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Outsourcing refers to the practice of buying services externally rather than producing them internally. There are a lot of issues that have to be addressed and understood before a company decides to offshore outsource. These issues can include various cultural obstacles, time zone differences, language barriers, complex geopolitical climates, ability or even inability to visit sites, volatile currency rates, stability and security concerns, along with visa restrictions.
Outsourcing is economically justifiable only once the wage differential is large enough to more than make up for lower labor productivity.For example, if the higher wages of American workers are consistent with their relative productivity, there should be no reason for a company to move its operation overseas. Yet current predictions have indicated that U.S. corporate demand for offshore outsourcing services continues to surge, despite a public backlash at home and ambiguous privacy laws overseas that raise the risk of companies committing intellectual property breaches.
Outsourcing is the movement of a function inside a company to an entity outside it. Before the word came into widespread use, people talked about "farming" or "contracting" things out. The corresponding opposite to outsourcing is to "bring it in-house." When something is brought in-house, the implication is that it will now be done properly; the implication of outsourcing something is that now it will be done cheaply. The outsourcing of functions has never been popular (to make an understatement) with employees affected by the action inside a corporation. But the activity only achieved a strongly negative flavor in general when the outsourcing became "off-shoring," meaning the shipment of jobs overseas. Until then a job might be outsourced but remained part of the U.S. economy; in its off-shored form it signaled trade deficits and lost jobs. The domestic form of outsourcing has always tended to benefit small business: small business was and is, more often than not, the recipient of the jobs farmed out by the large corporations. The outsourcing of a function, in fact, has been and continues to be an opportunity for a group of employees to set themselves up in business.
Outsourcing is also widely practiced by small business but usually for slightly different reasons. Small companies do not have the scale to support full-fledged accounting, payroll, and computer systems staffs of their own—or, if their managers try to do these jobs as well, they have to work too many hours. These functions, therefore, are farmed out. So are, frequently, large but intermittent jobs.
The driving force behind outsourcing, narrowly viewed, has always been and continues to be the desire to lower costs—although it has additional benefits. In times of shrinking economic activity, it easier to buy less of something or to eliminate buying something altogether than it is to lay off employees and to close departments. It is easier to shop an activity around when higher quality or greater speed is the objective than to get an internal supplier to change its behavior. Any manager of a small division in a large corporation whose main supplier is another and larger division knows how unresponsive the internal vendor can be. The external supplier, which, presumably, also has other clients, can be the source of interesting innovation.
Outsourcing also has its disadvantages many of which are easily overlooked in the hurry of achieving the costs savings that appear to be possible. When a company simply stops making some product and begins to buy it from the outside—and, furthermore, the product is widely available—outsourcing is generally fairly advantageous. But if the outsourced "object" is some kind of function normally handled in-house by a company, problems can arise. First, a portion of the function must be retained inside to act as an interface with the supplier—and because of language and other issues, this interface may start to grow rather large. Second, control is lost by distance and the presence of an institutional barrier. Solving problems can become more costly and take more time. If the function is unique, the buyer is exposed to risk due to potential vendor failure; the vendor may grow surprisingly independent, find other clients, raise prices, and erase the cost benefits. As Roger Parloff reports in Fortune, some contract producers overseas may establish a "third shift" to produce the buyer's own product, but relabeled and rebranded, for sale in competition but at a lower price. Close observers of the outsourcing phenomenon like to emphasize reality: outsourcing is just the old contracting; when, in addition, an ocean and/or a linguistic and cultural barrier is interposed, the initial cost advantage may disappear. Not surprisingly, as Business Week reports, western companies are beginning to buy up overseas suppliers, thus "internalizing" again what they had "outsourced" before.
