Transcript of "New Trends in Organizations Flexibility: Outsourcing"
NEW TRENDS IN ORGANIZATIONAL FLEXIBILITY: OUTSOURCING
Fernando Casani Fernández-Navarrete
MaÁngeles Luque de la Torre
Jesús Rodríguez Pomeda
Pilar Soria Lambán
UNIVERSIDAD AUTÓNOMA DE MADRID
Madrid, April 1996
In recent years, the need for flexibility which has been forced on management by the new competitive
environment has given rise to the development and the spread of outsourcing. In spite of its general use,
we think that on occasion it has been used incorrectly and to a lesser degree as a simplistic tool for
reducing staff. The object of this paper is to have a critical look at outsourcing along the following lines.
Firstly, we look at the effect of technological change and of the globalization of markets on the new
competitive environment and the reaction of firms adopting a more flexible organizational structure.
From this base, we develop the concept of outsourcing and its process of implementation and its
treatment in the literature. Our study is a critical analysis of the series of internal and external problems
posed by outsourcing in firms which have introduced it but have not up to now taken advantage of its
full scope. The final section gives a summary of main conclusions of the paper.
1. TECHNOLOGICAL CHANGE AND THE NEW COMPETITIVE ENVIRONMENT
Technological development induces and subsequently is affected by changes in the economic
environment. As history has shown, technology is the key factor in the creation or disappearance of a
business, as a result of new products replacing older ones, the opening of new markets, and radical
changes in production, sales and consumption; in other words, significant changes in the process of
added value. Therefore, technological change appears as a social process, whose sphere of influence is
as much within the firm (acquisition and development of know-how, learning patterns or management
models), as it is on the environment in which its business activities take place (institutional changes
which affect market regulation, tangible and intangible public infrastructure, etc.)
Presently, technology is changing the competitive environment. It is characterized by two sets of
interrelated factors. On the one hand, technological and organizational innovations foster cost reductions
in communications and transportation permitting decentralization; while on the other, institutional
changes facilitate liberalization of financial and commercial markets (Papaconstantinou, 1993, p.7).
Firms try to respond to this complex situation by using a growing ability to adapt. The increase in
commercial deregulation places a premium on rapid response to these changes because of greater ease
of entry to wider markets and the shorter time frame in which to take advantage of the resulting
competitive edge. The outcome is a qualitative change in the manner in which the firm carries out its
activities. A consequence is the appearance of new production models based on the interaction of their
components, which include the development of differentiated products, anticipated responses to the
market, a multi-faceted workforce, and flexible organizational schemes which yield cost reductions
while maintaining levels of quality (Boyer, 1995, p.107).
In the new competitive environment, flexibility becomes a key factor in defining the strategy and the
structure of the organization. The rapid changes in technology and the speed with which new products
are introduced into the market force on firms a process of adaptation in order to be able to respond to the
strategic moves of their competitors. Therefore, firms must have not only strategic management, but a
flexible organizational structure.
2.ADAPTATION OF ORGANIZATIONAL STRUCTURES
In this context, the classical organizational structures based on vertical and hierarchical structure are
giving way to horizontal organizations, broader and less hierarchical. Generally, it is alleged that the
traditional vertical structure slows decision-making and the implementation of processes, while the
horizontal structures, with the decision-making process decentralized to inter-functional teams, permit
the development of creative forces within the organization, fostering their learning abilities, and,
therefore, allowing the firm to better adapt to the new competitive environment, in which organizational
learning is becoming ever more important. Nevertheless, as we will show throughout this study, creating
horizontal structures does not eliminate the problems of the organizations, but on the contrary, they
simply exchanged for others.
As a result, smaller, more responsive and more dynamic organizations (learning organizations) arise
with staff who assume more responsibility and, therefore, are more committed to the goals of the firm
(loyalty). Firms are more customers satisfaction oriented, with special emphasis given to processes
rather than functions, focused on the analysis of the value given to the customer by each of the activities.
On the other hand, new trends in the organization of the firm tend to blur its limits when developing
structures bases on strategic flexibility and on co-operation between competitors, while at the same time
continuing to compete in the traditional way in other fields or sectors of activity. Similarly, technology
has eroded the barriers to co-operation between firms, by permitting easier co-ordination of the activities
of organizations which work together, reducing the transaction costs, especially in customer-supplier
As a result in some cases, internalization of activities by firms makes less sense, often resulting in a
process of spinning off organizational units and causing a reduction in size of the firms resulting in
smaller, more rationalized organizations, i.e. a learning organizations, with a variety of co-operation and
outsourcing agreements with other firms.1
The process of down-sizing organizations, which occurred mainly during the period of economic crisis
in the early 1990's, put special emphasis on the areas of cost reductions, concentrating primarily on staff
reduction and process re-engineering (Hammer and Champy,1993) with the aim of re-directing activities
towards the customer.
Since the mid-80's, the so-called Theory of Resources and Capabilities has gained increasing importance
in strategic management (Giget, 1984 and 1986; Grant, 1991 and 1992; Peteraf,1993; Prahalad and
Hamel, 1990 and 1994; Penrose, 1958; Selznick, 1957; Wernerfelt, 1984). One of the fundamental
concepts of this trend is that of core competence. In its most recent form, it consists of three inter-related
factors (Bueno, Morcillo and Rodríguez, 1995, pp.3).:
-intent, what the organization wants to do in response to their future strategic vision of the business.
-know-how, what the firm knows how to do as a result of accumulated experience derived for internal
as well specific external sources.
-capabilities, what the firm is able to do based on the professional skills and abilities it possesses.
