An Insight into the Pros and Cons of Outsourcing - Essay Example

? Is there evidence to support that the benefits of outsourcing and/or off-shore outsourcing outweigh the disadvantages Globalization and complexities in the trade relations have urged multinational companies to outsource their services to other countries where the cost incurred for development of the processes is far below the profit margins. Outsourcing and offshore outsourcing have increased to great extents but it has been also found out that there are certain risks and negative externalities attached with outsourcing. The paper through discussion of the benefits and disadvantages will exhibit evidences to show whether the advantages of outsourcing outweigh its disadvantages. Theoretical and empirical evidences are given for validating the hypothesis. 1. Introduction Diversity in trade relations with globalization has introduced various new business processes among which outsourcing is one of the most common term. Generally, outsourcing can be regarded as the “transfer of an internal service function to an outside vendor” (Benaud & Bordeianu, 1998, p.3). Developed countries like United States of America, Great Britain are randomly using outsourcing techniques for reaping profits. Now in this respect the notion of offshore outsourcing also holds a significant importance. The process of offshore outsourcing generally refers to practice of outsourcing to the vendors in the foreign countries for extracting the advantage of wage arbitrage. The companies who engage in offshore outsourcing engage “the foreign suppliers to perform some or all business functions in a country other than the one where the product or service will be sold or consumed” (Ramanathan, 2009, p.16). China is a country which has developed itself as the hub of manufacturing offshore. Developing countries like India in recent times can be regarded as a nucleus of technology enabled services. In developing countries mass of educated workers work at a much lower rate as compared to wage rate that their counterparts receive in the developed nations. In reality, a preconceived notion is that the organizations engaged in outsourcing will be on a regime of cost savings and their advantages will be surpassing disadvantages but it is a fact that there are various risks that will be taken into consideration. As for example one of the disadvantages of offshore outsourcing is that the outsourcing organizations become highly dependent on the external service providers (Ramanathan, 2009). There are other disadvantages associated with offshore outsourcing which will be discussed within the course of the paper. Thus as the topic directs the paper will be highlighting on the fact that whether strong empirical evidences are present which can support the statement that advantages of outsourcing and offshore outsourcing surpass its disadvantages and other bottlenecks (Ramanathan, 2009, p.16). 2. An insight into the pros and cons of outsourcing - a literature back with respect to outsourcing model Before making a proper assessment of whether the benefits of outsourcing outweigh its disadvantages, a proper study on the potential advantages and disadvantages of outsourcing and offshore outsourcing needs to be figured out in a proper manner. 2.1 Rationale for outsourcing With the increase in global competition and transforming business dynamics, the mechanics of outsourcing has changed a lot (Wee et al, 2010, p.2081). Before 1980s the functions of outsourcing, its processes and activities were normally executed within the firms. This was done through the process of outsourcing contracts operated within the firm along with the outsourcing contracts through the repurchase through supply contracts. But after 1980s with the use of outside suppliers within the global business milieu and the Third World countries immense thirst for development gave the multinational companies (MNCs) lucrative opportunities within the trajectory of offshore outsourcing. The MNCs have established local companies that are capable of producing at a very low cost and at an acceptable level of quality. From this, streamlining of the organizational structure along with reduction in the cost of manufacturing, the MNCs have utilized the ways of outsourcing in a rigorous manner for reaping ultimate benefit (Michela & Carlotta, 2011, p. 276). 2.1 Advantages from strategic dimension In the recent years there has been a strong transformation in the outsourcing strategies moving from different forms of production contracts which involve third parties to that of delivering services in different dimension ranging from innovations in technology to that of logistics, customer relations to those activities after sale (Saxena, 2009, pp. 21-22). The decisions related to outsourcing are not restricted to marginal productions with reticent technological content but it has extended its domain where requirement of core competencies are integral part of core business. In today’s world the firms consider outsourcing from a strategic perspective directed towards channelizing various important functions and processes via a stabilized network settled through multifarious agreements. From the studies of Quinn and Hilmer from