Outsourcing is the practice of using resources outside of the company. Outsourcing typically involves setting up contracts with third parties for managing manufacturing, business processes, and customer support. In a step forward, modern businesses hire external consultants, including contract staffing to fulfill knowledge or skill gaps within the company.

Companies look for outsourcing solution to bring down operational costs or a strategic management tool to focus on core business activities. As such, outsourcing tasks can range from customer support to manufacturing to specialized knowledge-intensive tasks. 

During globalization in the 1990s, outsourcing became an effective business strategy. Western multinational companies started exploring the opportunities to leverage lower labor costs in the Asia Pacific region. While China, Vietnam and Korea became manufacturing hubs for western multinational corporations, India, Philippines and Malaysia became centers for business process outsourcing. 

This post explains everything you need to know about outsourcing in business, starting from outsourcing meaning, outsourcing definition and examples, and how outsourcing works and the most outsourced servcies. 

Understandng outsourcing meaning and definition

The term ‘outsourcing’ is a short version of “outside resourcing” - a practice emerged in the 1980s when manufacturing processes in the US were contracted to external provider or an outside company to minimize expenses. This led to the definition of outsourcing as the practice of employing external providers to carry out certain aspects of the business.

Although initially outsourcing started in manufacturing, it soon spread to other segments like routine tasks such as bookkeeping, accounting and customer support to more advanced segments like IT support, software development and supply chain management.

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Companies may choose to outsource services onshore (within their own country), nearshore (to a neighboring country or one in the same time zone), or offshore (to a more distant country). Nearshore and offshore outsourcing have traditionally been pursued to save costs.

Outsourcing industry size and growth

The outsourcing industry consists of various segments within outsourcing. Hence, it is challenging to cumulatively present the outsourcing industry size. However, as per estimates by top market research firms, the outsourcing industry has grown from a USD 600 Billion industry to nearly a USD 1 trillion industry by 2023. The growth is believed to remain intact at a steady CAGR of 5-6%. The BPO industry alone is expected to clock a revenue of USD 400 billion by the end of 2024. 

Understanding How Outsourcing Works

When a company (known as client or client company) decides to outsource, it looks for other companies (known as external service provider/third party/outsourcing firm) who offer the service or tasks that align with the business function of the client. Here the core business or offering of the third party may only be a part of the larger offering by the client company.

Let’s take an example to understand this better.

Tesla, one of the largest EV manufacturers in the world, needs to manufacture various auto components to manufacture a single vehicle. It needs to design and build engines, batteries, tires, and various other auto parts. Since all these components need specialized manufacturing set up, Tesla has to set up manufacturing units for all these parts.

Alternatively, it can outsource components from third party manufacturers. It can outsource all the tires needed for its vehicles from a tire manufacturer. Similarly, it can outsource batteries from EV battery manufacturers like CATL or Panasonic. 

By outsourcing, Tesla does not have to set up manufacturing facilities for tires or batteries. This can significantly reduce costs and moreover, the company can focus mainly on its core business of manufacturing the best EV models at competitive prices.

Also Read: What is Offshoring?

Types of outsourcing

Based on where the external service provider is based, outsourcing can be divided into four primary types - onshore outsourcing, nearshore outsourcing, offshore outsourcing and onsite outsourcing. Let’s understand each type of outsourcing.

Onshore outsourcing

The term onshore is another term to mean the same country (literally sharing the same shore/coastline). Hence onshore outsourcing is when a company hires a third-party provider from its own country to fulfill its business needs.

For example, Dell (US-based computer manufacturer) hires Intel (US-based chip manufacturer) to supply chips for its computers and laptop. In this case, both companies are from the US and thus, they are engaged in an onshore outsourcing model.

Since both parties in this arrangement are from the same country, there is no language or cultural barrier. This allows smoother communication and easy integration, thereby allowing reduced time for output. On the flip side, this outsourcing model often leads to higher cost than other outsourcing types.

