Outsourcing: History, Trends, Pro and Cons, Real Cost Savings to Companies and Bottom Line Impact and Perceptions

Abstract

Outsourcing has been used by companies as a strategy to realize cost saving and to attain higher flexibility in staffing and general business agility. It was formally recognized in the late 1980s and organizations. Companies have been using outsourcing to derive benefits that it brings but it has been found out that a decision made by a company to outsource should be made carefully following some pitfalls it has and it does not necessarily lead to cost saving.

In order to avoid risks, companies have been selective about which functions to outsource and which ones not to outsource. Over time, companies all over the world have been increasingly engaging in outsourcing/ offshoring; the global IT and BPO market is approaching more than six hundred million U.S dollars. This paper looks at the history, pros and cons, trends, and real cost savings to companies and bottom line impact and perceptions of outsourcing.

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Introduction

According to Handfield (2006), outsourcing can be defined as “the strategic use of outside resources to perform activities traditionally handled by internal staff and resources” (Handfield, 2006, para 5). It is a strategy that an organization uses to contract out the major functions to the efficient service providers that are specialized, who turn out to be valued business partners.

Organizations have always engaged in hiring contractors to perform particular types of tasks or to stabilize troughs and peaks in the organizations’ workload, and have established long-term relationships with the companies whose ability serve to either supplement or complement their own.

Under the outsourcing topic, there are such terms as; “offshore” and “near-shore” outsourcing. Near-shore outsourcing involves sending work to the nearby neighbors while “offshore” outsourcing involves sending work overseas. However the term “offshoring” is the term used to refer to both “near-shore” and “offshore” outsourcing. In this paper, the history, trends, pros and cons, real cost savings to companies and bottom line impacts and perceptions of outsourcing are going to be discussed.

History of Outsourcing

Beginning from the industrial revolution time, corporations have been dealing with the issue of how they can effectively exploit the competitive advantage they have in order for them to increase their market share as well as their profit levels. Handfield (2006) points out that “the model for most of the 20th century was a large integrated company that can own, manage, and directly control its assets” (Handfield, 2006, para 1).

In the course of the 1950s and 60s, the “rallying cry” was diversification to make the corporate bases to be wider and to capitalize on the economies of scale. Through engaging in diversification, the companies had expectations of offering protection to their profits, even if expansion called for the need to have multiple management layers.

What followed was that the organizations’ efforts to engage in competition on a global level in the course of the 1970s as well as in 80s were frustrated by the absence of agility that came out from the bloated structure of management. In order for the organizations to bring up the level of creativity and flexibility, most of those that were large came up with a new strategy of putting focus on the core business.

This required companies to identify those processes that were critical and making a decision in regard with what process that could be outsourced.

There was no formal recognition of outsourcing as being a business strategy until the year 1989 (Mullin, 1996). A large number of organizations, however, were not fully self-sufficient; they engaged in outsourcing only those functions for which they did not have competency within the organization.

The next stage was the outsourcing support services. In the course of the 90s, while the companies started to put their focus more on those measures intended to save costs, they commenced on outsourcing functions that were vital in running a company but not linked to the core business specifically.

Those in the management positions engaged in contracting with the rising service companies to deliver “accounting, human resources, data processing, internal mail distribution, security, plant maintenance, and the like as a matter of ‘good housekeeping’” (Handfield, 2006, para 2).

The present state in outsourcing evolution is the setting up of strategic partnerships. Just until in the recent past, it had been quite clear that there was no organization that would make a move to outsource the core competencies; the functions which give an organization a strategic advantage or that enables the organization to be unique.

In most cases, the definition of a core competency is given as any function which “gets close to customers” (Handfield, 2006). In the course of the 90s, “outsourcing some core functions may be good strategy, not anathema” (Handfield, 2006, p.1). For instance, some companies outsource customer service, specifically for the reason that it is quite important.

Handfield (2006) points out that when Eastman Kodak decided to outsource the IT systems which undergird its business; this was taken to be revolutionary in the year 1989. However, in the actual sense, this was a consequence of rethinking about what their business was about. Several large companies whose management teams had determined that it wasn’t essential to possess technology in order to have access to information that was needed followed suit.

In the current times, the focus is more on setting up strategic partnership in order to obtain enhanced results and less on ownership. As a result of this, there is a higher likelihood for companies to choose outsourcing basing more on who can deliver the results that are more effectual for a particular function and less on “whether the function is core or commodity” (Handfield, 2006, para 3).