the strategic perspective outsourcing provides certain fundamental benefits. Firstly, it helps in maximizing the net result derived from the internal resources with focus on investments and efforts in areas where the firm performs the best. Secondly it helps in the creation and protection of various competitive advantages along with the augmentation of the core competencies. It also helps the firms in strengthening its best areas and develop a shield against the potential competitors. Thirdly outsourcing generally provide incentive to investments in the technology know how of the outsourced countries, upgrades technological forefront of the people of the outsourced nations. Specialization of labor occurs within these nations. Lastly, it can be stated that outsourcing helps in minimizing the risks within the changing market environment as well as rapidly developing technological arenas. The strategy of outsourcing transfers the risk outside the firm from the areas of change in technology and research and development costs. Thus the firms are able to shorten up the cycles of production and thus are aligned perfectly for responding to and delivering the needs of the customer at a much rapid pace and in a more flexible manner (Michela & Carlotta, 2011, p. 276). The theories related to outsourcing are rigidly different from the theories in other areas. The basic motivational element of outsourcing comes from concept of economies. Studies of Lacity and Hirschman in 1993 stated that theories of organizational behavior were also an influence of outsourcing. The decision making process associated with organizational behavior is relevant in case of outsourcing as it focuses on the decision of whether to develop a product in an internal or external basis (Weerakkody & Irani, 2010, p.615). 2.2 Negative externalities attached The mechanism of outsourcing is also not free from vulnerabilities. This is reflected through the views of various researchers. The researchers and scholars have opined that there emerges a wide range of risks in outsourcing scenarios which develop suboptimal and unwanted results. Among these negative effects unexpected rise in costs, evolution of disputes, litigations, lock as well as loss of organizational competencies are noteworthy. The risks may generate from different areas. Information technology industry is an area where offshore outsourcing has encountered its massive incorporation. The uncertainties can arise if there is a gap in the degree of expertise in the outsourcing and IT operations both on the client as well as on the vendor side. Availability of suppliers is a major constraint is a major impediment as well as a risk factor. There may also arise asset specificity issues which include investment on the vendor side which includes activities like training of the vendor, client personnel, modification of various processes for accommodating the clients and the tools system along with investment in hardware and so on. Imperfect market information associated with the market demand along with technological transformation and breakthroughs. Risks may also arise interdependence of the systems and processes that are outsourced. There may also generate problems in measurement like the differences in various interpretations of performance. The other risk factors also include loss of institutional knowledge with the displacement of employees. Additional risks are attached with outsourcing and that are cultural differences, barriers in language as well as geographical and time zone problem may also increase the risks (Herath & Kishore, 2009, p.313). It can be stated that various disadvantages of offshore outsourcing may be attributed in larger certain broad categories. These categories are “loss of control, loss of flexibility, possibility of misaligned incentives between the customers and the provider and cost overruns” (Carmel & Tija, 2005, p.121). 3. Evidences showing pessimism towards outsourcing In a survey made in USA by Prasanna B. Tambe and Lorin M. Hitt in 2010, it was found that about 15% of all the firms and around 40% of the technology firms that were surveyed in the offshore outsourcing activities around 8% of the total IT workers were reported to have been displaced due to offshore outsourcing which was more than around twice the percentage of any other type of employees in the survey (Tambe & Hitt, 2010, p.63). In India world famous computer manufacturing company Dell terminated the operation of a technical support in regarding severe complaints from the corporate customers. Some of the companies’ customers from USA complained that technical support representatives in India were highly difficult to communicate with and the people possessed thick accent as well as scripted responses. The corporate customers accounted for around 85% of the total business of Dell with 15% generating out of the consumer market. In the recent times the risks related to security like data security and confidentiality issues are more predominant in now days. In the year 2000, more than around 10 million credit cards were held by an independent sales organization and it was one of the worst financial disasters in that year. A company which was based on Charlotte known as Wachovia Corp used its third party partners in using a lot of due diligence. In the early days of electronic commerce investment in new services like that of electric bill presentment as well as payment mode were highly recognized. In today’s e commerce policies the prime priorities are that of risk management, recovery in disaster and that of security and privacy (Herath & Kishore, 2009, p.314). 