Search
LearnBlogCareersHelpLog InSign Up

What is Outsourcing?

definition

Outsourcing is when a company hires other companies or individuals to perform services and labor outside of its organization instead of hiring employees.

🤔 Understanding outsourcing

Outsourcing is when a company contracts outside of its organization for services and labor instead of hiring employees, building factories, or managing its supply chain. Companies can outsource their business processes, either domestically (onshore) or overseas (offshore). Companies that outsource offshore can cut labor costs in countries with a lower cost of living and take advantage of tax benefits. Offshore outsourcing can also give companies access to supply chain management and resources unavailable in the US. Companies can also outsource back-office business functions like human resources (HR) and information technology (IT), or front-office functions like customer support.

example

Let’s say a fictional restaurant app called Foodco wants to provide delivery of restaurant food in cities. It doesn’t want to pay the cost of hiring customer support representatives as employees in cities, so it outsources its customer service domestically to a company that hires cheaper customer service employees in rural areas (where the cost of living is cheaper.) Furthermore, Foodco has tech support needs for running the back end of its app — so, it outsources that work overseas to a company in Ukraine.

Takeaway

Outsourcing is like ordering takeout…

Someone else cooks for you, so you can do more work before dinner — or just enjoy a better meal than you can prepare yourself. Companies likewise outsource work because they benefit in some way. It could save them money in wages, free up resources for more core functions such as research and development, or expose them to highly skilled specialists — like an excellent chef.

illo-outsourcing-desktop mobile

Tell me more...

How does outsourcing work?
Why do companies outsource?
What are the types of outsourcing?
What are the pros and cons of outsourcing?
What are some criticisms of outsourcing?

How does outsourcing work?

Outsourcing is when a company hires a third party (another company, service provider, or specialist) outside of the company to handle some of its business operations.

Most people are aware that many big tech companies outsource the production and assembly of their products to other countries such as China and India because it gives them access to a larger workforce that will work for lower wages.

But companies can outsource all kinds of business functions, both domestically and offshore to other countries. Outsourcing can mean sending the manufacturing of a product overseas. Or it can mean hiring a delivery service to transport products and materials (supply chain management).

Companies can also outsource entire departments like information technology (IT), software development, and customer service. Or they can outsource work to specialists such as attorneys, accountants, or marketing experts.

Outsourcing has created opportunities for companies to create products for less money, hire entire departments without having to build their own, and gain access to specialists without having to employ them.

Why do companies outsource?

The main reason a company outsources jobs is cost-cutting. Companies might outsource manufacturing jobs to countries with lower wages and tax advantages. Companies can produce more products or services for less money by creating economies of scale.

It may be expensive to hire a factory overseas at first. But if you can produce more computers for less over time, it results in each computer costing less to make (a lower per-unit cost). This practice gives companies a competitive advantage in the marketplace —They can offer their computers at lower prices to consumers.

Smaller businesses that can’t afford to hire specialists full-time also can get access to expertise by outsourcing. A small business might outsource bookkeeping, for example, because it’s more cost-effective to hire an accounting firm than to employ full-time in-house accountants. This practice is also common for legal needs.

Outsourcing day-to-day operations such as product delivery, customer support call centers, and manufacturing can allow companies to focus more resources on their core competencies (their core business purpose), such as creating video games or designing shoes, for example.

Outsourcing business processes to a service provider or outsourcing company can give companies more flexibility. They are able to use resources on-demand (when they need them) instead of carrying the full-time cost of employees, delivery fleets, or manufacturing facilities.

A start-up with a design idea might outsource the production of their idea to test it in the market before investing in more development. This gives the company more flexibility because it only needs to pay for the production of the product when it needs production instead of maintaining an entire factory by itself.

What are the types of outsourcing?

Companies today outsource all kinds of business processes. This has given rise to Business Process Outsourcing (BPO) companies. BPO companies provide outsourcing services by connecting companies with outsourcing providers. Business process outsourcing can mean outsourcing back-office operations, including IT services, human resources, and accounting. Or it can mean front-office outsourcing operations. Front-office operations are more customer-facing, like technical support, sales, marketing, and customer support.

When a company outsources domestically, it’s often called onshoring. Companies outsource business procedures onshore to other companies because it's easier and more cost-effective than creating entire departments in-house.