Offshore outsourcing

As the name suggests, offshore outsourcing is partnering with vendors from offshore countries. Offshore means the client and external companies are located in different shores or different countries or regions. 

For example, Visa (US based payment card service company) hires Infosys (India based IT outsourcing company) to cater to all IT requirements. In this the client company is from the US and the third party service provider is from India.

Offshore outsourcing to India, Vietnam and Philippines offers client companies in western countries access to high-skilled labor at significant lower prices than their own countries. In some cases, offshore outsourcing allows companies to avoid stringent labor laws in their native lands. On the flip side, due to location in different time zones, language and cultural set up, conducting business can be challenging.

Nearshore outsourcing

Nearshore outsourcing is the hiring of third-party providers located in a nearby or adjacent country with the same language, skills and culture. This can make communication and onsite visits easier. For example, a company in the United States may prefer to outsource services to Mexico, since the nation is on the same continent and uses many of the same time zones.

Onsite outsourcing

With onsite outsourcing, contractors work on location at the company rather than at a remote location. This outsourcing type is often necessary for information technology (IT) functions. The external contractors might repair hardware, offer their expertise on construction or IT projects and consult with the relevant parties on a periodic basis.

Types of outsourcing services

BPO (Business Process Outsourcing)

BPO involves the outsourcing of routine services that are not part of the core business offering such as customer support, accounting, and  payroll management. Third party companies run these processes as part of the business but staying outside the company’s regular payroll.

LPO (Legal Process Outsourcing)

LPO is similar to BPO in all sense but it involves everything related to legal processes for the client company. The third party company in this case exclusively deals with all the legal matters for the client company. 

For example, a new company without an in-house lawyer could outsource legal research, contract management, document review, and other law-related tasks to a third-party law firm or lawyer.

KPO (Knowledge Process Outsourcing)

KPO is the latest extension to outsourcing where client companies hire third party companies to perform tasks that are critical to their core businesses.  Such tasks can be related to market research, data analysis, product development, and consulting. The external expertise of the in this case fill the skill gap within the internal resources of the company.

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ITO (Information Technology Outsourcing)

Modern businesses often hire external companies to handle their IT requirements and provide support for all things related to IT. The IT services that are generally outsourced are web development, software development, application management, and networking maintenance. 

Facilities Management Outsourcing

Facilities management outsourcing involves hiring of outsourcing provider for security, housekeeping, and maintenance of the facilities. This may also involve landscaping, electrical work, and other similar tasks.

Creative Process Outsourcing

When a company hires external agencies for outsourcing tasks like content creation, video production, graphic design, and voice recording, it comes under creative process outsourcing.

Manufacturing Outsourcing

Manufacturing outsourcing involves providing a contract to a third party company to manufacture the goods for another company. In this case, the client company has the right to retain its design and patent but shares it on license to the external company for a specific period during. 

For example, Wistron is a contract manufacturer that produces iPhones for Apple. In this case Apple is outsourcing its manufacturing part to Wistron while retaining its exclusive rights over design, software and other critical things related to iPhones.

Advantages of outsourcing

Staffing flexibility and cost saving

Outsourcing allows companies to manage operations seamlessly with fluctuating demands. It provides access to additional resources when necessary. When demand decreases, businesses can revert to internal operations without reliance on outsourcing.

For instance, an accounting department may face staffing shortages during auditing periods and tax seasons. In such cases, it may outsource some functions to obtain the required resources at a lower cost for a defined duration.

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Boosting core competencies

When a business grows, its back-office operations have to match the growth correspondingly. But adding more resources for back office work on a company's payroll may impact its financial resources. This may, in turn, hinder the achievement of its organizational mission.

In such scenarios, outsourcing of less critical office functions to a third party company facilitates the reallocation of resources to critical operations. This allows the company to focus on its most important activities and implement renewed growth strategies.

Better and scalable efficiency

Outsourcing can be a beneficial strategy for companies that need to manage costly or intricate office functions to maintain profitability. By delegating these functions to a third-party company, firms can enhance efficiency and productivity. This approach allows organizations to focus more on other business operations.