Pros and Cons of Outsourcing

The attraction for outsourcing is just tempting for business organizations to ignore. The companies are attracted by the short-time cost saving and long-term promise of higher flexibility in staffing and general business agility. However, since outsourcing involves a number of possible drawbacks and several critical success factors, the decision made in regard to outsourcing is not supposed to be made in a light manner.

Outsourcing is associated with a number of drawbacks. One of it is the hardship of having face to face communication and interaction with the business analysts as well as the end users.

For that reason, the projects that have requirements that are clearly defined which can utilize “modular and structured methodologies” and which are open to remote testing are, in general, well-matched for offshore development. In a similar manner, the applications that are, in relative terms, stable make it possible for the offshore project team to engage in focusing on the process as well as on the methodology instead of “firefighting” (Jones, 2003, p.4).

Contrary to this, “projects that require considerable end-user interaction and iteration during the lifecycle are not well-suited for offshore delivery”(Jones, 2003, p.4). In a similar manner, the pilot applications having procedures that are complex, substantial integration requirements with the rest of the systems, and “high business criticality are usually inappropriate for offshore delivery”( Jones, 2003, p.4).

Another problem is linked to overstating the cost saving that result from outsourcing by making an assumption that the entire work is supposed to be carried out offshore. Even if the offshore providers have significantly the labor rates that are lower, it is of great importance to engage in quantifying this benefit within the total costs context.

Thirdly, another possible problem that may be linked to outsourcing or offshoring is cultural difference. Even when considering domestic outsourcing, the disparity in the organizational cultures can turn out to be a big issue of concern. An outsourcer comes to the table with differences that may be based on such factors as societal beliefs, behavior standards, and organizational cultures which may be hard to understand.

“Introducing a conflict-avoiding culture in to a hard-driving, individualistic culture is but one example of potential organizational conflicts” (Jones, 2003, p.4). More complications and potential misunderstandings can be brought in by language and religious differences. In order to iron out things, it is important to ensure there is cross-cultural training (Jones, 2003).

The forth drawback is the likely effect that offshoring may have on staff of the company who may not be directly in the arrangements made in regard to offshoring. It is normal for the remaining staff to have worries that outsourcing of the extra departments is soon to be there. Dysfunctional and upsetting conduct can be made less by having constant communications of the organization’s staff members.

The fifth problem is the negative publicity may result from the misunderstandings of the motives behind offshoring as well as the gains of globalization. In relation to this, an example is given by Jones (2003) of a situation where outsourcing plans, of one particular company in the U.S, leaked out to a senator where he was misinformed that illegal aliens were being brought to the country to substitute the U.S laborers. In a situation like this, the company’s image may be spoiled even if the claims are presented on the basis of a false rumor.

Another potential drawback is the failure to set up a comprehensive plan which is supposed to obtain the approval of the senior management as well as the steering committee. On top of decreasing the negative effects of the problems that have been mentioned above, a good plan should encompass early and nonstop involvement of the professionals in the human resources department as well as the legal, public relations and outsourcing experts.

The work of the HR professionals is to keep the company’s staff informed; the legal experts can assist in navigating the complexities of contract as well as employment laws and the outsourcing experts can assist in advising and managing outsourcing evaluation as well as in the process of negotiation and implementation. The public relations experts can help in dealing with both the external and internal critics (Jones, 2003).

Trends in Outsourcing

The global IT and BPO or ‘Business Process Outsourcing’ market is reaching over six hundred million U.S dollars and it is increasing at a very high rate (Deloitte, 2008).In the current global economy, “investments in outsourcing and offshoring initiatives have never been higher or more critical to organizational success” (Deloitte, 2008, p.1).

However, companies are currently facing some outsourcing or offshoring risks which they need to address in order for them to operate successfully. Most of companies are trying to be careful about which functions or jobs to outsource and which ones they are not supposed to.

In recent times, several big companies in the United States such as J.P Morgan Chase, Dell Computers and Sears Roebuck & Co have engaged in scaling back or ending outsourcing agreements and consequently, thousands of jobs have been brought back in-house (Benman, 2007).

In a large number of cases, such jobs have been brought back from overseas. The “in-sourcing” or “back-sourcing” trend is gaining momentum in the American corporate world, as companies turn out to be more selective in regard to which functions need to be outsourced and which ones not to (Benman, 2007).

