Outsourcing

Outsourcing is the transfer of an activity or business process that could be performed internally to an independent specialist provider. The label became common in the 1990s, but the underlying make-or-buy decision is much older. A sound decision considers capability, quality, resilience and control as well as price.

When to use it

Consider outsourcing when an external provider may lower unit costs, raise service standards, supply scarce expertise, accelerate access to technology or release internal attention for strategically distinctive work. Use expanded throughout the 2000s and 2010s, including in government, but prevalence is not evidence that it suits a particular activity.

Origins

The practice has no single inventor. It developed from manufacturers’ long-standing make-or-buy choices and from contracting for professional services. In the 1980s, information-technology services became an important early market: rapid changes in hardware and software made specialist providers attractive to organisations that struggled to maintain the required investment and expertise. During the 1990s, the outsourcing label broadened to cover complete business processes.

What it is

The central question is: can another organisation perform this activity better, more reliably or at an acceptable total cost without weakening capabilities that matter to the strategy?

Peter Drucker argued that organisations should concentrate on customer-facing or strategically central “front room” work and obtain “back room” activities from providers for whom that work is core. This logic extends the manufacturing decision to make a component internally or buy it from a focused supplier. Applied broadly, it can produce vertical de-integration and “virtual firms” that coordinate, combine and market products or services supplied by others.

The traditional arguments for buying a component also apply to processes:

Lower costs

a specialist may spread fixed investment across customers and gain economies of scale.

Focus on the core business

capital, research and management attention can be concentrated on distinctive capabilities.

Higher quality

a provider whose position depends on the activity may invest more deeply in people, processes and technology.

Faster speed to market

the buyer and provider can develop complementary elements in parallel.

These are hypotheses, not guaranteed outcomes. Transaction costs, contract management, transition work, duplicated controls, supplier margins and exit costs can erase a headline saving. Quality can also decline when work is fragmented or incentives are poorly aligned.

IT services led early business-process contracting in the 1980s. Outsourcing later expanded into technical support, customer service, payroll, training, debt collection, claims management and many other functions.

It is useful to distinguish three provider choices:

Specialist providers

offer expertise, scale or scope in a defined activity.

Low-cost providers

operate from a lower-cost location and may or may not be specialists.

Overseas low-cost providers

combine external provision with relocation across borders—offshoring—often to Eastern Europe, South Asia, South-East Asia, China or South America for US clients.

Outsourcing and offshoring are therefore different decisions: work can be outsourced domestically or retained internally overseas. If quality or expertise is the main objective, a domestic specialist may be preferable to the lowest-cost location.