For example, a company specializing in 3D printing construction may prioritize hiring and training employees for better designs and more efficient services to its customers. For this purpose, it can outsource sales and marketing functions to a third party company and allocate its resources more effectively on design and product delivery.

Outsourcing vs. offshore outsourcing vs. offshoring

Often all these terms are used interchangeably but incorrectly. Outsourcing involves hiring another company for certain business segments. The hired company may or may not be from the same country as the client company. For example, if Dell hires Nvidia to supply chips for its computers, Dell is outsourcing a part of its manufacturing to Nvidia.

In contrast offshore outsourcing is hiring external companies/contractors from another country for manufacturing or conducting certain business processes. For example, if Goldman Sachs (American Company) hires TCS (Indian Company) to provide IT support, Goldman Sachs is going for offshore outsourcing for its IT services. 

However, in offshoring, the client company sets up its own business operations in another country. Although the company in foreign land remains a subsidiary to the parent company, it functions independently with an independent management team and local workforce. For example Unilever, one of the largest British FMCG companies, manufactures and sells products in India under its subsidiary Hindustan Unilever by offshoring its business to India.

Effective outsourcing strategy tips

Developing an appropriate outsourcing strategy is key to maximize the benefits of outsourcing services. Whether you're considering professional outsourcing, creative process outsourcing, recruitment process outsourcing, or project outsourcing, here are some best outsourcing tips that you can follow while partnering with third party companies.

1. Defining Objectives: The first step of a successful outsourcing strategy is to outline clear goals for your outsourcing arrangement. The goals may be based on cost reduction, efficiency improvement, or accessing specialized expertise.
2. Choosing the outsourcing model: Analyze your business needs and select the right outsourcing model, be it onshore or offshore outsourcing.
3. Research about the outsourcing companies: Whether looking for domestic third party companies or considering offshore outsourcing to foreign companies, do a thorough research about the companies. Check their expertise and previous track records to reach a conclusion.
4. Clear communication channels: Create clear protocols for regular updates and feedback between your team and the external vendor.
5. Develop a clear and comprehensive contract: Outline expectations, deliverables, and performance metrics in a detailed agreement to protect both parties.
6. Dedicated management: Assign a dedicated team or individual to oversee the outsourcing process and maintain quality control.
7. Focus on knowledge transfer: Facilitate knowledge sharing between your in-house team and outsourced employees for operational outsourcing success.
8. Start slow and small: Begin with administrative tasks or smaller projects to gauge the strengths and capabilities of the companies before you commit any large-scale .
9. Monitor performance: Regularly assess the outsourcing arrangement's effectiveness using predefined KPI (key performance indicators). 
10. Be flexible to change: Make changes to your strategy according to changing business needs and market conditions.

FAQs

What is outsourcing in simple words?

Outsourcing is a business strategy where an external company does specific tasks for another company. The tasks can be related to providing certain services or manufactue goods and products for the company.

What does outsourcing mean in business?

Outsourcing in business is a measure to provide contract to a third party company to do certain tasks instead of doing it within the company. The measure is a popular cost-effective solution for businesses to optimize costs while maintaining quality and expertise.

What is an example of outsourcing?

Service sector outsourcing example - Flipkart contracting customer support services to a BPO company customer support in multiple languages.

Manufacturing sector outsourcing example - Toyota, one of the largest automobile companies in the world, outsourcing safety system production to a specialized safety system manufacturer like Minda Corp.

What is known as outsourcing?

Hiring of external service providers to handle specific business functions for another company is known as outsourcing.

What is meant by outsourcing company?

An outsourcing company provides specific services or capabilities that are related to business processs of other companies. Outsourcing generally works on contractual terms and can provide services to multilple companies at once.

For example - Nvron Life Science Ltd, a pharmaceutical independent contractor, manufactures pharmaceutical drugs and medicines for various pharmaceutical companies.

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