Outsourcing

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.

MAJOR CATEGORIES

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.

BROAD FORCES AND TRENDS

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.

BIBLIOGRAPHY

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.

                                            Darnay, ECDI

Outsourcing

BIBLIOGRAPHY

Outsourcing is a process whereby an organization contracts with an outside entity to perform some business function previously done “in-house.” Practically any function can be outsourced, from manufacturing labor to customer service. The spatial distance between the core firm and the contractor can vary greatly. Offshoring denotes an outsourcing of business functions to a contractor located in a foreign country. Domestic outsourcing occurs within a single country, and can even involve two firms located directly adjacent to one another. The temporal relationship between core and contractor firms can also vary, from a decades-long partnership to temporary services rendered for a single day. Due to the complex nature of the phenomenon and the inadequacy of existing data, no precise metric is available with which to quantify the extent of outsourcing or its growth over time. Those interested in the issue of measurement should consult Robert C. Feenstra (1998). Social scientists generally agree, however, that outsourcing has proliferated globally since the 1970s.

To explain this proliferation of outsourcing, scholars situate it in relation to the larger phenomenon of economic globalization. In this view, the mid-twentieth century was dominated by large oligopolistic firms catering to regional markets within the nation-state. These firms were vertically integrated; that is, they controlled both supplier and distributor firms. They located their headquarters and production facilities proximate to supplier and consumer markets. Work was organized to achieve economies of scale and to maximize the volume of goods produced. Workers were in turn offered job security and generous wages.

Commencing in the 1970s, several major changes to the organization of economies and states dramatically transformed ideas of how a successful business should be designed. Business leaders now sought to “pare down” their organizations, by outsourcing all but a small core of essential functions. These streamlined firms would then be integrated into a web of strategic alliances with other firms around the world. But what were the changes that led to the emergence of what Manuel Castells (2000) calls a “network society”? First, firms experienced increased competition due to a deregulation of business relationships and the removal of barriers to trade across nations. Second, the ownership structure of firms underwent a transformation, as institutions purchased large portions of corporate stock. While individual shareholders are typically passive, institutional investors actively demand that managers maximize short-term profits. Third, advances in communications and transportation technology (especially personal computers and Internet access) enabled the coordination of production across great distances.

Intensified competition, a shareholder conception of control, and new technology increased the feasibility and attractiveness of outsourcing. As Paul Osterman (1999) documents, outsourcing decreases labor costs insofar as contracting firms pay on average lower wages and offer fewer benefits. Outsourcing also relieves the core firm from the responsibility of ensuring that working conditions meet state regulations. In the United States, for example, should a contracting firm be found to have forced employees to work overtime, it and not the core firm would be found culpable. More generally, outsourcing is believed to maximize flexibility. Temporary workers may be contracted to meet seasonal fluctuations in business activity, and production processes can be quickly reengineered to match changes in consumer demand, while relationships with suppliers can be terminated should production schedules be altered.

The proliferation over the past three decades of offshoring and domestic outsourcing has invoked considerable debate within nations. It is important to consider the points of view of two main parties: states and workers. Governments of states targeted by firms as sites of outsourcing can take a range of positions. At one extreme is a developmental state actively encouraging investment. At the other is staunch opposition to outside investment, most likely when the outsourced activity is perceived as vital to national security. For example, in April 2006 plans to outsource the inspection of incoming containers at U.S. ports to a Dubai-based company were canceled after U.S. Congressional leaders protested over potential security risks.

When confronted with proposals by domestic firms to offshore production, governments may accuse firms of behaving greedily or unpatriotically. This is especially the case when the outsourcing will entail plant closings, or when the domestic firm is outsourcing not for economic survival but to achieve a higher rate of return on investment overseas. Politicians may even pass legislation to discourage foreign investment by domestic firms. Such protectionism, however, represents what Robert Reich labels “vestigial thought” (1992, p. 154), insofar as it remains wedded to a vision of unitary firms producing and selling goods within a single nation-state. In fact, managers, when deciding to offshore production, are merely responding to the shifting rules of the larger game of global capitalism. Governments intent on protecting domestic jobs would be wiser to cooperate to reshape the rules of this game rather than demonizing individual players.

