The decision to outsource or insource could allow an organization to free up resources and to focus on core issues that could fetch higher returns (Kav'i' & Tav'ar, 2008).
Williamson's transaction cost theory in outsourcing suggests that markets are applied in low-cost transactional cost while hierarchies are applied in high transaction situations (Kav'i' & Tav'ar, 2008). Markets here refer to outsourcing or purchase from an external source while hierarchies refer to insourcing or making within the company. According to the resource based view, companies typically outsource no-core activities thereby conserving scare resources. The economic theory of comparative advantage provides the motivation for international outsourcing (Schniederjans & Zuckweiler, 2004).
Outsourcing excess manufacturing demand to smaller domestic or international firms is a strategic approach to balance the total production needs with the customer demand. A same form may keep functions such as production in-house but outsource other functions such as the use of lawyers, accountants and consultants. The decision is typically "buy-or-make" decision on products, processes and facilities.
The decision to outsource should typically be a five-stage evaluation process - identifying and weighting performance categories; analysing technical capabilities; comparing internal and external capabilities; analysing supplier organisational capabilities; and determining total acquisition costs (Conklin, 2005). This is applicable in all sectors - manufacturing or the service industry.
3. Benefits and risks in outsourcing
Outsourcing has several benefits applicable to all organizations although certain decisions have to be taken based on the industry and the business environment. Outsourcing frees an organization from the non-core functions which take up a lot of time (Potk'ny, 2008). Choosing the right method of outsourcing and the right partner can strengthen the company's key abilities and give it a competitive advantage. The organization can conserve resources as it does not need to invest in training and retaining specialized experts. Any changes in technology and skills of human resources that become necessary are provided by the service provider and the company need not invest in such areas every now and then. Apart from enabling focus on core activities, outsourcing reduced operating costs as well as the overhead costs. Loh and Venkatraman (1995) emphasize that the control issue is the major inhibitor in outsourcing decisions. In shifting the locus of competencies to external service providers, the company hands over the decisions rights over the assets to the vendors, who might not share the same goals and objectives as the client organization. There is also a possibility of deliberate opportunistic behavior by the vendors as they may indulge in self-serving behavior before and after the contract.
Outsourcing can improve a company's benchmarking and target setting but all depends upon the inter-company processes and structure that foster collaboration and trust (Conklin, 2005). Due diligence in outsourcing decisions is not enough as has been proved by the scandal of Satyam Computer Services, an Indian outsourcing firm (Pettibone, 2009). This should be an eye opener for the firms