What is outsourcing?
Outsourcing refers to the organisational strategy of sub-contracting particular services or processes to a specialist third party provider. For example, IT infrastructure management, cybersecurity and software development are all services, roles and functions that are commonly outsourced by organisations instead of them directly employing the specialists who carry them out.
Manufacturing is another process that is often outsourced. Apple, for example, designs and develops all of its hardware and software technology in-house but outsources the physical manufacturing process of its devices such as iPhones, iPads and Apple Watches. Apple’s deep, long term relationship with the Taiwanese manufacturer Foxconn is one of the great outsourcing case studies and credited with making a big contribution to the former becoming the world’s biggest company.
Roles and functions organisations most often outsource
Other services and functions often outsourced include:
- Manufacturing and assembly of goods
- IT and software development
- Customer service and technical support
- Human resources, such as recruitment and payroll processing
- Accounting and finance
- Supply chain and logistics management
- Marketing and advertising services
- Legal services
What’s the difference between outsourcing and contracting or using a service provider like an electrician?
While outsourcing involves contracting third-party providers to fulfil functions or execute processes, not every engagement of specialists not directly employed by an organisation or business counts as outsourcing. For example, outsourcing and contracting are similar in that they both involve bringing in a third-party to perform a specific task or service. However, there are some key differences between the two.
Outsourcing generally refers to the practice of a company delegating a non-core business function to an external vendor or provider. The goal of outsourcing is often to improve efficiency, reduce costs, or access specialized expertise. Outsourcing can involve long-term contracts and the transfer of significant control and decision-making power to the vendor. A mature, well developed outsourcing relationship like that between Apple and Foxconn is essentially a business partnership.
Contracting, on the other hand, generally refers to the practice of hiring an individual or company to perform a specific task or service on a project basis. The goal of contracting is often to bring in specialised expertise or additional resources for a specific project or task. Contracts tend to be more short-term and the company hiring the contractor retains more control and decision-making power.
A service provider like an electrician or car mechanic is a contractor that provides a specific service to a client. An electrician is an example of a service provider who provides electrical installation, maintenance, and repair services to the client. The service provider is hired to do specific task.
Why do organisations use outsourcing?
There are many different reasons why an organisation may take the strategic decision to use an outsourcing partner rather than hire directly and execute inhouse. However, among the most common include:
Cost savings
Outsourcing can be a cost-effective way to access the resources and expertise needed to optimally perform a specific function or process. Outsourcing can also help organisations reduce labour costs, eliminate the need to invest upfront in expensive equipment or technology, and reduce overhead expenses.
Improved efficiency and performance through focus on core competencies
Outsourcing can help organisations improve efficiency by allowing them to focus on their core competencies and delegate non-core functions to specialised vendors.
Back to the Apple example, when the late Steve Jobs returned to revive the company as chief executive in 1997, he prioritised renewing its early laser focus on innovation, design, and customer friendliness.
Current Apple CEO Tim Cook was brought in as Senior Vice-President for Operations by Jobs in 1998 with a mandate to focus on that trifecta. That led, explains an insightful blog post by Kusucorp, to the company outsourcing manufacturing after Cook implemented significant supply chain reforms.
“Manufacturing can quickly become a distraction for the management team. As Apple prioritised innovation, design, and customer experience, it became a no-brainer that manufacturing would be deemed a non-priority and thus outsourced to specialists.”
Access to specialised expertise
Outsourcing can provide organizations with access to specialist expertise and skills that may not be available in-house.
Flexibility
Outsourcing can provide organisations with the flexibility to scale their operations up or down as needed, depending on changes in demand or market conditions. One of the reasons IT outsourcing is so common is that while most modern businesses and organisations have IT infrastructure and software development needs, the scale of needs often fluctuates significantly with project cycles.
Working with an outsourcing partner means the number and profile of IT specialists an organisation has access to, , eg. software developers with skills in a particular programming language, can expand and contract as needed.
Risk management
Outsourcing can help organisations manage risk by transferring the risk of certain functions or processes to specialised vendors.
