Outsourcing is a business practice of hiring someone outside the company to carry out tasks, handle functions or provide services that are usually done (or could be done) in-house. This practice is sometimes known as 'contracting out'.
These days, you can outsource almost any business task or function. The different types of outsourcing services range from bookkeeping and payroll to logistics and manufacturing. You can even outsource entire business departments, such as customer service or IT support.
Businesses often outsource to cut costs, improve efficiencies, access external expertise and gain other benefits. However, outsourcing can also lead to loss of control in your business. Analyse the advantages and disadvantages of outsourcing to understand potential issues.
This guide covers key outsourcing considerations and helps you decide if outsourcing is right for your business. It explains how to choose an outsourcing partner and negotiate service level agreements between two contracting parties.
Types of outsourcing services
According to recent global research, disruptive outsourcing - led by cloud and automation - is fundamentally transforming traditional outsourcing models.
In the past, businesses typically outsourced their non-strategic activities or back-office operations, usually to achieve cost-savings and improve productivity. Nowadays, companies are increasingly looking for outsourcing solutions to improve their competitive advantage.
Disruptive outsourcing solutions
The latest developments in outsourcing often incorporate some of Industry 4.0 technologies, including:
- cloud technologies
- cognitive automation
- robotic process automation
These new technologies are revolutionising the way businesses work. They enable efficiencies, faster growth, improved time to market and increased productivity and competitiveness.
Find out more about disruptive outsourcing in Deloitte's 2018 global outsourcing survey.
Examples of outsourcing
Common outsourcing processes and activities include the following:
- IT functions - you can outsource most IT functions, from network management to project work, website development and data warehousing. You may benefit from the latest technology and software upgrades without having to invest in expensive systems or keep up with industry trends.
- Business processes and HR - outsourcing activities such as recruitment, payroll and secretarial services gives you access to specialist skills, but you only pay when you need to use them.
- Finance - you already outsource auditing, so why not do the same with your entire accounting function, including bookkeeping, tax management and invoicing?
- Sales and marketing - many organisations use a consultant or an agency to handle marketing communications. Smaller businesses, or those in specialised markets, can also outsource sales to specialist agencies.
- Health and safety - there are consultants who specialise in health and safety compliance tasks. They may be able to ensure you meet all the requirements, including those for complex risks, more cost-effectively than you can.
- Operational outsourcing - this often includes cleaning, catering, facilities management, deliveries, installation, repairs and after-sales services.
Read about the advantages and disadvantages of outsourcing.
Online outsourcing refers to services that are delivered over the internet. These range from conventional business functions, such as bookkeeping, to technical and IT services, such as website hosting.
The benefits of online outsourcing
Outsourcing work online delivers a range of benefits, including:
- Reduced costs - you pay for services only when you use them, with little or no investment in new equipment, staff or training.
- Greater efficiency - you don't need a complex IT network or a specialist IT department.
- Commercial advantage - you can work closely with business partners and customers. It also enables staff to work remotely and have access to high-performance software at affordable rates.
- Better use of people - staff can concentrate on business-critical and value-added operations.
Implementing an online outsourcing solution
Choosing and using an online outsourcing solution needs careful consideration:
- Do the research - does it make sense for your business? Will it give you access to new markets or technologies? Do your competitors outsource any of their processes - if so, what?
- Identify the advantages - will you save time and money, improve your e-commerce capabilities or gain a competitive advantage?
- Perform a cost/benefit analysis - what will it cost and how long will it take to pay for itself?
- Assess the suppliers - draw up a supplier shortlist and ask them questions about cost, deliverables, security, ownership of data, and termination clauses.
- Try before you buy - if you take advantage of low cost/no cost trials, make sure you are protected against damage to your data.
- Assess the impact across your business - how will e-outsourcing affect other areas of your business? What processes will you need to modify?
- Create an implementation schedule - think about running your conventional system alongside the online outsourcing solution until you are happy with it - keep staff, customers, suppliers and business partners fully informed.
- Regularly review your arrangements - ensure that online outsourcing delivers what was promised.
Discover more advantages and disadvantages of outsourcing.
Like other business decisions, outsourcing requires careful planning and consideration. You shouldn't rush into outsourcing without carefully examining a wide range of possible issues.
