Outsourcing 101 - A Primer
by A.B. Maynard
Originally published at
Evaluation Center. Used by permission
Definitions and Options
is a very diverse topic, and there are many different
outsourcing options and outsourcing service providers to
choose from. Companies are telling the
that they need a clearer picture of outsourcing, its
potential benefits, and common pitfalls. They want
examples of different types of outsourcing and advice on
whether outsourcing is right for them. This primer
addresses these questions. In addition, the
is launching a research initiative into outsourcing and
launching the Outsourcing Evaluation Center to help
companies in their journey towards outsourcing, whether
they are outsourcing for the first time or the fifth.
is Part One of a three-part note and will discuss the
history of outsourcing, describe outsourcing pros and
cons, and introduce offshoring concepts.
Two will define and describe common types of
Three will recap outsourcing approaches and categories,
describe recommendations for firms looking to outsource
and describe recommendations for outsourcing providers.
A CEO sits
in his office one day, and begins to wonder about his
company . . . His number one competitor sells its
products and services for lower prices than his company,
is able to provide 24-hour customer service, and lately
has been offering a slew of innovative new products. The
CEO has read his competitor’s annual report, and noted
that they were profitable again this year. The
competitor’s revenues are the same as the CEO’s company,
but its costs are lower. Meanwhile, the CEO’s company is
unable to raise prices, can’t afford to offer 24-hour
customer service, and the competitor is starting to take
market share at every turn. And, by the way, the CEO’s
company lost money again this year. The CEO continues to
ponder . . . “Both companies have similar transaction
volumes. How does my competitor do it? Why are they able
to offer lower prices, better service, and do it
Wall Street is demanding that the CEO’s company become
profitable . . . Now!
What is the
CEO going to do? How is the CEO’s company going to
reduce costs so it can be profitable, and begin to
invest more capital in research and development, sales,
step this CEO takes is to hire away one of his
competitor’s senior managers to learn all of his
competitor’s secrets. Once the new manager is on board,
the CEO questions the manager to find out how his
competitor is doing so well. The answer is baffling . .
. he learns that its executives aren’t more educated
than his team, it doesn’t spend any more money on
marketing activities, and its existing products are not
any better. Each company has about the same number of
sales people, they get mentioned the same number of
times in trade articles, and they look similar in many
respects. Only one thing seems to be different . . . all
of the competitor’s non-core activities are outsourced,
and sixty percent of its remaining staff is located
offshore, in either India or China!
The CEO vows
to learn more about outsourcing and offshoring.
English language (and most likely in other languages),
“outsourcing” is a relatively new term. A 1967 edition
of Merriam-Webster’s Seventh New Collegiate Dictionary
does not carry a listing for “outsourcing,” but a recent
check of Merriam-Webster’s Online Abridged Dictionary (http://webster.com/home.htm)
found the following entry:
Pronunciation: -"sOr-si[ng], -"sor-
Function: noun Date: 1982 ”The practice of
subcontracting manufacturing work to outside and
especially foreign or nonunion companies”
term is relatively new, the concept of outsourcing has
been around for a long time.
the term outsourcing has evolved to include all parts of
the enterprise, not just manufacturing. In many ways,
outsourcing is a synonym for sub-contracting. Literally
any activity that is performed by a company can be, and
probably has been, outsourced.
Outsourcing is not the same as Offshoring
a company contracts work from another company, it is
called outsourcing. Outsourced work performed locally
(i.e. in the same country) is called “onshore
outsourcing”. Outsourced work performed in other
countries that are in roughly the same time zone is
called “nearshore outsourcing”. For the United States,
nearshore would include Mexico, Canada, and many
Caribbean Islands. Outsourced work that is performed in
countries that are many time zones away or a long
distance away is called offshore outsourcing. Examples
of offshore locations for the U.S. include China, India,
Singapore and South Africa.
or not, outsourcing began to emerge a few thousand years
ago; it started with the production and selling of food,
tools and other household supplies. If you go back far
enough in the history of humanity, each person or family
provided everything for themselves. They gathered their
own berries and nuts, hunted their own food, grew their
own crops, skinned hides for clothing and so on. Then
villages began to spring up, and people began to
specialize. As such, they began to barter with each
other for goods and services, and soon money was
invented to help simplify the bartering process. In
effect, each worker was outsourcing some activities to
a few thousand years to the industrial age. Very few
companies, if any, in the 1800s and early 1900s
outsourced any part of their processes; they were
vertically integrated organizations. They may have
produced or mined raw materials (steel, crops, rubber)
and converted that raw material into finished products,
and then shipped the finished goods on company owned
trucks to company owned retail stores for sale to the
public. They were self-insured, did their own taxes,
employed their own lawyers, and designed and constructed
buildings without assistance from other firms. In short,
they outsourced very little.
specialization, especially of services, led to
contracting, which eventually led to outsourcing. The
first wave of outsourcing began during the boom of the
industrial revolution, and fueled the large-scale growth
of services such as insurance services, tax services,
accounting services, legal services, architecture and
engineering services, and others. The companies who
performed this work were typically located in the same
country, most likely the same city, as was the customer.
