What Is Outsourcing? How Outsourcing Works

Outsourcing is a business strategy in which companies hire outside suppliers to provide specific goods or services, instead of producing the goods or services in-house. The term outsourcing comes from the combination of “outside” and “resourcing.”

Business process outsourcing (BPO) applies specifically to companies that contract out various aspects of their operations to a third-party vendor. For many years, the outsourcing market revolved around the manufacturing industry, but today outsourcing has expanded to include many types of goods and services.

Outsourcing and offshoring are two related, but different, concepts. Offshoring specifically refers to the relocation of a business process to a foreign country. If a third party handles operations in the foreign country, that is considered offshore outsourcing. Offshore outsourcing is fairly common in manufacturing or supporting processes, such as accounting, but not all offshoring involves outsourcing, and there are many ways to outsource without moving operations to a foreign country. Nearshore outsourcing refers to outsourcing in a nearby foreign country, such as when United States-based companies move their manufacturing operations to Mexico.

Outsourcing can help avoid the time-consuming process of hiring and training new staff, while allowing the businesses to grow.

• Cost savings: Outsourcing can sometimes lower costs. For example, a company may want to reduce their labor costs by hiring freelancers, who do not receive benefits or require office space and therefore may be cheaper than full-time employees. Companies can also reduce labor costs by outsourcing operations to a location with a lower minimum wage.
• Focus on core competencies: Outsourcing makes it possible for companies to temporarily expand when demand is high, while allowing their teams to focus on the aspects that made the business successful in the first place. This is especially true of startups, which often operate on a smaller scale.
• Staffing flexibility: It can be more cost-effective for some companies to hire short-term outside contractors when demand is high than to hire new employees that they may not be able to afford during times of less demand. For example, e-commerce retailers may outsource customer service during the winter holidays.
• Specialization: While most companies appreciate staff members who are skilled in multiple areas, it sometimes makes more sense to bring in a specialist than to train employees. A contractor may have expertise and experience that existing staff lack, and will be able to execute a specific task quickly, without delaying regular operational tasks.
• Logistical ease: Outsourcing services such as customer support and shipping sometimes makes more sense from a logistical perspective. These intermediaries may be available outside of normal business hours, allowing companies to provide essential services when their local, full-time employees are not available.

Outsourcing isn’t a one-size-fits-all solution. Bringing third parties into business operations can introduce a host of new issues that are ultimately the hiring company’s responsibility.

• Logistical and communication issues: Adding a third-party service provider to business operations can create new communication and logistics issues, especially if the two companies have very different business practices, company cultures, or project management styles. Without direct oversight, it can be harder to catch these problems in the early stages, and they may be more difficult to fix than internal issues. This is especially relevant when working across time zones.
• Security vulnerabilities: Allowing third parties to access company information may create security vulnerabilities. Keeping track of which contractors have access to which systems is necessary but time-consuming.
• Structural instability: There is no guarantee that the outsourcing company providing a service will not go out of business, costing the hiring business time, money, and possibly consumers.
• Hidden costs: While hiring independent contractors can save a company money, outsourcing services may come with hidden costs, such as last-minute changes in the supply chain. Ultimately, it may end up being more costly to pay for outsourced services on a project-by-project basis than to hire someone full-time.

Some specialized business functions are especially well suited to outsourcing. These are some of the most popular outsourcing categories.

1. 1. Engineering process outsourcing (EPO): Engineering process outsourcing involves assigning specific engineering functions and tasks to an outside team. For example, some automotive companies outsource product development to access new markets and improve quality.
2. 2. Information technology outsourcing (ITO): Some companies prefer to use an external provider for IT services, such as software development, application development, telecommunications, or technical support, like call centers and customer support.
3. 3. Knowledge process outsourcing (KPO): Knowledge process outsourcing refers to outsourcing core business processes, such as bookkeeping, data entry, marketing research, intellectual property research, or content creation.
4. 4. Legal process outsourcing (LPO): Not all companies have lawyers on staff, but most companies will require legal services at some point. Some companies choose to outsource legal processes to third-party lawyers, who can take on non-substantive but essential legal work such as document review.
5. 5. Recruitment process outsourcing (RPO): Many companies hire third-party organizations to find new talent. Recruiters work on identifying, attracting, screening, shortlisting, and interviewing suitable candidates.
6. 6. Human resource outsourcing (RHO): Human resource functions such as payroll, background checks, updating policy manuals, benefits administration, and staffing can all be outsourced to human resource professionals.

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