Introduction
In the recent years, various organizations have adopted outsourcing and/or off shoring as part of their long-term strategic management practices in their supply chain management. Tambe and Hitt (2010) define outsourcing as the process of contracting work to a third party. On the other hand, off shoring entails seeking provision of services from a foreign country.
With the drastic revolution in technology advancement in the 21st Century, the IT industry has become one of the sectors in which outsourcing is prevalent (Michela & Carlotta 2011). Firms in the IT industry are increasingly turning to outsourcing of function and processes by establishing a network of contracts with renowned outsourcers.
As a result, the outsourcers exclusively adopt the role of supplying the necessary services or products. Some of the reasons that have motivated firms to adopt outsourcing include an increase in the intensity of competition and the emergence of a dynamic business environment.
Furthermore, the need to deliver a high level of customers’ satisfaction coupled with the need to attain a high level of profitability has also enhanced incorporation of outsourcing amongst organizations.
Considering the fact that organizations have to operate under these organizations, the need for a high level of adaptability, flexibility, and capability has increased significantly (Wee, Peng & Wee 2010, p. 2081).
The concept of outsourcing and off shoring has been in existence in firms’ supply chain-management practices for a number of decades now (Gupta, Seshasai, Mukherji, & Ganguly 2006). However, its relevance in the IT industry has increased significantly over the recent past probably at the start of the 21st Century.
Firms can accrue a number of benefits through incorporation of outsourcing and or off shoring. Some of the major benefits relate to cost reduction, improved operational flexibility, accessing new technology, and capacity to offer high quality products and services. However, a number of risks factors are associated with outsourcing and off-shoring (Herath & Kishore 2007).
This aspect accentuates the importance of firms conducting cost-benefit analysis prior to incorporating outsourcing and or off shoring in their supply chain management practices.
The cost-benefit analysis will aid in determining whether the benefits are more than the costs and hence its feasibility. This paper intends to analyze whether the advantages of outsourcing outweigh the disadvantages.
Analysis
Advantages of off shoring and or outsourcing
Creating and protecting firms’ competitive advantage
According to Tho (2012), outsourcing enables organizations to transfer non-core activities to the provider of the services. The supplier of the services in turn assumes the responsibility of delivering the non-core service, which provides an opportunity for the firm to focus on developing its core competencies.
Through outsourcing, firms are in a position to nurture areas that are vital for their success. Ultimately, the firm can create and protect its competitive advantage effectively. Through effective implementation of outsourcing, a firm can implement effective human resource development, which emanates from the fact that the firm can acquire new ideas on how to develop its human capital.
There are numerous benefits associated with nurturing core competencies. Some of these benefits relate to providing the firm an opportunity to improve its market share. Additionally, the perceived customer benefits with regard to the final product improve significantly. This aspect makes it difficult for competitors to imitate the firm’s product or service.
Development of core competency also contributes towards the attainment of advantages associated with economies of scale. One of the main sources of competitive advantage with regard to economies of scale relates to specialization. Through outsourcing, organizations can accrue the benefits associated with the specialized skills of the outsourced vendor.
According to Schniederjans, Scherniederjans, and Schniederjans (2005), outsourcing and outsourcing enables organizations to attain their profit maximization objective. This aspect emanates from the fact that the firm can outsource some of its business activities from low cost providers and ultimately the firm is in a position to cater for the cost of operation.
Due to profit maximization, firms are in a position to streamline their cash flows. Profit maximization is one of the major factors that can contribute towards development of competitive advantage amongst firms for a firm is in a position to cater for its cost of its operation.
Freeing up company resources
Outsourcing provides organizations with an opportunity to concentrate on aspects that contribute to a high level of competitive advantage. This element increases the effectiveness and efficiency with which an organization allocates its resources.
For example, through outsourcing firms save on the cost of investing in certain technologies necessary for the firm’s operations. Information Technology is one of the main areas that firms are increasingly outsourcing. Focusing in such an area safeguards the firm against the cost of implementing costly IT technologies.
Tadelis (2007) asserts that outsourcing enables organizations’ to free some of its resources. By outsourcing and or off shoring some of the activities, organizations are left with some resources such assets that can be converted into real cash. The freed resources can be used to undertake other tasks and activities.
For example, the firm can invest the money saved through outsourcing in other more lucrative avenues. The ultimate effect is an improvement in the firm’s profit maximization objective. One of the cost elements that organizations can eliminate relates to cost of labour.
According to Schniederjans, Scherniederjans, and Schniederjans (2005), human resources constitute the largest proportion of firms’ cost of operation. Through outsourcing and or off shoring, an organization can eliminate a significant proportion of labour cost.
