How Outsourcing Works

What is Outsourcing?

labor costs
­Many companies choose to outsource overseas because of lower labor costs.
© Strdel/AFP/Getty Images

When businesses need expertise or skills that they don't have within their organization, they often turn to outsourcing to solve their problems.

Outsourcing means just what it says -- going "out" to find the "source" of what you need. These days many business outsource for what they need to serve their customers, both internal and external. An external customer is the entity that ultimately purchases a company's product or services, while an internal customer is the company's own employees or shareholders. Business can obtain both products like machine parts, and services like payroll, through outsourcing.


 Outsourcing probably can trace its roots to large manufacturing companies, which hired outside companies to produce specialized components that they needed for their products. Automakers, for instance, hired companies to make components for air conditioning units, sound systems and sunroofs. In some cases, they moved entire factories to foreign countries.

The big shift in recent years, however, is service outsourcing, which refers to

companies hiring outside businesses to provide specialized work and expertise.

Outsourcing offers many advantages. For instance, outsourcing allows companies to seek out and hire the best experts for specialized work. Using outsourcing also helps companies keep more cash on hand, freeing resources for other purposes, such as capital improvements. It's also often cheaper in terms of salaries and benefits and reduces risks and costs.

Outsourcing can also help a business focus on its core components without distractions from ancillary and support functions. Another advantage -- such as the one involving the fictitious Smith & Co -- involves speed and nimbleness. It's sometimes quicker and more efficient to hire a specialist to do something than it is to bring your company up to speed.

Many large companies use outsourcing to fill roles in their organization that would be too expensive or inefficient to create themselves. Smaller companies also turn to outsourcing, though the cost savings is sometimes diminished.

Outsourced manufactured components can include building components for aircraft, computer networks or automobiles.

Outsourced service functions can include:

  • Call centers
  • Payroll and bookkeeping
  • Advertising and public relations
  • Building maintenance
  • Consulting and engineering
  • Records
  • Supply and inventory
  • Field service dispatch
  • Purchasing
  • Food and cafeteria services
  • Security
  • Fleet services

This list makes it easy to see why outsourcing has impacted practically all sectors of the business world. Nearly every business has at least one or more of these functions.

However, outsourcing has some inherent disadvantages. The company often has less direct oversight and control of the product or service it's purchasing, which can threaten the relationship between the company and its customers.

Communication can cause problems. Outsourcing overseas can lead to language barrier issues. Outsourcing, especially offshore, is sometimes criticized, which can mean bad public relations for a company. Security issues, such as keeping proprietary information private, also can arise. Hiring an outside company presents challenges to the hiring company.

Outsourcing's impact is, therefore, far reaching. Check out the next page to learn more about the economics of outsourcing.