Corporate Outsourcing: Causes, Advantages, and Workforce Impact

Introduction to Corporate Outsourcing

Initially a product of the 1990s, outsourcing has since become a significant part of doing business for corporate America. With businesses throughout the country looking to augment their competitive standing in an increasingly global marketplace, they have found that they can reduce costs and maintain quality through greater dependence on foreign service providers for functions seen as secondary to their core operations. Outsourcing relationships have evolved from unsophisticated agreements based on cost reduction to multidimensional partnerships that sustain the core activities of client companies. The new pattern is toward outsourcing relationships that function increasingly as true partnerships. Outsourcing service providers are assuming expanded roles in domains that were conventionally performed by employees within the organization, such as corporate strategy, information management, business investment, and internal quality initiatives. [1]

Outsourcing has received heightened attention due to the accelerated relocation of jobs to foreign countries and the sudden vulnerability of high-skilled, modern service-sector jobs that were once believed immune to displacement. Services that were formerly non-tradable have become entirely tradable as a result of advances in communications and computer technology. [2] The United States has a workforce of approximately 140 million. The web-based magazine CIO.com, aimed at Chief Information Officers of technologically advanced companies, reports that businesses are turning to outsourcing to exploit a labor cost difference of as much as 70%. The five largest U.S. companies employing workers in India are General Electric, Hewlett-Packard, IBM, American Express, and Dell. Computer-related jobs are considered particularly at risk of being outsourced and offshored, according to Todd Tollefson of TechsUnite.org, an internet users' group for technology workers affiliated with the Communication Workers of America.

The history of outsourcing began with basic "back office" functions — support services and call center jobs. Today, high-level administrators, software developers, and engineers are also being outsourced. Outsourcing is no longer confined to the technology sector; it has expanded into healthcare, encompassing medical transcription, records management, and radiologic imaging. Even patent lawyers have been placed on notice. [3] IT services companies are racing to offer customers low-cost, flexible services staffed by technology professionals in lower-wage countries such as India, China, and Mexico. [4] According to the research firm Gartner, 10% of jobs in the U.S. computer services and software industry could be transferred to cheaper locations by the end of 2005, translating to roughly 500,000 positions among the highest-paying roles. [5]

Orange, for example, planned to outsource approximately 1,500 call-center jobs to India, conducting initial tests with two subcontractors based there — Convergys and Vertex — with a 215-seat call center in Delhi handling customer service calls during peak hours. [6] U.S.-headquartered Hewlett-Packard similarly announced plans for significant outsourcing. [7]

Many companies are progressively expanding the range of HR activities they outsource, and some are consolidating them with a single provider through end-to-end outsourcing contracts. In the United States, HR has become the top-ranked outsourced business process among companies that outsource at least one function, according to Gartner. [8] A July 2004 survey conducted by SHRM — the Society for Human Resource Management — titled "Human Resource Outsourcing" found that the practice of transferring one or more HR functions to an outside service provider is not new; it is carried out by roughly one-sixth of all organizations. For several years, companies have engaged outside providers to handle certain HR functions, but the trend is accelerating and vendors are taking on a broader range of services. [9] At the same time, 31 companies — including pioneers BP America and British Telecom — have entered into contracts totaling $11.2 billion covering most of more than 20 HR processes. [10]

Forrester Research has estimated that the number of outsourced jobs will rise to approximately 600,000 by 2005 and surge to 3.3 million by 2015, including positions requiring management and life sciences expertise. [11] Gartner reports that more than 300 of the Fortune 500 companies already have business relationships with IT service firms, and forecasts that by 2004, more than 80% of U.S. businesses will be formulating plans to use offshore IT services — with over 40% having already completed some form of offshore IT pilot program or using IT services with a foreign component. Forrester Research's November report confirmed that IT work is indeed moving offshore, projecting that the number of computer-based jobs shifting to foreign countries will rise from 27,171 in 2000 to a cumulative total of 472,632 by 2015. Forrester researchers further anticipate that allied services — including call centers and back-office accounting — will follow the same trajectory. By 2015, a net 3.3 million U.S. jobs and $136 billion in wages will have shifted offshore to countries such as India, Russia, China, and the Philippines, according to Forrester. [12]

However, some argue that offshore outsourcing poses economic dangers as well. New Jersey has already banned offshore outsourcing of state government work, and labor organizations have begun to question the impact of offshore outsourcing on the American workforce. At the same time, corporations are under enormous pressure to capture the savings available from having software development or applications management performed in Bangalore or Beijing. The prevailing economic environment means that many companies are struggling simply to maintain — let alone improve — sales and profitability. [13] Nevertheless, irrespective of these concerns, corporate America continues to outsource on a large scale while also realizing tangible benefits from the practice.

