006). It thus becomes extremely difficult and expensive to reverse such decisions and bring them back into direct organisational control (De Boer & Others, 2006).

Although outsourcing initially appears to be extremely attractive because of significant cost differentials between doing and buying, environmental and situational changes often lead to the neutralisation of such cost advantages (Hansen & Others, 2008) (Baloh & Others, 2008). India, an extremely important hub for outsourcing of call centre activity, as well as a range of business process activities in finance and banking, became an attractive destination for outsourcing because of its large pool of adequately capable but economically priced workers (Hansen & Others, 2008) (Baloh & Others, 2008). Increasing demand for suitably equipped workers has over time driven salaries up by more than 3 times, thus revising the revenue and profitability forecasts of the service providers and forcing them to take corrective action, either by escalating prices or by recruiting cheaper people and then training them up to required levels (Baloh & Others, 2008). It also needs to be realised that service providers have to make profits at prices that organisations treat as normal costs (Hansen & Others, 2008) (Baloh & Others, 2008).
Outsourcing to cheap labour regions automatically provides suppliers with cost differentials; the same however does not hold true where services are outsourced to other firms in the same location (Holland & Others, 2005) (Baloh & Others, 2008). Service providers in such cases have to work in cost environments that are similar to the one faced by the outsourcer and have to achieve their cost economies through other means (Holland & Others, 2005) (Baloh & Others, 2008). Outsourcing is also normally associated with reduction in labour work force, a development that has repeatedly been found to be associated with decrease of morale in the people left behind in the organisation after job cuts, increased insecurity among employees, and significantly increased attrition, which in turn has to either be controlled or neutralised through increased employee engagement and fresh recruitment (Baloh & Others, 2008).

The quality of services outsourced becomes totally dependent upon the existing and adopted processes of service providers (Doig & Others, 2001). With there being a natural tendency to increase profits, service providers can on occasion forsake adherence to contracted quality levels in the interest of improving their profitability; such possibilities require outsourced activity to be closely monitored and followed up (Doig & Others, 2001).

Most service providers build up operational scales by providing the same sort of service to a large number of clients (Baloh & Others, 2008). These circumstances hold good for basic activities like security and laundry services, as well as for bespoke activities like Call Centre or business processing work (Baloh & Others, 2008). The internal prioritising of clients in terms of importance at the service provider’s end could lead to lesser attention being given to particular clients with consequently adverse effects upon their operations (Doig & Others, 2001) (Baloh & Others).Successful outsourcing has become associated with appropriated selection of outsourcing activity and a range of precautions that need to be taken for successfully initiating, developing and executing outsourcing strategies (Burnes & Anastasiadis, 2003).

Core and Non-Core Functions

At the core of the selection process is the differentiation between core and non-core activities (Lamminmaki, 2003). Core activities are those that are essentially mainline to particular organisations and are essential for the delivery of the key products and services. Such activities are associated with specific organisational skills and competencies and form the main activity of organisations, around which the rest of their activities are structured (Lamminmaki, 2003). Non-core activities on the other hand represent the many supporting activities, many of which are staff in nature, and which have to be regularly carried out for businesses to run smoothly (Burnes & Anastasiadis, 2003) (Lamminmaki, 2003).

The majority of management and outsourcing experts feel that core activities should essentially be kept within the organisation, whilst non-core activities should be carefully outsourced (Lamminmaki, 2003). Core activities differ from firm to firm; laundering for example constitutes a core activity of laundries, whereas it is a non-core activity for restaurants. Accounting firms keep the confidential and complex accounting work of their clients in-house, even as they hive off the preparation of routine tax returns to outside service providers. Keeping core activities within organisations helps them in sharpening their focus on their key activities, improving core competencies, acquiring skills, enhancing scales and sharpening competitive advantage (Burnes & Anastasiadis, 2003) (Lamminmaki, 2003). Such benefits, if properly utilised, can be instrumental in improvement of organisational performance (Lamminmaki, 2003).

Outsourcing of non-core activities on the other hand enables firms to eliminate the distractions that occur from their constant engagement in a range of side activities with consequent diffusion of management effort and reduction of focus on key issues (Burnes & Anastasiadis, 2003) (Lamminmaki, 2003). Non-core activities are by and large decided with the help of some commonly used criteria, namely whether they are routine in nature, whether they are delineated properly, whether they are capable of being assessed and managed from a distance, whether they can be readily made available by competent and established suppliers, and whether they are provided in essentially competitive environments (Lamminmaki, 2003). The distinction between core and non-core activities is however slowly becoming blurred and activities that even a few years ago were considered to be absolutely core are now slowly being taken up for outsourcing (Lamminmaki, 2003).

Whilst foods and beverages have traditionally been considered to be integral to the image and attraction of hotels, there is a growing feeling in hospitality circles that the two businesses, namely providing rooms and service and running food centric activities, are essentially different and that the provisioning of foods and beverages has little in common with the primary objective of hotels to provide comfortable and attractive accommodation (Lamminmaki, 2003).

Conclusions

Outsourcing, as evident, can help organisations through various ways in significantly improving performance, reducing costs and enhancing competitive advantage. The fundamental premise of outsourcing lying in enabling organisations to build specialised skills, competencies and economies of scale by focussing on key areas of work, the adoption of such strategy leads to synergising the actions of different organisations whereby organisations can improve their performance and quality improve, reduce their costs, improve customer relationships and engagement and add to their competitive advantage (Aron & Singh, 2005).

It is also plain that whilst outsourcing can lead to significant benefits, the process entails a range of risks and challenges and needs to be implemented with great thought and planning (Mark & Others, 2005). The most important decision that needs to be taken in such do or buy decisions is the core or non-core nature of the function to be outsourced, there being general agreement on the need for most organisations to keep core activities in-house and outsource those that are non-core, where cost savings can be achieved, where outsourcing can lead to performance improvement and where it does not add to risks (Aron & Singh, 2005) (Moses & Hlstro, 2008).

The size of the organisations is also a relevant factor in outsourcing decisions and strategies. Organisations that are small in size may not be able to take advantage of outsourcing benefits because of their inability to attract extremely competent suppliers who could provide the advantages of both specialisation and scale economies (Aron & Singh, 2005). On the other hand the loss of control that is normally associated with outsourcing, compounded with lesser than normal attention by the supplier, could lead to adverse effects upon the operational performance and customer satisfaction of smaller firms (Aron & Singh, 2005).
Organisations also on occasion consider purchasing other firms in order to gain the scale and specialisation benefits available with such businesses. Companies like GE, who came to India to outsource their transaction based operations finally purchased the operations of Indian outsourcers and set up their own in-house units (Harland & Others, 2008). Retailers of hot dogs and hamburgers could buy from producers or decide to acquire one of their suppliers in order to integrate vertically upwards. Such strategic decisions are guided by a range of factors including the size of the buying and target companies and the synergies that can be achieved during the process (Mahnke, 2001).

Whilst such strategies are by and large not viable because of the impracticality of taking over different and essentially non-core businesses, they afford a route to large organisations to achieve scale economies and acquire specialised skills without compromising control (Mahnke, 2001). Managements also need to be very careful about the extent of outsourcing to which they can commit their organisations, because whilst outsourcing can lead to reduction of costs, improvement of performance and sharing of risks, too much of outsourcing can lead to loss of control, reduction of competence in key areas, and stifling of internal innovation as well as specialisation (Mahnke, 2001).

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