What is Outsourcing and how it is beneficial to businesses globally?
What is outsourcing? Outsourcing is more than purchasing, and it is more than consulting. It is a long-term results-oriented relationship for a whole business activity over which the provider has a large amount of control and managerial discretion. Outsourcing is the use of outside business relationships to perform necessary business activities and processes in lieu of internal capabilities. The term outsourcing describes a number of situations.
A computer chip maker hires a staffing company to monitor and manage all of their non-exempt hiring.
A university hires an information technology company to manage all of it's desktop PC's and staff the user help desk .
Those who provide outsourcing are often referred to as outsourcing partners, suppliers and providers. Those who are purchasing the outsourcing services are called buyers or users. Outsourcing takes place when an organization transfers the ownership of a business process to a supplier. The key to this definition is the aspect of transfer of control. This definition differentiates outsourcing from business relationships in which the buyer retains control of the process or, in other words, tells the supplier how to do the work. It is the transfer of ownership that defines outsourcing and often makes it such a challenging, painful process. In outsourcing, the buyer does not instruct the supplier how to perform its task but, instead, focuses on communicating what results it wants to buy; it leaves the process of accomplishing those results to the supplier.
What define outsourcing are more the circumstances of the relationship than the nature of the work performed—that is why the label 'outsourcing' is applied to a lot of situations.
Outsourcing vs. Suppliers
Replacing or substituting the services of an external provider for internal capabilities characterizes outsourcing relationships. Importantly, outsourcing applies to an activity an organization did do or would have done itself Funded. A bank doesn't say that it's "outsourcing" the production of mops, brooms and chemical cleaners when it buys cleaning materials for its janitorial staff from a supply service. That same bank may 'outsource' cleaning services, or even outsource purchasing, but the difference is that cleaning and purchasing are things a bank would reasonable do, manufacturing and transporting mops, brooms, and chemical cleaners are not. Outsourcing is not about "supplying" commodities or totally unrelated products or services.
Outsourcing vs. Consulting
The difference here is both difficult and easy to see. The difficult part is that many firms simultaneously position themselves as offering consulting and outsourcing services, they don't clearly distinguish the two, and in the process they confuse the situation. It's easier when you think clearly about what the differences truly are. Consultants advise us on how to do something. Outsourcing providers actually do it. Sometimes a consultant will deliver a business service or product, and that's when they are acting like a provider, and other times an outsourcing provider will advise, but generally the distinction is easy to see. Most professional services firms fall into one of three categories. There are the consultants. There are the providers. There are the hybrids. The reality is that many firms are both consultants and providers, but play different roles with different clients and at different times.
Outsourcing vs. Jobbing and Out-Tasking
Outsourcing relationships are high value-add, durable and on going—they are not a one-time only deal. Hiring a provider to set up your technology, or a manufacturer to handle production when demand exceeds capacity, or using FEDEX to deliver overnight packages is not outsourcing. Outsourcing relationships are high level, contractual relationships for a fixed period of time, usually measured in years, but they are assumed to be continuous. Provider and user often work to define the service delivered. There is frequent interaction between user and provider and a lot of communication. The outsourcing service is customized to the needs of the user.
All of the elements of outsourcing combined are what make it a unique management practice. Outsourcing providers are partners, given significant managerial discretion for how to deliver the service, who manage the day-to-day delivery of that service. The value they create is based on being a long-term partner who understands the business, can deliver on the requirements of the relationships, and look ahead to how they can better service client firms.
In the last ten years there has been explosive growth in the use of outsourcing. There are three distinct stages in outsourcing's evolution tied to executives' mind-sets rather than to a calendar.
As managerial understanding of outsourcing's values proposition advances then the number of applications for outsourcing multiply. As they multiply, the applications mature from tactical and short-term to strategic and long-term, and eventually transformational and evolutionary.
Since 1990 there has been an explosive growth in the use of outsourcing. From near zero when outsourcing first emerged in the late 1980's to $100 Billion in 1996 (according to Harvard Business Review) to an estimated $318 Billion by 2001.
Along the way outsourcing has matured into an indispensable management tool. As famed management writer Peter Drucker notes, of all the powerful management tools to emerge in the last half of the 20th century outsourcing uniquely compels managers to ask "what to do," increasingly the central management challenge.
Drucker's thoughts appeared in a 1994 Harvard Business Review article. In the preceding years outsourcing's value and role were seen as tactical and immediate. The U.S. business environment of the late 1980's and early 1990's was in transition, and many organizations needed serious change. There was economic uncertainty and pressure. Corporate America was emerging from a period of significant corporate restructuring and large-scale downsizing. Japanese management theories were influencing American business and a quality revolution was underway.
Outsourcing the term and the concept emerged from its application in three places. For manufacturing many firms used foreign labor to make components and products. Outsourcing was also first used to describe relationships between firms and their providers of support services like payroll, security, grounds keeping, maintenance, janitorial, and food services. Companies like ADP, Aramark, and ServiceMaster took on these services. Often outsourcing was used to describe longstanding relationships. At the same time large firms, especially Fortune 500 Firms like Kodak, were working with traditional hardware and software providers such as EDS, IBM, AT&T, CSC, and others to provide a full array of technology services. It was through these relationships that outsourcing as a managerial practice grew and flourished.