Reasons Companies Outsource

The primary rationale for outsourcing remains cost savings, strategic focus, and access to specialized expertise. Resource-related motivations — such as relieving resource constraints, reducing IT staff, and gaining additional IT capacity — together account for 51% of responses in industry surveys. European businesses cite providers' specialized expertise as the leading driver of outsourcing, while U.S. businesses favor outsourcing primarily as a vehicle for saving time and money. [14] Geographic location is becoming increasingly irrelevant in the delivery of these types of services. Moreover, the ready availability of large pools of technically skilled and computer-literate workers overseas has eroded what was once considered the exclusive competitive advantage of the United States and other advanced economies. [15]

Outsourcing helps companies become more flexible, more dynamic, and better able to adapt to changing market opportunities. [16] Increased flexibility can attract customers to an offshore model or a hybrid of offshore and onshore services. By maintaining capabilities in both the United States and Asia, an IT services company can offer clients 24/7 support — what EDS refers to as "follow the sun" capability. [17] Companies operating in India and elsewhere are developing a significant competitive edge in outsourcing by delivering high-quality services at lower costs. In the current internet era, where a company's geographic location matters little and information can be transmitted rapidly at minimal cost, enterprises will continue to enhance efficiency and seek to control expenditures by focusing on their core competencies and outsourcing the rest. In a recent Outsourcing Institute survey, companies reported an average 9% reduction in costs through outsourcing. [18]

Cost advantages are therefore supported by lower compensation levels. Hewlett-Packard has estimated the salary of a skilled programmer in India at approximately $20,000 annually — a small fraction of the cost of a senior U.S. technology worker. Other factors favoring the offshore shift, according to Forrester, include the availability of low-cost, high-bandwidth telecommunications, standardized business applications, and web-based collaborative tools. [19] Because outsourcing can dramatically reduce labor expenses, it enables companies to offer a range of products — from software to tax calculation services — at lower prices or higher profit margins. Higher profitability in turn allows enterprises to purchase new equipment, build laboratories, and conduct scientific research, even in high-cost locations such as Silicon Valley. According to researchers, cost savings from outsourcing enabled companies to create 90,000 new jobs in 2003, with more than 10% of them in Silicon Valley or elsewhere in California. Projections indicate that outsourcing will generate 317,000 new job openings in 2008 and 151,340 in California alone. [20]

An additional rationale for outsourcing is cost predictability. Companies are able to convert variable costs into fixed ones, knowing in advance what they will pay per unit of work. Outsourcing is particularly well-suited to companies facing high-volume demand for functions that fall outside their core competencies. [21] As Adam Smith observed as far back as 1776, "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest." [22] Following Smith's reasoning, modern companies participate in the global market and pursue their own advantage by making the most efficient use of their resources, thereby maintaining their competitive position.

Outsourcing is also frequently a by-product of another powerful management tool: business process reengineering. It allows an organization to immediately realize the expected benefits of reengineering by engaging an external firm that has already been reengineered to international quality and process standards. Outsourcing can also involve the transfer of assets from the client to the provider — machinery, services, transportation, and licenses employed in current operations all carry value and may be effectively sold to the provider as part of the deal, resulting in a cash inflow. In cases where an organization lacks the required internal resources — for instance, when expanding capacity in a new region — outsourcing becomes a practical and essential alternative to building capability from the ground up. [23]

For U.S. consumers, competition generated by outsourcing produces more and better economic choices. The desire to satisfy consumer expectations drives all innovation. Competition sustained through outsourcing has positively influenced the welfare of both consumers and producers. Participation in global trade enhances our ability to obtain the products and services we value most at lower cost. If companies did not outsource, or if governments erected barriers to outsourcing in an effort to "protect" American workers, the incentive to produce would diminish due to reduced profit potential and higher prices for consumers. [24]