According to Benman (2007), among the jobs that were outsourced a number of years ago were such operations as “AT & T call centers”. At the present, these are among the jobs that are first being brought back. However, there exist no “hard data” in regard to the actual number of jobs that have been in-sourced by companies in the recent years.

Benman (2007) points out that “it is certainly not a tsunami of jobs washing back on U.S shores. A large portion of the data on outsourcing itself dates back to 2004, a time the American jobs outflow to nations abroad was a “hot topic in the U.S presidential campaigns” (Benman, 2007, p.1).

Between the year 2000 and 2004, an estimate was given by the ‘Forrester Research’ which indicated that four hundred thousand service jobs had been lost to the overseas outsourcing. In addition, it was also estimated by McKinsey Institute that offshoring would rise at a rate of between thirty and forty percent, having about 3.3 million jobs being moved to overseas countries by the year 2015. Frightening figures like these ones are a reason why the labor groups support any measure taken to in-source jobs.

Cost Saving to Companies and bottom line impact and perceptions

Even if there has been rapid maturity of the outsourcing market in the last few decades, there is still encountering of a large number of business organizations that regard outsourcing as being a cost saving activity (Longbottom, 2007).

These organizations are, in most cases, the ones that direct their blame to the outsourcing providers claiming that that the costs that were saved were not large enough, if ever they were there. They claim that the outsourcing company was not flexible; that it did not respond to the needs of the company accordingly (Longbottom, 2007).

However, Longbottom (2007) goes ahead to ask a question: “why should outsourcing be any cheaper?” (Longbottom, 2007, para 3). He points out that in the past, a company “could identify specific tasks that could be outsourced and shared with other companies, so gaining a degree of cost saving” (Longbottom, 2007, para 3).

An illustration is given of the case where there was attaining of success by break/fix outsourcing for the reason that business organizations came to a realization that it wasn’t cost-effective in a situation where there were trained engineers just staying around waiting for a computer to break down – “and that as these devices became more resilient, paying a professional to sit around and do crosswords didn’t make sense at all” (Longbottom, 2007, para 5).

By the business organization outsourcing this function, the outsourcing company could engage in sharing of these skills around, making sure that the engineer had a higher level of utilization.

Each individual company could pay for a particular percentage, like twenty percent, of the nominal time of the engineer and the outsourcing company would be sharing this engineer like between seven companies. This implies that each party in this will be nominally satisfied (Longbottom, 2007).

Considering task outsourcing, a business organization which is task oriented will possess internal resources which just spend the whole day performing repetitive tasks. This therefore implies that outsourcing has no benefits in utilization and there is still requiring of a dedicated resource.

Therefore, the only way to realize cost saving is having the resource costing less. Considering the fact that a large number of companies did not consider this as an issue rises much concern. Longbottom (2007) points out that in a large number of cases for those companies that ran to India to obtain skilled resource which was available at 40% of the cost in the United Kingdom, “history has begun to repeat itself” (Longbottom, 2007).

It is pointed out that in the course of the 1990s, “the Celtic Tiger of the Irish economy was driven by the availability of cheap, highly skilled labor…however, as more companies dived in to the market, these cheap, highly skilled people were rapidly soaked up” (Longbottom, 2007, para 8).

What was left were only two groups and these included those people who were highly skilled that were being paid reasonable salaries and the other group consisted of those who were less skilled and provided cheap labor (Longbottom, 2007).

The companies operating in Ireland that have attained success are those that made a decision to capitalize on the skilled labor at a competitive market rate. The same case has applied in the Netherlands and also, to a particular extent, in the Philippines and India. With no doubt, the same case will apply in China as well as in the Eastern Europe.

While the initial round of the skilled laborers are hired up, “pay rates will automatically rise and the cream of the skilled crop will move around in the global market to gain the top salaries”(Longbottom, 2007, para 10).

Indeed, Ireland is a nation having a population of about four million people and India is larger with over one billion people. However, not all these one billion inhabitants are individuals who are information technology experts and there is no possibility that all of them will ever be experts in this field. Even if great efforts are being carried out to ensure as many people as possible get skills, the market is approaching a saturation level.

Taking the case of China where about three hundred and fifty million people are learning conversational English, this is not supposed to be seen as having three hundred and fifty million people who will turn out to abruptly form part of cheap labor force “that will be either available to use in an offshoring manner, nor as a massive overwhelming threat to how we do business in the West” (Longbottom, 2007, para 11).