Before implementing the outsourcing decision, it is imperative for organizations to ensure that they undertake a comparative analysis between outsourcing and undertaking the task itself. The comparative analysis should aid in determining the cost differences. Additionally, outsourcing enables firms to eliminate other operational costs associated with in-sourcing.
Schniederjans, Scherniederjans, and Schniederjans (2005) opine that outsourcing contributes towards cost reduction because the cost of the outsourcing might be lower than the cost of in-sourcing.
In summary, off shoring and outsourcing enhances organizations to attain their cost minimization objective, which emanates from the fact that the organization can eliminate some cost elements that would have otherwise been incurred if the organization in-sourced the task (Tadelis 2007). Cost reduction is one of the key merits of off shoring and outsourcing.
Swiftness and expertise
Through outsourcing, organizations are in a position to attain the benefits associated with expertise, which emanates from the fact the firms can select the most effective outsourcing firm to provide the intended products or services.
In most cases, the outsourced firms are effective in their respective tasks due to nurturing their technical and equipment expertise. Due to their expertise, the outsourced firms are in a position to undertake their tasks faster in addition to generating better quality results.
Through outsourcing and off shoring, organizations are in a position to develop high competitive advantage due to gaining knowledge and expertise. This element emanates from the sharing of tasks and knowledge between the two parties involved. The knowledge and expertise gained contributes towards increment in the firm’s productivity and competitiveness.
Considering the changes in the current business environment, knowledge has been ranked as one of the most important elements in firms’ quest to attain a high competitive advantage. Outsourcing and off-shoring provide firms with an opportunity to nurture their competitive advantage with regard to human capital.
Risk sharing
In the course of their operation, firms cannot safeguard themselves from risks. However, they can incorporate strategies aimed at mitigating the adverse effects or risks. One of the risk mitigation strategies that firms might consider includes risk sharing. Outsourcing provides firms with an opportunity to undertake risk sharing (Isaca 2006).
Through outsourcing, firms can reduce or eliminate the impact of some of the risks that the firm might occur in the firm’s course of operation. Through outsourcing, firms can transfer or share a certain proportion of the risk totally, which is realisable by transferring some of the firm’s responsibilities to the outsourcer. In most cases, the outsourced vendors are specialist in their area of operation.
As a result, they are in a better position to plan and implement risk mitigation strategies. Dhar and Balakrishnan (2006) are of the opinion that the risk-sharing characteristic of outsourcing can be associated with the diversification strategy that is adopted by organizations. Occurrence of risks adversely affects the competitiveness and performance efficiency of most firms. However, such risks may be mitigated through outsourcing.
Disadvantages of outsourcing and off shoring
Loss of managerial control
Contracting forms the foundation of outsourcing and off shoring, which emanates from the fact that the two parties have to enter into a formal agreement detailing their roles and responsibilities. Rawdan (2008) asserts that outsourcing and off shoring leads to loss of managerial control, which arises from the fact that the outsourced firm is given the discretion to undertake the specific task.
The degree in which firms incorporate the concept of outsourcing determines the extent to which they lose their managerial control. By giving up some tasks to another company, the outsourcing firm cannot supervise the activities, processes, and infrastructure of the contracted firm as well illustrated in the case of off shoring whereby the outsourced firm and the contracting firm might be located in diverse geographical areas (Rawdan 2008).
This aspect may hinder the firm’s operational efficiency because of a number of reasons. Firstly, the two firms might not uphold similar mission and standards. Additionally, the outsourced firm might not produce the intended outcome, which might culminate in increment in business risk.
Product quality
According to Elmuti, Grunewald, and Abebe (2007), outsourcing may adversely affect the quality of the product. In their outsourcing process, firms have high expectations that they will receive high quality products or services. However, the quality of the product or service may be compromised.
Elmuti, Grunewald, and Abebe (2007) assert that product quality in outsourcing is dependent on the effectiveness with which the outsourcing contract is outsourced. Findings of a survey conducted by the World Bank in China reveal that outsourcing leads to a decline in the effectiveness with which the firms undertake quality guarantee.
Additionally, poor contract enforcement in China is likely to exacerbate the problem (Lu, Ng, & Tao 2012). Existence of such inadequacies with regard to product quality may result in customer dissatisfaction. Ultimately, the employees may consider seeking substitute product, which might affect the firm’s productivity.
Hidden cost
Considering the fact that outsourcing hinges on contracts, the outsourcing firm is required to sign a contract with the outsourced firm detailing the role of each party. The contract might not detail every requirement for the particular task to be undertaken. Consequently, the additional cost of executing the task that might be incurred rest on the outsourcing firm.
