BUS101: Introduction to Business

Outsourcing business functions to developing foreign countries has become a popular way for companies to reduce cost.

LEARNING OBJECTIVES

Explain why companies outsource

KEY TAKEAWAYS

Key Points

• Outsourcing is the contracting of business processes to external firms, usually in developing countries where labor costs are cheaper.
• This practice has increased in prevalence due to better technology and improvements in the educational standards of the countries to which jobs are outsourced.
• The opposite of outsourcing is called insourcing, and it is sometimes accomplished via vertical integration. However, a business can provide a contract service to another business without necessarily insourcing that business process.

Key Terms

• offshoring: The location of a business in another country for tax purposes.
• outsourcing: The transfer of a business function to an external service provider.
• insourcing: The obtaining of goods or services using domestic resources or employees as opposed to foreign.

Outsourcing

Overview

Outsourcing is the contracting out of a business process, which an organization may have previously performed internally or has a new need for, to an independent organization from which the process is purchased back as a service. Though the practice of purchasing a business function – instead of providing it internally – is a common feature of any modern economy, the term outsourcing became popular in America near the turn of the 21^st century. An outsourcing deal may also involve transfer of the employees and assets involved to the outsourcing business partner. The definition of outsourcing includes both foreign or domestic contracting, which may include offshoring, described as "a company taking a function out of their business and relocating it to another country".

Outsourcing: Outsourcing is the process of contracting an existing business process to an independent organization. The process is purchased as a service.

The opposite of outsourcing is called insourcing, and it is sometimes accomplished via vertical integration. However, a business can provide a contract service to another business without necessarily insourcing that business process.

Reasons for Outsourcing

Companies outsource to avoid certain types of costs. Among the reasons companies elect to outsource include avoidance of burdensome regulations, high taxes, high energy costs, and unreasonable costs that may be associated with defined benefits in labor union contracts and taxes for government mandated benefits. Perceived or actual gross margin in the short run incentivizes a company to outsource. With reduced short run costs, executive management sees the opportunity for short run profits while the income growth of the consumers base is strained. This motivates companies to outsource for lower labor costs. However, the company may or may not incur unexpected costs to train these overseas workers. Lower regulatory costs are an addition to companies saving money when outsourcing.

Import marketers may make short run profits from cheaper overseas labor and currency mainly in wealth consuming sectors at the long run expense of an economy's wealth producing sectors straining the home county's tax base, income growth, and increasing the debt burden. When companies offshore products and services, those jobs may leave the home country for foreign countries at the expense of the wealth producing sectors. Outsourcing may increase the risk of leakage and reduce confidentiality, as well as introduce additional privacy and security concerns.