4. Proper policy implementation making advantages surpass the disadvantages In a consulting survey of Delloitte with 25 world class organizations which covered various industries argued that the aura of outsourcing is not so fruitful. Outsourcing also lacked encouragement. Their results stated that around 2 one quarter of the companies returned their business back to their in house mechanisms when they realized that they were able to execute properly the business functions at lower cost levels. From the survey report of the companies it was revealed that the process of outsourcing was not a process directed towards saving of money. Hidden costs are major constraints in the path of outsourcing. The reports stated that although outsourcing generate a spree of cost reduction in the initial phase, simplify projects as well as infuse expertise in house but it was a learning procedure for many of the companies that the problems escalated the costs as well as friction which led ultimately to the translation in higher costs as compared to the originally anticipated costs. In the month of May, 2006, the survey of Information Week focused on 42 business technology professionals which also pointed that outsourcing did not yield proper results. The respondents in the survey were questioned with answers having ratings from 1 to 10. In the result it was found that the respondents were satisfied only reasonably with the performance of their vendors. They were also disappointed with the cost for value of the service. Around forty five percentage of the respondents stated that poor service and flexibility lack were the reasons for imparting pessimistic approach towards outsourcing. Hidden costs were also recognized as a serious problem. Now the hidden costs of outsourcing were not anticipated at the time of contracting. Now a company who outsources can be attacked with unanticipated escalated expenditures if there is reliance of the company on the services of outside consultants for evaluation procedure. It is the real hidden cost that tremendously gets reflected in the dimension of transfer of knowledge, scope of work along with the cost engaged in the ongoing management of the outsourcing relationship (Tadelis, 2007, pp.262-263). The data discussed above highlights the fact that although outsourcing is a lucrative endeavor of business expansion and profit venture, in reality a large number of firms have not successfully run their outsourcing processes and they removed their business back to their own in house mechanism. With the growth in outsourcing the decision associated with outsourcing becomes crucial. Actually it is a decision making process which allows the firm in examining the decision of whether to outsource an activity or performing that within the organization. In this respect, the approaches of transaction cost economics (TCE) as well as resource based view (RBV) are noteworthy. The TCE theory directs that it is characteristics of a transaction that determine which of the governance structures like market, hierarchy or that of alliance are the most efficient form of governance structure. Within the decision of outsourcing business, TCE states that a firm will be performing an activity within a hierarchical governance structure at the juncture when high transaction cost is anticipated. Within the transaction cost are included aspects of negotiation, monitoring, enforcing as well as resolving of disputes attached with a contract of outsourcing. The RBV approach focuses on the building of idiosyncratic resources as well as capabilities which the competitors of the companies will face difficulty in understanding as well as imitating. With the successful implementation the firm will be able to gain competitive advantage. From the perspectives of RBV approach, the outsourcing can actually enhance the value of the firm helping it to make access to various resources as well as capabilities that it currently has. The studies of TCE and RBV points out that the outsourcing decisions of the firms are based on whether the outsourcing decisions reduce cost or builds strategic advantages. Much of the research also stated highlighted that cost reduction and reaping strategic advantages are two mutually exclusive phenomenon. With the increase in the outsourcing process a large number of firms are on managing portfolio contracts. Current research aims at either cost cutting or those strategic advantages. In this respect the statement of Oh et in 2006 can be stated as, "Information technology outsourcing can help to reduce firms' information technology spending or provide opportunities to better compete and expand in the marketplace" (Pouder et al, 2007, p.6). It is a fact that when there is an announcement of dual outsourcing motives then both the advantages of cost cutting and strategic benefits are reaped. Previous