In the past few years, most firms used outsourcing strategies as a way of managing their operations. Outsourcing is the use of outside organizations to provide services for a firm. Offshore outsourcing is a form of outsourcing, and it is defined as the use of an outside service provider in the operations of a firm from another country other than the one where the firm is based (Evaristo, Nicolas, Prikladnicki & Avritchir, 2005, p. 3). Outsourcing as a way of improving a firm’sfirm’s performance has grown quickly in the past decades. According to surveys that have been conducted recently, over 80% of big and medium companies across the world depend on outsourcing. Reports indicate that firms are outsourcing service providers for work that was initially performed internally. Thus, it is impossible for firms not to outsource in the globalized economy (Burkholder 2006, p. 45).
There are a number of benefits that a firm gains from outsourcing. This includes the reduction in costs of production and provision of quality services. Furthermore, there is the increased flexibility and link to new technology sources. Outsourcing also enables employees in a firm to work extra hard towards attaining service value and increased output. The need to gain a competitive advantage such as reduced expenses and technical knowledge is also a reason that forces firms to outsource their operations. The US-based firms take advantage of outsourcing to explore the IT progression opportunities and workforce in the global market. IT sourcing globally creates strategic benefits for firms that include low cost and skilled labor access. This also promotes access to potential markets (Earl, 1996, p. 25).
Although outsourcing is associated with a number of advantages, there are also several risk factors that firms face (Earl, 1996, p. 25). The employment of resources in a firm’sfirm’s processes does not always lead to a competitive advantage in the firm. The market growth has been at a faster pace during the early 2000s. However, in recent times, it has decreased due to many economic pressures that firms face.
Firms have to look for ways to cut costs like reducing staff numbers. Firms should develop additional resources and capabilities for them to become global players in the offshore outsourcing market (Barney, 1991 p. 99). There are various risks that arise from outsourcing, such as unexpectedly high costs, disputes, and litigation, lock-ins, and loss of competency of the organization (Bali & Rivard, 2003a p. 211). It can be noted that outsourcing comes with both advantages and disadvantages. However, there is evidence to support that the disadvantages of outsourcing outweigh the benefits.
Challenges of Outsourcing
Strategic Decision Challenges
Outsourcing is an aspect that has been adopted by many firms across the world. There are various perspectives to understand the sourcing of decisions employed by firms. The main ones include production and transaction cost economics, resource-based views (RBV), and resource-dependence views. For the Resource-Based View (RBV), the resources in a firm and how they are used is the main determinant of its competitive advantage. Highly valued and scarce resources enhance the competitiveness of a firm. The competitive advantage can exist for a long period. In this case, the firm can shield against resource limitation, transfer, or substitution. Knowledge is regarded as the cornerstone to the success of a firm. This is emphasized by the knowledge-based theory. Knowledge is a resource that is difficult to imitate and a complex one. Thus, heterogeneous knowledge bases and know-how abilities are the main determinants of competitive advantage. This also enhances corporate performance (Wee, Peng & Wee, 2010, p. 613).
However, some scholars have raised concerns about the internal expertise and intellectual property that is lost when a firm outsources its information systems (Evaristo, Nicolas, Prikladnicki & Avritchir, 2005, p. 3). This is one of the negative aspects that is associated with outsourcing. Whenever there is outsourcing, the risk of foregoing the knowledge of the firm arises. The creativity of a firm cannot be taken for granted. It is determined by the cumulative knowledge generated over the years of operations. Resources and organizational processes, entrepreneurial and experimental competencies cannot come from external sourcing (Earl, 1996 p. 26).
There is some level of a paradox when firms outsource using resource-based view or knowledge-based view. Those firms that use outsourcing have always used resource-based view to make their outsourcing decisions. Firms can use the sharing arrangement to acquire beyond its boundaries those resources that it lacks. Outsourcing has been taken as one of the ways that firms gather knowledge from suppliers. Therefore, information systems outsourcing should be regarded as a means of incorporating the information.
These risks are described as long-term, and their nature affects the internal part of an organization. Those firms that practice outsourcing often find it hard to avoid these risks. A firm that subcontracts an activity for a long time may face undesirable consequences. This includes the loss of the experts who have been with the company. Those employees whose skills are being outsourced are forced to retire or change employment to look for a place where their skills are needed. According to Earl (1996, p. 30), outsourcing for prolonged periods leads to a loss of expertise to the outside providers and lack of prolonged leadership edge expertise as these outsiders providers may not be there in the future. The firm also faces the risk of spreading its expertise among the many clients that exist due to competition. Managers are warned of the disadvantages that they may face as far as their ability to survive is concerned. This is if their core competencies are slowly losing through outsourcing.
Vendor Selection Challenges
There are various challenges that are associated with the outsourcing process. This is particularly during the selection and the bidding processes. For example, during outsourcing, there may be several suppliers interested in placing their bids. However, the problem may be the lack of mediators to assist in picking vendors. There is the possibility of the suppliers delivering something different from what they included in their initial suggestions. It is also hard to determine the value and requirements of the services needed. For most suppliers, their bids are based on inadequate information. In this case, the environment in which they operate is often incorporated to analyze the exact service expenses, as well as the essential technicalities.
