Outsourcing and Offshoring

Outsourcing affects hundreds of thousands of employees around the world every year and generates over $100 billion in outsourcing contracts in the United States alone. In simple terms, outsourcing is the contracting out of noncore organizational activity to an outside vendor. Outsourcing occurs both domestically [Page 610]and globally. Offshoring is the term used to describe the process whereby jobs are contracted out globally, usually to countries with talented but comparatively less expensive human resources. Current estimates indicate that over 80 percent and perhaps 90 percent of larger companies outsource at least part of their businesses. Although outsourcing initially targeted only transactional-type jobs like housekeeping and catering, it has moved to high-skill technical jobs such as information technology and human resource management. Activities that are often outsourced include information systems/technology, real estate and physical plant logistics, human resources, customer service, finance, marketing, and sales.

Offshoring, because it involves the transfer of jobs from one country to another, is politically controversial. Companies feel pressured to use this kind of outsourcing to maintain price competitiveness but often downplay the use of these practices. In 2004, Foresster Research projected that by 2015, 3.4 billion U.S. office-based jobs will go offshore. This is 10 times the number experienced in 2003. The main countries that have benefited from this practice have been Mexico, China, India, and other Asian countries.

Supporters of this practice suggest that these job losses will be replaced by higher-level technical and analytical jobs in other sectors spurred by the increased demand and purchasing power of the recipient countries. Until these new jobs are created, there are fears of unemployment in the countries where companies use this outsourcing practice. Questions of ethics and quality of the services provided are an area of debate.

It has been proposed that firms outsource to realize strategic advantages from cost savings, increased focus on core competencies, and increased strategic flexibility. Other common reasons include cost reduction, control and cash infusion from sale of assets, and personnel reductions. Outsource service providers through economies of scale and scope and technical expertise can provide services at a lower cost with skilled employees and up-to-date resources. Outsourcing strategy decisions are based on two management theories: the resource-based view of the firm (RBV) and transaction cost economics (TCE).

The use of the resource-based view (RBV) of the firm has directed most corporations to focus on core competencies. Companies now realize that it is most profitable to focus resources on those things they do uniquely well. The underlying assumption of the model is that resources are both unevenly distributed among competitors and are not perfectly mobile. Therefore, the greatest profits and competitive advantage come from focusing on an organization's inimitable resources.

The choices that companies make on what functions or job types to outsource have been guided by transaction cost economics. TCE theory helps the organization determine which of their supportive, noncore functions they should buy and which they should produce or make in-house. The theory focuses on transactions rather than commodities or technology, stating that it is transactions that mainly determine the efficiency of one mode of exchange over another. The make or buy decision is made using TCE to evaluate the governance structures of firms and markets and to determine which is best suited to economize on transaction costs. The efficiency is determined by comparing costs of planning, adapting, and monitoring task completion under each governance structure. Contributors to these costs include uncertainty, frequency with which the transactions occur, and the degree to which specific investments are required to realize least cost supply. Simply stated, it answers the question: Should the firm make or buy the product or service?

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