In essence, this was onshore outsourcing.
manufacturing outsourcing for low-tech items such as
toys, trinkets, shoes, and apparel goods and later,
higher value manufactured items like high-tech
components and consumer electronics. Manufacturing was
the first activity to begin to move to offshore
locations in search of lower costs. As transportation
and logistics improved through improved infrastructure
and the use of computer technology, the cost of
transportation went down, and offshore manufacturing
went up. As education and skills improved in lower wage
countries, manufacturers moved up the value-curve.
recently, outsourcing has moved into the world of
information technology, pension and 401k benefits, data
transcription, and call center operations. This realm is
made more and more possible by continued investment in
education, improved information technology, the wide
adoption of the Internet, and the broad, but still
emerging, availability of low cost telecommunications
and data communications in third world countries.
Does It Work?
How does a
company engage and pay for the services of an
outsourcing provider? Simply, the company contracts with
an outsourcing provider to do a defined scope of work,
and the outsourcing provider charges the company a fee.
The fee can take many forms: by the transaction, by
labor hour, cost per unit, cost per project, an annual
cost, cost by service levels, or other possible
for the fee, the customer is provided a product or
service at a guaranteed quality or service level. Many
contracts stipulate specific, measurable metrics called
Service Level Agreements (SLAs). These SLAs might define
the acceptable quantity of defects per lines of software
code, quantity of rings to answer a telephone call,
quantity of calls to correctly answer a query, average
response time, quantity of transactions completed per
unit of time, and so on. Many times the SLAs also have
penalties associated with not meeting the specified
metrics, and sometimes have rewards for exceeding the
say, there are a multitude of ways to perform
outsourcing services, and a multitude of ways to
construct outsourcing agreements.
There are a
number of reasons that drive companies to outsource some
or many of the work activities. The list of reasons
costs (or lower total costs). Sometimes achieved
through lower wages costs, but also through economies
of scale by providing the same service to multiple
service. Often, better educated or skilled people
perform the task, and thus perform it better.
expert skills. An outsource firm is allegedly an
expert in that particular activity, and thus should be
able to do it better than the customer.
processes. Given that outsourcers are very experienced
at a particular set of processes, they can help the
customer to improve their processes.
focus on core activities. Outsourcing frees management
from having to worry about the inner-workings of a
non-core activity. The customer focuses on their core
competence, the outsourcer focuses on theirs.
often can gain economies of scale. For example, it
doesn’t make sense for 500 companies to have expertise
in the new tax laws for 401(k). The outsourcing company
can have 3-4 people focused on it, and leverage the
knowledge over those 500 companies. This is an important
point because costs aren’t just getting re-categorized
or shuffled around, there is overall new efficiency in
the supply chain.
mistake about it. Except for two or three very specific
examples, the number one reason that companies outsource
is to reduce their costs for the same or better service
Not Do It?
is not right for every company.
company may be too small to effectively outsource
(although a concept called “shared services” could be
right for such a company).
company’s culture may not appropriate for outsourcing.
- There may
be customer reasons that limit or prevent the
company’s ability to outsource.
government agencies do not allow their contractors to
outsource anything to an offshore location.
Outsourcing takes a type of management leadership that
may be different than that which exists within the
concludes Part One of a three-part note.
Two will define common types of outsourcing categories.
Three will recap outsourcing approaches and categories,
and offer recommendations for firms looking to outsource
and recommendations for outsourcing providers.
About the Author
Maynard has over twenty years of technology,
industry, management consulting and application software
experience. He is an experienced executive with
leadership experience in the software industry, Big 4
Consulting and Fortune 1000 industrial companies where
he gained extensive experience in outsourcing, I.T.
Services, and enterprise software solutions. In addition
to the previous responsibilities and directing client
outsourcing sites, he has managed offshore outsourcing
provider selection, implementation and program
serves as the Outsourcing Specialist for Technology
Evaluation Centers, and is President of Agilocity
Consulting, a firm dedicated to helping companies
improve their agility and velocity through technology,
outsourcing and offshoring. A.B. can be reached at