As the world has become more connective, businesses have also become more competitive. Companies have been forced to use various cost-cutting strategies to increase profits and keep shareholders happy. One of the most effective strategies is known as outsourcing. In this article, we will break down what outsourcing is and why so many businesses do it!
What is Outsourcing?
Outsourcing is the act of a business hiring another business or freelancers to perform a function that they traditionally would perform themselves. For example, instead of a business hiring employees to handle customer support, they would hire an external company whose employees would perform support-related tasks. When outsourcing functions, a company does not have to deal with hiring, training, and managing employees and instead can focus on other key business areas. Now you know what outsourcing is, let’s look at the reasons why companies do it.
1. Save Costs
Outsourcing’s popularity has coincided closely with the rise of the internet. Thanks to improved communication technology, companies based in developed countries can now hire employees in developing countries and instantly save on salaries. For example, an American company could hire a full-time software developer for $100,000 per year or an equally experienced developer from countries like Ukraine or India for $30,000 per year or less. Salaries are one of the biggest expenses companies face, and by performing arbitrage on labor markets via outsourcing, they can instantly increase their profitability. Cutting costs is the easiest way for companies to improve their profitability, and outsourcing is an incredibly effective way to do this.
Outsourcing doesn’t just help companies save on salary costs but also reduces hiring, training, and firing costs. Companies spend millions of dollars on recruiting employees, training them, and if something goes wrong, firing them. In many countries, companies are forced to pay severance when letting an employee go, which can really hurt a company’s profitability. When outsourcing, companies don’t have to worry about sick leave, holiday pay, overtime, and other extra payments, which can cause salaries to skyrocket. Another way that outsourcing helps companies save money is by reducing their payroll tax. Companies have to pay a percentage of their employees’ wages in taxes, but that is not the case for outsourced workers.
2. Access Global Talent Markets
One of the major benefits of outsourcing is it helps companies utilize the very best talent. For example, if a company lacks qualified employees for specific roles, they can simply connect with a 3rd party firm specializing in that function. We are now seeing certain countries specializing in certain business functions and building a competitive edge. For example, the Philippines has established itself as a major customer support and business admin specialist. Companies that need high-quality and professional English-speaking customer support but still want to save costs can now connect with one of the many firms in the Philippines and instantly gain world-class support capabilities. They no longer have to worry about training local staff or dealing with unprofessional companies in developing countries. Thanks to globalization, companies don’t have to settle for local employees. If they aren’t satisfied by the talent in their region or country, they can search the globe and find the very best talent for their firm.
3. Focus on Key Competencies
In the ultra-competitive marketplace, companies can’t afford to be generalists. They need to find small niches and establish a competitive edge. To build this edge, many companies are pouring all of their resources into their business’ key functions and outsourcing all other business areas. For example, a company that manufactures pools wants to outcompete its rivals by spending all resources and time on designing and building the best pools in the world. To free up time and resources, they outsource all functions that aren’t directly related to manufacturing pools, such as marketing, customer support, accounting, and more.
Companies that have chosen to specialize view outsourcing as a way to focus on business functions that they excel at. Their thought process is, “Why would we spend our time doing functions like accounting when we are not an accounting firm?” They believe that performing tasks that are too far away from their key function leads to inefficiencies, and other specialist companies can handle their functions more effectively.
4. Expand to New Markets
Many companies have goals of expanding internationally and tapping into new markets. Unfortunately, if a company offers a physical product, this can be costly and risky. Therefore, to ensure a smooth entry to new markets, companies will outsource production and logistics to a 3rd party based in the country they wish to expand to.
For example, a Swedish company that produces microphones might want to start selling its products in China, but the costs are prohibitive. So instead, they could find for external help a local Chinese company to produce the microphone in China and handle the shipping. By outsourcing, the Swedish company can sell their product at a price where there is significant demand and does not have to worry about purchasing a factory in China or trying to navigate the logistics of delivering their products throughout China.
Without outsourcing, many companies would not be able to offer their products internationally as the costs would be too high. Outsourcing also helps companies reduce risks when entering new markets as they can reduce bureaucratic red tape by contracting a local operator who is already licensed and knows how to operate within the local laws.
5. Improve Failing Aspects
Thanks to collecting and analyzing data, companies are constantly studying their different functions and performance. As a result, many companies can quickly realize areas of their business where they are performing poorly. These failing aspects can seriously negatively impact the company’s financial performance and reputation. For example, a company may receive thousands of complaints about slow customer support, rude employees, and failure to solve problems. Companies can analyze the data and calculate how many customers and how much revenue they are losing through offering poor customer support.
To respond to this challenge, companies will often shut down their internal customer support team and hire a specialist 3rd party. By hiring a 3rd party focused on providing incredible customer support, a company can quickly fix a weakness without spending a huge amount of money and time on firing, hiring, and training new customer support staff. The speed at which a company can solve a lagging business function and the effectiveness of the solution is why outsourcing is such a common strategy.
Outsourcing has proved a very effective model for businesses looking to cut costs, improve efficiency and focus on their key business function. Many companies would not be profitable if they didn’t outsource certain departments. However, outsourcing is not a perfect solution and can lead to various issues, including loss of control, communication issues, and a decline in quality. Outsourcing alternatives such as extended teams are being used to produce superior outcomes than traditional outsourcing.