What is outsourcing?

Mar 05, 2008

If at first “outsourcing” was primarily referred to as the action of subcontracting certain parts of a business to a third party, usually a company which offered lower prices for such labors, in present days “outsourcing” has become a subject of debate between economists worldwide who question the benefits or claimed disadvantages of such processes. 

During the 80's the word “outsourcing” first became part of the economists vocabulary. It was used in referring to situations when firms expanded their purchases or manufactured physical inputs, such as car-making companies that acquired window cranks or seat fabrics from outside the firm rather than making them inside.1 Things changed in 2004 when the word took on a different meaning; it referred to a specific segment of the growing international trade in services which consisted of “long-distance” purchasing of services abroad.

Gregory Mankiw, the chair of the American Council of Economic Advises, stated in a press interview in 2004 that: “...outsourcing is a growing phenomenon, but it's something that we should realize is probably a plus for the economy in the long run. We're very used to goods being produced abroad and shipped in by ships or planes. What we are not used to is services being produced abroad and being sent here over the Internet or telephone wires. But does it matter from an economic standpoint whether values of items produced abroad come on planes and ships or over fiber-optic cables? Well, no, the economy is basically the same.”

Although this comment was followed by quite a few critics, it nevertheless establishes the truth about what outsourcing really is. It involves a transfer of the management of an entire business operation to an external service provider. This is made by an agreement between the parties involved, the supplier and the client company. Under such a contractual agreement, the supplier acquires the means of production in the form of transfer of persons, assets and other resources from the client and the client company agrees to buy the services from the supplier by the terms of contract. Usually, typically outsourced segments include information technology, human resources, facilities, accounting etc.

An outsourcing process first begins at a strategic level, where the decision is taken by a board approval. Outsourcing represents a divestiture of a business function implying the transfer of people and the sale of assets to the supplier. The supplier is usually chosen through first creating a shortlist of possible suppliers which are then asked to form a proposal and a price. The manner of choosing can involve a competition between suppliers in order to insure the best choice possible for the client company. Crucial to every outsourcing deal is the contract agreement which defines how the client and the supplier will act towards each other. It is a legally binding document that is core to the governance of the relationship. Near the end of the contract term a decision will be made to terminate or renew the contract. Termination may involve taking back services which is called insourcing , or the transfer of services to another supplier.

Apart from this process, “offshoring” is a term often confused with outsourcing despite obvious technical differences. Outsourcing implies contracting with a provider, which may or may not imply some degree of offshoring. Basically, offshoring refers to the transfer of an organizational function to another country, regardless of whether the work is outsourced or stays within the same company. Despite the differences stated, outsourcing and offshoring will become two gray terms thanks to the increasing globalization of outsourcing companies, like the presence of Indian outsourcing companies in the US and UK. Pete Foster, a research director at PAC (Pierre Audoin Consultants), said the United Kingdom's use of India is largely driven by historical and cultural links to the country, but companies may be forced to look elsewhere, as skills and resources become scarcer and costs start to rise. Thus, the primary rival to Indian outsourcing providers will be Romania, as the country benefits from an abundance of well-educated and highly skilled workers who have a better understanding of Western European culture than their Asian counterparts.

Also, Romania provides much cheaper costs for IT development, at higher quality services and has an arguable closer cultural affinity to western countries than Asian or Indian states. Such features could be the future reasons why Romania will take an important segment on the market of outsourcing and offshoring services.

Outsourcing is, without a doubt, the future of multinational companies since it has become a matter of choice between which supplier to use and it is not anymore a question of whether or not to do it. Large entrepreneurs see a chance to turn around dying businesses, speed up their pace of innovation, or fund development projects that otherwise would have been unaffordable. By outsourcing, the costs of development and production are lowered at amazing rates, but the profits gained by this are unmatched by the enormous gains in efficiency, productivity, quality, and revenues that can be achieved by fully leveraging offshore talent.