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Reasons for Business Process Outsourcing

By | December 1st 2009

By Prof Ndede Amadi

Business process outsourcing is an arrangement where one company (the supplier) provides services on behalf of another company (the buyer) that could be or has been far provided in-house. It constitutes subcontracting a service such as product design or manufacturing, accounting or bookkeeping services to a third-party.

The decision to outsource or to do the work in-house is generally based on the desire to achieve lower production costs, make better use of facilities and other resources such as office space, equipment, and furniture; focusing energies on core competencies of the buyer, or just making more efficient use of labour. Why companies outsource:

Cost savings – involves lowering of the overall cost of the outsourced service to the buyer of outsourced services. It can be achieved by reducing the scope of the work, defining quality levels, re-pricing, re-negotiation, or by cost re-structuring. Cost savings can often be achieved by accessing lower cost economies through off-shoring caused by the wage gap between developed and developing countries;

Focus on core business – involves the buyer of the outsourced services sub-contracting to the supplier company non-core business processes to allow focus resources (investment, people, and infrastructure) on developing the core and critical business processes. For example, it is not uncommon for a non-IT organisation to outsource its IT technical support to a specialized IT services company.

Cost restructuring – is achieved through operating leverage, a process that compares fixed costs to variable costs and manipulates the balance between the two. Outsourcing will have the effect of shifting the balance of this ratio from a fixed to a more variable cost balance and by making variable costs more predictable. A variable cost balance is more favourable since it allows the company to be more flexible in its operations;

Improved quality – is achieved by setting and agreeing on pre-specified and pre-defined service quality levels between the two companies through contracting out the service with a new service level agreement;

Knowledge - is achieved by accessing a wider experience and knowledgebase of the expert company (the supplier) and by obtaining intellectual property rights;

Contract – the services are provided through a legally binding contract;

Operational expertise – is achieved by accessing operational best practices from the supplier company that would be too difficult or too time consuming to develop in-house;

Access to talent – is achieved through access to a larger talent pool and a sustainable source of skills, particularly in science and engineering projects;

Capacity management – achieved through an improved method of capacity management of services and technology whereby the risk of providing the excess capacity is borne by the supplier and not the buyer of the services;

Catalyst for change – achieved by using an outsourcing agreement as a catalyst for major step changes that can not be achieved by the buyer company alone. The supplier of outsourced services becomes a change agent in this process;

Enhance capacity for innovation – is achieved when the buyer of outsourced services uses knowledge provided by the supplier of the services to supplement limited in-house capacity for product innovation;

Reduced time to market – is achieved through acceleration of the development or production (of a product) through the additional capability brought by the supplier of outsourced services;

Co-modification – is achieved when a wide range of relatively smaller businesses are able to get access to services previously only available to large corporations. The current trend in standardizing business processes (e.g. IT Service provision and software application development) is enabling businesses to intelligently buy at the right price;

Risk management – is achieved through partnering with a supplier of outsourced services, a buyer company is better able to mitigate some of its own risks;

Venture Capital – is achieved when the outsourcing relationship is between countries that match government funds venture capital with private venture capital for startups.

Tax Benefit – is achieved when the outsourcing relationship involves a country that offers tax incentives to move manufacturing operations to counter high corporate taxes within another country.

Although the main objective of outsourcing is often cost reduction, many companies do not realize any cost benefits from the arrangement. Researchers say about 80 per cent of companies that outsource customer service projects with the primary goal of cutting costs, have not achieved that goal. They attribute the scenario to the high staff attrition at the buyer company, along with the hidden costs of client loss due to increased frustration during the transition period.

Therefore, if not carefully managed, outsourcing can fail in cutting costs.

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