Usage of Outsourcing in a Company as a Strategical Move

The ultimate aim of all organisation is to get their work done effectively and efficiently, that which would reduce cost but increase productivity. This would in turn increase profit. Initially, outsourcing was mainly for activities such as cleaning, catering and security and so on. But in the recent years, it has been used for critical and vital operations of the organisations. 20th century holds the increasing popularity of outsourcing, which has made it a controversial subject as well. Companies outsource to save money on wages. They outsource their needs offshore to save labour cost. IT sectors, call centres are the major once that are being outsourced. The cost of hiring one staff for a call centre is equal to the cost of hiring five in India. During the Industrial Revolution from 1750-1900 there was a growing need for outsourcing. This was a time where production was on the rise. Many companies were hiring third parties to perform functions they needed in order to operate efficiently. It was common for companies to outsource administrative and legal needs. One of the common during this time was the off-shore outsourcing. It did become more popular in the 1950's. There as a need for low-cost production of toys, electronics, and clothing. Outsourcing can be highly efficient and profitable. Outsourcing means hiring a third party to perform the needs of the operation. Offshore outsourcing is when those needs are fulfilled in another country. Some people are for outsourcing but not offshore outsourcing. The research presented throughout this paper will ultimately cover the pros and cons of outsourcing and offshore outsourcing. The hospitality industry needs to learn why this business practice can be beneficial for financials but devastating to customer service and the public eye. (Karsten Bjerring Olsen 2006)

Research Objective

• And how is outsourcing decision affected by labour cost?
• Effect of labour cost on the organization.
• Does saving cost on labour save the organisations outsourcing considering the other costs and policies involved in the outsourced country?

Harvard Business Review commented on outsourcing as one of the important business concepts and management tools in the world since the last 75 years. With new technological revolution, and the development trend of global economic integration, the global industrial chain detailed division of labour and resources optimization and integration has become increasingly obvious and gradually developed into a product of the deepening of division of international outsourcing. Studies suggest that outsourcing has an adjustment effect on economy, accorded to the phenomenon which final product price decline when factor price changed in multi-stage enterprise. The shift in the demand for high labour markets are adversely affected when there is a shift in the demand towards low labour. This would reduce job stability and increase unemployment. Depending on the specific modelling approach, low-skilled workers may lose or benefit from outsourcing.

Motivation for Outsourcing

The three major motivations for outsourcing are cost, strategy and politics. The political climate favoured privatization because of the belief that private firms are more efficient and provide better service than the public counterparts. Cutting the cost of providing services also drove the British government’s outsourcing efforts. (Wang Tingting, 2014)

Cost Driven Outsourcing

In theory, outsourcing for cost reasons can occur when supplier’s costs are low enough that even with added overhead, profit, and transaction costs suppliers can still deliver a service for a lower price (Bers, 1992; Harler, 2000). How can an organization achieve enough savings to cover an additional layer of overhead and still meet profit requirements yet perform a function for less than another organization already doing the function? Specialization and economies of Scale. Although organizations may outsource for cost-related reasons, there are no guarantees that expected savings will be realized. (Tibor Kremic, 2006)

Strategy-Driven Outsourcing

It is not just cost that drives outsourcing but also strategies such as competence and flexibility. This helps in improved business performance, in various areas of the business. The organisation is forced to concentrate their scarce resources to certain areas because of the competition. Other strategy issues that lead to outsourcing are restructuring, rapid organizational growth, changing technology, and the need for greater flexibility to manage shifts in demand. However, there are certain shortfalls when it comes to outsourcing for strategic reasons. Organizations may “give away the crown jewels” if they are not careful. IBM is used as a frequent example of a company that outsourced the “wrong” things (the operating system). If organizations outsource the wrong functions they may develop gaps in their learning or knowledge base which may preclude them from future opportunities. (Tibor Kremic, 2006).

Theories

Transaction Cost Economics (TCE) theory provides a theoretical foundation for addressing outsourcing from a cost perspective. TCE states that the allocation of economic activity among firms depends on balancing each firm’s internal costs against the cost of transacting for goods and services in the market. TCE focus on two major costs a. the production cost – the cost of producing goods and services, b. coordination cost - costs of controlling and monitoring workers if the goods are produced internally or vendors if purchased in the market. (Satyendra Singh, Michael H. Zack 2006). Resource-based theory views a firm as a collection of productive resources and organizations compete based on having or controlling unique, valuable and hard-to-imitate resources. Rather than competing with a specific product/market position, a set of resources could be used to create various products for various markets. This theory talks from the point of view of the gap in resource an organization has. (Satyendra Singh, Michael H. Zack 2006). Intuitional Theory provides a theoretical foundation for explaining the imitative behaviour regarding outsourcing. The institutional theory posits that organizations within the same organizational field grow increasingly similar. (Satyendra Singh, Michael H. Zack 2006).