Outsourcing jobs to a foreign country is called offshoring. The United States has a high cost of living, which typically translates to higher wages. Businesses often take advantage of the cost savings of using developing markets with lower labor costs, such as India or China, as a labor force.

Offshore outsourcing to a country close to the United States, such as Mexico or Canada, is called nearshoring. Many auto manufacturing jobs were nearshored to Mexico because of lower labor costs. Outsourcing to a country far away like India, China, or Malaysia is called farshoring. Many call centers and customer service departments were farshored to India and the Philippines because workers in those countries speak English and work for lower wages. More recently, “reshoring” has become a trend. Labor costs in countries like China and India have been increasing. Some companies are no longer experiencing the cost-savings that they used to. So, they are bringing their offshore outsourcing back to the United States.

What are the pros and cons of outsourcing?

PROS

Allows companies to focus on core services: Outsourcing can free up time and resources so a business can focus on its core purpose and future strategy.

Increased efficiency: Outsourcing service providers that specialize in a process or service may offer better quality products and services, which results in getting the job done right the first time. Cost-savings: Outsourcing business processes for less than it would cost in-house can free up money for investment in other areas of a business. Access to expertise: Outsourcing can give a firm access to specialists or facilities they may not have in-house or may not be able to afford to develop in-house.

Competitive advantage: Cutting costs of production and/or services can allow a company to charge less for its goods or services giving it an advantage over other companies in the same industry. If a company can sell products or services for less, it will generally sell more products and services than other companies.

Flexibility: Outsourcing allows companies more flexibility to respond to changes in demand in the marketplace. For example, if a company outsources product delivery, it won’t waste money owning a big delivery fleet that isn’t needed during slow times when it gets fewer orders for products.

CONS

Unemployment: Some economists blame outsourcing for domestic unemployment because it sends many jobs overseas. But others argue that many jobs just don’t exist anymore because of advancements in technology (robots building cars, for example).

Exploitation: Critics argue it's not fair to pay someone $2 per hour for a job that would fetch $15 or more in the US. Some overseas factories have been accused of poor working conditions with long hours and an unsafe environment.

Information leakage: Outsourcing providers who work for many companies in the same industry can steal information. They can sell intellectual property or trade secrets to competing companies, or use the information to create their own products.

Lack of quality control: Outsourcing to too many players can make it hard for companies to track the quality of the products that are manufactured. Savings decreasing: Wages in other countries are increasing as their economies improve. This trend makes outsourcing less profitable than it once was.

What are some criticisms of outsourcing?

In addition to the cons listed above, many people feel outsourcing doesn’t benefit the people who are given the work.

Job losses and harsh economic conditions of the Great Recession of 2008 led to a rise in independent contractors. The growth of the digital economy has also contributed to an increase in “gig workers” who can leverage technology to work for themselves. Today over 30% of the US workforce are independent workers in all kinds of industries.

Companies that outsource specific skill sets or temporary projects on-demand to gig workers don't have to pay employee benefits like healthcare. The more companies outsource their business processes, the more opportunities outsourcing brings to gig workers.

While this gives people more freedom to create an income, it also strips away the benefits of healthcare and retirement programs built into traditional employment. Recently app-based outsourcing companies — such as in the ridesharing industry — have come under scrutiny by lawmakers who question whether workers are truly contractors or should be classified as employees and get employee benefits.

20200220-1095425-3297810

Related Articles

What is CAGR?

Updated March 13, 2020

What is Profit?

Updated January 10, 2020

What is market capitalization?

Updated January 10, 2020

What is Capitalization Rate?

Updated January 13, 2020

What is an Income Statement?

Updated March 17, 2020

What is a Balance Sheet?

Updated March 18, 2020

What is the Stock Market?

Updated January 10, 2020

What is Forex?

Updated January 10, 2020

What is an Exchange Rate?

Updated March 3, 2020

You May Also Like

What is Overhead?

February 25, 2020

Overhead costs are ongoing business expenses that keep the business running beyond the direct costs of a product or service.

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.
Robinhood Financial LLC provides brokerage services. Robinhood Securities, LLC, provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. Robinhood U.K. Ltd (RHUK) provides brokerage services in the United Kingdom. All are subsidiaries of Robinhood Markets, Inc. ('Robinhood').
© 2020 Robinhood Markets, Inc. Robinhood® is a trademark of Robinhood Markets, Inc.