Outsourcing is a contractual relationship between one business and another. The outsource, the company trying to outsource some organizational function, can have the outsourcer company provide manufacturing, product design, product distribution, IT services and infrastructure support, and about everything else including strategic planning support. There are many reasons why companies turn toward outsourcing, including reducing costs, access to expertise, and increased production capacity, as illustrated in Benefits of Outsourcing. 1 At the same time, there are many reasons that outsourcing can create problems as illustrated in Risks of Outsourcing. There is, however, one major reason that outsourcing creates problems. Outsourcing causes the organization to lose its absorptive capacity in the area that was outsourced. As noted in an earlier chapter, having absorptive capacity means that a company is able to evaluate new technological development because the company or the owner has insight and expertise into a particular area. Organizations with absorptive capacity have developed knowledge structures and insight in a particular domain. Having absorptive capacity gives an organization the ability to understand, assimilate and exploit new knowledge and information, and then to apply it to solving problems and developing commercially viable products. If an organization outsources an ability or capability, which is a core competency, then the organization may not be able to understand and recognize when an emerging technology is important. In the worst case, the organization may not be able to develop products because it does not have the know-how since it has already lost the ability to learn-by-doing and learn-about.
Benefits of Outsourcing
- Simplifies management and can increase flexibility.
- Management can focus on core competencies.
- Can reengineer and downsize organization.
- Helps develop strategic alliances.
- Can improve the quality of service to customers and within organization.
- Reduces short-term costs and transactions costs.
- Possible large influx of cash resulting from transfer of assets to the new provider especially in outsourcing IT.
- Access to technical expertise and the ability to free in-house resources. Outsourcer has access to technology and to specialized expertise.
- Eliminates a process area that was a headache.
- Outsourcer has above-average management skills.
- Outsourcer has better cost control because they have benchmarked best of breed processes.
- Outsourcer has capacity on demand and bulk purchasing power.
Risks of Outsourcing
- Loss of control.
- Costs may be greater than anticipated.
- Transition costs including process reengineering and severance pay.
- Managing the outsourcing agreement.
- Vendor may not implement emerging technologies.
- Poor customer service.
- May lose good staff.
- May hurt current employee’s morale and performance.
- Vendor may not survive.
- They know all of your secrets and you might not be able to get away from them.
- Very high lock-in and switching costs.
- Limits your options and the ability to develop additional core competencies.
- Loss of absorptive capacity. They may not be able to recognize a new opportunity or take advantage of a new opportunity.
- Because company has lost the ability to do something, they may not be able to do it for a long time.