Management: Outsourcing and Insourcing

Make or Buy

An organization exists mainly for the purpose to provide a good or service and make a profit. The inevitable long-term objectivity is profitability. Profitability results from the efficient use of resources while manufacturing or production is being undertaken. This economic efficiency is usually pursued by organizations in the shape of reducing costs and more efficient processes.

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In order to achieve this state of lower costs, higher profits, and efficient utilization of time, energy and the factors of production a firm is usually faced with a choice amongst production alternatives. This business decision aims to compare the costs and benefits of manufacturing a product contrary to purchasing it from a third party. For e.g. in the aircraft manufacturing industry costs are reduced by outsourcing different parts of production to various firms. The different parts of the aircraft such as the fuselage, engines, wings, interior etc are all built-in separate facilities across Europe and assembled in the main Airbus factory in Toulouse, France. Otherwise, if the company has the required capacity and resources, it can produce the product on its own and thus limit dependence on other third-party firms.

The decision depends on both qualitative and quantitative factors. The qualitative aspect covers the quality of the product and the long-term relationship prospective with the third-party or sub-contractor. On the other hand, the quantitative aspect is evidently the cost, since the primary objective is to reduce costs.

Therefore, we will closely analyze the advantages and problems related to both outsourcing i.e. buying and sourcing i.e. making a product. We will look into the two cases before we draw a conclusion regarding business decisions.

Benefits of Outsourcing

Through outsourcing, firm partners with third-party supply chain companies to produce their products. Again the decision is based on projected lower costs, efficient energy, and factor and time utilization. External service providers overtake a certain part of the business process on a contractual basis. Outsourcing is gaining pace across the world with sectors of information technology, human resources, customer support, marketing, research and development and accounting being outsourced. For e.g. many large firms in the United States are outsourcing their customer service centers to India in order to reduce costs thus opening up many job opportunities in the country. Outsourcing helps companies worldwide to save money, time and resources and leads to faster growth. Following are some of the numerous advantages that outsourcing carries.

Focus on Core Activities

As a company expands and grows, it pays little attention to core activities that essentially form the backbone of the company. By outsourcing certain functions, the company is able to ease the burden off itself and enable it to focus on other aspects without sacrificing quality or service. Moreover, since third-party organizations are specialists in certain fields, they have a better understanding of certain business processes and their experts deal with them. For e.g. many companies hire marketers from renowned marketing agencies to share their expertise with the business and handle marketing operations through their wider experience and knowledge base.

Cost Efficiency

Companies are able to attain lower costs through cost-restructuring and also re-define quality levels with access to low-cost economies. For e.g. the IT industry in India is booming and many foreign firms use it to outsource business processes at cheaper prices and at a superior quality.

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Operational Control

Certain operational costs vary over time and at times also go out of control for the firm. Those operations whose costs are getting out of control should be considered for outsourcing. Certain departments which are underperforming or mismanaged should also be considered for outsourcing. Through outsourcing, the outsourcing company can bring better management skills, knowledge and expertise which would otherwise be unavailable. For e.g. several airlines are unable to handle catering services for in-flight meals therefore they outsource them to renowned caterers such as Gate Gourmet a famous airline catering firm. This subcontracting help airlines save costs as well as utilize top-notch products and services.

Continuity and Risk Management

When a company is facing a high employee turnover, this can have adverse effects on its operations. With outsourcing there is continuity and it also eliminates the risk of substandard levels of operation. For e.g. if the marketing head of a company resigns and several other marketing department employees move to better jobs, it is in the best interest of the company to outsource marketing functions to keep operating efficiently.

Develop Internal Staff

On-site outsourcing can also develop internal staff. For e.g. an IT firm needs to undertake a big project for which it is not equipped. It would outsource the project to another IT firm and through on-site outsourcing reap several benefits. For e.g. the experts working on the project could share expertise with internal staff. This way the internal staff can also polish their skills.

These were some of the benefits of outsourcing. There are other several benefits that include tax saving, reduced time to market, and enhanced capacity for innovation to name a few. Moreover, outsourcing also has its disadvantages as discussed in the following text.