Quite important is the way information technology companies in India like TCS are building offices outside the country in the emerging markets to pursue lower salaries. Longbottom (2007) points out that the previous model of approaching an outsourcer in India for “Indian resources on a labor arbitrage basis is not sustainable in the long term” (Longbottom, 2007, para 12).

There has been consistent increase in the salary within the double digit range in the course of the few years that have passed and some of the people who are highly skilled have been migrating to Western Europe and also to the United States.

It has also been found out that the Indian outsourcing companies such as TSC, Wipro and Infosys among others do not want to be perceived as “just” cost-effective outsourcing companies any longer. They rather want to be seen as serious “global systems integrators”. This implies that there is ongoing placing of the cost argument on the “back-burner” in the best way possible. Indeed, there can be expectation of the appearance of new offshoring companies in such regions as North Africa, China among other areas.

However, globalization means that there is occurrence of wage inflation at a higher rate. It is pointed out that as on one hand it took Ireland about a decade to move from an “emerging, low-cost outsource provider market to a level playing-field, on the other hand, it’s looking like India will have done it in les than half that time” (Longbottom, 2007, para 13).

However, this does not mean the end of far-shoring. So long as outsourcing is done for the right reasons; in like such situations as where there is unavailability of appropriate skills locally to perform particular tasks or where particular tasks may call for having a situation where particular tasks are being undertaken in a better way by those companies that are specialists in them, then it may not be a great deal where the task is performed. But the cost must be taken as a secondary consideration.

Conclusion

A large number of companies across the world are using outsourcing as a source a source of competitive advantage in order to win the competition in the global market. Outsourcing, as a business strategy, brings in benefits to companies such as short-time cost saving and long-term promise of higher flexibility in staffing and general business agility. However outsourcing has some pitfalls which make the companies to carefully consider the decision to outsource.

These include; hardship of having face to face communication and interaction with the business analysts and the end users, overstating the cost saving that result from outsourcing by assuming that the whole work is supposed to be undertaken offshore, cultural differences, the possible effect that offshoring may have on staff of the company who may not be directly engage in the arrangements made in regard to outsourcing, negative publicity that may come out from the misunderstandings of the intentions behind offshoring, and lack of success in setting up a comprehensive plan which is supposed to receive the approval of the top management and the steering committee.

In order for the organizations to bring up the level of creativity and flexibility, most of those that were large came up with a new strategy of putting focus on the core business. This required companies to identify those processes that were critical and making a decision in regard with what process that could be outsourced.

There was no proper recognition of outsourcing as being a business strategy until the late 1980s. In the 90s, while the companies commenced on focusing more on those measures intended to save costs, they started outsourcing functions that were very important in running a company but not linked to the core business in particular.

The present state in outsourcing evolution is the setting up of strategic partnerships. There are higher chances for companies to prefer outsourcing basing more on who can deliver the results that are more effective for a particular function and less on whether the function is core.

The global IT and BPO market is approaching more than half a billion U.S dollars and it is increasing at a very high rate. But corporations are currently facing some outsourcing or offshoring risks which they need to address in order for them to operate successfully. Most of companies are trying to be careful about which functions or jobs to outsource and which ones they are not supposed to.

In the corporate United States, some of the corporations are starting in-source some of the jobs that they were formerly outsourcing and being quite selective about which jobs to actually outsource. Outsourcing does not necessary lead to cost saving or remarkable cost saving.

References

Benman, K. (August, 2007). Out with outsourcing? Nwitimes.com. Retrieved from, http://www.nwitimes.com/business/local/article_0c7f9860-5448-53f7-b902-a259be53ee7b.html

Deloitte. (January, 2008). Deloitte white paper suggests risk intelligent approach to outsourcing and offshoring. Deloitte.com. Retrieved from, http://www.deloitte.com/view/en_GX/global/press/global-press-releases-en/a0091060261fb110VgnVCM100000ba42f00aRCRD.htm

Handfield, R. (2006). A brief history of outsourcing. NC State University. Retrieved from, http://scm.ncsu.edu/scm-articles/article/a-brief-history-of-outsourcing

Jones, W. (2003). Offshore outsourcing: Trends, pitfalls, and practices. Sourcing and Vendor Relationships. 4(4), 1 – 27.

Longbottom, C. (30 January, 2007). Outsourcing won’t save money. Business. Retrieved from, http://www.theregister.co.uk/2007/01/30/outsourcing_wont_save_money/

Mullin, R. (1996). Outsourcing: Managing the outsourced enterprise. Journal of Business Strategy, 17 (4), 28 – 36.