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Updated Wednesday, 22nd March 2006

There are few companies that haven’t considering outsourcing in recent years. What does it mean, and what makes outsourcing so compelling?

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Call centre: an example of outsourcing Copyrighted  image Icon Copyright:

The decision to avoid DIY and to Get Someone In (GSI), is a form of outsourcing. This practice, buying a product or service that was previously provided in-house, has been a major global trend affecting organisations of all sizes. The private sector has outsourced heavily in recent years, especially with regard to IT but also increasingly in human resources. For example, IBM’s UK call management centre, is staffed and managed by the agency Manpower. In the public sector, outsourcing was driven in the 1980s and 1990s by compulsory competitive tendering and the British Government’s market testing programme.

Organisations are seldom capable of excelling equally at all the activities along their supply chain. From the 1980s onwards, there was a growing belief that organisations might improve their performances if they concentrated on those activities that they did well. These activities were their 'core competencies', around which they should build a sustainable competitive advantage. They should use outside suppliers to perform all other ‘non-core’ activities. This led to a rise in outsourcing: the external purchase of goods and services that had previously been produced internally.

"the logic has sometimes seemed so compelling"

In recent years, such has been the passion for outsourcing that some managers have begun to contemplate extensive dismemberment of their organisations. The logic has sometimes seemed so compelling that the only real uncertainty has been knowing when to stop.

Sub-contracting has been an age-old practice in the building trade. But we now find construction companies that used to employ a rounded repertoire of skills left with only a rump of surveyors and managers, having outsourced all their construction workers. These companies are even debating which professional and managerial tasks can be outsourced!

Under these conditions the structural integrity of the organisation is radically altered. Extensive outsourcing seems to be the ultimate form of flexibility.

Recently, many companies have moved dramatically away from making things to buying them. Within the computer industry, the trend since the invention of the personal computer has been towards assembling, and away from designing and making the electronics and software. Until the introduction of PCs, major computer manufacturers such as IBM did everything from producing the silicon for chips, via writing the operating software and programs, to maintaining the computers after they were sold. Today, most PCs are assembled almost entirely from purchased components, including the hardware (such as monitors, microprocessors, and drives) and the software installed on the computer.

Similarly, a number of leading car manufacturers have decided that their expertise lies more in designing and selling cars rather than making and assembling them. It is predicted that some may even totally outsource vehicle assembly to specialists in the future!

The outsourcing of HR is especially significant. Some observers see outsourcing as a key trend (perhaps even the key trend) shaping the future of HR. They envision HR departments focused entirely on strategic activities, all performed with an in-house staff consisting of a small number of high level contributors. All the transactional and administrative activities are left to contractors.

A classic example was the deal signed by BP with Exult Inc (based in California) which in 1999 was the biggest HR outsourcing contract on record anywhere in the world. BP agreed to pay Exult (now Hewitt Associates) $600 million to take over all its HR transactional services. The idea was that BP would retain "only the elements that required judgement and policy" and the arrangement would allow BP to cut 40 per cent of its HR staff.

Barclays Bank has also outsourced much of its HR, while BT has used its technological capabilities to establish a HR service centre and it sells this service to other corporate customers. Virtual corporations and extensively outsourced organisations amount to very much the same thing. A virtual corporation resists investment in fixed assets and resists the recruitment of a large, permanent staff. Instead, these organisations outsource support services, hire temporary staff and focus on adding the maximum value to a selected number of core competencies.

Many management gurus argue that strategic focus should lie in a unique set of core intellectual and service capabilities. Success lies in investing in special skills and intellect and using these through best-in-the-world systems.

When deciding which of a firm’s activities can be outsourced, it is usually argued that the first step is to understand the firm’s value chain and the relationships among its service activities. The next step is to ask whether the firm can perform a service activity on a level comparable with the best organisations in the world. One way to test this is to carry out a benchmarking study.

One of these management gurus, Peter Drucker, argues that companies will eventually outsource all functions that do not have a career ladder to senior management. He contends that corporations, once built to last like pyramids, will be more like tents which can be more easily erected and taken down. Under these circumstances, managers must take responsibility for their own career development by exploring their own skills and correcting for anything they lack. He suggests that information will replace authority as the executive’s primary tool and the road to information literacy will lie through identifying knowledge gaps.

Drucker dismisses participation and empowerment – and emphasises that to build 'achieving organisations', power must be replaced by responsibility. However, we should pause before uncritically accepting these kinds of bold projections – even from such an eminent guru. The benefits of outsourcing (such as lower costs and better specialist skills) have to be considered alongside the disadvantages (such as damage to staff morale and problems in maintaining quality of service).

Most reviews of outsourcing either accept it as a fait accompli or emphasise its economic advantages. Some reviews, however, have urged caution. For example, it has been argued that the perceived benefits of outsourcing have hidden the associated costs. In particular, there is the danger of ‘throwing out the baby with the bathwater’.

In the move from integrated organisations to networks, there is also a danger of losing the intangible benefits and capabilities of:

  • information sharing
  • corporate culture
  • communication and co-ordination
  • flexibility and robustness
  • motivation and learning

Let’s consider the advantage and disadvantages of outsourcing.

Advantages of outsourcing:

  • reduced costs
  • increased capacity, leading to faster and more flexible supply
  • reduced capital employed
  • reduced headcount
  • more accurate operating costs
  • greater focus on core business activities
  • reduced inventory

Disadvantages of outsourcing:

  • access to suppliers’ expertise
  • no control over future price rises
  • loss of in-house expertise, perhaps irretrievably
  • loss of control
  • under-utilisation of in-house assets
  • risk to continuity of supply
  • the cost and difficulty of managing the supplier
  • risk of commercial secrecy or confidentiality
  • loss of quality control

To clarify these ideas, let’s return to our DIY example.

Advantages of getting someone in:

  • reduced costs – the job done right the first time!
  • increased capacity, leading to faster and more flexible supply – getting each job done as required and several jobs done at once
  • reduced capital employed – no need for tools and ladders
  • reduced headcount – house owner free for other tasks
  • more accurate operating costs- firm quotations for all work
  • allows owner to concentrate on core business activities, for example being a husband/wife and father/mother
  • reduced inventory – no need to stock paint, thinners etc

Disadvantages of getting someone in:

  • access to suppliers’ expertise
  • no control over future price rises
  • loss of in-house expertise, perhaps irretrievably
  • loss of control
  • under-utilisation of in-house assets – house owner may just watch TV with the time saved!
  • risk to continuity of supply – the contractor disappears to another job regularly
  • the cost and difficulty of managing the supplier
  • risk of commercial secrecy or confidentiality – information may be passed to a burglar
  • loss of quality control

As you can see, outsourcing presents some costs as well as benefits.

About this article

This article is taken from the Open University Business School courses: Managing Human Resources and Managing Performance and Change.





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