Most of the complexities associated with outsourcing fall into five broad categories:
- productivity - eg it can fluctuate and doesn't always match that of internal staff
- communication - eg problems cause errors, delays and lower productivity
- culture - eg lack of cross-cultural understanding can lead to miscommunication
- organisational readiness - eg weaknesses in own internal systems, processes etc
- costs - including labour, overheads, travel, management required, etc
Cost savings are one of the most common reasons companies outsource. However, the total cost of outsourcing isn't always easy to work out. Make sure that you fully consider all costs, and reflect on other key areas, before outsourcing business-critical functions.
Avoid outsourcing pitfalls
To avoid common outsourcing pitfalls, consider the following:
- What are your core strengths and what are secondary? What processes are you thinking of outsourcing and why? Is the function a key task which your business needs to control directly to ensure its future competitiveness?
- What are the costs of doing it in-house? Include hidden costs such as office space and staff costs. Also, what are the costs of not outsourcing? Will your business suffer if it doesn't invest in the expertise or the facilities that an outsourcing partner might provide?
- Check the return on investment (ROI) - ask potential service providers for help, as many offer an ROI calculator.
- Would it be helpful to use a consultant to help you find a service provider?
- Are you prepared to spend the time and energy required to manage the outsourcing relationship?
Be sure that you are ready to outsource, and clear on the benefits of doing so, before you take the plunge.
Mitigate outsourcing risks
Outsourcing benefits go hand in hand with risks. Not all will be avoidable, but there is a way of mitigating their impact.
Before agreeing an outsourcing contract, you need to plan what you will do if problems arise. For example, if the provider you've chosen isn't able to complete the tasks, you may want to consider having other service providers that you can turn to relatively quickly or taking the outsourced processes back in-house.
It is important that the contract between you and the outsourcing company sets out the circumstances in which you can make such changes. If not, the outsourcing company could claim compensation. See service level agreements.
How common is outsourcing?
In 2018, the global outsourcing market amounted to $85.6 billion. However, it's been estimated that as many as 50 per cent of outsourcing deals end badly. This isn't a reason to reject outsourcing. It simply proves how important it is to carefully choose an outsourcing partner and manage your supplier relationship.
Advantages and disadvantages of outsourcing
Outsourcing is a common practice of contracting out business functions and processes to third-party providers. The benefits of outsourcing can be substantial - from cost savings and efficiency gains to greater competitive advantage.
On the other hand, loss of control over the outsourced function is often a potential business risk. You should consider carefully the pros and cons of outsourcing before deciding to contract out any activities or business operations.
Advantages of outsourcing
There are many reasons why a business may choose to outsource a particular task, job or a process. For example, some of the recognised benefits of outsourcing include:
- improved focus on core business activities - outsourcing can free up your business to focus on its strengths, allowing your staff to concentrate on their main tasks and on the future strategy
- increased efficiency - choosing an outsourcing company that specialises in the process or service you want them to carry out for you can help you achieve a more productive, efficient service, often of greater quality
- controlled costs - cost-savings achieved by outsourcing can help you release capital for investment in other areas of your business
- increased reach - outsourcing can give you access to capabilities and facilities otherwise not accessible or affordable
- greater competitive advantage - outsourcing can help you leverage knowledge and skills along with your complete supply chain
Outsourcing can also help to make your business more flexible and agile, able to adapt to changing market conditions and challenges, while providing cost savings and service level improvements.
Disadvantages of outsourcing
Outsourcing involves handing over direct control over a business function or process to a third party. As such, it comes with certain risks. For example, when outsourcing, you may experience problems with:
- service delivery - which may fall behind time or below expectation
- confidentiality and security - which may be at risk
- lack of flexibility - contract could prove too rigid to accommodate change
- management difficulties - changes at the outsourcing company could lead to friction
- instability - the outsourcing company could go out of business
Offshore outsourcing, although potentially more cost-effective, may present additional challenges such as hidden costs of provider selection or handover, severance and costs related to layoffs of local employees who will not be relocated internationally, etc. Even simply managing the offshore relationship can prove challenging due to time zones, different languages or cultural preferences.
You should examine carefully all the pros and cons of outsourcing to make sure that the benefits outweigh the risks. Before deciding on your strategy, it may be worth looking at some common outsourcing considerations.
Choose an outsourcing partner
Outsourcing is about creating a successful partnership. Choosing a company to outsource to is very different from choosing an ordinary supplier. You're embarking on a long-term, contractual relationship, so take time to carefully examine potential service providers.
Credentials and track record
- Does the provider have a track record of service commitment?
- Has it been recognised within its own industry?
- Does it track customer satisfaction levels?
- Is the business expanding?
- How good are the service level agreements it offers?
