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An academic view of Outsourcing (part 1)

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WHAT IS OUTSOURCING?

Outsourcing means procuring from external suppliers services or products that are normally a part of an organization. In other words, a firm takes functions it was performing in-house (such as accounting, janitorial, data entry, Web research, Internet marketing, trading promotion or call center functions) and has another company do the same job. If a company owns two plants and reallocates production from the first to the second, this is not considered outsourcing. In addition, if a company moves some of its business processes to a foreign country but retains control, we define this move as offshoring, not outsourcing. For example, China’s Haier Group recently offshored a $40 million refrigerator factory to South Carolina (with huge savings in transportation costs).

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A firm that outsources its internal business activities is called the client firm. A company that provides outsourcing is called the outsource provider.

Early in their life cycle, many businesses handle their activities internally. As businesses mature and grow, however, they often find competitive advantage in the specialization provided by outside firms. They may also find limitations in locally available labor, services, materials, or other resources. So organizations balance the potential benefits of outsourcing with its potentials risks. Outsourcing the wrong activities can cause major problems.

Outsourcing is not a new concept; it is simply an extension of the long-standing practice of subcontracting production activities. Indeed, the classic make-or-buy decision concerning products are examples of outsourcing.

So why has outsourcing expanded to become a major strategy in business the world over? From an economic perspective, it is due to the continuing move toward specialization in an increasingly technological society. More specifically, outsourcing’s continuing growth is due to (1) increasingly expertise, (2) reduced costs of more reliable transportation, and (3) the rapid development and deployment of advancements in telecommunications and computers. Low-cost communication, including the Internet, permits firms anywhere in the world to provide information services that were previously limited geographically. This communication ability also supplies the connectivity needed to support the global outsourcing growth engine.

Some examples of outsourcing:

  • Call centers for the French in Angola (a former French colony in Africa) and for the U.S. and England in India
  • DuPont’s legal services and Procter & Gamble’s (P&G’s) finance services routed to the Philippines
  • Electronic Data Systems (EDS) providing information technology for Delphi Automotive and Nextel
  • IBM handling travel services and payroll, and Hewlett-Packard providing IT services to P&G
  • ADP providing payroll services for thousands of firms.
  • Solectron (a specialist in electronic assembly) producing many of IBM’s computers
  • Production of the Chrysler Crossfire, Audi A4 convertible, and Mercedes CLK convertible by Wilheim Karmann in Osnabruck, Germany

Outsourced manufacturing, also known as contract manufacturing, is becoming standard practice in many industries, from computers to automobiles.

Paralleling the growth of outsourcing is the growth of international trade. With the passage of landmark trade agreements like the North American Free Trade Agreement (NAFTA), the work of the World Trade Organization (WTO) and the European Union (EU), and other international trade zones established throughout the world, we are witnessing the greatest expansion of international commerce in history....

Source: Operations Managements 9th edition by Jay Heizer and Barry Render (2010).

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