Valuable insights in the link between offshore outsourcing and productivity may also be drawn from researchers studying the phenomenon's impact on labour markets. In this regard, the effect on skill-intensity is of particular interest since a higher skill-intensity may be associated with higher labour productivity, under some reasonable assumptions. In this connection, however, one must be careful with interpretation as the skill-intensity is most commonly proxied by the non-production workers' share of the total wage bill. Feenstra and Hanson (1999), who base their research on Leamer (1998), provide an important study of offshore outsourcing and its impact on the labour market. The methodology they apply has been the foundation for many later studies. They investigate the impact of offshore outsourcing on the skill-intensity of US manufacturing industries over 1979-1990 and find that international outsourcing has a positive and significant effect on the increase in the non-production workers’ wage share. (Karsten Bjerring Olsen,2006).

The IT sector in India is booming and it will soon surpass the $50 Billion mark. India is considered/ preferred to be the IT outsourcing location. English apart; the Indian education system also fosters strong skills in mathematics and science. The same holds true for higher education and skilled human power. The easy accessibility of the telecom bandwidth in India for the IT department. The natural time difference is also a compelling part stands favourable. (Outsourcing: Past, Present and Future)

Analysis

The rapid growth of outsourcing suggests that both public and private organizations expect benefits from outsourcing. Naturally different organizations in different circumstances will expect different benefits. For example, all organizations may expect costs savings even though in government outsourcing, the typical cost savings are only about half of what the private sector achieves. It is impossible to exhaustively list every conceivable benefit but many of the desired benefits are general enough that they are shared across organizations. The expected benefits of outsourcing may include realizing the same or better service at a lower overall cost, increased flexibility and/or quality, access to the latest technology and best talent, and the ability to re-focus scarce resources onto core functions. For the political organization, additional expected benefits may include better accountability and management, and a better political posture. There also appears to be an expected benefit of mimicking competitors or “getting rid” of troublesome functions. (Economic Times) An incremental analysis is one of the easiest and quickest methord to analysing decisions and saves significant time and confusion compared to preparing and comparing side-by-side income statements. The incremental amounts are based on the difference in the cost of buying a product or service from an external supplier compared to the cost of producing the item or providing the service in-house. The 'make' part of the decision is called insourcing and the 'buy' part of the decision is called outsourcing. Before taking into consideration whether to outsource the organisation should consider checking the following costs, Incremental Costs Incremental costs are the additional costs incurred from outsourcing. The key cost is the purchase price of the products or the cost of the services that are being provided by other companies.

Incremental Cost Savings

Incremental cost savings are reductions of costs that will no longer be incurred as a result of outsourcing. They are often called avoidable costs because if a company outsources, it can 'avoid' certain costs. Variable product cost savings are always incremental. Because they reduce total costs, they cause profits to increase. In some situations, a portion of fixed costs can be saved such as equipment rental costs or supervisor salaries that can be avoided. When companies evaluate the cost to produce products, they typically list each of the four manufacturing costs separately---direct labour, direct materials, variable overhead, and fixed overhead costs. The first three costs are variable, which are incremental cost savings. Fixed overhead costs that are avoidable are incremental because these costs can be 'avoided' if outsourcing occurs. Opportunity Costs Opportunity costs are the costs forgone as a result of selecting a different alternative. They are always incremental. For example, if a company decides to outsource, it is able to lease its factory space that the product being outsourced no longer will occupy. Outsourcing products or services should generally be pursued if profits are expected to increase. It is especially important to consider the qualitative issues as well. Accept or Reject?

• If incremental cost savings plus opportunity costs are less than incremental costs, reject the special order, unless qualitative characteristics overwhelmingly impact the decision.
• If incremental cost savings plus opportunity costs are greater than incremental costs, accept the special order unless qualitative characteristics overwhelmingly impact the decision.
• If incremental cost savings plus opportunity costs are equal to incremental costs, focus primarily on qualitative characteristics to evaluate the decision. There should always be a consideration of quality regardless if the choice is to outsource or insource. Qualitative issues related to outsourcing include:
• The quality of the insourced product or service
• The timeliness of receiving deliveries of the outsourced product or service
• The effect on personal lives of employees terminated if outsourcing occurs
• The effect on the morale of existing employees that become concerned with keeping their jobs once they hear that other employees are being terminated. (Outsourcing Decisions, Chapter 21)

Conclusion

Information technology is one of the commonly outsourced function, there are other functions that are being outsourced due to the less cost involved as well as the advance in technologies. In a survey done by one of the big audit and accounting firms, the chances of more areas of operations being outsourced, such as the Financial and Accounting sector, Real estate and facility Management, Human Resources, Customer Services, procurement etc. Financial and Accounting, There a significant increase in the outsourcing of Financial and Accounting services. In the survey about 30% of the participant expect an increase in outsourcing of financial services. The non-traditional will be supported by the increasing availability of the global service providers. However, some financial and accounting operations such as the accounts payable, are being experimented by companies. Real estate and Facility Management, The second largest administrative cost for any companies. Human resource HR outsourcing for the past couple of years have not found the correct balance between comprehensive solution and targeted companies that address the specific business issues. Call centre management is one of the commonly outsource business in the HR division. Expat Administration, HRISM maintenance and support are the other areas outsourced under HR division. (Deloitte 2014)