The selection of suppliers in this situation is often problematic. The standard that is used to measure their capabilities is the cost efficiencies that they can deliver. The other issue is associated with the suppliers out-bidding themselves. This may lead to the inability of the suppliers to proceed with the deal effectively. Therefore, the outsourcing firm is often put under pressure. Thus, the firm has to re-negotiate or even dismiss the deal at an early stage. The parties involved often incur substantial costs. This leads to misgivings over the economic feasibility of such deals. For firms to avoid such scenarios, they should have expertise in determining when such can arise. Hence, the challenge that is posed to the manager is to select viable vendors who are experienced in the assessment of the project’sproject’s scope and the ability to foresee such problems arising (Weerakkody 2010, p. 624).
Outsourcing is also known to introduce operating risks to the firms concerned. This is especially with regard to operations at the seller locations. The risks cannot be blamed on the vendors. However, they are caused by the complexity of the operation. This includes the geographical distance between the customer and the seller. The risks are also caused by the cultural gap in the environment that the vendor and the client operate and/or the communication and transmission system limitations that exist between the two parties (Weerakkody 2010 p. 624). Offshore outsourcing poses many other risks that need to be considered before the selection of a vendor is done. Some of these risks include cost savings risks, internal employee issues, management complexity, geographical risks, risk of Intellectual Property (IP) loss, internal data sharing, global cultural environment, financial risks, and difficulties in communication and coordination (Evaristo, Nicolas, Prikladnicki & Avritchir, 2005, p. 4; Kliem, 2004 p. 22). These risks make the selection of a viable vendor in the appropriate country challenging (Tambe 2010 p. 67)
Vendor Management Challenges
Earl (1996 p. 30) proposed that various vendor management challenges arise out of operations within the IT industry, and its development is uncertain. The end-users are also not always sure of their requirements. There is the risk associated with new technology and changes in business requirements. Therefore, the implementation is not an easy task. While clear and specifications of the problem and expectations are necessary, he argues that a clear project management period that requires no changes to specifications and rigid timing and budget controls can lead to applications. These applications do not often find their potential or create user-specialist conflicts (Earl, 1996 p. 30).
It is advisable for firms to refrain from rigid outsourcing. Therefore, the contracts have different clauses advice build from the various outsourcing literature. Companies develop agreements on the annual evaluation, and the short-term contracts are the ones that are signed. A one year review tends to be expensive as they involve annual contracts that are costly. Short term agreements are likely to lead to cost payments. In addition, disparities in the sections of the agreements may not anticipate all the reservations. Paying for a flexible contract can be better than having to specify the tight contracts arising out of the performance. Managers may have to deal with the challenge of determining the duration of the agreement. This is due to many suggestions regarding what is beneficial.
The vendor can demand to be paid in full without accomplishing their duties as designated. The deliberate underperformance is termed as shirking. This occurs due to the variations of the vendor’svendor’s incentives for hard work. It may also be due to the inability to detect under-performance. This can be facilitated by inadequate information. It has been asserted that can use the information the legitimate contracts for uses it was not intended. This phenomenon is described as poaching. This means reversing business processes, misdirecting them through theft, and reselling them or reusing them as a direct competitor against a client (Pouder, Cantrell & Daly, 2007, p. 10).
Stealing of intellectual property has become significant for organizations because the information is a valuable asset for organizations. The Lock-in situation for the client is a result of his or her not having any other source of backing, goods, or services. Under such conditions, the client is forced to pay the current supplier any amount of money that is demanded. The loss of bargaining power and the attached price increases happened very fast and consistent. This ensured that it gained a name, vendor holdup, according to the outsourcing literature (Kliem 2004 p. 22).
There are various risks that emanate from outsourcing transactions. These are locked-ins that arise from various situations. Lock-ins may be due to asset specificity. They can also be caused by fewer suppliers. In addition, the degree of client’sclient’s expertise can also lead to lock-ins. This is also due to contractual amendments that are costly due to uncertainty, unexpected transaction, and management costs, and disputes and litigation that arise out of measurement challenges and supplier’ssupplier’s expertise in IT operations.
Technology and Technical Challenges
According to Earl (1996 p. 28), outsourcing leads to various technical and technology challenges. This is due to the problem of legacy in IT skills. Vendors that are sometimes chosen to supply the services are technologically ahead of their clients. There is also the problem of lack of technological synchronization between the two because of the distance arising out of them working across sites. There are other technical challenges that arise out of outsourcing. This includes the communication infrastructure. Furthermore, there is the complexity and configuration control. Moreover, this can be due to the absence of versioning of objects. Apart from these elements, there are many other issues, such as expensive data conversions, among many others.
Benefits of Outsourcing
Most firms use outsourcing as an attempt to reduce production costs and improve on their positioning strategically (Bolumole, 2001 p. 87). Although outsourcing that arises out of cost reduction is normally short-lived, this does not discourage firms from outsourcing. On the other hand, outsourcing that is motivated by strategic positioning is a long term aspect. This presents numerous opportunities that lead to many results. These include repositioning in the market, adapt to the altering business environment, products of better quality, and speed improvement in the market.
