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The source of political controversy, job loss, one fantastic movie and one pretty racist sitcom, most people have heard of outsourcing.

What is often less clear is what outsourcing really means, and if it's really as big a threat to your job as it seems.

What Is Outsourcing?

Outsourcing is when a company hires an external third party to do work that it otherwise would have done in-house. Companies typically do this to save money, finding a third party who can do the same work for less than the company would have spent employing its own staff.

There are a few key points to understand about outsourcing:

First, contrary to popular impression, outsourcing does not automatically refer to sending jobs overseas. While a company might outsource work to a foreign company, it can just as easily outsource to a firm down the street. Outsourcing overseas is called "offshoring."

Second, and relatedly, outsourced labor is not always done off-site. An outsourced contractor might still bring its staff into the company's building. For example, a company might outsource its technical support department. In this case, the company would lay off its own technicians and the service provider would bring its staff into the offices.

Third, outsourcing is not restricted to manufacturing and call centers. Companies can outsource virtually any part of their business model.

Finally, outsourcing is not the same thing as purchasing a product or service. While the distinction can sometimes be fine, outsourcing refers specifically to finding a third party to do work the company would otherwise have done itself. A law firm is not outsourcing when it buys paper plates, since it would never have manufactured this product on its own.

Typically, the clearest signal of outsourcing is when a firm lays off staff, since this is an indicator that the company considers their function a part of its business model.

For example, consider Widget Co. As a cost-cutting measure the firm might outsource its administrative staff to Admins Inc. Instead of hiring its own receptionists, then, Widget Co. would rely on staff provided by Admins Inc. This would be outsourcing in action.

Why Do Companies Outsource?

Most companies rely on outsourcing to at least some degree. Usually this means hiring an outside firm to handle issues such as human resource management, accounting, benefits management, technology, component manufacture and more. There are a few reasons why a company might do this, including but not limited to:

• First, and most common, a company might outsource to save money.

In most cases this means that the third party can provide the product or service more efficiently than the company could do so itself.

Exactly how the third party does so is case-specific. A third party might take advantage of economies of scale, for example, doing something more cheaply because it focuses entirely on this one service. Or the third party might allow a firm to split costs on a service it relies on relatively rarely. For example, a midsize company might feel like it only really needs IT support for 10 hours a week. In this case it would be wasteful to hire someone full time.

Or, a car company might outsource manufacturing brake pads to a third party vendor, feeling like this vendor can make the component more cheaply than it could do so itself.

• Second, a company might outsource for expertise.

Many specialty services firms are built on the business model of expertise outsourcing. For example, a company could hire its own accountants or in-house counsel to handle financial and legal matters. It might, however, outsource these functions to an accounting or legal firm in a belief that these specialty firms can provide a higher quality of service.

• Third, a company might outsource in order to keep up with its own growth or avoid complications.

If a company has grown quickly, it is often easier to outsource key functions than to hire and train staff. In this case, the company is simply trying to keep up with its own rate of change and may feel like it's easier to reach for a third party that can provide pre-built corporate functions as necessary.

For example, a company that just rapidly expanded might outsource its benefits and human resources functions rather than try to keep up with its own rate of personnel growth. Or a laptop manufacturer might outsource making its monitors to avoid building an entire new plant for that one component.

How Does Outsourcing Work?

Ultimately, outsourcing is about a third party finding some specific advantage in a given field. A third party might provide a service cheaper or better for a number of possible reasons, including but not limited to:

• Management, training and equipment costs

When a company outsources, it saves the direct costs of training the relevant staff. It typically doesn't directly purchase that staff's equipment or even have to oversee their work.

For example, if a company outsources its human resources to a third-party firm, those HR managers might all work in some off-site office. The company wouldn't have to buy their computers, hire their managers or spend on any associated overhead. On the other hand, all of those costs plus a profit margin would be built into the price.

• Specialty expertise

A third party might develop a specific expertise in a given area, typically born of focusing on the same thing over and over again.

For example, a cell phone manufacturer might outsource the production of its casings to a third party that makes the best cases on the market. If the cell phone manufacturer doesn't think it can make a better case, it will outsource the job.

• Competitive, comparative or efficiency advantages

A third party might have some specific advantage that lets them do a job better or cheaper.

This is where offshoring typically comes in. Manufacturing companies and call centers frequently outsource to third parties in countries like India and China because labor in those countries is so much less expensive than in the U.S. An Indian call center firm can offer to answer the same phones for a fraction of what it would cost an American company.

A third party might be physically closer to raw materials; it might have different local regulations; it might have a more educated work force. There are any number of ways that a third party firm can get an advantage.

Logistics and communications technology have made this form of outsourcing particularly cost-effective. As it became increasingly easy and inexpensive to communicate and move products around the world, companies quickly found that the savings of a local advantage outweighed the costs of doing business across state and national lines.

What Are the Advantages and Disadvantages of Outsourcing?

As discussed above, the advantages of outsourcing typically include:

• Cost savings

• Expertise

• Easy access to solutions

The disadvantages tend to be a little harder to spot on a corporate level. They can include:

• Quality control

When a company outsources, it loses control over a section of its business. If the laptop manufacturer above outsources its monitors to a third party it can't directly oversee the production of this component. This might save the company a lot of money, but can also cost a lot of money if the third party does a lousy job.

This is a particular risk when outsourcing to save costs. Often a third party will offer to do the same job cheaper specifically because they employ less oversight and have lower standards. Companies need to be careful of this.

• Friction and communication problems

Hiring a third-party firm adds extra levels of communication and legal concerns, all of which can create extra steps and build friction into a business process.

This may not be a problem with routine functions. Outsourcing janitorial duties, for example, typically involves relatively few issues. However, if a company outsources day-to-day functions it can slow down work significantly, create additional legal concerns and harm corporate security.

• Reputation damage

Offshoring has become a relatively controversial practice. Many Americans blame it for job loss and a changing economy, and as a result companies which rely heavily on offshore outsourcing can face a reputational issue. This is particularly a risk for companies that offshore customer-facing roles such as customer service.

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