Outsourcing is a strategic decision by a company to reduce costs and increase efficiency by hiring another individual or company to perform tasks, provide services, or handle operations that were previously done by employees within the company. In other words, outsourcing is the practice of getting certain job functions done outside a company. The process of outsourcing business functions is also called contracting out.
Outsourcing can involve large third-party providers such as IBM for IT services or simply hiring temporary office workers or independent contractors.
Common Types of Outsourced Work
The type of outsourcing work depends heavily on the needs of the business and the industry they operate in. The most commonly outsourced activities include:
Below are several examples of how companies outsource certain functions:
Company A is rapidly growing and is in need of more office space. However, the company is situated in a very expensive location and there is no room to expand. The company can outsource some of the work that takes up office space (for example, data entry or customer service support) to reduce the need for additional space.
Company B enjoyed great success over the past year and is currently looking to expand its product line. However, the company is constrained by a limited amount of workers. Therefore, to expand its product line in-house, Company B would need to slow down production on some of its existing products. The company can outsource the work to an external local factory to lessen its labor constraint.
Company C is a car manufacturer facing increasing raw material and labor costs. Therefore, the profit margin on its manufactured goods is steadily decreasing as costs increase. The company can outsource part of its production process, e.g., the manufacturing and installing of windows in their cars. Assembling time and costs can be saved by outsourcing an expensive production process to an external company that can do it at a cheaper cost.
Reasons for Outsourcing
The most common reasons to outsource include:
Reducing operating, labor, and overhead costs
Focusing more on the company’s core competencies, and thus improving its competitive advantages by outsourcing time-consuming processes to external companies
Freeing up internal resources and using the resources for other purposes
Mitigating risk by sharing risks with external parties and building meaningful partnerships
Improving flexibility and efficiency by delegating responsibilities that are difficult to manage and control to external companies
Disadvantages of Outsourcing
Although there are several reasons to outsource, there are also disadvantages to the practice, such as:
Risk of losing sensitive data and the loss of confidentiality by outsourcing activities or processes to external parties
Loss of management control and the inability to control operations of activities or processes that are outsourced
Outsourcing companies may impose hidden or unexpected costs by creating lengthy contractual agreements with lots of fine print
Lack of quality control, as outsourcing companies are often profit-driven rather than focused on doing a good job
Thank you for reading CFI’s guide to Outsourcing. To learn more and expand your career, explore the additional relevant CFI resources below.