Disadvantages of Outsourcing

Outsourcing also has its disadvantages along with the numerous advantages we just discussed. It is important that the advantages outweigh the disadvantages for outsourcing to be a success. Since outsourcing requires some business functions to be operated and controlled by a third party, this causes several concerns for the company itself. Some of the disadvantages associated with outsourcing include the following.

Loss of Managerial Control

Since outsourcing is done on a contractual basis the company’s processes, departments or functions that are being outsourced are fully managed and controlled by a third party. There is always the risk that the outsourcing company may not live up to the standards of the company in terms of quality and performance. That is why many firms refrain from outsourcing primarily because of lack of control.

Hidden Costs

Although overall the company is cutting back on costs considerably because of outsourcing, outsourcing itself carries several hidden costs. Although the contract clearly states all the required details, any additional items not part of the contract will be treated as additional charges to be borne by the company itself.

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Security and Confidentiality

Organizational information is the essence of any organization and when it comes to outsourcing this data must be shared with the outsourcing company. A risk exists that the confidentiality of the data a company lends out to the outsourcing company may be misused. This is a major source of concern for many organizations since rivals would do anything to lay hands on certain important company data. This can easily be routed to rivals through outsourcing companies. Therefore an outsourcing company must be thoroughly evaluated for confidentiality.

Quality Problems

It is certain that the outsourcing company will be primarily motivated by profit. Therefore it may overlook quality for profit. A contract usually outlines the price therefore the only way to make a profit is to lower expenses and the only way to lower expenses is by compromising on quality. For e.g. a construction company may use substandard cement to cut back on costs and make a bulk of profits.

In-sourcing

In-sourcing on the other end is when a company makes all the necessary components on its own, assembles them, and sells a final product or service. What happens is that a certain function, process or job is assigned to an internal but independent entity within the organization. Internal employees are often trained or skilled experts recruited on a temporary basis to perform certain tasks which would have otherwise been outsourced. For e.g. in a technical equipment manufacturing firm, previously the manuals of the designed equipment were written by outsourced companies, now, they have invested in extensive training on engineers to enable them to write the manuals themselves.

In-sourcing, just like outsourcing has its own set of benefits and problems. Some of the advantages of insourcing rather than outsourcing include the following.

High Control

As compared to outsourcing, in-sourcing offers full control and management to lie within the hands of the company. Since in-sourcing takes place within the company or factory premises, managers and directors can monitor the proceedings and ensure quality and performance are not being compromised.

Ability to oversee the entire program

With production taking place within the radius of the company, the entire program can be monitored and processes can be streamlined to ensure quality. Although profit is still the main objective, illegal means to reduce costs such as substandard material and inefficient use of resources will be curtailed.

Economies of Scale/Scope

The company, through in-sourcing, will be able to expand and eventually achieve economies of scale through which it will attain cost advantages. The average cost per unit for a producer will decrease and profits will rise. This unit cost will be achieved as the size of the facility increases through in-sourcing activities. For e.g. Samsung, produces its own machinery which is then used to produce various consumer and industrial products.

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These were the benefits of in-sourcing as compared to outsourcing. However, in-sourcing also has certain disadvantages, these include the following.

Strategic Flexibility

Through in-sourcing, a company expands and diversifies. For this the company requires flexibility in its workforce, resources, management, time and energy. This is essential because, given the current economic environment; problems need to be dealt with swiftly and efficiently, therefore, strategic flexibility is very significant. The subheading is not indented but the body of the subheading is indented.

High Investment

As compared to outsourcing, in-sourcing requires a considerable amount of investment. Investment in new machinery, raw materials, equipment, training and development and space is required. For e.g. Airbus Industry decides to manufacture its own engines instead of relying on General Electric, Rolls Royce etc. This will call for a huge amount of investment in the factors of production and training and development of employees.