Cost Reduction as a Benefit of Outsourcing
Firms have been able to improve their short term performance due to cost reduction that arises out of outsourcing (Tadelis, 2007 p. 265). Most companies compare the financial implication of outsourcing to the cost in the attainment of resources for internal enhancement. This is used to assess the associated advantages. Multiple gains or profits of a vendor’svendor’s ability, which eventually decreases the client’sclient’s costs of operation, leads to a provision of services at a reduced cost. The relative cost advantages of the vendors may arise from extending the economy’seconomy’s capacity. This can also be prompted by the services outsourced by many clients. In addition, this is boosted by undertaking many projects that share capabilities.
Outsourcing is also able to produce the required cash. This is from selling assets or proceedings received from transferring staff to sellers. Cost merits may be generated from the reduction or elimination of new investments or renewals of the same (Gilley & Rasheed, 2000 p. 763). This emanates from vendor services. This can be achieved through efficient technologies compared to the abilities of the clients, which can be expensive when developed internally. The internal costs of administration, politics, and bureaucratic procedures can also be reduced through outsourcing (Gilley and Rasheed, 2000 p. 763).
Strategic Advantages of Outsourcing
The strategic advantage as a motive of outsourcing enables firms to perform their operations on a long term basis. The benefits show an open window to create value that is enhanced by the relationship between the firm and vendors. For instance, a firm can match a vendor’svendor’s skill and expertise in its value chain and be able to venture into good growth opportunities. A firm often achieves this when it transfers logistics to a vendor who has the capabilities in supply chain and worldwide markets (Pellicelli 2011 p. 280).
Quicker, higher quality, and versatile services result from good performance competition in the global market (Daugherty and Pittman, 1995 p. 54). Equally, IT is outsourced by companies to enhance accessibility to the seller’sseller’s systems. A firm is eventually able to venture into new business opportunities or respond to demand changes from consumers. Firms are motivated to be strategic in their outsourcing so as to be able to attain the core competencies. It is expected impact is to enable affirm to improve on its performance (Gilley 2000 p. 765).
Empirical studies reveal that firms that are strategic in their outsourcing have shown consistent improvement in their performance. There are positive cumulative abnormal returns for those firms that used motivated, strategic outsourcing for information technology and the chance for new operational processes. Although there are no crucial results from outsourcing advertisements with attempts to enhance strategic effectiveness, firms have attained a lot through strategically outsourcing their processes.
The Dual Advantages of Portfolio Contracts Outsourcing
With the wide growth of outsourcing, many firms nowadays are going for portfolio contracts of outsourcing (Tadelis, 2007 p. 265). There is a tendency in a contemporary investigation being undertaken to evaluate the advantages that accrue to firms. This is in reference to when the firms outsource with both motives, including cutting costs and maintain strategic competitiveness. Information Technology outsourcing is critical in reducing spending. This is also critical in providing chances to enhance the competitiveness and the expansion of the market. Firms enjoy the double benefits when they go for portfolio contracts with cutting costs and strategic advantages.
Investors examine available information about the decisions that managers should make on short term results. They also examine the projected earnings. A dual contract received in the market means a firm is working towards increasing its financial performance and improving its long-term strategic advantage (Tadelis, 2007 p. 265). Moreover, investors use short-term information to make conclusions on long-term customers. Investors are given information about long-term and short-term cost-cutting benefits by the managers. This is achieved by advertising the double motives of outsourcing. This helps to remove the uncertainty of opportunities for increased performance profits.
There is evidence to support the argument that the disadvantages of outsourcing outweigh the benefits. This argument is supported by the various limitations of outsourcing that are more than its benefits. There are fewer benefits that a firm gains from outsourcing compared to the limitations. The benefits include a reduction in costs of production, the creation of value through the strategic motive of outsourcing, and the dual benefits that arise from portfolio contracts of outsourcing. Outsourcing also enables the employees in a firm to work harder towards attaining service value and increased output. The need to gain a competitive advantage such as reduced expenses and technical knowledge is also a reason that forces firms to outsource their operations.
Although outsourcing is associated with some advantages, there many disadvantages, which outweigh these benefits that firms may accrue. These limitations or challenges are put into various groups. This includes strategic decision challenges. In addition, there are vendor selection challenges. Furthermore, there are vendor management challenges. Lastly, there are the technology and technological challenges. The employment of resources in a firm’sfirm’s processes does not always lead to a competitive advantage in the firm. It has also been noted that market growth was at a faster pace during the early 2000s. However, the pace has decreased due to many economic pressures that firms face in the global market.
Today, firms are using much administrative time to look for ways they can employ to cut costs like the reduction of staff number and increase in standardization. Firms that wish to become global players in the offshore outsourcing market should develop additional resources and capabilities. There are other various risks that arise out of outsourcing, such as unexpected high costs, disputes, and litigation, lock-ins, and loss of competency of the organization. Therefore, the disadvantages that come with offshore outsourcing are more than the associated benefits.
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