Like states, workers in existing core firms may view outsourcing as against their interests. After all, the flexible labor markets required by global capitalism entail the replacement of secure jobs offering middle-class incomes with insecure jobs and low wages. The competition among states to attract investment capital is in fact often labeled a “race to the bottom.” Yet workers and their unions are hampered in their capacity to take action against individual firms, since strikes or work stoppages may only quicken the pace at which work is outsourced. As Jeffrey Sallaz (2004) has documented, unions lack the means to influence the rules of the game at a national or global level, and so fight to slow the pace at which work is outsourced from core facilities to allow older workers time to adjust to the “new economy.”

To conclude, as competitive global capitalism has eclipsed oligopolistic national capitalisms, outsourcing has emerged as a strategy used by private firms to cut labor costs and increase flexibility. Of immediate interest to social scientists in the coming years will be the question of how the economic trend toward outsourcing is affected by political developments involving the global “war on terror,” heightened border security, and resurgent nationalisms.

SEE ALSO Globalization, Social and Economic Aspects of; Trade

BIBLIOGRAPHY

Castells, Manuel. 2000. The Rise of the Network Society. 2nd ed. Malden, MA: Blackwell.

Feenstra, Robert C. 1998. Integration of Trade and Disintegration of Production in the Global Economy. Quarterly Journal of Economics 12 (4): 31–50

Osterman, Paul. 1999. Securing Prosperity: The American Labor Market, How It Has Changed, and What to Do about It. Princeton, NJ: Princeton University Press.

Reich, Robert B. 1992. The Work of Nations: Preparing Ourselves for 21st-Century Capitalism. New York: Vintage.

Sallaz, Jeffrey J. 2004. Manufacturing Concessions: Attritionary Outsourcing at GM’s Lordstown, USA, Assembly Plant. Work, Employment, and Society 18 (4): 687–708.

Jeffrey J. Sallaz

Outsourcing

What It Means

Outsourcing occurs when one business firm hires another business firm to perform one or more jobs on its behalf. For instance, a software company, rather than hire its own accountants to work in-house, might hire an accounting firm to keep its financial affairs in order; the software company is outsourcing its accounting work.

Increasingly, the term “outsourcing” has taken on the meaning of the word “offshoring.” Offshoring is outsourcing to a foreign country where labor is cheaper. It has become extremely common for U.S. corporations to move portions of their operations to countries like Mexico, India, China, or the Philippines, where workers typically make only a fraction of the wage that Americans would make doing comparable work. Offshoring has moved millions of American jobs to other countries. For this reason outsourcing has become a very controversial topic and a major issue in the political arena.

When Did It Begin

In the middle and latter part of the twentieth century, corporations wanted to expand and vary their business holdings. A maker of processed foods, for instance, might try to grow by buying a business firm that manufactured lightbulbs, a firm that made movies, and a firm that provided life insurance. Among other benefits, these acquisitions would position the overall corporation to remain profitable in a wide variety of economic circumstances (if the processed-food business was in a slump, another sector could make up for those losses). Beginning in the mid-1980s, however, corporations increasingly found that running such diverse operations resulted in a lack of focus, and many corporations sold off subsidiaries (businesses they controlled), returning to a core group of businesses that took best advantage of their particular strengths. This idea of core competence (the centering of a business around the strengths that could give it an advantage over its competitors) became one of the driving concepts in the corporate world. Part of the streamlining that corporations undertook to establish a core competency led to the outsourcing of basic operations that could be more efficiently handled by an outside company.

The offshore outsourcing trend started in the 1960s, when U.S. companies began to move manufacturing facilities to Mexico and, later, to other global sites offering cheap labor. Even taking into account foreign trade restrictions and the added expense of transporting goods back to the United States, companies typically found that they could reduce costs by 30 to 50 percent by moving the physical production of their goods to less-developed countries. Some items commonly manufactured abroad at the time included clothing, household furnishings, and electronics. Increasingly since this time, U.S. companies that have offshored their production work have focused more on managing the company and on sales and other service components of their businesses: those aspects requiring more human judgment and contact with consumers.

