Outsourcing is when a company purchases products or services from an outside supplier rather than performing the same work within its own facilities, in order to cut costs. In other words, outsourcing is an organization's contractual relationship with a specialized outside service provider for work traditionally done internally by that organization. The decision to outsource is a major strategic one for most companies because it involves weighing the potential cost saving against the consequences of a loss in control over the product or service. Some common examples of outsourcing include manufacturing of components, computer programming services, tax compliance and other accounting functions, as well as payroll and other human resource functions.
The growth in outsourcing in recent years is partly the result of a general shift in business philosophy. Prior to the mid-1980's, many companies sought to acquire other companies and diversify their business interests in order to reduce risk(Foxman 78). As more companies discovered that there were limited advantages to running a large group of unrelated businesses, however, many began to divest subsidiaries and refocus their efforts on one or a few closely related areas of business(Foxman 80). Companies tried to identify or develop a core competence, a unique combination of experience and expertise that would provide a source of competitive advantage in a given industry. All aspects of the company's operations were aligned around the core competence, and any activities or functions that were not considered necessary to preserve it were then outsourced.
Successful outsourcing thus requires a strong understanding of the organization's capabilities and future direction. As Vince Elliot explained in Outsourcing Without Risk, "Decisions regarding outsourcing significant functions are among the most strategic that can be made by an organization, because they address the basic organizational choice of the functions for which internal expertise is developed and nurtured and those for which such expertise is purchased. These are basic decisions regarding organizational design." Outsourcing based only upon a comparison of costs can lead companies to miss opportunities to gain knowledge that might lead to the development of new products or technologies. Business Week called companies that had outsourced too many of their core functions "hollow corporations," and claimed that they had relinquished their reason for existence.
Outsourcing can be undertaken to varying degrees, ranging from total outsourcing to selective outsourcing. Total outsourcing may involve dismantling entire departments or divisions and transferring the employees, facilities, equipment, and complete responsibility for a product or function to an outside vendor. In contrast, selective outsourcing may target a single, time-consuming task within a department, such as preparing the payroll or...