When Should We Outsource Activities?

“Whenever a company produces a service internally that others buy or produce more efficiently or effectively externally, it sacrifices competitive advantage” (Quinn, James Brian, Thomas I. Doorley, Penny C. Paquette “Technology in services: rethinking strategic focus” Sloan Management Review, Winter 1990). Thus, any activity not considered a core competency has the potential to be outsourced, but what are the advantages of outsourcing?

The big disadvantage of outsourcing that used to be mentioned is the “loss of control”. Although with the information systems that today are in place, and managing properly the relationship with the outsourced firm by having regular meeting and conference calls, we should be able to overcome that “disadvantage.” In reality one of the biggest handicaps for outsourcing could be “the loss of power” for some managers. For instance, we could have a Supply Chain Director managing more than 1,000 workers and after outsourcing the distribution centers network he could be managing just 20 people. So that strategic focus could be seen for some managers as “loss of power and control.”

Activities like transportation, warehousing, co-packing, publicity, payrolls, or legal support have been outsourced during many years in order to materialize the outsourcing advantages. However, the outsourcing process continues its evolution and its getting further. In the last years some companies have implemented outsourcing AND offshoring strategies in order to enhance the outsourcing benefits. For example, DHL is outsourcing globally some IT activities in India, or Telefonica is outsourcing call centers in Colombia.

The long tail concept introduced for Chris Anderson in 2004 is supporting the access to outsource for very small firms or low volume activities. For instance, Legalitas in Spain offers outsourcing legal advice for just 15 €/month, or outsourcing the marketing creation of a PC wallpaper can be sold in Internet for just $ 50.

Once that we have identified a potential outsourced activity, the next step would be answering the following question: How can we “guarantee” that we should outsource that particular activity? We should outsource it, if we are able to answer affirmative to the following three questions:

1. Are we reducing complexity or increasing flexibility? If managing the outsourced firm is being easier than managing that activity internally. From the change management perspective, this is an important issue because outsourcing important activities are probably creating some internal conflicts with trade unions. Moreover, those processes could affect staff morale (thinking that their jobs are in danger in the current or in the future coming from outsourcing processes.)
2. Is the service being improved? If the outsourced firm has more expertise or specialized resources to perform those activities, the outsourced firm is likely improving the current service.
3. Are we improving our cost structure or reducing our assets? Companies with higher expertise and more specialized resources should have better processes (reducing the cost of “poor” quality) and higher productivity. Moreover, better processes and resources allow companies to use less experienced and cheaper workers to perform activities. For example, warehouse men using well design processes supported by radio frequency just would need a very short training about products, their location, picking strategy, etc. The location and type of business that the outsourced firm performed can create a competitive advantage from the labor cost point of view what it is so important in intensive manpower industries like services. Cost reductions is going to support turnaround projects, but assess reductions offer one of the best opportunity in turnaround projects to improve cash (selling warehouses/buildings, machines, etc.)