Outsourcing: The Drawbacks

An overview of the downside to outsourcing 

Outsourcing is a powerful tool that can be used to improve performance, optimise costs, and refocus on core competencies. However, outsourcing is not without its drawbacks and sometimes outsourcing initiatives often fall short of business expectations. Failing to recognise and manage these drawbacks often leads to outsourcing initiatives either becoming cost neutral or unable to deliver business gains. The drawbacks of outsourcing include:

Loss of core competencies

Defining activities that can be best performed by external vendors requires a robust understanding of where the organisation’s competitive advantage originates from. A major source of competitive advantage is the way an organisation configures and links various elements of its value chain. Extensive outsourcing can disrupt value chain linkages and the ability of the organisation to establish itself as a cost leader or a differentiator. An organisation’s internal value chain allows it to gain competitive advantage and sometimes defining what is core and non-core becomes unclear, raising the risk of inadvertently outsourcing a core activity.

Reputational Damage

Cost optimisation is a major reason for outsourcing, this is often achieved by utilising a low-cost country sourcing strategy. Whilst this approach can deliver the immediate objective of cost reduction, it does have the risks of reputational damage.

Brand loyalty and recognition forms the basis of competitive differentiation for most organisations. Therefore, any negative corporate social responsibility or sustainability action taking by the external vendor can have an adverse impact on the reputation of the outsourcing firm. Reputational loss can be particularly damaging for organisations with strong brands as consumers are willing to switch products or services very quickly.

People Issues

The effective management of personnel challenges is key to achieving the objectives of outsourcing. Broadly, employees perceive outsourcing as an underestimation of their capabilities and usually leads to loss of critical expertise as employees decides to leave the organisation. Outsourcing does have a negative effect on employee job security and loyalty even if they retain their positions within the organisation. These effects on employee morale often translates into lower productivity and disruptive actions that impacts business performance. Ethical approaches and open communication are key to managing personnel issues in outsourcing.

Loss of Information

Data and information sharing are a common requirement in most outsourcing initiatives. This requirement also comes with intellectual property and data leakage issues. Organisations are now ‘knowledge driven’ and it is critical for firms to guard their intellectual property especially where the external provider is also used by competitors. Although protective actions can be taken by the external provider, these actions do increase asset specificity and supplier lock-in. In situations where data leakage and potential loss of IP is an issue, the preferred option is to retain the activity in-house and prevent suppliers from becoming competitors in the long run.

Supplier Lock in

Supplier dependence can be the consequence of outsourcing, this occurs where the outsourcing firm has incurred high sunk and switching costs. These costs usually prevent the outsourcing firm from switching thus leading to supplier lock-in.

Sunk costs are dedicated and specific investments both parties in an outsourcing arrangement make. These investments cannot be transferred to another supply relationship even if the outsourcing firm decides to switch source of supply. In the event where most of the dedicated investment has been made by the outsourcing firm, its ability to switch easily is severely restricted by high switching cost. This keeps the outsourcing firm locked-in thus putting the supplier in an advantageous position where it can dictate terms and exploit its position.

Outsourcing does have several benefits, but these can only be achieved if the outsourcing organisation have visibility of the pitfalls that can influence the outcome of outsourcing. It is also crucially important for organisations to understand how they will fully manage these pitfalls of outsourcing before commencing on any outsourcing initiative.

By Daniel Usifoh