This paper seeks to explain the advantages of outsourcing (buying) against insourcing (making) with examples from any manufacturing or service industry. This discusses the problems or disadvantages of outsourcing using also examples. For this paper, e-commerce and hospital industries are used as examples to dramatize the possible advantages and disadvantages of outsourcing over insourcing. This paper will also discuss possible ways of overcoming the possible problems of outsourcing.
Analysis and Discussion
The opportunity cost of making a decision
The economic theory asserts that every decision that a company or an organization makes must be one that will attain or at least contribute to the attainment of its own economic objective, which is more profit. The requirement to meet profit is supported by the concept of opportunity cost, whereby it is assumed that no organization would go into business to lose money. In simple terms, the stockholders or owners of the business could opt to place their money in the bank and earn interest income without risking their resources in business. In exchange for business risks, therefore, these capital or resource owners need to be earning above their cost of capital or opportunity cost in order to stay in the business organizations where they invest (Slavin, 1996; Samuelson and Nordhaus, 1992).
Translated from the organizational level, the company must therefore earn profits by means of more revenues or less cost of doing business. The decision to outsource over that to insource is, therefore, a decision that is expected to attain cost reduction that will ultimately increase profit and that would keep the owners in maintaining their investment in companies or would justify further investments.
What are the advantages of outsourcing
Outsourcing can be a way of attaining the objective of cost savings
It is argued that it would cost less to ‘buy’ outside the organization than to ‘manufacture’ or do the service inside the organization by having more people as employees. In order to attain this advantage, there must be a way to compare the cost of outsourcing with insourcing. This would therefore require a way of measuring the actual cost of two alternatives.
This would involve the ability to +identity what are variable costs or relevant costs as a result of resorting to outsourcing (Atkinson, Anthony, et al., 2005). One that would produce a higher return on investment would be a more advantageous choice between the two options.
In the hospital industry, it is argued that hospital administrators can “save money, improve service and reduce hassle” (Williams, 2004). Thus in 2003, 16% of hospitals’ total budgets accounted for outsourcing activities their activities, and the said figure was expected to be 30% in five years. Outsourced functions in the hospital industry include cafeterias, housekeeping, security, and other non-core services. Even patient care functions that may include radiology, laboratory services, and nursing radiology were noted as part of what we’re being outsourced by hospitals (Williams, 2004). Given the expanding use of outsourcing in the industry, there is evidence to sustain the economic reason for doing so.
The advantage of such outsourcing activities had even felt eve in clinical engineering or medical equipment management. It was also found that clinical engineering departments are not immune from being targets for outsourcing based on the increase from the not-for-profit share services programs of the 1970s into for-profit equipment maintenance programs in 1980. Outsourcing could indeed be considered to have exerted its considerable influence on many business functions (Williams, 2004).
As to whether outsourcing in the medical equipment management resulted in reduced cost or improved service, experts from either insourcing or outsourcing have their separate positions. Those who favor outsourcing as beneficial argue for the right setting if outsourcing is to be handled properly (Williams, 2004). Examples of equipment manufacturers which provide outsourcing include Philips, the GEs, and Siemens. The management of these equipment manufacturers is no longer part of the hospitals, but they do offer equipment management programs as independent service organizations or third parties (Williams, 2004).
Under the e-commerce industry, the examples of outsourced services include those from the marketing aspects of an e-commerce site which may take the form of online organic marketing, Search Engine Optimization (SEO), data storage and data processing services, CRM, ad servings, and similar third-party services (ArticlesBase.com, 2009).
Outsourcing can improve or increase divisional or organizational effectiveness and efficiency
Divisional or organizational effectiveness is attained (ArticlesBase.com, 2009) if, after outsourcing, the organization could now concentrate better on its core business, which would allow the company to have competitive advantages on things it could do better than competitors (Porter, 1998). Divisional and organizational efficiency will also come out as a result of less cost for a division or division in delivering the same product or service to customers. The net effect of this advantage is still to minimize cost as in the first advantage. In addition, this will increase value to the customer because of greater effectiveness.