Tactical Outsourcing
In the first stage, tactical relationships, the reasons for outsourcing were usually tied to specific problems the firm was having. Often the firm was "in trouble" to begin with and outsourcing was a direct way to address the lack of financial resources to make capital investments, inadequate internal managerial competence, an absence of talent, and a desire to reduce headcount. Outsourcing often accompanied large-scale corporate restructuring. Many tactical relationships were forged to create immediate cost savings, eliminate the need for future investments, to realize a cash infusion from the sale of assets and to relieve the burden of staffing.
The focus of tactical outsourcing is the contract, constructing the right contract, and holding the vendor to the contract. The expertise for constructing these arrangements emerged from purchasing. Frequently the contract was simply a fee for services. Much of the value stemmed from the discipline of spending dollars externally. When managers created successful tactical relationships the value of using outside providers was clear: better service for less investment of capital and management time.
Strategic Outsourcing
As some pushed for more value from outsourcing relationships the goals of these relationships changed. Executives realized that instead of losing control over the outsourced function they gained wider control over all of the functions in their area of responsibility, and they were better able to direct their attention to the more strategic aspects of their jobs. Instead of facilities managers worrying about staffing janitorial positions, they were more focused on infrastructure issues. Technology executives handed the running of the data center to a service provider and turned their attention to serving the needs of internal customers. The logic remains compelling.
How outsourcing was used and where it was applied changed. The size of outsourcing relationships jumped and the scope of the service provider's involvement grew. Outsourcing changed from being a tactical tool to becoming a strategic tool by virtue of the dollar value of the relationships, the integrated scope of services, and the length of the new relationships. Most importantly, the managerial mindset about the nature of the relationships matured from one between buyer and supplier to one between business partners. Strategic outsourcing relationships are about building long-term value.
Professors Quinn and Hilmar coined the phrase strategic outsourcing in 1994. But forward thinking executives, like Katherine Hudson of Eastman Kodak as early as 1989, was practicing it earlier. In that year Eastman Kodak and Katherine Hudson signed a landmark ten-year outsourcing deal with IBM for $250 Million. This outsourcing was not about fixing a troubled function, avoiding a problem, or restructuring. The Kodak-IBM deal was about identifying the core competencies of the firm, partnering with a provider to deliver the non-core activities, while focusing the firm's resources on the core competencies of the firm. For the IT operations at Kodak it was a matter of focus, IT's role, and the direction IT would take for the next decade. The decision to outsource was very much strategic, and the role the provider (IBM) took on was critical. The rationale for outsourcing was focusing on core competencies, or as Katherine Hudson said, "our mission doesn't say `be the world leader in computing'"*.
Instead of working with a host of vendors to get the job done, in a more strategic model corporations work with a smaller number of best-in-class integrated service providers. The working relationships with providers evolve from adversarial vendor-supplier relationships to long-term partnerships between equals where the emphasis is on mutual benefit. Michael Corbett defined strategic outsourcing as, "the redefinition of the corporation around it's core competencies and strategic, long-term, results-oriented relationships with service providers." It is fundamentally redefining the business and separating the core from non-core activities and making decisions about how to get the work done.
Transformational Outsourcing
Transformational outsourcing is the term used to describe third generation outsourcing. If the first stage of outsourcing was about doing the work with the existing rules, then the second stage is about using outsourcing as the corporation is redefined. The third stage is using outsourcing to redefine the business.
To survive today, organizations must transform themselves and their markets in an ever more daunting challenge to redefine the world before it redefines them. And outsourcing has, once again, emerged as the single most powerful tool available to executives seeking this level of business change. This new transformational outsourcing recognizes that the real power of outsourcing is in the innovations that outside specialists bring to their customers' businesses. No longer are outsourcing service providers simply viewed as tools for getting more efficient or better focused, they are seen as powerful forces for change — allies in the battle for market- and mind-share.
Outsourcing can be used to radically change the definition of the business—open new markets, deliver new customers, and create new products. Outsourcing is leverage. Here outsourcing is a vehicle for changing the firm's relationships with customers, employees, and business partners by working with best in world partners. It's enabling growth. It's the way to grow by alliance. When managers realize that outsourcing relationships are a way to invest in the future of the firm they are thinking differently. Transformation outsourcing is not about creating dependence, it's about actively creating interdependencies that serve the interests of all parties. Mission Foods uses Ryder Logistics to deliver it's products to new markets in ways the company could never have done alone. Where once firms kept outsourcing in the background, never letting their customers know part of the work was delivered by a third party, now firms co-brand products/services and firms march out their outsourcing providers to instill confidence in customers and business partners. "No longer are outsourcing service providers simply viewed as tools for becoming more efficient or better focused, they are seen as powerful forces for change, allies in the battle for market and mind share," says Michael Corbett. Outsourcing relationships have the power to thoroughly redefine how business is done.