Strategic outsourcing: Definition, types and benefits

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strategic outsourcing

The world economy and business are endlessly developing, inventing new forms and methods of business processes arrangement. As a result, a new method of doing business has emerged. It is called strategic outsourcing. 

It is not always necessary for permanent employees to perform non-core functions. You can entrust some processes to a specialized subcontractor and boost your business productivity. 

This tendency has become very popular recently. It is estimated that 300.000 positions are outsourced every year. 

This gig economy is flourishing, and more and more businesses overtake it.

According to various studies, the outsourcing model will allow most companies to reduce operating costs by about 35%. It will increase the return on equity by an average of 6% while accelerating the growth rate of income. 

According to Industry Week Census on Manufacturing, 54.9% of US companies outsource manufacturing and 43.8% outsource equipment maintenance.

What is strategic outsourcing?

It is a relatively young business management approach. To learn more about it, you can check out some top online courses here.

Strategic outsourcing is a long-term, result-oriented business relationship between the Customer and the Service Provider. 

The services can include a single business process, a set of processes, or a complete cycle of one or more processes. The key idea is to optimize production processes and reduce costs associated with the main activities of the company.

 In some cases, this business arrangement is much more important than maintaining control over the activities of individual departments or preserving non-core assets and jobs.

The outsourcing service provider takes responsibility for human resources, processes, technologies used together with responsibility for the results that these resources bring and for which the client has signed a contract. 

Accountability for results is what separates strategic outsourcing from the narrower and more traditional provision of services and hiring additional staff.

The goal of an outsourcing project is to use external resources in such a way that the technologies and know-hows presented on the market are used with the greatest benefit to improve the efficiency of the company and its competitiveness.

The result of the successful outsourcing project is the construction of a value chain in such a way that all stages of internal business processes are provided with strategically important resources.

It is important to formulate your strategic position in order to determine the possibility of outsourcing the individual components of the value chain. The strategic rationale for an outsourcing project is to implement the five principles of strategic positioning, according to Michael Porter :

  • competitiveness of goods and services;
  • company image;
  • sales opportunities;
  • organizational and technical characteristics of the company;
  • the financial condition of the company.

How did outsourcing appear?

It is believed that the strategic outsourcing approach was born in the United States. In the 1920s, General Motors was headed by Alfred Sloan. He had the task to win market share from the main competitor – the company of Henry Ford.

Sloan was the first who decided to divide enterprise operations into main and additional ones. He discovered that it is possible to significantly reduce costs and optimize business processes by giving secondary functions to the contractor. This delegation of non-profit functions of the company to a third party specializing in a particular industry became known as outsourcing

The struggle of two automotive giants has shown that in conditions of fierce competition, no company can be self-sufficient, relying only on its own resources.

Historically, outsourcing was first recognized as a business strategy in 1989. Regularly used throughout the 1990s, the outsourcing tool has been firmly integrated into world business processes.

From the beginning, outsourcing has been used mainly in services such as professional security services, logistics, spare parts production, cleaning services, catering, infrastructure management, technical and administrative maintenance of facilities, services in the leisure sector and the hotel sector.

In 2009, it received a new round of development. It was stimulated by the global financial crisis. And outsourcing became increasingly important in the field of attracting human resources (HR), high-tech industry (IT), and a wide range of financial services.

Types of strategic outsourcing

We can name the following main types of outsourcing:

1. Production outsourcing. 

This type of outsourcing is typical for big companies with a large production cycle. Very often, it makes no sense to organize certain stages within their own capacities. 

For example, automotive production is a complex process where many operations are outsourced to outside performers and producers.

The Ikea company does not have a production unit in its structure at all. But it has over 2,500 partners that manufacture products for the Swedish concern under contracts. The customer of these works focuses only on the design solutions and builds a sales structure.

2. IT-outsourcing

Services of a certified IT specialist are not cheap, and not every company has enough work for a permanent employee. In such cases, outsourcing becomes a good solution for both start-ups and large corporations. 

There are two main types of IT outsourcing:

  • maintenance of equipment (computer network servicing and other desk services);   
  • software development and network infrastructure creation.

IT outsourcing allows businesses to solve the problem of qualified personnel, save money on the purchase of equipment and software updates.

Alibaba, an international e-commerce company, did not employ permanent software developers. It used the US outsourcing services to launch its platform. And Cisco, one of the IT giants, outsources its technical support services to India and the Philippines.

3. Business processes outsourcing

Business Process Outsourcing

It implies the transfer of internal business processes to an external contractor. Since the end of the 90s, companies began to outsource such business processes as accounting, marketing research, hiring personnel and others to external firms. 

In most cases, this outsourcing type deals with high-level processes. These are usually associated with financial management or legal support of the business.