- who the provider's existing customers are
- how satisfied their customers are
- what the provider's strengths are
- how they deal with problems
To answer these queries, try speaking to the provider's existing customers with an industry profile similar to yours.
Current and future capabilities
Visit each potential service provider. Look at the working environment and ask about staff retention and turnover. Check their IT systems and equipment, management processes and quality assurance procedures. Is their company known for driving innovation and keeping up with emerging technologies?
Check that your potential provider is financially stable. If it is a limited company, get copies of its recent accounts, ask for banker's references and consider getting a report from a credit checking agency. Ask your potential service provider if they plan to subcontract any of your work and apply the same checks to any subcontractors.
Communication and cultural discrepancies
If you choose to outsource to a company outside the UK, remember that distance and time zone differences will make communication and control more difficult. Language barriers and different business cultures can also present problems. You may also need to allow for exchange rate fluctuations in your costings.
Ability to collaborate and innovate
You will want someone who can manage change when necessary, be resourceful in meeting your goals and requirements, and willing to commit to building a strong relationship. Relationship management will be critical in outsourcing. How will your relationship be managed and how good - and available - is your relationship manager?
For more best practice advice, see outsourcing: seven top tips.
Service level agreements
A service level agreement (SLA) sets out what services the supplier is expected to provide and to what standards. The SLA typically forms part of the more detailed supply of services contract between you and your outsourcing partner.
What should an SLA include?
Typical SLAs include:
- a description of the services provided
- the agreed standards of service
- the agreed delivery timetable
- responsibilities of supplier and customer
- provisions for legal and regulatory compliance
- mechanisms for monitoring and reporting of services
- agreed payment terms
- how disputes will be resolved
- confidentiality and non-disclosure provisions
- termination conditions
SLA compensation clauses
If service providers fail to meet agreed levels of service, SLAs usually provide for compensation, commonly in the form of rebates on monthly service charges.
Identify the most critical parts of the deal and have strict penalties for not meeting these. Build frequent performance reviews into the SLA. Try to build a flexible SLA, so that you can adapt it as your business needs change or new technologies evolve.
Find best practices to help you manage your suppliers.
When entering an outsourcing contract you should ensure that you're interpreting the contract in the same way as the outsourcing company. This is a long-term partnership and misunderstandings could cause difficulties.
All outsourcing contracts should contain an exit clause. You should ideally agree your exit strategy during the formation of the outsourcing contract. A clearly defined exit strategy should help you to avoid difficulties if the relationship with your provider turns sour.
SLAs are complex documents. It may be worthwhile getting advice from a service management consultant or a commercial lawyer. See how to choose and work with a solicitor.
Outsourcing: seven top tips
Outsourcing is when you contract out a business function to a third party over a long period of time. Outsourcing can bring a lot of benefits to your business and help you focus on core activities. However, there are risks to giving up direct control.
Follow these top tips for successful outsourcing:
- Consider carefully: Take your time making decisions and make sure you are clear about the terms on which you and the supplier are working together. See outsourcing considerations.
- Good relationship management: This calls for constant communication and flexibility. Make the most of online project management and collaboration tools to help you stay on top of projects and in control of the company. Remember that although the supplier takes responsibility for the process, you still need to actively manage the relationship. Nominate a member of staff to take responsibility for liaison.
- Communicate internally: It's equally important to establish effective and regular communication within your business. Staff may have particular concerns about their own jobs, so keep them informed. If staff are being transferred to the outsourcing provider under the arrangement, as sometimes happens, you will need to consider the relevant employment law. See responsibilities to employees if you buy or sell a business.
- Commit long term: You are likely to get the best results if you can stay with your supplier for several years. Switching suppliers can be disruptive, so it pays to commit to building a long-term relationship from the outset.
- Be flexible: You may need to renegotiate the contract before the end of the term. A flexible contract benefits both parties, allowing the supplier to innovate and you to react to changing circumstances. See how to negotiate the right deal with suppliers.
- Measure success: There should be financial benefits, but other reasons for outsourcing are harder to quantify. These could include improving customer service, reducing errors or increasing speed to market. Include these factors in your assessment and consider how you'll measure them. See measure performance and set targets.
- Plan a clear exit strategy: The relationship might end prematurely or may simply have run its course. Either way, make sure that your service level agreement contains a clear exit strategy. It should detail how the outsourced functions should be brought back in-house. It should clarify who owns what assets and specify when compensation is due, and how much. See service level agreements.