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What is outsourcing?

Outsourcing is the business practice of hiring a party from outside of a business to provide services and create goods that have traditionally been performed in-house by the company’s own employees and staff. Outsourcing is a practice generally undertaken by companies as a cost reduction measure. As such, it can affect a wide range of jobs, from customer support to manufacturing to the back office.

Outsourcing was first recognized as a business strategy in 1989 and became an integral part of the business economy throughout the 1990s. The practice of outsourcing is the subject of considerable controversy in many countries. Opponents argue that this has caused the loss of domestic jobs, particularly in the manufacturing sector. Advocates say that this encourages companies and businesses to allocate resources where they are most efficient, and that outsourcing helps to maintain the nature of market economies globally.



Understanding outsourcing

Outsourcing can help businesses significantly reduce labor costs. When a company uses outsourcing, it uses outside organizations not affiliated with the company to perform certain tasks. External organizations usually set up different compensation structures with their employees than those of the outsourcing company, which allows them to finish the job for less money. This ultimately allows the outsourcing of money to reduce its labor costs. Businesses can also avoid expenses related to overhead, equipment and technology.

In addition to cost savings, companies can use an outsourcing strategy to better focus on the fundamental aspects of the business. Outsourcing non-core activities can improve efficiency and productivity, as another entity performs these smaller tasks better than the business itself. This strategy can also lead to faster turnaround times, increased competitiveness within an industry, and lower overall operational costs.

Businesses use outsourcing to reduce labor costs and business expenses, but also to allow them to focus on key aspects of the business.

Examples of outsourcing

The main benefits of outsourcing are the savings in time and money. A PC manufacturer can purchase internal components for its machines from other companies to save on production costs. A law firm can store and back up its files using a cloud service provider, giving it access to digital technology without investing large sums of money to own the technology.

A small business may decide to outsource accounting tasks to an accounting firm, as this can be less costly than hiring an internal accountant. For other companies, outsourcing functions of human resources departments, such as payroll and health insurance, is beneficial. When used properly, outsourcing is an effective strategy for cutting costs and can even provide a business with a competitive advantage over its competitors.

Outsourcing criticism

Outsourcing has drawbacks. Signing contracts with other companies can take time and extra effort on the part of a company’s legal team. Security threats occur if another party has access to confidential company information and that party experiences a data breach. A lack of communication between the company and the outsourced provider may occur, which could delay the completion of projects.

Special considerations

International outsourcing can help companies take advantage of differences in labor and production costs between countries. Price dispersion in another country can encourage a company to outsource all or part of its operations to the cheapest country in order to increase profitability and remain competitive within an industry. Many large companies have eliminated all of their customer service call centers in-house, outsourcing this function to third-party equipment located in lower cost locations.

Key points to remember

  • Businesses are using outsourcing to reduce labor costs, including staff salaries, overhead, equipment and technology.
  • Outsourcing is also used by companies to compose and focus on key aspects of the business, by outsourcing less critical operations to external organizations.
  • On the downside, communication between the company and the external supplier can be difficult and security threats can intensify when several parties can access sensitive data.

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