Each type of outsourcing is still not just a common service. It is complete control over a separate business process or service. It most often requires individual compliance with the customer’s conditions.

Advantages of outsourcing

Nowadays, all businesses experience persistent pressure from shareholders demanding better profits. At the same time, high market competition forces the companies to struggle for each client by way of improving the quality of their goods and services and reducing their price. 

Hence, the company’s management has no choice but to save on costs, including costs associated with the company’s non-core activities. And strategic outsourcing became one of the main competitive advantages allowing to solve these tasks in a more efficient way. 

The rapid development of telecommunications means (e-mail, smartphones, 4G) has greatly simplified the coordination of remote activities giving impetus to strategic outsourcing. There are four main economic benefits of the transition to this business model.

1. Cost reduction

Cost reduction is one of the key reasons for transferring part of the functions to an outside provider. It is necessary to analyze the activities of the company to determine the most burdening processes. It may apply to both direct costs and indirect ones.

Involve third-party companies that specialize in strictly defined areas of activity, and also have quite a lot of practical experience. It will help analyze and determine the feasibility of outsourcing certain functions that reduce costs.

Lower labor costs and operational efficiency are the main reasons to optimize the finances of the company. For example, the wages of workers in China or India are much lower than those in the United States.

2. Converting fixed costs to variables. 

There are two main aspects here. Businesses can reduce overall costs by using the ready-made infrastructure of another company. For example, the costs of supporting certain activities like capital construction and the payment of wages.

Secondly, there is a redistribution of risks, some of which are transferred to the involved parties.

Thus, outsourcing contracts stipulate that payment for work performed by an outsourced provider will depend on specific results.

3. Improved performance

Strategic outsourcing provides companies with global access to technology, talent, and other resources.

A third-party provider can deal with its area of work more professionally without the need for upskilling.

Narrow specialists know how to use alternative approaches to coordinate certain processes. Thus they can cope with bigger volumes of work.  The total costs of an outsourcer are significantly lower for performing the same activities. This is due to his specialization in a specific field and high qualifications.

4. Resources reallocation

Outsourcing allows for flexibility in allocating resources.

In this case, there are two advantages.

The first consists of the redistribution of resources. Here, resources can be working time, efforts, fixed assets, space, money, etc.

Freeing up resources to maneuver them to tackle more pressing or vital problems allows the company to achieve better results in its main activity. Outsourcing also allows businesses to partially redistribute investment capital into activities that are strategically more important for the company. The company stops investing in infrastructure, paying only for outsourcer services.

Disadvantages of outsourcing

Despite the fact that outsourcing has undeniable benefits, there are certain risks when switching to it. Outsourcing too many operations can reduce the efficiency of some activities.

Moreover, working with many outsourcers can lead to higher costs. Overall, you should be aware of the following potential issues:

1. The risk of poor-quality problem solving

Many outsourcing companies position themselves as professionals. But in most cases, the quality of services can only be evaluated after the actual work is done.

2. Information leakage risk

Confidentiality conditions are prescribed in the contract and officially enshrined. And yet, it is almost impossible to prove that the contractor has any relation to the disclosure of the customer’s internal information.

3. Dependence on external performers

The delegation of certain functions to a partner means breaking the corporate unity of the company. If the contractor does not bring the desired result, you may incur losses.

4. Lack of control over the processes delegated to the outsourcer

Since the tasks are handled by a third party, it is quite difficult to track the stages of their implementation in a completely transparent manner.

Key takeaways

The minuses of outsourcing are really minor compared to the clear advantages of the service. It explains its growing popularity all over the world. 

The main benefit of outsourcing is the reduction of gross costs and the possibility for the company to focus its resources on core activities. 

Outsourcing of secondary functions allows the customer to gain access to the most up to date technologies, increase capitalization, engage first-class specialists, and gain additional advantages of cheaper financial resources. 

At the same time, transferring secondary functions, the customer company has the ability to control the quality and result of the work performed.

The contractor performs the same functions as the main company. However, a narrow-profile specialist can cope with this task more efficiently, overtaking the load from the client.

It is vital to take into account outsourcing risks, but they are only potential. Businesses can avoid these risks with a careful selection of a reliable partner with a good reputation.

Therefore, companies with far-ranging plans need to consider strategic outsourcing to remain competitive.

About the Author:

Oliver Smith

Oliver Smith is a talented writer and editor. He specializes in content related to digital marketing, SEO, SMM, eCommerce. Also, Oliver is a freelance guest post writer and an enthusiastic blogger who helps B2B companies reach their audiences more effectively. When he isn’t writing, you can find him at the gym, snowboarding, or doing some other sports activities. Oliver is a caring husband and father of two cute girls.

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