According to Tadelis (2007), most of the hidden costs that are associated with outsourcing and off-shoring are associated with scope of work and transfer of knowledge. Other hidden costs are also associated with the cost of maintaining the outsourcing relationship between the two parties (Tadelis 2007).
For example, in most cases, the firm offering the outsourcing services design and develop outsourcing contracts. As a result, the outsourcing firm will be required to hire the services of a lawyer in order to review the contract. This element represents an additional cost on the part of the contracting firm (Sako 2005).
Hindering innovation
One of the major risks of outsourcing is associated with the fact that it contributes to loss of skills and innovativeness amongst the employees, which emanates from the fact that an organizations employees are not given an opportunity to try out the outsourced function. According to Bradshaw and Hayday (2007), one of the most effective ways through which organizations can enhance innovation and development of skills amongst employees is by assigning challenging tasks to employees.
Once the task is outsourced, it becomes challenging to revert the task because it would amount to breach of contract, which might lead to the firm incurring financial loss. Rawdan (2008) opines, “The greater the asset specificity of the outsourcing program, the large the risk of exposure” (p.16).
Security threats and loss of confidentiality
In the course of a firm’s operations, intelligence constitutes one of the key significant sources of competitive advantage. The provider of the outsourced firm might require the firm providing the service to submit certain information (Michela & Carlotta 2011).
Example of such information may relate to product designs and formulas, which presents a confidentiality risk to such an organization. According to Weerakkody and Irani (2010), loss of confidential information may adversely affect the firm’s competitiveness.
Prior to implementing the outsourcing decision, it is paramount for the firm being contracted to review the contract to determine whether its data is adequately protected. Additionally, the contracting party should also ensure that a penalty clause is incorporated in the event of such an incident occurring.
The high rate of technological innovation especially with regard to Information Communication Technology (ICT) presents a major challenge to most organization. Security is one of the major issues being associated with outsourcing and off shoring. To prevent loss of confidential data and information, it is also necessary for the contracting firm to ensure that its computer security system is configured effectively.
This element will safeguard the firm against cases of infiltrated by the outsourced firm. The contracting firm should also restrict access of its computer system. Additionally, a background check on the outsourced firm should also be conducted to determine the credibility of the outsourcing firm.
Perception of outsourcing and off shoring
Outsourcing and off shoring may adversely affect employees and customers. One of the issues that are likely to be greatly impacted relates to loyalty. Announcement of outsourcing some functions may result in generation of negative perception regarding the employer by the employees, which may culminate in the employees losing focus hence decline the employees’ productivity.
According to Elmuti, Grunewald, and Abebe (2007), outsourcing may culminate in organization downsizing some of its operations. This move may lead to some employees losing their jobs, which may adversely affect the employees’ level of loyalty to the organization due to increased job insecurity. According to Rawdan (2008), “production and other performance metrics fall in the wake of the announcement” (p.16).
Elmuti, Grunewald, and Abebe (2007) further assert that increased outsourcing culminates in employees developing a perception that they are insignificant. Findings of previous studies conducted reveal that the rate of employee turnover is high amongst unsatisfied employees compared to satisfied employees upon implementation of outsourcing (Elmuti, Grunewald & Abebe 2007).
On the other hand, customers may react negatively. Some customers may have adverse perception regarding some activities being outsourced from some locations. For example, customers in the United States have developed a negative perception regarding the local firms outsourcing services from certain foreign locations.
On the other hand, customers may not be willing to pay high prices for products and services in order to enable firms to attain a high level of profitability through off shoring.
Conclusion
The above analysis has illustrated that outsourcing is one of the aspects that organization are increasingly focusing in their strategic supply chain management practices. The IT industry is one of the economic sectors within which outsourcing is increasingly being undertaken.
One of the factors that have led to an increment in the relevance of outsourcing amongst organizations relate to the changing nature of the business environment. Additionally, the increment in the intensity of competition within the business environment has also stimulated the growth of outsourcing.
The evaluation conducted reveals that there are a number of advantages and disadvantages associated with outsourcing. One of the major advantages is associated with development in firms’ ability to create and protect their competitive advantage. Outsourcing enables firms to create their competitive advantage by focusing on their core competencies.
By transferring some of the business activities and responsibilities to the outsourced vendor, the firm can focus and nurture its core competencies. Additionally, firms also derive competitive advantage from outsourcing by developing economies of scale. For example, the firm is in a position to reduce the cost of operation.
