Discuss the advantages and disadvantages of outsourcing. How do firms make decisions related to outsourcing?

Question

What will be an ideal response?

Answer 1

In past decades, multinationals have been spreading their activities across borders and forming global value chains which consist of a network of affiliates and partners. They coordinate the operations of the network members which are related to the firm through multiple arrangements ranging from subsidiaries to contracted suppliers. Multinationals make the decision regarding internalizing and externalizing activities by assessing risks and opportunities while prioritizing the protection of their core competencies. Then activities which are externalized or outsourced are mainly those which are peripheral to their operations. In this way, greater efficiencies can be generated both by increasing the cost effectiveness and the quality of the non-core activities and enabling management focus on the core activities. As such, outsourcing is no longer considered purely on a cost basis, but rather as a function of overall business strategy (Van Weele, 2009).

In order to maintain competitiveness in the current business environment, multinationals need to consider moving each activity to the most efficient locations whether in terms of cost advantages or improved quality. On the other hand, spreading activities across a global or even a regional value chain significantly increases coordination and monitoring costs. As such, the multinationals can be diverted from focusing on their core activities and may face inefficiencies in undertaking non-core activities, as such activities are often not their specialization. Internalization of activities enables the firm to protect its know-how, and eliminates the challenge and the cost of finding and managing relationships with partners (Oshri et al., 2009). In formulating international value chains, coordination arises as an important consideration for the firm. Entry mode decisions are affected by the level of control which is necessary for efficient coordination of the value chain. When firms internalize activities, they are faced with fewer concerns related to control and monitoring. They can also protect their know-how and are not burdened with challenges stemming from vendors’ management. In contrast, when firms externalize activities, they may be able to find specialized vendors who can increase efficiency, then the management can focus on other areas and lower costs. However, firms also face the risk of losing know-how and additional burdens related to vendor monitoring and control. Overall, the decision to internalize or externalize an activity is affected by the level of control necessary and firms prefer to maintain control over activities involving know-how.

Considering that most of the activities which are outsourced are not the firm’s core activities, the firm can also improve efficiency and quality by externalizing the non-core activities to third parties who specialize in the particular activity. In addition, firms can also access the third parties’ tangible and intangible resources by outsourcing (Oshri et al., 2009).

Outsourcing relationships by definition lead to transfer of the management and/or the delivery of a process or a given task to a third party. Most issues stem from the vendor and the company trying to maximize their own utility instead of acting together in collaboration. A considerable level of the outsourcing relationship can be managed by establishing long lasting relationships, thus the success of the outsourcing arrangements in part relies on the success of the company’s managers and their ability to clarify what is needed, choose accordingly and handle issues with vendors successfully. In this respect, trust and minimisation of cultural issues gain considerable attention.

Developing trust is a key component in reducing risk in outsourcing relations (Moe and Šmite, 2008). Academics and researchers alike focus on efforts to improve communication in global relations through emphasising collaboration and continuity (Bhat et al., 2006). Collaboration is working together with the vendor to improve performance, continuity is working with the same vendor over a long time building a relationship of trust and improving performance through the expectation of a long relationship (Gottschalk and Solli-Sæther, 2006).