The majority of U.S. enterprises are satisfied with their decision to outsource human resource services, and more plan to outsource additional services by 2008, according to a survey by the human resources outsourcing firm Hewitt Associates Inc. The survey found that 89% of companies are content with their outsourcing activities and 20% reported unexpected benefits. Access to enhanced services, the ability to focus on core business operations, and cost differentials remained the top-ranked reasons companies prefer to outsource. Among the 129 large companies studied, 94% had outsourced at least one HR function, with outplacement services, employee assistance programs, and 401(k) or defined-contribution plans being the most common. [25] As long as workers in India and other locations remain available and capable of performing equivalent work at lower wages, U.S. enterprises will increasingly view outsourcing as a means of controlling costs and remaining globally competitive. [26]

Advantages of Outsourcing

Outsourcing has helped U.S. firms reduce expenditures on computer hardware, software, and other start-up costs by sourcing these products offshore. Cost reductions have indirectly benefited U.S. companies by enabling them to win business they would not otherwise have secured, and thus to employ workers they would not otherwise have hired. [27] An additional advantage of outsourcing order fulfillment is that companies are not required to manage the employment issues of the contracted workers. The outsourcing vendor has the flexibility to hire and dismiss workers as needed, with the key obligation being the delivery of top-quality services at the agreed-upon fee. The greatest financial advantage of outsourcing is cost savings. Client companies benefit from the capacity of outsourcing providers to manage peak demand periods — historically the most expensive times for client companies to fill orders on their own. Another advantage is the ability to leverage the provider's infrastructure. When performing work internally, a company must own or lease facilities, maintain technology systems, and invest in capital equipment. By engaging firms that specialize exclusively in fulfillment, outsourcing clients are freed from investing in non-core competencies. [28]

Among the most practical benefits of outsourcing an entire IT function is that management is relieved of constant internal pressure to consider outsourcing as a future cost-reduction measure. Furthermore, organizations that adopt outsourcing tend to treat the outsourced operation as a settled matter and redirect their attention toward evaluating whether additional activities might be candidates for outsourcing. [29]

The most experienced users of outsourcing have found that its greatest benefit is the assurance of obtaining measurable results for money spent. Skilled outsourcing contract negotiators seek terms that tie payments to the delivery of specific outcomes, with penalties for failure to achieve agreed results. [30] Outsourcing also provides access to workers for projects beyond the capacity of regular maintenance staff — whether because a project is too large or because it requires specialized skills. It is particularly well-suited to supplementing regular staff during peak or seasonal periods or in response to unexpected operational demand. Outsourcing providers typically supply their own supervisors, relieving the client organization of that responsibility. [31]

The foundational principle of outsourcing is that specialists are brought in to handle support functions, allowing company management to focus on its primary business — whether that is insurance, distribution, or manufacturing. Outsourcing means management can concentrate on what the company exists to do rather than being diverted by time-consuming tactical issues associated with support services it neither fully understands nor prioritizes.

Organizations may also consider outsourcing as a means of accessing technical resources and expertise that would be both costly and time-consuming to develop in-house. For example, an outsourcing provider may possess specialized experience in converting systems from mainframe to PC-based client-server applications. It is generally more cost-effective and faster for an organization with such a project but no internal expertise to outsource it to a qualified supplier. The case for outsourcing is further supported by the observation that career and training opportunities will be greater for staff employed by an organization whose core product is software — rather than insurance or biscuits. Staff may benefit from being able to move into other opportunities that would never have been available to them within an internal department facing constant cost-reduction pressures. [32]

Outsourcing allows organizations to respond more readily to fluctuations in labor requirements or to access workers with particular skills when the market is such that union-scale wages are insufficient to compete with the private sector. For small local governments, outsourcing can also provide access to an inventory of specialized skills that would otherwise be unavailable if a full-time position could not be justified. [33] The need for personnel, even within a single project, varies over the project lifecycle. Many organizations, structured along traditional line-management arrangements, find it difficult to accommodate variable staffing requirements. This challenge is compounded in some countries by employment laws that make it difficult to hire, lay off, and re-hire staff.

Outsourced arrangements permit a far more flexible employment structure for the host organization. The supplier staffs to meet varying requirements and is far better positioned to redeploy employees on other projects when the host organization does not need them. [34] Outsourcing also provides an opportunity to evaluate workers in practice. When an individual proves particularly capable, the client company may choose to hire that person directly. Conversely, the client avoids the risk of hiring an underperforming employee without adequate time for evaluation. If a contract worker proves entirely ineffective, the client can simply request that the contractor replace the individual without direct involvement in the employment decision. Furthermore, because contract workers are not on the client company's payroll, the client is not required to provide retirement benefits or medical coverage. [35]