More Detailed Information

Outsourcing offers many advantages. For instance, the software company that outsources its accounting duties might find that the accounting firm can get the work done more efficiently because that is their specialty; the accounting firm would probably also charge less money than the software company would have to pay to maintain its own accounting department. Outsourcing can also make a company more adaptable by allowing for staff reductions and a stable staff size. If the software company’s accounting workload suddenly doubles because new tax laws were passed, it can simply pay its partner accounting firm more money to take care of the extra work rather than undertake the cumbersome work of hiring several new in-house accountants and then firing them if, down the road, the accounting workload eased up.

Outsourcing enables companies to devote their energies to what they do best. This can be particularly important in the early stages of getting a business off the ground. A fledgling business is usually short-staffed, so delegating tedious, noncore tasks to other firms makes sense. Another advantage to outsourcing is that it can increase the level of accountability related to certain tasks. Because the accounting firm is being paid a fee, the software company can clearly demand excellence. If the accounting firm does not deliver an adequate level of service, the software company can terminate the contract and find another firm. The same issues are less clear-cut when working with in-house employees.

But the risks of outsourcing are real. The company that delegates its operations to another firm loses control over the end result. Though the company can fire the firm it hired to do the work, the firm might have done the work so badly as to cause irreparable harm before the problem is even discovered. While this may become less of a risk over time, as a company develops solid working relationships with its partner firms, the risk at the outset of an outsourcing relationship is substantial.

Offshoring is one type of outsourcing that has brought American companies clear gains, but it has raised the opposition of American workers, many of whom have lost jobs because of the practice. When a U.S. shoemaker moves its manufacturing facilities to the Philippines, the motive behind outsourcing is unmistakable: the shoemaker can pay much lower wages in the Philippines than it paid American workers. The outsourcing allows the shoemaker to cut a large chunk out of its operating costs and to make substantially more in profits.

When a company chooses to offshore its production facilities, it can have a domino effect on the industry: once a single shoemaker has made such a business move, competing firms have to do the same if they want to stay in business. With its operating costs dramatically lowered, the first shoemaker can set its prices as far below those of its competitors as it wants. It can easily drive its competitors out of business if they keep their manufacturing facilities in the United States. This model explains the inevitable nature of the most controversial types of outsourcing today. Without government intervention restricting such business practices, the market seems to make it impossible for companies to do otherwise than move American jobs to other countries.

Recent Trends

Although most people currently associate outsourcing with the movement of manufacturing jobs overseas, professional jobs, too, are increasingly being outsourced to countries where salaries are lower. Most notably, large numbers of high-tech jobs, such as computer programming, have been moved to India, which has a very educated but much lower-paid labor force than the United States. Some estimates predict that more than 3 million white-collar jobs will be moved overseas by 2015, representing a loss to American workers of roughly $135 billion. Accordingly, there is a great deal of popular opposition to the concept of outsourcing, and the issue has become increasingly central to national politics since the beginning of the twenty-first century.

Many economists and free-trade advocates argue, however, that opposition to the phenomenon of overseas outsourcing is short-sighted. According to economic theory, the world economy grows more efficient when high quality goods and services can be produced more cheaply. Additionally, some economists assert, the rise in income of workers in impoverished countries ultimately represents new markets for American products. From an economic point of view, to oppose outsourcing is to oppose the inevitable changes that capitalism brings, some of which have substantial benefits.

OUTSOURCING

In the 1990s and into the beginning of the twenty-first century, technological advancements continued to develop at breakneck pace. This was especially true of the Internet technologies used during e-commerce. Keeping up with all these developments and making solid, informed decisions about them became difficult or impossible for many companies, who needed to focus most of their resources on core business competencies to be successful. For this reason, it was common for organizations to outsource, or have other vendors handle, different aspects of their e-commerce initiatives.

