Outsourcing Advantages And Disadvantages

Activities/processes that are not-part of my core business are eligible for outsourcing unless they contribute to give a strategic advantage. For instance, it is unlikely that Carrefour or Wal-Mart would outsource their data mining IT capabilities regarding the confidentiality of this information and the advantage it gives them and to their suppliers. Similarly, Dell is also unlikely to outsource its IT department since its IT capabilities are key to its operations/logistics strategic advantage.

Dell may want to keep the control on it to be sure that any issue is solved very quickly in order to avoid any disruption in its supply chain organization. May be part of Dell’s IT organization could be outsourced but not the whole. However any non core business activity that does not provide a strategic advantage could potentially be outsourced. Once a company has completed the review of its activities/processes along the 3 first criteria, it should analyze the supply market to assess if it can offer an improved service at a lower cost. In the case, the supply market is not mature the company should keep the activity in-house.

Otherwise it could start discussing with potential partners. The current maturity of the logistics market explains why logistics outsourcing is currently booming. For a long time carriers and shippers could only offer some basic shipping services. However, they have recently upgraded their service by offering various IT services (pallet tracking, reduction of transaction costs through interconnections of networks… ) and have reached a level of service that enable industrial companies to evaluate the opportunity to outsource their whole logistics. Every activity/process is eligible for outsourcing as far as its supply market is mature.

For a long time, companies were only considering outsourcing labor-intense production process or IT maintenance or payroll management. Recently, some functions/processes like HR management, accounting/finance, IT, procurement or logistics have started to be outsourced. The maturity of the supply market rather than the nature of the activity/process by itself is a limit to outsourcing. BPO is not only suitable for large companies. SMEs can also take advantage of it to improve their capabilities. Most companies use outsourcing to lower their cost, focus on core-business and improve their capabilities.

SMEs may less benefit from a cost reduction than large companies since they often have less plethoric labor than the latter. However they often have fewer specialists among their personnel and those ones are often oblige to manage several functions within the company rather than focus on one. These companies have also fewer resources to launch regular business process reengineering actions to improve their operations. As result, outsourcing an activity/process to a specialist may represent a valuable opportunity for them to improve their capabilities.

However having fewer resources than large businesses it may be more difficult for them to manage an outsourcing effort and may be less inclined to launch it. One of the motivations of the client being to variabilize a fixed cost, the pricing mode should not be fixed cost but a price per transaction. The provider and its client should define a price for each transaction based on the current cost minus an improvement objective. This offers quick wins to the client and a target to reach and a commitment to the provider.

This price should be planned to regularly decrease based on the continuous improvement objectives on which the provider is committed. Then, since the volume of business may evolve over time, a cell revenue and some volume discounts should be considered. In an outsourcing deal, the provider integrates the fixed costs of its client. As a result he may want to protect against any decrease in the volume of transactions made with the client. As a result, the provider may require its client to commit on a minimum volume of business (chosen at a level that still offers the client some flexibility).

Similarly, if the volume of transaction increases the client may want the provider to share with him the economies of scale. Some discounts based on certain volumes of business made in a given year should be considered. The provider and its client may want to go further a simple transactional relationship and create a partnership in which both partners share risks and rewards. In that case, the provider may accept to lower the price of transactions or have part of its compensation tied to a specific value realized by its client, such as an increase in profits, an increase in the stock price or a decrease in operating costs.

Further than tied compensation or bonuses, a provider could receive stock options or shares of its client to motivate him to reach some service levels and price-reduction targets. Only providers with a large financial base can accept such deals since it requires a superior financial solidity to absorb new assets long-time before receiving associated cash-flows. In all cases (transactional arrangement or partnership), both partners need to measure costs, value created and service level to be able to assess the value of the deal at any time. This is even more crucial when incentives are at stake.

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