Strategic Finance and the Outsourcing Decision
For a long period of time, the term outsourcing has been associated with cost reductions. Outsourcing is generally considered to be an operational tool or at best a tactical tool. However, this has changed in the past few years. There are many companies across the world which have outsourced or offshored some of their functions and cost reduction was not the major driver behind these decisions. The concept of outsourcing has evolved from the tactical front and now has some strategic aspects as well. In this article, we will have a closer look at the strategic aspects of outsourcing decisions.
The term outsourcing is generally meant to denote the fact that work has been sent out of the company and will be performed by a third party. This third party may or may not be located in a country that has low-cost labor. However, for the most part, it is located in a country that is cheaper to operate in. For the purpose of this article, outsourcing will also include offshoring. This means that the company does not outsource work to a third party but instead sets up its own shared services center in low-cost countries.
Why Offshoring is a Strategic Decision?
Over the years, many companies have started offshoring their business. This means that instead of outsourcing work to a third party, they set up their own center and outsource work to that center. This can be said to be strategic in nature for the following reasons:
Outsourcing is also Becoming Strategic
With the change in the requirements of the customers, outsourcing companies have also realized that they can no longer survive by only providing labor arbitrage. Companies are not looking at lower costs only. Instead, they want a system wherein they can rely on their partner for value-added services. This is the reason why outsourcing companies are trying to move up the value chain by providing turn-key strategic solutions.
Earlier, the service provided was operational. This meant that the requirement gathering and planning were done by the client. They would clearly define a task and then provide it to the outsourcing company who would execute it at the lowest possible cost. Hence, the client would most probably be billed for the number of man-hours that were used to execute a project.
However, over time, outsourcing companies have started providing strategic services. This means that companies can now outsource their entire functions. For instance, companies can simply hand over their technology function to a third-party organization. The job of requirement gathering, selection of tools, and implementation of the latest versions of the software will then be the responsibility of the outsourcing company. Hence, they will perform the same job as the clients own shared service center but will try to do so at a lower cost. In such cases, the clients are billed per project instead of being billed per hour of work. This is because the client no longer decides the scope of work or the number of man-hours which it will take to accomplish.
The bottom line is that the outsourcing decision is no longer an operational or a tactical decision. Instead, this decision has become strategic in nature as illustrated by the article above. Hence, the tools and techniques of strategic finance need to be deployed before deciding whether or not outsourcing and offshoring should be used by a company.
Authorship/Referencing - About the Author(s)
The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.