Outsourcing 1

Outsourcing

Amanda Turitto

BUS 630 Managerial Accounting

Don Frey

March 14, 2011

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Outsourcing

To be successful in today’s competitive global market, companies must fully

take advantage of any and all business aspects through which they can gain and maintain

a competitive edge over other companies in the same line of business. Outsourcing has

become one such possible business aspect, giving many companies the opportunity to

essentially hire an outside company to complete some of its production and/or service at a

reduced cost and/or increased productivity rate. However, the decision to outsource is

not in itself an indication of increased profit. Many factors, both positive and negative,

must be considered before deciding whether outsourcing is the right answer for a specific

company.

Before a company can determine whether or not it would be beneficial to

outsource any part of its business, it is essential to have a complete working knowledge

of outsourcing. BusinessDictionary.com defines outsourcing as “contracting, sub-

contracting, or ‘externalizing’ non-core activities to free up cash, personnel, time, and

facilities for activities where the firm holds competitive advantage” (2011). The online

reference source expands its definition of the increasingly-popular business practice by

saying “firms having strengths in other areas may contract-out data processing, legal,

manufacturing, marketing, payroll accounting, or other aspects of their businesses to

concentrate on what they do best and thus reduce average unit cost. Outsourcing is often

an integral part of downsizing or reengineering, and is also called contracting out”

(BusinessDictionary.com, 2011).

The website SOURCINGmag.com features an article by Dean Meyer titled “4

Advantages to Outsourcing” that touches on four points that must each be taken into
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consideration when determining whether or not a company would benefit from

outsourcing. The article lists the four advantages to outsourcing as:

• Advantage #1: Outsourcing can save you money

• Advantage #2: Outsourcing can help you share risk

• Advantage #3: Outsourcing can help accommodate peak loads

• Advantage #4: Outsourcing can help develop your internal staff

(Meyer, 2005)

The article goes into detail to explain each advantage separately. Meyer explains the first

advantage of outsourcing (saving money) happens because “economies of scale save

money when unit costs go down as volumes increase. External service providers can

achieve economies of scale unavailable to individual firms when they combine the

volumes of multiple companies” (2005). Simply put, this advantage means that if a

company can produce its ‘units’ (whether it be product or service) at a lesser cost, then

each ‘unit’ produces more of a profit. In many cases, this lesser cost is made possible

when companies decide to outsource some or all of its production. As with any business

aspect, outsourcing does have certain stipulations that must be met before money will be

saved. Below are the three conditions that must be met, including a short explanation of

each:

1. Economies of scale must exist- as explained above, outsourcing must prove that

unit cost will decrease, therefore increasing profit per unit

2. The economies must be accessible across corporate boundaries- outsourcing

companies will only agree to become involved if they find that they will have

multiple clients for their business

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3. The savings must be sufficient to outweigh the additional cost of paying other

shareholders a profit- some companies say that outsourcing is only ‘worth it’ if

profits increase a minimum of 20% after all costs and fees

(Meyer, 2005)

The second advantage of outsourcing Meyer discusses is the sharing of risk. As

described in the article, the ‘portfolio effect’ is a term used in financial circles by which

companies share risk; “in investing, it’s best to diversify your portfolio rather than put all

your money in one stock. By spreading your risk, you reduce your total risk” (Meyer,

2005). Such is also the case with regards to outsourcing. Meyer believes that

diversifying by way of outsourcing allows a company the elasticity to remain successful

even in the wake of possible mistakes (2005).

The third advantage discussed in the article is that outsourcing can help

accommodate peak loads. The article states that “outsourcing can be used to minimize

fluctuations in headcount that could result from peaks and valleys in demand” (Meyer,

2005). In order for this outsourcing scenario to prove successful, a company needs to be

vigilant in determining the point at which outsourcing will be financially a better decision

than trying to keep all production in-house.

Lastly, outsourcing can have the advantage of allowing a company to develop

its internal staff. The two strategies mentioned in the article that are believed to help

achieve this advantage of outsourcing are:

1. Contractors can be used to off-load less interesting “commodity” or end-of-life

work, or to handle peak loads. This leaves staff free to pursue new,

developmental opportunities.
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2. Consultants and vendors can be used to bring in new ideas and to train internal

staff.