It can reconfigure human resource capital
Outsourcing could also bring out the best in people, which could increase their most productive contribution to the organization. This could be, in effect, an act to reconfigure the human resource capital (ArticlesBase.com, 2009). This advantage is therefore closely related to improving divisional or organizational effectiveness and efficiency since human resources would be converted to their greatest value contribution in delivering goods and services to customers.
What are the problems or disadvantages of outsourcing?
It could create more cost than insourcing
Outsourcing is not without problems since its nature involves cost or use of resources. Economically speaking, there is always an opportunity cost for making a choice. In this particular case, the opportunity cost would be the net advantage of having undertaken to insource or produce its own product or service when the latter would have been better than outsourcing.
Although it was asserted from another side of the coin that outsourcing produce cost and time savings due to reduced cost of maintenance and from the net benefit of a third party’s expertise in design, optimization, and functionality, it is possible for outsourcing to cause greater cost than the expected advantage. This could occur in case there is an error in the preparation of cost information for comparative purposes, or there is an error in appreciating the differential costs of the two alternatives.
Outsourcing could not be as simple as deciding to purchase that may easily guarantee a better result than insourcing. Third-party providers of outsourced services may not really produce what they have represented in the real sense and which could cause more problems than anticipated. Thus, an outsourcing contract may also involve some maintenance costs that may not have been factored in when the decision to outsource was made. Instead of actually reducing the number of personnel, the outsourcing contract could possibly cause discomfort or headache to management (Williams, 2004) by not delivering as promised or represented. Of course, the parties can assert their rights in court, and this may come as a surprise and thus may entail an additional cost to the company which has decided to outsource.
Outsourcing can create overreliance or dependency on third parties
The business organization is presumed to be an independent and sustainable organization where its own people may be relied upon for the smooth running of the organization. The organizational desire for better profit on the basis of less cost and thus resorting to outsourcing may create a greater risk of loss of control due to overreliance on third parties (ArticlesBase.com, 2009). Since third parties are independent organizations, then they may come out exerting too much power, which could result in the company having decided to be outsourced some functions as a candidate for being acquired from the third party providing the outsourced product or service. This is in the context of vertical integration (Brigham and Houston, 2002).
It may appear that the selection of a third party is indeed a viable one to provide the outsourced product or service, but actual performance could be deficient. Although the company’s management may be viewing it as a simple economic decision that will give a better profit, the decision could affect the strategic direction of the organization which has decided to outsource (ArticlesBase.com, 2009). It is possible that it may be more costly to insource the same service or product, yet it may have already created a competitive advantage to the company without its knowledge, and yet it still decided to outsource the same for cost considerations.
This could create a problem in the strategic position of the company in relation to competitors (Porter, 1988; Pearce and Robinson, Jr., 2004). It could be as simple as removing the competitive advantage. Thus, not only will the company lose the competitive advantage when it outsources, the decision even could cause its eventual downfall.
Under Porter’s five force model, one of the forces is the bargaining power of the supplier (Porter, 1980). If this supplier’s power is strong, the same could be an industry threat to the organization designing its strategy. Thus, outsourcing could result in encouraging an industry threat instead of protecting the organization from industry threats. This would be causing a greater cost than an advantage in the long run, although it may appear attractive in the short run. (ArticlesBase.com, 2009).
To rely and depend much on a third party to provide the outsourced product or service could remove the company’s negotiating power instead of strengthening, and the end result could be the loss of the business. This could be aggravated if valuable human resource capital would be more motivated to leave the company because they believe that could be of better use of the service or function being outsourced (ArticlesBase.com, 2009). Thus the employees who will feel alienated could apply to the third-party organizations, and this could create a vacuum in terms of knowledge and expertise, which are possible sources of significant competitive advantage for the organization.
The decision to outsource could be an act of giving up some or all control over some material functions of the organization which has decided to outsource (ArticlesBase.com, 2009)
How to overcome the disadvantages of outsourcing?
The company should know the cost of the alternatives. Before proceeding with the decision, there must be good preparation to prevent possible problems in the implementation of any outsourcing agreement. There is a need to prepare for the bidding on the outsourcing contract correctly. After a company has decided to outsource, hospital management should consider several factors to be defined before the contract goes out to bid.
