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A Brief History of Outsourcing

The following report is introductory to Dr Handfield’s research on Current Trends in Production Labor Sourcing.

Since the Industrial Revolution, companies have grappled with how they can exploit their competitive advantage to increase their markets and their profits. The model for most of the 20th century was a large integrated company that can “own, manage, and directly control” its assets. In the 1950s and 1960s, the rallying cry was diversification to broaden corporate bases and take advantage of economies of scale. By diversifying, companies expected to protect profits, even though expansion required multiple layers of management. Subsequently, organizations attempting to compete globally in the 1970s and 1980s were handicapped by a lack of agility that resulted from bloated management structures. To increase their flexibility and creativity, many large companies developed a new strategy of focusing on their core business, which required identifying critical processes and deciding which could be outsourced.

Initial stages of evolution

Outsourcing was not formally identified as a business strategy until 1989 (Mullin, 1996). However, most organizations were not totally self-sufficient; they outsourced those functions for which they had no competency internally. Publishers, for example, have often purchased composition, printing, and fulfillment services. The use of external suppliers for these essential but ancillary services might be termed the baseline stage in the evolution of outsourcing. Outsourcing support services is the next stage. In the 1990s, as organizations began to focus more on cost-saving measures, they started to outsource those functions necessary to run a company but not related specifically to the core business. Managers contracted with emerging service companies to deliver accounting, human resources, data processing, internal mail distribution, security, plant maintenance, and the like as a matter of “good housekeeping”. Outsourcing components to affect cost savings in key functions is yet another stage as managers seek to improve their finances.

Strategic partnerships

The current stage in the evolution of outsourcing is the development of strategic partnerships. Until recently it had been axiomatic that no organization would outsource core competencies, those functions that give the company a strategic advantage or make it unique. Often a core competency is also defined as any function that gets close to customers. In the 1990s, outsourcing some core functions may be good strategy, not anathema. For example, some organizations outsource customer service, precisely because it is so important.

Eastman Kodak’s decision to outsource the information technology systems that undergird its business was considered revolutionary in 1989, but it was actually the result of rethinking what their business was about. They were quickly followed by dozens of major corporations whose managers had determined it was not necessary to own the technology to get access to information they needed. The focus today is less on ownership and more on developing strategic partnerships to bring about enhanced results. Consequently, organizations are likely to select outsourcing more on the basis of who can deliver more effective results for a specific function than on whether the function is core or commodity.

What is outsourcing

Outsourcing can be defined as “the strategic use of outside resources to perform activities traditionally handled by internal staff and resources”. Sometimes known also as “facilities management”, outsourcing is a strategy by which an organization contracts out major functions to specialized and efficient service providers, who become valued business partners. Companies have always hired contractors for particular types of work, or to level-off peaks and troughs in their workload, and have formed long-term relationships with firms whose capabilities complement or supplement their own. However, the difference between simply supplementing resources by “subcontracting” and actual outsourcing, is that the latter involves substantial restructuring of particular business activities including, often, the transfer of staff from a host company to a specialist, usually smaller, company with the required core competencies.

Why do companies outsource

Here are some common reasons:

  • Reduce and control operating costs
  • Improve host company focus
  • Gain access to world-class capabilities
  • Free internal resources for other purposes
  • A function is time-consuming to manage or is out of control
  • Insufficient resources are available internally
  • Share risks with a partner company

In earlier periods, cost or headcount reduction were the most common reasons to outsource. In today’s world the drivers are often more strategic, and focus on carrying out core value-adding activities in-house where an organization can best utilize its own core competencies.

Main factors influencing successful outsourcing

The critical areas for a successful outsourcing program as identified are:

  • Understanding company goals and objectives
  • A strategic vision and plan
  • Selecting the right vendor
  • Ongoing management of the relationships
  • A properly structured contract
  • Open communication with affected individual/groups
  • Senior executive support and involvement
  • Careful attention to personnel issues
  • Short-term financial justification

Outsourcing process

There are four main aspects to a typical outsourcing program:

  • Program Initiation
  • Service Implementation
  • Final Agreement
  • Program closure

Program Initiation

At the start of any outsourcing program, there are a variety of ideas and opinions about the purpose and scope of the program, what the final result of the program will be, and how the program will be carried out. The Program Initiation Stage is concerned with taking these ideas and intentions and documenting them to form the basis of a draft contract

Service Implementation

Service Implementation covers the activities required to take these ideas and intentions and develop them into a formal, planned outsourcing program and to make the transition to the outsourced service. Specifically these activities are:

  • Defining the transition project
  • Transferring staff
  • Defining the Service Level Agreement (SLA)
  • Defining service reporting
  • Implementing and handing over the service
  • Implementing service management procedures

During the hand–over phase it is imperative that continuity of service is maintained at all times, that there is no reduction in the quality of the delivery and that timescales and deadlines are not compromised.

Final Agreement

The draft contract produced at the Initiation stage is generally amended during negotiations and the final Contract is produced on completion of the negotiation cycle.

Program Closure

In order to gain maximum benefit, the program should go through a formal close down. There is no point in continuing to argue lost causes once irrevocable decisions have been taken. Staff and companies alike need to accept the new situation and move forward. However, there will be a lot of information generated during the life of the program, and this will have been stored with varying degrees of formality by the team members. This information needs to be formally filed away for future reference.

How to decide whether to outsource

There are no simple criteria to conduct an outsourcing versus in-house analysis. The benefits associated with outsourcing are numerous, and one should consider each project on its individual merits. Ongoing operational costs that may be avoided by outsourcing are also a consideration. In a nut shell, outsourcing allows organizations to be more efficient, flexible, and effective, while often reducing costs.

Some of the top advantages brought by outsourcing include the following:

  • Staffing flexibility
  • Acceleration of projects and quicker time to market
  • High caliber professionals that hit the ground running
  • Ability to tap into best practices
  • Knowledge transfer to permanent staff
  • Cost-effective and predictable expenditures
  • Access to the flexibility and creativity of experienced problem solvers
  • Resource and core competency focus