Outsourcing refers to obtaining certain services or products from a third party company, essentially sourcing something like accounting services or manufacturing of a certain input to another company. While many think outsourcing refers to using a service provider in another (usually cheaper) country that is not necessarily the case. Outsourcing can be done to a company that is located anywhere, the location isn’t important.
The key reasons a business would choose to outsource are:
- Cost: Often some services or products can be obtained for a far lower price while obtaining the same level of quality. Even when the quality is not quite as good as could be done internally the cost savings are so significant that the trade-off is deemed acceptable by management. Services outsources often include internal business departments like finance or IT, where significant cost savings can be obtained.
- Specialization: Some business processes or products are very specialized and outsourcing to another provider provides access to higher quality. In manufacturing for example, every computer maker doesn’t need to specialize in making micro-chips, they can outsource it and get a higher quality product than they could likely build themselves. Any business that has suppliers for inputs to their manufacturing process are essentially choosing to outsource part of their manufacturing process.
- Flexibility: For many companies outsourcing provides the benefit of only having to pay for precisely what you need. If you staff a full finance department you have to pay the salaries even during down times, whereas if you outsource your finance services you only pay for the hours worked. Similarly if a business needs only a small number of a specific input for their manufacturing process it wouldn’t make sense to build the capacity to manufacture that component themselves. Outsourcing provides the flexibility to only pay for what you need.
Offshoring refers to obtaining services or products from another country, and is often what news articles are really referring to when they discuss outsourcing. While much offshoring involves outsourcing production to another company it can also refer to simply re-location certain aspects of a business to another country. The services and products are all still provided in the same country, but they are now in another country. For example, when a car manufacturer in the U.S. opens a factory in Thailand to make certain parts they are offshoring, as everything is still happening within the same company.
The key reasons a business would choose to offshore are:
- Cost: Often the biggest driver to offshoring is being able to produce goods or have services provided in a far cheaper country. Whether this is having car parts manufactured in Thailand or IT services provided from India the cost savings to a company based in the U.S. can be significant.
- Tax & Tariffs: Many decisions around offshoring are driven by a desire to take advantage of certain tax or tariff relief in some countries. There are many loopholes in tax and tariff regimes in many countries that can allow companies to generate great savings and import products for use relatively cheaply.
- Control: A key reason a company would choose to offshore (as opposed to outsource) is that they don’t want to relinquish control of part of their production (or internal business services) to a third party. Some production inputs are very sensitive or time dependent and if a supplier didn’t deliver precisely as expected it could be disastrous to the company doing the outsourcing. In these situations a company may choose to offshore and ultimately retain full control and responsibility.
Offshoring vs. Outsourcing
When deciding between offshoring or outsourcing there are many factors that need to be considered, and the ‘right’ decision will vary from company to company. Ultimately there can be significant cost savings or specialization benefits from both offshoring and outsourcing, which is what drives many companies to choose these routes. Often it’s worth consulting with experts in everything from process management to tax to ensure the best decision possible is made. Often what seems like a great outsourcing or offshoring arrangement can have many hidden costs, reducing the benefit. Many companies who have mismanaged outsourcing or offshoring have later reversed the decision, making for a very costly error over time.