This would include for the hospital to conduct an inventory of functions and what equipment is being maintained (Williams, 2004). This should also include conducting an in-depth analysis of the functions that these perform. Management should know that services must continuously be outsourced and which functions should be stopped by evaluating the effects of outsourcing programs to defined objectives. Management should have a complete inventory of equipment that would be managed by the outsourcing company, or the management could face the risk of unnecessary overruns (Williams, 2004).
Hospitals are advised to be absolutely sure of what equipment they need to cover as these hospitals get upset when these companies providing outsourced services notify the hospitals that they must increase the price of the product or service. In addition missing too much equipment missed during the bidding process could result in a losing situation for the contracting company as the same could create problems (Williams, 2004). Defining clearly the equipment should be made by the hospital. Relying on inventories provided by the contracting company should be avoided, for this would have the effect of letting the contract have a say in what needs to be done under the contract (Williams, 2004).
It is suggested that the inventory of all equipment should be complete between the hospital and the contractor (Williams, 2004).
One factor that is suggested to be clear in the contract is the role of the clinician in making the equipment available to the contractor. The hospital could retain control over the cost on this aspect (Williams, 2004). Another fact is the performance measures by which the contractor will be judged (Williams, 2004). Contractors must have their limits, and there should be boundaries on when their services should be terminated that the ownership of the data after termination should be thoroughly spelled out. Failure to do a clear definition may cause frustration and cost overruns that would outweigh the expected benefits (Williams, 2004).
Since outsourcing the medical equipment management function could mean reduced costs, improved service, and fewer headaches for a hospital, or the reverse could happen in the outsourcing program is not successful. Thus, there are certain guides that must be done to ensure the success of the outsourcing program.
It is important for the hospital to know the performance metrics of their in-house programs. Knowing these metrics require that the decisions to outsource should use realistic evaluations of costs (Williams, 2004). This would entail, therefore able to prepare a comparative cost comparison of options. Service levels must also be realistic. Service levels represent the ability to know the level of demand where services would be needed by the customer, and the same would properly determine the proper evaluation of costs (Williams, 2004). There must also be a realistic level of management commitment that is necessary for the success of the outsourcing program (Williams, 2004).
Hospitals should not outsource for the wrong reasons.
To ensure this, hospital management should take a look carefully at its existing department and determine really if there is indeed for outsourcing. Some management may resort to outsourcing to solve a personality problem or a personal issue in the organization (Williams, 2004), but before management realizes the same, the program may have failed, and it would be harder to solve a problem that is created in the process. The problem may just be needed to reassign some people to their proper places to become productive. An attempt to use outsourcing for the purpose of making the investment to make an in-house program effective or for the purpose of reducing the amount of oversight the department requires would not automatically solve the problem, according to experts (Williams, 2004).
It is even advised by some experts that a hospital does not need to outsource any function that could not be presently done in-house for the simple reason that the hospital cannot expect someone outside the system to solve a problem that could not be solved in-house (Williams, 2004). The rationale appears logical and reasonable since what should be outsourced is one that would promote the greater objective of the organization.
To prevent a sudden unprepared shift to outsourcing, there is a need to analyze one’s situation before one should talk to contractors. A company needs to know its priorities and know what issues should solve that a contract for outsourcing cannot solve (Williams, 2004).
To conclude, the economic net benefit is pervading reason why companies should go into outsourcing. However, their things are that must be considered before the same should be adopted by manufacturing or service industries. In the same way that countries practice free trade based on political and economic grounds (Slavin, 1996), companies may be restrained by legislation as to the limit of what they can or cannot outsource when outsourcing would involve other countries. Economic reasons are, however, very influential in making the decision to outsource because of the opportunity cost of resources.
Thus it would be harder to prohibit what can be outsourced using the internet. A decision to outsource may not resort to insourcing, and no amount of legislation could force private companies to adopt the same still if they will be losing money in running their organizations eventually. This would mean not sustaining these organizations, which must always be in need of resources to sustain their mission and vision (Massie, 1987; Plunkett and Attner; Pearce, and Robinson, Jr., 2004).
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