A key decision concerning the supply of a good or service is whether it should be provided by the organisation itself, or whether an outside source should be used. Bailey et al. (2008) suggest that, in making such decisions, the following issues should be considered:
How strategically important is the item?
How competitive is the cost of internal supply?
How much does the item affect other products or services?
How much does it affect performance?
Is it linked to other strategic issues?
A useful example here is that of training. Many organisations prefer to train their own staff, even though outsourced training is readily available, often at very competitive cost. However, internal training enables them to have more effective quality control over an activity considered to be of high strategic importance.
Other strategic issues which may point towards internal supply are:
The need to retain key skills and expertise. An organisation may consider that these are an essential part of its human capital which, once lost, may be costly and difficult to regain.
Security and confidentiality risks. Outsourced suppliers must have information if they are to provide the required services or products. In spite of all precautions, it can be very difficult to prevent leakage of sensitive or commercially valuable material.
Concern about loss of customer focus or quality. However careful an organisation is, an outsourced supplier will have other customers and it can be very difficult to ensure that service and quality are always up to the required standard.
Reasons for Outsourcing
Cost reduction is most commonly the key factor in the outsourcing decision, but there are others. Organisations in all sectors are increasingly pressed for resources and may simply have no spare capacity. Even if internal supply is possible, they may prefer to concentrate on their core activities, rather than divert resources to peripheral functions which could be done more cheaply and quite adequately by others.
One important benefit of outsourcing is that the customer has access to the benefits of advanced technology and professional expertise. The specialist provider should be able to use these effectively in many ways, for example in maximising opportunities for scale economies, even when demand patterns are volatile.
Understanding the Costs of Outsourcing
The decision as to whether to supply or outsource must take all factors into account, and here the process involved is different to that of conventional costing.
A simplistic comparison of in-house and outsourced supply may show what appears to be a lower total cost. However, the real situation is often more complex, firstly because there is a cost for not providing an in-house service, and secondly because there are hidden costs in outsourcing. To understand these further, we need to consider the nature of overhead costs.
The fact that a good or service is not provided by the organisation does not mean that there is no further requirement to manage its provision; there will still be costs for administration and management, including the following:
Routine activities such as quality checks, dealing with queries and processing payment;
Liaison with suppliers and monitoring of their performance;
Maintenance and improvement in the efficiency of the suppliers.