literature suggested that the core competencies of the firm should be done within the organization without offshore outsourcing. But the studies of Pouder et al 2007 revealed different implications (Pouder et al, 2007, pp. 5-6). A unique study of Pouder et al in 2007 revealed that realizing the dual perspective a firm can realize the actual benefit and can create value through the process of outsourcing. Pouder et al deviated from collecting data from the IT sector outsourcing and concentrated on various outsourcing announcements made in Business wire, Wall street journal, Lexis Nexis database within a time span of 1991 to 2004. The data were studied rigorously consistent with the theoretical foundation. The researchers also concentrated on the data which provided sufficient information regarding the motive of the firm with respect to outsourcing. 226 announcements ultimately matched the criteria. With execution of proper statistical methods it was found that the announcement of the outsourcing contracts along with attempts in cost reduction as well as gaining strategic advantages led to the increase in value of the shareholders. But the prior research in this field have overlooked the impact of dual outsourcing motives which actually gives the investors an idea that the managers are focused on nourishing the short hand as well as the long term results (Pouder et al, 2007, pp. 6-13). 5. Conclusion Outsourcing is a latest trend with expansive potential applied by the multinational corporations in countries where they will be able to cut the cost and reap optimum profits to the firms. Basically it has become a strategic intervention for the firms for reaping benefits and reducing risks. It helps in the development of diverse competitive advantages with acceleration in the areas of core competencies. Developing an overseas market potential through outsourcing and offshore outsourcing creates a virtual shield for the companies against their potential rivals. Flexibility and delivering the needs of the customers are made in a smooth manner. But apart from the advantages it has been found both theoretically and empirically that there are certain robust disadvantages like loss of control, cost overruns, miscommunication between the outsourcing companies and their vendors and so on. Empirical evidences reveal within the information technology sector a large number of firms have encountered huge losses and they have piled up their business and started to work in their own organization. Customer complaints of miscommunication and misjudgment have been also the reason that these companies are not so successful in their outsourcing venture. Again majority of the literature have focused their studies on the information technology sector and they have propounded for either focus on cost cutting or gaining strategic announcement. These studies also advised the companies to work on the core competencies within the organizations. But empirical evidences of the studies Pouder et al in 2007 revealed that attaining dual perspective is not mutually exclusive and focusing on core competencies increase the value of the firm. Thus evidences suggest that benefits surpass the disadvantages and proper implementation of strategies will reap both short run and long run benefits to the firms. References 1. Benaud C L & Bordeianu, S (1998), Outsourcing Library Operations in Academic Libraries: An Overview of Issues and Outcomes, Libraries Unlimited 2. Carmel, E & Tija, P, (2005), Offshoring Information Technology: Sourcing and Outsourcing to a Global Workforce, Cambridge University Press 3. Herath, T & Kishore, R, (2009), Offshore Outsourcing: Risks, Challenges, and Potential Solutions, Information Systems Management, Vol.26, Issue.4, pp. 312-326 4. Michela P & Carlotta M (2011), Outsourcing strategies. How to formalize and negotiate the outsourcing contract, The Journal of the Faculty of Economics, Vol.1 Issue.1, pp. 5. Pouder et al, (2007), The Impact of Outsourcing on Firm Value: New Insights, SAM Advanced Management Journal , Vol. 76 Issue: 2, pp. 4-116 6. Ramanathan, T,R, (2009), The Role of Organisational Change Management in Offshore Outsourcing of Information Technology Services: Qualitative Case Studies from a Multinational, Universal-Publishers 7. Saxena, 2009, Business Process Outsourcing for Strategic Advantage, Excel Books India 8. Tambe, P, B & Hitt, L,M (2010), IT jobs requiring interpersonal interaction or physical presence in fixed locations are less likely to be sent out of the country, communications of the acm, Vol. 53, Issue. 10, 62-70 9. Tadelis, S (2007), The Innovative Organization: Creating Value through outsourcing, California Management Review, Vol.50, Issue. 1, pp. 261-276 10. Wee et al, (2010), Modelling of outsourcing decisions in global supply chains.An empirical study on supplier management performancewith different outsourcing strategies, Department of Industrial and Systems Engineering, Chung Yuan Christian University, Republic of China,Vol.8, Issue No. 7, pp. 2081-2094 11. Weerakkody, V & Irani, Z, (2010), A value and risk analysis of offshore outsourcing business models: an exploratory study, International Journal of Production Research, Vol. 48, Issue 2, pp. 613–634 Read More