Strategic Finance and the Outsourcing Decision

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Strategic Finance and the Outsourcing Decision

For a long length of time, the phrase outsourcing has been connected with cost savings. Outsourcing is often regarded to be an operational tool or at best a tactical one. However, this has altered in the last several years. Numerous firms throughout the globe have outsourced or offshored part of their services and cost reduction was not the key driver behind these moves. The notion of outsourcing has expanded from the tactical front and now contains some strategic components as well. In this post, we will take a deeper look at the strategic components of outsourcing choices.
 

Defining Outsourcing

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The phrase outsourcing is often used to convey the fact that work has been outsourced out of the organization and will be completed by a third party. This third party may or may not be situated in a nation that offers low-cost labor. However, for the most part, it is situated in a nation that is cheaper to operate in. For the purpose of this essay, outsourcing will also encompass offshore. This implies that the corporation does not outsource work to a third party but instead sets up its own shared services center in low-cost nations.
 

Why Offshoring is a Strategic Decision?

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Over the years, numerous corporations have begun outsourcing their company. This implies that instead of outsourcing work to a third party, they build up their own center and outsource work to that center. This may be stated to be strategic in nature for the following reasons:
 
  • When a corporation hires third-party outsourcing providers, they are often employing them for the short term. This implies that today third-party providers of service are cheaper in a certain nation, then the task will be outsourced there. However, tomorrow, if a cheaper option arises, then the job will be transferred to the cheaper nation. By contrast, when a corporation sets up its own office in a given nation, they are often in it for the long term. This suggests that even while labor cost arbitrage is an extra benefit, it is not the key determining factor.
  • Companies generally make the offshore option because of the availability of cheaper and better-quality resources. For instance, it is a recognized fact that there is a lack of Science, Technology, Engineering, and Math (STEM) professionals in the United States. Over the years, American corporations have had to depend on visa regimes to obtain the essential employees immigrated and then supply them with positions. In the near term, this may be a cheaper and less difficult choice. Hence, if we merely go by the net present value estimates, this may be a superior alternative
  • However, American corporations have discovered that if they take the difficult early steps and establish their own company in low-cost nations such as India, they receive greater access to the talent pool at cheaper pricing. They no longer have to depend on complicated immigration rules which might alter at the whim of a nationalistic administration. This is the reason why many corporations have formed their own offshore offices through a partner company. It is correct, that this partner firm is a different legal entity and may be closed and relocated to another place if necessary. However, this is not what occurs in most circumstances. There are several instances of shared service centers that have currently been effectively running in organizations like India.
 

Outsourcing is also Becoming Strategic

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With the shift in the expectations of the consumers, outsourcing businesses have also understood that they can no longer exist by merely supplying labor arbitrage. Companies are not aiming at reducing expenses exclusively. Instead, they want a system whereby they can depend on their partner for value-added services. This is the reason why outsourcing businesses are seeking to advance up the value chain by delivering turn-key strategic solutions.
 
Earlier, the service offered was functioning. This meant that the requirement collecting and planning were done by the customer. They would explicitly outline a job and then offer it to the outsourcing business which would perform it at the lowest feasible cost. Hence, the customer would most probably be invoiced for the number of man-hours that were employed to accomplish a project.
 
However, over time, outsourcing organizations have begun delivering strategic services. This implies that firms may now outsource their whole operations. For instance, firms might simply give over their technological function to a third-party group. The work of requirement collecting, selection of tools, and installation of the newest versions of the program will thereafter be the duty of the outsourcing business. Hence, they will execute the same task as the client’s own shared service center but will aim to do it at a lesser cost. In such circumstances, the customers are invoiced per project instead of being billed per hour of labor. This is because the customer no longer chooses the scope of work or the number of man-hours which it will take to achieve.
 
The bottom line is that the outsourcing choice is no longer an operational or a tactical one. Instead, this choice has become strategic in character as indicated by the article above. Hence, the tools and approaches of strategic finance need to be applied before choosing whether or not outsourcing and offshore should be utilized by a corporation.
 
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