Outsourcing as a Strategic Management Concept Explained

Definition of Outsourcing

Outsourcing is defined as the contracting of another person or company to perform a specialized function (Lacity and Hirschheim, 1993). It can also be defined as contracting out a business process to a third party. In the current business environment, virtually all businesses outsource in some way. The term outsourcing not only refers to the large-scale contracting of firms to perform specific functions, but also refers to any non-core activity that a business contracts out to another company. For example, an insurance company could outsource its janitorial operations to another company, which would ensure that the insurance company can focus on its core business. Outsourcing ensures that a business can concentrate on its core activities and its overall strategy (Grossman and Helpman, 2005). The firms contracted to perform or offer the service have the necessary expertise and have specialized in the type of work being contracted out.

Outsourcing offers a company greater budget control and flexibility, because the company is able to limit its expenses (Feenstra and Hanson, 1996). Compared to providing a service or function in-house, businesses often prefer to outsource since this offers reduced costs. Outsourcing is a cheaper way to carry out non-core functions of a business. Functions such as human resources, information technology, finance and accounting, and call center operations can be easily outsourced to firms that have better expertise performing these functions. This ensures that the business is able to focus solely on its core activities. This is a strategic management concept because it reduces the resources required by a company. A company that is able to focus on its core business is more likely to succeed, since it would invest and concentrate on its main activities. Focusing all its resources toward its primary activity ensures that the company remains on course and is not distracted by peripheral functions.

Outsourcing is the practice used by companies to reduce operational costs by shifting portions of non-core work to other companies instead of performing them internally. As a strategic cost-saving approach, outsourcing can be effective if implemented properly. It is widely recognized that it is cheaper to buy goods or services from a company that deals exclusively with those goods or services rather than producing them internally. The advantages that a business gains from outsourcing some of its functions far outweigh the benefits of handling those functions in-house. With the advancement of technology, companies are now able to contract some of their business functions to other countries where services are offered at far lower rates. The contracted companies have the capability to perform and deliver excellent service, making them attractive partners. For example, many companies have outsourced their customer service function to call centers located in India. These call centers offer high-quality services at very low rates, which is attractive for a company looking to reduce its operational costs, since maintaining an internal call center is costly to run and operate.

According to Feenstra and Hanson (1999), many United States companies choose to outsource in order to avoid certain costs such as high taxes, labor costs, excessive government regulations, and high energy costs. High corporate taxes and mandatory employee benefits are further incentives for outsourcing. Once a process has been outsourced, the company is only charged for the service offered by the contracted company. The outsourced company takes care of all additional charges, reducing the burden of ensuring compliance and paying necessary taxes. Accounting responsibility is reduced, and business managers can focus on more productive functions.

The History of Outsourcing

It is widely recognized that companies have been struggling with how to increase their profits, grow their markets, and exploit their competitive advantages (Duhamel et al., 2012). The models used in the past were not favorable for global companies, as they were primarily focused on assets. Today, many business factors demand that managers look beyond their core competencies alone. Understanding how a business can reduce costs while increasing productivity and customer service has taken center stage. Companies have realized that the customer is central to success, and they are now looking for strategies to stay close to their customers at all times. Outsourcing of customer service and information technology are two key areas that can provide a company with advantages over its rivals. A well-managed outsourced customer service operation ensures a business can attend to its customers' requests at all times, regardless of location, while the business receives consolidated performance reports.

Kelly (2002) notes that during the 20th century, the ability for a company to own, directly control, and manage its assets and processes was the primary measure of its success. This was considered a sound strategy because the business could monitor all its assets and processes and control the direction in which the company moved. The diversification rallying cry began in the 1950s and 1960s, allowing businesses to take advantage of economies of scale and broaden their corporate bases. Diversification enabled companies to protect their profits and expand their operations, but it also resulted in multiple management layers. The organizations that attempted to compete globally in the 1970s and 1980s were handicapped because they were not agile. The lack of agility was a result of bloated management structures within those organizations (Handfield, 2008). In order to increase creativity and flexibility, many large organizations formulated a new strategy that focused on the organization's core competencies. This required organizations to identify their critical processes and decide which processes could be outsourced.

As a business strategy, outsourcing was formally identified in 1989 (Lonsdale and Cox, 2000), but most organizations were not yet fully self-sufficient. Many opted to outsource only those functions for which they lacked internal competency. In the evolution of outsourcing, the baseline stage involved using external suppliers to deliver essential but ancillary services. The outsourcing of support services was the next step in this evolution. When organizations began to focus on cost-saving measures in the 1990s, they started to outsource functions that were necessary for running the company but not specifically related to its core business. Managers began to contract with emerging companies that offered services such as human resources, accounting, security, data processing, plant maintenance, and internal mail distribution. In the 1990s, organizations were more focused on increasing revenues while reducing costs. It was this desire that led most organizations to discover the value of contracting out certain business functions. The outsourcing of specific components in order to achieve cost savings in key functions represented another stage in the evolution of outsourcing, which at this point was primarily used to improve company finances.