Innovation
Outsourcing allows organisations to leverage the expertise and resources of the vendor, which can lead to increased innovation and improved performance.
Meeting compliance
Outsourcing certain functions can help organisations to meet compliance regulations, for example, for IT security, data privacy, and regulatory compliance.
In conclusion, organisations make the strategic decision to outsource functions and processes when it makes more economic and strategic sense than performing them in-house. Some combination of the reasons above is most often why outsourcing makes strategic sense.
Downsides to outsourcing
Like any other strategic decision, opting to outsource functions and processes to gain the advantages outlined above also involves trade-offs. Potential drawbacks or disadvantages associated with outsourcing include:
Loss of control
Outsourcing can result in a loss of control over the outsourced function or process, which can make it difficult for the organisation to monitor and ensure work is being performed to the desired standards.
For example, the British fast-fashion ecommerce company Boohoo suffered reputational damage as a result of an investigation that uncovered poor and sometimes illegal working conditions at factories manufacturing it outsourced was sub-contracted to. The company claims it was not aware its outsourcing partner was itself sub-contracting work to these factories and so unable to ensure they met its corporate standards.
Quality issues
Outsourcing can result in quality issues if the vendor is not able to meet the organisation’s standards, if communication is poor or corners are cut intentionally to improve profit margins.
Dependence on vendor
Outsourcing can lead to dependence on the vendor, which can make it difficult for the organisation to move work to another provider if the relationship becomes problematic.
Cultural differences
Outsourcing, when providers operate in nearshore or offshore locations, can also involve the management of cultural differences and differences in business practice, which can make it difficult for the organisation and the vendor to communicate effectively and align expectations.
Language barriers and time zone differences
Other potential issues related to the geography of an outsourcing partner are language difference and time zone differences which can hinder effective communication.
Security and data privacy
Outsourcing can raise security concerns, particularly if sensitive information is being shared with the vendor. In the EU for example, organisations outsourcing IT functions that involve access to and the processing or transfer of personal data must make sure their vendor works in a way that is GDPR compliant.
Job loss impacting in-house moral
If outsourced roles and functions were previously directly employed in-house, the strategic change can impact on the moral and motivation of remaining employees who have seen colleagues lose their jobs.
Lack of knowledge transfer
The outsourcing provider may be reluctant or not capable to transfer their knowledge to the client organisation.
Competing priorities
The goals and objectives of the vendor might not align with those of the client organisation if one or both parties does not approach the relationship collaboratively and sustainably. Both partners in an outsourcing relationship have an obligation to maximise outcomes for their own investors, shareholders and employees. Well run, mature organisations understand that doing so sustainably requires win-win relationships but there is a risk one side prioritises their own short-term gain at the expense of the other’s interests.
For a deeper dive on this topic, read our blog post When does IT outsourcing work and when doesn’t it?
A successful outsourcing strategy and relationships optimise advantages and mitigate or avoid disadvantages
A good outsourcing relationship between client organisation and outsourcer can become a genuine strategic edge for the former, as the previously mentioned Apple-Foxconn partnership demonstrates.
But making smart decisions on what to employ for and execute in-house and what to outsource can be a decisive factor in the success of failure of companies at all levels. You can read my personal experience of making a mistake with a decision to bring web development in-house at a start-up I co-founded – When is outsourcing software development the right choice for your organisation?
There are three key pillars of a successful outsourcing strategy:
- Outsourcing the right functions and processes
- Working with the right outsourcing partner
- A clear and equitable framework for sustainably optimal execution and mutual benefit
If each of these pillars are in place, the end client should benefit from the noted advantages of outsourcing while avoiding the strategic approach’s potential risks.
The geography of outsourcing – onshore, nearshore and offshore
There are some functions and processes that need to be outsourced to a local provider for practical or regulatory reasons. Security, catering, some kinds of data processing and handling etc. Other times client organisations simply prefer a local outsourcing solution because physical proximity is seen as key to successful collaboration, logistics etc.
Outsourcing that is based in the same country can be referred to as onshore outsourcing, distinguishing it from nearshore and offshore models.