Outsourcing, as already noted above, may be divided into "domestic" and "overseas" categories—not taking "oceans" too literally in this definition: "over-the-border" would be more accurate. Data on outsourcing are not specifically collected except in the context of mass layoff data published by the U.S. Bureau of Labor Statistics. BLS specifically reports separations caused by "domestic relocation" as well as "out-of-country" relocations every quarter. Under both categories, BLS breaks down separations further into two categories: relocation "within company" and to a "different company." When the separations are due to relocation to another domestic site but the jobs are relocated to a "different company," one might speak of genuine "outsourcing." In the other category, however, any relocation overseas could be classified as outsourcing, "out" in this case meaning out of the country. Using these definitions ("domestic/different company" and "out-of-country"), BLS data indicate that off-shoring is the much larger component. In the fourth quarter of 2005, mass layoffs caused by out-of-country relocations caused 2,047 separations; relocations domestically to a different company caused 401. But total domestic relocations (including the 401 above) were 4,224. These jobs may also have been relocated to reduce wages. Data for a year earlier, the fourth quarter of 2004, indicated 5,258 separations caused by relocating jobs offshore; domestic relocations caused 8,093 separations, but of these only 808 were relocated to another company.
Outsourcing can also be defined as the transfer of specialized functions and the relocation of complete operations. When a business owner hires a payroll service to avoid spending weekends preparing payroll, he or she is transferring a specialized function, payroll. When a large corporation hires a company in India to provide over-the-phone tech support for computer and software installation, again a function has been transferred. But when a producer of bedsprings closes its U.S. factory and opens a factory in China, it has outsourced a complete operation.
Broad statistics are not available to measure which of these categories is more prevalent. What is clear is that computerization generally and the Internet specifically have produced a significant opportunity for the outsourcing of functions that require skills in symbol manipulation (thus engineering and technical functions) and/or linguistic skills that can be deployed by telephone. Data keying was an early activity outsourced, typically, to India—where knowledge of English is widespread. Engineering and technical support have gained share overseas; software engineering is growing—despite equally energetic growth in information technology (IT) employment here; interpretation of medical and other lab results by distant experts is growing; and, most recently, legal research and brief preparation are gaining as an outsourced activity.
At any point in time, outsourcing will tend to be defined by prevailing conditions in the structure of an industry, the national economy, and, currently, the global economy. Economies show a cyclic movement between centralization and decentralization driven by a mix of factors: resources, technology, stage of development, confidence, communications, etc.
The cycle can be illustrated at the micro level by a process in which an enterprising contractor begins to build homes by working closely with small companies that specialize in concrete, carpentry, electrical work, plumbing, roofing, and so on. Gradually, to get ever better control, the contractor acquires little companies, hires his own craftsmen, and becomes a major building company that does its work exclusively with its own people. Many years later, during a prolonged recession in construction, the company may begin spinning off its functions until it retains only a managerial core which, as at the beginning, works with independents.
During a centralization phase an enterprise favors vertical integration; during decentralization, it favors specialization. In the early 21st century, with outsourcing common, the economy appears to have a decentralizing tendency; this movement already manifested itself in the last quarter of the 20th century. Large corporations are specializing in finance and technology and shedding the labor-intensive execution functions. This is possible, first, because human and other resources are widely available and differentially priced across the globe. Labor costs are very high at the center of the developed world and relatively low in the growing economies. Second, communications and global financial systems have matured so that overall control is relatively easier. Third, until the sudden shadow of terrorism appeared, stability reigned across much of the globe.
Outsourcing as an attractive mechanism to achieve strategic aims will continue until wage rates equalize across the globe—assuming nothing else changes first. However, trends in energy, increasing international instability, and consequently rising anxieties may cause it to diminish in the future as popular reaction causes political action. Change, in any case, is certain.
Goodwin, Bill. "Outsourcing Users Taken by Surprise." Computer Weekly. 18 April 2006.
"More U.S. Workers Have IT Jobs Than Ever Before." InformationWeek. 24 April 2006.
"New Spin on Telework: Call center shift could mean home is where the job is." Employee Benefit News. 1 May 2006.
"Off the Record: The hidden costs of offshoring—Saving money south of the border can be an expensive proposition." InfoWorld. 24 April 2006.
"Open Season On Outsources; More Western giants are snapping up Indian companies that specialize in back-office operations." Business Week. 17 April 2006.
Parloff, Roger. "Not Exactly Counterfeit." Fortune. 1 May 2006.
U.S. Department of Labor. Bureau of Labor Statistics. "Mass Layoff Statistics." Available from http://www.bls.gov/mls/home.htm. Retrieved on 30 March 2006.
Wilson, Taylor H. "Outsourced Around the World in a Billable Hour." Texas Lawyer. 1 May 2006.
Zimmer, Matt. "Outsourcing: From soup to nuts or a la carte?" Club Management. December 2004.