(Meyer, 2005)

The first point mentioned above is explained as a way to use contractors for completion

of simple day-to-day/ mundane tasks in order to allow the company’s employees to be

available for more complex operational tasks. The second point mentioned includes the

company bringing in consultants to help employees increase their skill set and/or

productiveness (Meyer, 2005). Of course, each company will face its own variations of

the above-mentioned advantages which must then be analyzed in order to prove whether

outsourcing will provide the desired outcome for the company. However, when all of

these four stipulations are met, they combine to prove successful at indicating that the

company may in fact benefit from some level of outsourcing.

As with any business concept, outsourcing is not a fail-safe way for a company

to increase productivity and/or reduce production costs. Disadvantages to outsourcing

that must be considered by companies can be broken down into economic, business

strategy, and human resource management disadvantages, and are each outlined in the

article “Disadvantages of Outsourcing.” The article, authored by K Sholastica, explains

that while outsourcing can occur within the nation, “outsourcing, today, refers to giving

out work to foreign companies, which are based in nations where labor cost is low,”

including India, China and Brazil (2010). Because of Sholastica’s definition of

outsourcing, his article is based upon the theory that outsourcing is used to help a

company save money.

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Economic disadvantages of outsourcing include two main effects- (1) a

reduction in the number of available jobs in the company’s home nation, and (2) the

company may lose some foreign exchange as a result of the outsourcing (Sholastica,

2010). Business strategy disadvantages of outsourcing include the possibility for

compromised product/ service quality, as well as outsourcing becoming a possible

“grudge factor” (Sholastica, 2010). Whenever a company decides to outsource

production and/or service, they run the risk that the company to which the production/

service is outsourced to may not have the same quality standards as the company doing

the outsourcing. By outsourcing the production/ service, the company essentially trusts

the people actually doing the work to hold up the company’s quality standards.

Sholastica (2010) explains this phenomenon by stating that “the quality of the

output tends to be compromised as a result of unawareness of the American culture

among the working people…This often results into the development of cultural barriers

and a certain grudge among the people doing the work and their customers.” Lastly,

outsourcing can produce certain disadvantages when considered from a human resource

perspective. As explained by Sholastica, oftentimes the employees actually completing

the work are literally around the world from the clients with whom they are working, and

because of that purely geographical factor, disadvantages can arise. Sholastica says “the

time difference forces them to work throughout the night, which has an effect on their

health as well as their constitution. The second aspect is that the work is many a times of

clerical nature, leading to many arguments by philosophers claiming that outsourcing

kills of the ability of an entire generation to think properly” (2010). Personal, religious
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and political differences between employee and client may also play a role in scenarios

such as this.

Countless examples exist in today’s business world of companies large and

small that have decided to outsource differing levels of their business. One such example

includes technology giant International Business Machines Corp. Commonly known as

IBM, the company agreed in 2003 to “take over most of the computer operations of auto-

parts maker Visteon Corp. in an outsourcing deal that the companies say is likely to be

valued at more than $2 billion over 10 years” (Hechinger, 2003, p. B.3). In researching

this example of outsourcing, I learned that to large companies such as IBM, outsourcing

has proven to be valuable because “it frees them from making huge investments for

information technology that they may not need in the future” (Hechinger, 2003, p. B.3).

This is a condition I had not previously considered, but which would be a huge selling

point for companies aiming to land contracts with companies looking to outsource.

Week 6 of BUS 630: Managerial Accounting touched on the topic of outsourcing with

the discussion example of the decision of whether it would be more financially beneficial

for Han Products to make or buy ‘part S-6’ for its production line.
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References

Anonymous. (2011, March 8). Issues for Strategic and Effective Outsourcing Addressed

at IQPC's Contract Manufacturing for Pharmaceuticals and Biotech. Business

Wire. Retrieved from http://proquest.umi.com/pqdweb?

did=2286767631&sid=5&Fmt=3&clientId=74379&RQT=309&VName=PQD

BusinessDictionary.com. (2011). Retrieved from WebFinance, Inc. website:

http://www.businessdictionary.com/definition/outsourcing.html

Hechinger, J. (2003, February 12). IBM Gets $2 Billion Outsourcing Job. The Wall Street

Journal, p. B.3. Retrieved from

http://proquest.umi.com/pqdweb?

did=287888721&sid=1&Fmt=3&clientId=74397&RQT=309&VName=PQD

Meyer, N. D. (2005). 4 Advantages to Outsourcing. Retrieved from

SOURCINGmag.com website:

http://www.sourcingmag.com/content/c051011a.asp?action=print

Sholastica, K. (2010, September 23). Disadvantages of Outsourcing. Retrieved from

Buzzle.com website:

http://www.buzzle.com/articles/disadvantages-of-outsourcing.html