Quality

Outsourcing companies that supply certain components or products are usually specialists in their respective fields. For e.g. Dunlop Tires is an established tire company with expert knowledge and superior quality. In-sourcing of tire production by a car manufacturer may not be as superior as compared to Dunlop.

Make or Buy Decision

We have looked into the advantages and disadvantages of both outsourcing i.e. “buying” and in-sourcing i.e. “making”. A decision regarding whether to outsource or in-source is a highly strategic decision and depends on several factors ranging from costs, resources, capacity, and time to management, control, quality and performance.

Given the global competition that reigns in today’s world companies have to constantly re-assess their processes, functions, technologies and products/services. Making this decision in a planned and a prudent manner has a direct impact on the organization’s performance and growth. The factors that affect the make or buy decisions for a company include the following:

Environmental uncertainty

Environmental uncertainty is a major reason why firms look towards outsourcing. This is because, given the environmental situations, the firm faces several challenges. These may be in the form of a financial crisis due to inflation or difficulty in obtaining resources. Therefore, firms usually adopt outsourcing as a solution to their problems.

Competition in the supplier market

This is another reason why firms indulge in outsourcing. With increased competition in the supplier market, prices fall and quality levels rise as each supplier targets attaining the greatest market share. This can be exploited by the firm in the form of lower costs and superior quality.

Monitoring Suppliers Performance

With lower levels of monitoring available, firms would prefer in-sourcing as with outsourcing the firm never knows what the outsourcing company is up to. Monitoring in this case is limited whereas with in-sourcing the firm has full control and monitors the proceedings regularly.

Core Competencies

The relationship of the product or service with the buying firm’s core competencies is also a key factor. If the organization has many non-core processes which are consuming lots of time, effort and resources to be performed in-house then it would be a wise decision for the organization to shift them to outsourcing companies.

Resources

In order to undertake in-sourcing activities efficiently and effectively, a firm needs to have the appropriate amount of resources in terms of labor, land and most importantly capital to be able to afford in-sourcing. Conversely, if the company does not have enough resources to support in-sourcing it would move towards outsourcing.

Costs

Costs, whether they are fixed, variable, cost of production, maintenance etc all add to the company’s headache. Before making a choice between in-sourcing and outsourcing a company needs to analyze the costs associated with each one. These costs can be direct and indirect. It should calculate these costs and then make a decision based on lowest cost of production.

Conclusion

It is a proven fact that outsourcing, even with its drawbacks, does save manpower, time, effort and money given that the firm has a number of non-core procedures. For e.g. data entry, accounting audit, marketing, research, and development etc. These are all examples of fields that can and are being outsourced. Major companies such as Dell, Hewlett Packard, Linksys and Symantec have outsourced several processes and functions. In-sourcing on the other hand is also beneficial for certain firms. It guarantees control, growth and economies of scale. However, both outsourcing and in-sourcing have their disadvantages. Therefore, a firm, when deciding whether to “make” or “buy” should go through several factors which were discussed earlier such as costs, resources, core competencies, supplier performance, and environmental uncertainty before arriving at a decision. The decision is a very important one and should be dealt with rationally and analytically. For some firms such as Linksys, outsourcing is better whereas for others such as Samsung, in-sourcing has worked. Moreover, organizations can also outsource and in-source simultaneously and reap the benefits of both alternatives.

References

  1. Burt, David N., Donald W. Dobler, and Stephen L. Starling. (2003) World Class Supply Management: The Key to Supply Chain Management. 7th edition. Boston: McGraw-Hill/Irwin
  2. David M. Haugen, Susan Musser, Kacy Lovelace. (2009). Outsourcing. Greenhaven Press.
  3. Balakrishnan, Jaydeep,(2005) “The Theory of Constraints and the Make-or-Buy Decision: An Update and Review.” Journal of Supply Chain Management: A Global Review of Purchasing & Supply 41, no. 1, 40–47.
  4. Journal article by James Brian Quinn, Frederick G. Hillmer. (1995). “Strategic Outsourcing” The McKinsey Quarterly, No. 1
  5. Encyclopedia of Management. Make-Or-Buy Decisions. 
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