Nearshore and offshore outsourcing involve functions and processes being moved abroad. There is no official rule that dictates when nearshore becomes offshore but the former typically refers to destinations involving a short haul flight or overland trip while the latter would involve a long haul flight.
Eastern Europe is, for example, considered a nearshore outsourcing destination for client organisations located in Western Europe and central America a nearshore destination in relation to North American markets. India, China, and the Philippines would be considered offshore outsourcing destinations in relation to Europe and North America.
Nearshore and offshore outsourcing markets are most commonly chosen for cost factors, but the greater availability of required skill sets or specialist infrastructure can also be important. Manufacturing, customer or technical support and IT services like software development that can be performed remotely are among the most functions and processes outsourced to nearshore and offshore locations.
Find out why nearshoring works well for us and why it is our preferred outsourcing solution in our dedicated blog post.
Outsourcing examples
We’ve already mentioned Apple’s integrated manufacturing partnership with Foxconn as a high profile example of outsourcing. IKEA, whose corporate strategy combines outsourcing with insourcing (its Swedwood Group subsidiary manufactures a majority of IKEA products at sites in lower-salary economies), is another prominent example of an outsourcing success story.
If you’ve been to a big concert, major sports event or festival in the last several years, there’s a high chance venue safety and security was outsourced to G4S, Securitas or another security outsourcing company.
For IT outsourcing examples, including projects with Nestlé, Bosch, you can refer to our K&C case studies.
Outsourcing Ethics
Cost and other efficiencies by an outsourcing strategy should, of course, be achieved within a framework that is compatible with the end client’s ethics and CSR policies. To ensure that, client organisations should vet outsourcing partners to ensure their practices and standards meet not only local laws and regulations but their own corporate ethics.
An outsourcing partner’s compliance with ethical guidelines should be monitored on an ongoing basis.
Tip: clearly and contractually stipulate and control rules around outsourcing partners further sub-contracting any parts of the functions and processes they are responsible for. The longer the chain, the harder it becomes for the end client to remain confident ethics remain compatible with its own along it.
Outsourcing Trends
The global Business Process Outsourcing market is expected to continue to grow rapidly over coming years across all the major sectors of IT outsourcing, Business Process Outsourcing and Contract Manufacturing.
Market intelligence company GrandViewResearch estimates the total value of the global BPO market at $261.9 billion in 2022 with IT and telecoms outsourcing the most valuable sub-sector. It accounted for 34% of the whole market. Between 2023 and 2030, the global outsourcing market is expected to grow by a very robust CAGR of 9.4%, taking its value to $525.2 billion – almost double the 2022 value.
Source: GrandViewResearch
Other market intelligence sources indicate that the global outsourcing market is even bigger. For example, Statista forecasts that the IT outsourcing segment alone will be worth $587.3 billion by 2027 from $430.5 billion in 2023. Key statistics from Statista’s forecast include:
- Revenue in the Segment IT Outsourcing is projected to reach US$430.50bn in 2023.
- Revenue is expected to show an annual growth rate (CAGR 2023-2027) of 8.07%, resulting in a market volume of US$587.30bn by 2027.
- The average Spend per Employee in the Segment IT Outsourcing is projected to reach US$123.60 in 2023.
- In global comparison, most revenue will be generated in the United States (US$156.20bn in 2023).
However, while the strategic importance of outsourcing continues to grow, alongside the sector’s market value, recent geopolitical trends including Russia’s invasion of Ukraine and growing tensions between the West and China will have an impact. End clients of outsourced professional and manufacturing services can be expected to place increasing emphasis on mitigating geopolitical risk.
Despite the evolving nature of globalisation, especially with regard to a new focus on supply chain security and geopolitical risks, the benefits of outsourcing mean the sector is expected to keep growing quickly to the end of the decade. The impact of the Covid-19 pandemic and new technologies that support remote work will underpin growth of nearshore and offshore outsourcing of professional services such as accounting, HR and software development and other IT services.
Economic headwinds expected throughout 2023 are also likely to benefit professional services outsourcing as companies and other organisations prioritise cost efficiencies and flexibility.
