Outsourcing is subcontracting a process, such as product design or manufacturing, to a third-party company. The decision to outsource is often made in the interest of lowering firm or making better use of time and energy costs, redirecting or conserving energy directed at the competencies of a particular business, or to make more efficient use of land, labor, capital, (information) technology and resources. Outsourcing became part of the business lexicon during the 1980s.

Overview

Outsourcing involves the transfer of the management and/or day-to-day execution of an entire business function to an external service provider. The client organization and the supplier enter into a contractual agreement that defines the transferred services. Under the agreement the supplier acquires the means of production in the form of a transfer of people, assets and other resources from the client. The client agrees to procure the services from the supplier for the term of the contract. Business segments typically outsourced include information technology, human resources, facilities, real estate management, and accounting. Many companies also outsource customer support and call center functions like telemarketing, cad drafting, customer service, market research, manufacturing, designing, web development, content writing, ghostwriting and engineering.

Outsourcing and offshoring are used interchangeably in public discourse despite important technical differences. Outsourcing involves contracting with a supplier, which may or may not involve some degree of offshoring. Offshoring is the transfer of an organizational function to another country, regardless of whether the work is outsourced or stays within the same corporation/company.

With increasing globalization of outsourcing companies, the distinction between outsourcing and offshoring will become less clear over time. This is evident in the increasing presence of Indian outsourcing companies in the US and UK. The globalization of outsourcing operating models has resulted in new terms such as nearshoring, noshoring, and rightshoring that reflect the changing mix of locations. This is seen in the opening of offices and operations centers by Indian companies in the U.S. and UK. A major job that is being outsourced is accounting. They are able to complete tax returns across seas for people in America.

Multisourcing refers to large (predominantly IT) outsourcing agreements. Multisourcing is a framework to enable different parts of the client business to be sourced from different suppliers. This requires a governance model that communicates strategy, clearly defines responsibility and has end-to-end integration.

Strategic outsourcing is the organizing arrangement that emerges when firms rely on intermediate markets to provide specialized capabilities that supplement existing capabilities deployed along a firm’s value chain. Such an arrangement produces value within firms’ supply chains beyond those benefits achieved through cost economies. Intermediate markets that provide specialized capabilities emerge as different industry conditions intensify the partitioning of production. As a result of greater information standardization and simplified coordination, clear administrative demarcations emerge along a value chain. Partitioning of intermediate markets occurs as the coordination of production across a value chain is simplified and as information becomes standardized, making it easier to transfer activities across boundaries.

Deciding to outsource

The decision to outsource is taken at a strategic level and normally requires board approval. Outsourcing is the divestiture of a business function involving the transfer of people and the sale of assets to the supplier. The process begins with the client identifying what is to be outsourced and building a business case to justify the decision. Only once a high level business case has been established for the scope of services will a search begin to choose an outsourcing partner.

Supplier proposals

A Request for Proposal (RFP) is issued to the shortlist suppliers requesting a proposal and a price. The suppliers are usually chosen based on location and at the lowest possible cost to the company.

Supplier competition

A competition is held where the client marks and scores the supplier proposals. This may involve a number of face-to-face meetings to clarify the client requirements and the supplier response. The suppliers will be qualified out until only a few remain. This is known as down select in the industry. It is normal to go into the due diligence stage with two suppliers to maintain the competition. Following due diligence the suppliers submit a "best and final offer" (BAFO) for the client to make the final down select decision to one supplier. It is not unusual for two suppliers to go into competitive negotiations.

Negotiations

The negotiations take the original RFP, the supplier proposals, BAFO submissions and convert these into the contractual agreement between the client and the supplier. This stage finalizes the documentation and the final pricing structure.

Contract finalization

At the heart of every outsourcing deal is a contractual agreement that defines how the client and the supplier will work together. This is a legally binding document and is core to the governance of the relationship. There are three significant dates that each party signs up to the contract signature date, the effective date when the contract terms become active and a service commencement date when the supplier will take over the services.

Transition

The transition will begin from the effective date and normally run until four months after service commencement date. This is the process for the staff transfer and the take-on of services.

Transformation

The transformation is the execution of a set of projects to implement the service level agreement (SLA), to reduce the total cost of ownership (TCO) or to implement new services. Emphasis is on 'standardisation' and 'centralisation'.

Ongoing service delivery

This is the execution of the agreement and lasts for the term of the contract.

Termination or renewal

Near the end of the contract term a decision will be made to terminate or renew the contract. Termination may involve taking back services (insourcing) or the transfer of services to another supplier.

Reasons for outsourcing

Organizations that outsource are seeking to realize benefits or address the following issues:

Cost savings
The lowering of the overall cost of the service to the business. This will involve reducing the scope, defining quality levels, re-pricing, re-negotiation, cost re-structuring. Access to lower cost economies through offshoring called "labor arbitrage" generated by the wage gap between industrialized and developing nations.

Cost restructuring
Operating leverage is a measure that compares fixed costs to variable costs. Outsourcing changes the balance of this ratio by offering a move from fixed to variable cost and also by making variable costs more predictable.

Improve quality
Achieve a step change in quality through contracting out the service with a new service level agreement.

Knowledge
Access to intellectual property and wider experience and knowledge.

Contract
Services will be provided to a legally binding contract with financial penalties and legal redress. This is not the case with internal services.

Operational expertise
Access to operational best practice that would be too difficult or time consuming to develop in-house.

Staffing issues
Access to a larger talent pool and a sustainable source of skills.

Capacity management
An improved method of capacity management of services and technology where the risk in providing the excess capacity is borne by the supplier.

Catalyst for change
An organization can use an outsourcing agreement as a catalyst for major step change that can not be achieved alone. The outsourcer becomes a Change agent in the process.

Reduce time to market
The acceleration of the development or production of a product through the additional capability brought by the supplier.

Commodification
The trend of standardizing business processes, IT Services and application services enabling businesses to intelligently buy at the right price. Allows a wide range of businesses access to services previously only available to large corporations.

Risk management
An approach to risk management for some types of risks is to partner with an outsourcer who is better able to provide the mitigation.