What Is Outsourcing?

The Advantages and Disadvantages of Outsourcing in Business

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Outsourcing (also sometimes referred to as "contracting out") is a business practice used by companies to reduce costs or improve efficiency by shifting tasks, operations, jobs or processes to an external contracted third party for a significant period of time. The functions that are contracted out can be performed by the third party either onsite or offsite of the business.

Examples of Outsourcing

Outsourcing is a cost-saving measure, and the practice can have significant impacts in sectors like manufacturing.

In the U.S., for example, manufacturers have outsourced jobs overseas to countries like China and Bangladesh. This practice is also known as "offshoring," which involves outsourcing to a third party in a country other than the one in which the outsourcing company is based in order to save on labor costs.

Outsourcing is not limited to manufacturing jobs. Customer service jobs, such as those in a call center, and computer programming jobs are also outsourced by companies seeking ways to reduce costs. A large number of companies outsource at least some functions of human resources tasks, such as employee benefits management and payroll.

Outsourcing can also involve the purchasing of components from another source, such as components for computer equipment. The component can be purchased for a lower cost than it would be for the company to manufacture that component themselves, and the component may be of higher quality.

IT services can also be outsourced. For example, cloud computing and software-as-a-service (SaaS) offer companies access to computer services and tools that were once managed in-house by a company's IT department. 

Benefits of Outsourcing

Outsourcing can free up cash, personnel, facilities and time resources for a company.

It can result in cost savings from lower labor costs, taxes, energy costs and reductions in the cost of production.

In addition to cost savings, a company may also employ an outsourcing strategy in order to focus on its core business competencies. This allows the company to devote more resources to what it does well, which can improve efficiency and increase its competitiveness. Production can be streamlined and production time shortened while reducing operational costs.

Those non-core functions that are outsourced will usually go to outside organizations for whom that function is a core business competency, further benefiting the business through the improved management of those functions.

A company may also choose to outsource in order to avoid government regulations or mandates, such as environmental regulations or safety regulations and requirements.

Disadvantages of Outsourcing

While outsourcing has many advantages, it also presents some disadvantages. The relationship with the third party that takes on the outsourced functions must be managed.

This includes the negotiating and signing of contracts, which requires time and the involvement of a company's legal counsel, as well as the day-to-day communication with and oversight of the outsourced work.

Security is an important factor in outsourcing. The relationship will inevitably involve the third party organization's access to sensitive business data, trade secrets and other confidential information that is necessary for it to perform its contracted function.

There may also be some negative public relations impacts for a company when outsourcing results in the loss of a large number of jobs.

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