What Are the Risks and Rewards of Outsourcing?

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One of the primary reasons why firms do not hesitate to outsource is that they are of the opinion that the results will be far more effective than they would be in the case of the decision to simply do it themselves. They are also aware of the fact that the longer it takes them to design and execute their own strategies and tactics, the greater the risk that they will find that they have taken this course of action unnecessarily. They recognize the need to remain highly nimble and flexible in their operational efforts and so they do not want to get stuck within a rigid time frame. The additional advantage of employing the services of an outside firm is that, as it operates according to a client’s requirement, the firm can ensure that its outputs are of the highest possible standard.

Another reason why firms do not hesitate to outsource is that they are aware of the reality that it takes far less time and resources to hire an external organization than it does to maintain and develop internal talent. This is especially the case with tasks that involve fewer task-specific investments, such as those that deal with marketing, sales, customer service, information technology, finance, accounting, administration, or human resources. External labor tends to work at lower wages, is subject to lesser regulations, and has access to a wider range of skilled and trained individuals. Firms therefore find that it saves them the time and expense of training their own employees as well as the expenses that come with them.

On the negative side, firms that fail to invest in quality may also suffer from the inability to meet the required benchmarking and are likely to suffer in quality, efficiency, and reliability. For example, if the firm’s primary key performance indicators do not reflect its core competency level, then it may suffer from the decision to outsource. The firm may end up suffering from the decision to outsource if it is unable to improve its performance even after spending millions of dollars on quality improvements. Furthermore, outsourcing lowers the firm’s ability to retain quality and staff, as well as its capacity to gain access to proprietary information.

Firms must also consider which of the following is not a good way to increase the firm’s productivity? A. The decision to outsource is based on the misimpression that the firm can improve the firm’s productivity by hiring external labor to perform specific tasks that are difficult or time-consuming for the firm to perform alone. This misimpression leads firms to evaluate the firm’s actual output, not its potential output.

This means that the decision to outsource actually increases the firm’s total cost of ownership for two reasons: it lowers the firm’s productivity by decreasing the number of task-specific investments made, and it exposes the firm to a greater risk of the firm engaging in a succession of costly behavioral events. First, the decision to outsource lowers the total number of direct investments made by the firm. Specifically, this means that firms cannot make as many new strategic decisions as they might otherwise, because they do not have as many of their own processes, people, and resources at their disposal. If the decision to outsource entails the hiring of additional people or an expansion of the firm’s current internal staff, the firm will have to invest additional capital in those tasks (assuming that it does not employ those resources in order to create new tasks in order to keep existing work flowing). Moreover, if the firm engages in a series of complex and time-consuming activities, it will also incur further direct costs: it will need to hire more people and produce more work-related materials, and it will need to expand its internal capacity to more adequately handle such activities.

Second, the decision to outsource opens the firm up to a higher risk of experiencing a decline in its effective capacity. As mentioned previously, this comes from the decreased number of direct tasks that a firm can perform. Moreover, it is difficult for a firm to design itself in advance in terms of a higher capacity for doing tasks: if it does not yet have a reliable internal design capacity, it must rely on outside sources for this capacity, and the design capacity of its external suppliers may not necessarily be as effective as the internal design capacity of the firm. To remedy this problem, the firm must either expand its internal design capacity (which will increase its ability to design effectively) or it must find ways to make its external suppliers more effective in terms of designing its capacity for capacity planning.

Third, the decision to outsource has an effect on the firm’s profitability. On one hand, it means that the firm will probably perform less than it did before because it does not have as many functions to perform. Moreover, the loss of a handful of functions usually means a decrease in the firm’s revenues. Thus, the decision to outsource makes the firm loses money if its income is insufficient to cover the expenses it incurs for its new set of activities. If the business were to experience a revenue decline of five percent per year, it would become “close to impossible” for the business to stay in business. This means that the firm will have to reduce some of its operations or perhaps close down entirely.

Finally, the decision to outsource can have a profound effect on the firm’s knowledge, as it could lead it to perform fewer functions, thereby reducing the scope of its internal design capacity and hence decreasing its ability to design effectively for the market in which it operates. Outsourcing is often associated with lower levels of total technical know-how, especially for less specialized tasks. In addition, it reduces the firm’s ability to develop higher marketing costs because it is dependent on outside expertise. The firm may be forced to reduce marketing expenses to more affordable levels. These two implications combined mean that Outsourcing opens the firm up to certain risks, but it also has several significant benefits.

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