Outsourcing provides firms with an opportunity to free up some of its resources. The freed up resources can be utilized in other avenues. For example, the firms may decide to invest such an amount in other economic avenues hence increasing the chances of achieving their profit maximization goal. Additionally, outsourcing provides firms with an opportunity to nurture their level of operational expertise.
This aspect emanates from the fact that the two parties can share their expertise, which culminates in development of the firm’s competitive advantage. Risk sharing is also another major advantages associated with outsourcing. The risk sharing characteristic emanates from the fact that the outsourcing firm transfers a proportion of its business activities to the outsource dealer.
Despite the aforementioned merits, there are a number of demerits associated with outsourcing. Loss of managerial control is one of the major disadvantages associated with outsourcing. The outsourcing firm may not have the capacity to control the activities of the outsourced vendor, which means that the firm might not attain the desired results.
Outsourcing may result in the quality of the product being compromised. This aspect might occur due to poor contract enforcement, which limits quality guarantee. Outsourcing also culminates in decline in the level of innovativeness and skills development amongst the employees, which arises from the fact that the employees are not challenged to undertake some of the business activities that might stimulate innovativeness and skills development.
Exposure to security threats and loss of confidentiality also constitutes another disadvantage of outsourcing. This arises from the fact that the firm might be required to disclose and share some information that might compromise its competitive advantage. Increased reliance on outsourcing may lead to a decline in the level of customer and employee loyalty. Employee loyalty may be affected adversely due to increased job insecurity.
On the other hand, some customers might hold negative reservations with regard to outsourcing or off shoring from certain locations. In spite of this aspect, the advantages of outsourcing outweigh the disadvantages for the advantages of outsourcing contribute towards the long-term survival of firms. On the other hand, the involved parties can address the disadvantages of outsourcing adequately through the incorporation of appropriate strategies.
Reference List
Bradshaw, P & Hayday, B 2007, ‘Non-profit governance models: problems and prospects’, The Innovation Journal, vol.12 no.3, pp. 1-22.
Dhar, S & Balakrishnan, B 2006, ‘Risks, benefits, and challenges in global IT outsourcing; perspectives and practices’, Journal of Global Information Management, vol.14 no.3, pp. 1-32.
Elmuti, D, Grunewald, J & Abebe, D 2007, ‘Consequences of outsourcing strategies on employee quality of work life, attitudes and performance’, Journal of Business Strategies, vol.3 no.3, pp. 1-28.
Gupta, A, Seshasai, S, Mukherji, S & Ganguly, A 2006, Off shoring: The transition from economic drivers towards strategic global partnership and 24 hour knowledge factory, Pace University, Bangalore.
Herath, T & Kishore, R 2007, ‘Offshore outsourcing: risks, challenges and potential solutions’, Journal of Information Systems Management, vol.26 no.4, pp. 312-326.
Isaca, J 2006, The risk of IT practitioner guide, Rolling Meadows, Illinois.
Lu, Y, Ng, T & Tao, Z 2012, ‘Outsourcing, product quality and contract enforcement’, Journal of Economics and Management Strategy, vol.21 no.1, pp. 1-30.
Michela, P & Carlotta, M 2011, ‘Outsourcing strategies: How to formalize and negotiate the outsourcing contract’, Annals of the University of Oradea, Economic Science Series, vol.20 no.1, pp. 274-77.
Rawdan, M 2008, An empirical investigation of the link between transaction cost and governance structures of off shoring, ProQuest, New York.
Sako, M 2005, Outsourcing and off shoring: Key trends and issues, Oxford University Press, Oxford.
Schniederjans, M, Schniederjans, A & Schniederjans, D 2005, Outsourcing and in sourcing in an international context, M.E Sharpe, Armonk.
Tadelis, S 2007, ‘The innovative organization; creating value through outsourcing’, California Management Review, vol.50 no.1, pp. 261-279.
Tambe, P & Hitt, L 2010, ‘How off shoring affects IT workers’, Communication of The ACM, vol. 53 no.10, pp. 62-72.
Tho, I 2012, Managing the risks of IT outsourcing, Routledge, New Jersey.
Wee, H, Peng, S & Wee, P 2010, ‘Modelling of outsourcing decisions in global supply chains: An empirical study on supplier management performance with different outsourcing strategies, ‘International Journal of Production Research, vol.48 no.7, pp. 2081-2094.
Weerakkody, V & Irani, Z 2010, ‘A value and risk analysis of offshore outsourcing business models; an exploratory study’, International Journal of Production Research, vol. 48 no.2, pp. 613-634.