Outsourcing

Outsourcing is a business arrangement in which one organization contracts with another organization to perform services that it normally would have done itself. This occurs generally in areas outside of an organization's core competencies in order to take advantage of cost savings.

Several different types of outsourcing should be distinguished. Probably the most common kind involves a private company hiring another company in its own country to provide certain services. For example, a computer manufacturer, such as IBM, may hire an outside contractor to clean its facilities. In this case, the service provided is clearly outside of IBM's core competencies.

A second kind of outsourcing would be a government organization hiring a private company to do some of its work. A typical example here would be a school contracting out its food service, so that the workers providing the food service are private employees and not government employees. Here again, serving food is clearly not within a school's core competencies.

The most controversial type of outsourcing occurs when a private company hires a foreign company to do work for it. This outside contracting, known as “offshore” outsourcing, has become more and more common in the past 20 years. Much computer technical support for U.S. companies has been outsourced to India through a variety of subcontractors in recent years.

Why do organizations outsource? Not surprisingly, the chief reason is to reduce costs. If the company has its own employees perform the service, then it must pay them as it would any of its employees. For a company that treats its employees well, this could be a large cost—the company may well be able to find outside workers who can do this non-core service adequately at a much lower price. The workers may be cheaper because they live in a foreign low-wage country (in the case of offshore outsourcing), or they may [Page 643]be cheaper because they are nonunion or live in low-wage areas of the United States (in the case of domestic outsourcing).

Outsourcing may also provide the company with access to more expert employees and more up-to-date technologies. The vendor—the company to whom business is outsourced—often has highly skilled employees who are specialists in specific areas. By focusing on particular services, vendors are more easily able to adopt new technologies and avoid technological obsolescence. A company that tries to perform services that are outside of its areas of core competency may be stretching itself too thin and be unable to take advantage of new technologies as they come into use.

By hiring outside workers, a company is able to turn fixed costs into variable costs and avoid the costs associated with constantly hiring and training new workers. The ease of changing vendors compared to changing full-time, in-house employees gives the company significant flexibility in running its business. The fixed costs of the in-house employees are by definition unchangeable in the short run; they can make it that much more difficult for the company to respond nimbly to market conditions. Outsourcing turns these into variable costs, thereby enabling management to react better to the vicissitudes of the market.

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