Even leading international companies with large departments devoted to information technology (IT) often find it more cost-effective to outsource certain aspects of e-commerce rather than develop the expertise themselves, which can require hiring scarce workers and investing large sums to train and retain them. Accordingly, it's not surprising that a survey from CommerceNet found nearly 75 percent of e-commerce firms outsourced parts of their work in early 2001, or had plans to do so. Eighty-seven percent of the companies surveyed viewed outsourcing as an effective way to scale their business offerings based on fluctuating revenue streams.

OUTSOURCING EXAMPLES

While it's possible for a company to outsource virtually any kind of service, in the early 2000s several were especially common in the e-commerce arena. Among them were IT management; logistics and order fulfillment; Internet video production, management, and distribution; customer relationship management; and Web site development and hosting. The ease and cost efficiency of handling different aspects of e-commerce in-house was easier and more cost-effective for some companies than it was for others, so companies outsourced services differently.

Many companies looked to outside parties to handle online order fulfillment (filling and shipping orders they received via the Internet) instead of building or renting their own warehouse operations, which required special expertise for e-commerce. This freed them to focus on core competencies like creating new products and services, and marketing. Logistics & Distribution Report indicated that many Fortune 500 companies were outsourcing transportation, warehouse management, and inventory management by the late 1990s. In 1999, third-party logistics contracts grew by 16.5 percent, and revenues totaled $46 billion. According to the publication, growth rates were expected to reach 15 to 20 percent by 2003.

When companies rely on third-party fulfillment providers, they normally manage the front end of e-commerce (the content and appearance of their Web site) and leave the rest to the third party. In other words, the third party receives orders from customers, manages the inventory of available products in its warehouse, and coordinates shipping. Some also provide value-added extras like customer service.

Another example of outsourcing involves application service providers (APSs), third parties who manage business applications for companies so they can focus more on their core business. These applications often involve things like payroll, billing, and customer service. The software systems offered by the ASP are sometimes Web-based, so that client companies do not have to host the software and devote resources to maintaining and updating them. Although ASPs held the potential to simplify things for client companies, they also moved long-held control over internal systems and data to outside parties, which made some organizations uncomfortable.

THE FUTURE OF OUTSOURCING

According to a March 2001 survey conducted by Merril Lynch, chief information officers in the United States and Europe were planning to scale back IT spending on outsourcing, among other areas of IT. However, despite this indication of possible cutbacks, the market for outsourcing was substantial. IT Outsourcing Market Forecast, a study from market research firm Input, projected that the information technology outsourcing market would grow 22 percent annually between 1998 and 2003, reaching $110 billion.

However, as with any kind of business practice, the use of outsourcing as an approach will vary depending on the service involved. For example, the future of outsourcing looked especially positive in the area of customer relationship management (CRM)—database systems companies use to maintain details about their customers, including their contact information and preferences for products and services. A July 2001 Harte-Hanks survey found more than 80 percent of companies in North American were outsourcing the task of building and maintaining their CRM systems. On the other hand, Frontline Solutions cited results from an Aberdeen Group survey that indicated outsourcing business-to-business software applications was not as promising. Although more and more software applications were available from ASPs, Aberdeen's survey of the Oracle Applications Users Group found that less than five percent were using ASPs, and 82 percent were not planning a strategy involving them.

FURTHER READING:

Chow, Elsie. "Outsourcing E-commerce Fulfillment." Warehousing Management, December 2000.

"CommerceNet: Most E-commerce Firms Outsource Work." Nua Internet Surveys, April 30, 2001. Available from www.nua.ie.

"CyberAtlas: U.S. Firms Prefer to Outsource CRM." Nua Internet Surveys, July 9, 2001. Available from www.nua.ie.

"E-marketplaces Remain Erratic." Frontline Solutions, May 2001.

"Input: Outsourcing Worth USD110 billion by 2003." Nua Internet Surveys, October 6, 1999. Available from www.nua.ie.

King, Julia. "E-commerce Solution: Let Someone Else Sell Your Product." Computerworld, November 13, 2000.

SEE ALSO: Application Service Provider (ASP); E-commerce Consultants; E-commerce Solutions