Management by competences consists in identifying what the firm knows how to do best (with respect
to its competitors) based on its key organizational capacities and concentrate on preforming these
A flexible structure would be, for example, the so-called Irish Shamrock, proposed by Handy (1989)
activities. Starting from Porter's concept of the chain of value, each of the core and support activities of
the organization are analyzed to determine those which generate low value or do not create core
competence and which can be performed by other companies through contractual agreements or by
means of a co-operative process (Bueno, 1996, p.233). It may even be assumed that each firm competes
not only with its direct competitors, but with all its possible suppliers for each activity in its chain of
value. Therefore, if an internal activity of the firm can be carried out more efficiently by a supplier, it
may be preferable to sub-contract the activity and concentrate on those at which it is more efficient. In
practice, therefore, the firm may analyze each task that it performs and concentrate on its core
competence and critical strengths.
Concentration by the firm in developing its core competence makes it worthwhile to co-operate with
other firms to perform its non-basic activities (strategic outsourcing). As shown in Figure 1., the
outsourcing process begins with the external sub-contracting of simple activities for which there are
many suppliers, such as, security and building maintenance. Later, sub-contracting can de done of more
strategic activities which require a closer relationship with the supplier, such as, logistics, distrubution
and even product design. At the limit is the concept of the virtual corporation where the firm offering
the product to the customer is perceived as a single highly-integrated company, when in reality it is an
organization formed by multiple companies involved in the production of specific goods or services.
Each of the companies focuses on its core competence and takes part in some of the necessary phases to
produce a final product which meets the needs of the customer. Thus, maximum efficiency is achieved
as each task in the chain of value is carried out by a specialist in that area.
FIGURE 1.- THE EVOLUTION OF OUTSOURCING
PROXIMITY TO PRODUCT
DESIGN DE FINANCE
LYBRARY INFORMATION SYSTEMS
Source: Arthur Andersen, EIU (1995)
In the following sections we will make a detailed study of the characteristics that outsourcing exhibits in
this process leading to the virtualization of the firm, and the internal and external problems associated
with its implementation.
3. OUTSOURCING: CONCEPT AND PROCESS
There are two basic types of outsourcing:
a) The first type is defined as the process by which a task or activity traditionally performed within the
firm is transfer out to an external supplier.
b) The second type, used more in practice and which may cause confusion, defines the process as any
activity carried out outside the firm regardless of whether this activity had previously been carried out
by the firm.
Nevertheless, and independent of the interpretation that is adopted, one must keep in mind that the
process of outsourcing is not a mere service of classical sub-contracting, but implies a much deeper
relationship between the client and the supplier. Outsourcing is a long-term link tied to the performance
of certain essential tasks by specialists -but not in the area of its core competences- who over time
become strategic partners.
For the relationship to work efficiently, both organizations must accept the fact that each one has to
share with the other certain strategic decisions. The financial remuneration received by the supplier may
even depend on the results obtained, in such a way that both share in the risks and the profits of their co-
operation. The fundamental characteristic which differentiates tactical outsourcing (or merely sub-
contracting) from strategic outsourcing is the establishment of a co-operative relationship which grows
proportionally with the interrelationship between the externalized function and the rest of the business
process. However, in practice, it is not always easy to identify the boundary between sub-contracting
and strategic outsourcing2.
In parallel with outsourcing, and also in response to the need to modernize organizations, the concept of
re-engineering has emerged. Both concepts may be considered instruments to use in response to the
rapid changes in the business environment, with the aim of obtaining a clear improvement not only in
one's competitive position but also in business profits through the management of business processes.
Re-engineering is a radical internal re-structuring; while outsourcing is co-operation with external
suppliers. According to Rueda and Molina (1995), the difference between these two terms from a
conceptual point of view is to be found more in the temporal environment and the ability to control
resources than in the content (see Figure 2.).
FIGURE 2. EVOLUTION OF CO-OPERATION MODELS
COOPERATION MODELS TRENDS
RESOURCES erna strategic
external filiation OUTSOURCING
with a partner
Source: Rueda y Molina (1995) CAPABILITY & FLEXIBILITY
TO REACH THE OBJECTIVES
From here on, the term outsourcing will be used exclusively to mean strategic outsourcing.
3.1.1. SOME DATA ON THE USE OF OUTSOURCING
No precise data exists which would permit us to accurately quantify the volume of economic activity
that outsourcing operations have reached, nor the sectors nor principal activities in which it is being
used. Nevertheless, a few studies and some partial estimates permit us to see the main trends. An
empirical study published in the Economist Intelligence Unit in co-operation with Arthur Andersen
(1995) contains the conclusions of a survey of 303 senior executives from global businesses throughout
North America and Europe. The results (see Figure 3.) show that outsourcing is widely used in an
extensive range of activities by major American and European companies, especially the later.
FIGURE 3. A COMPARISON OF OUTSOURCING IN EUROPE AND NORTH AMERICA
TRANSPORTION & SHIPPING 24%
North-America Source: EIU (1995)
It is worth pointing out that in the telecommunications sector, the objective of the large consortiums
which are being formed is to externally manage the communications of the major companies in the
world. CONCERT, a global company formed by BCT and MCI, estimates that the outsourcing services
in the sector today represent a $69,000m. business and that this figure will reach $156,000m. by the year
Meanwhile in the financial sector, a study done at a world level by Ernst & Young (1995) shows that the
evolution of outsourcing has not only stablized, but that its rate of growth is quite high (see Figure 4.).
FIGURE 4. THE EVOLUTION OF OUTSOURCING IN FINANCIAL INSTITUTIONS
CREDIT CARD RETAIL RETAIL LOCKBOX
CHEQUE PROCESSING TREATEMENT
Fuente: Ernst & Young (1995) ATM DRIVING & SWITCHING
Por su parte, EDS, principal proveedor mundial de servicios informáticos con más de un 25%
del EDS, the world's leading supplier of data processing services with more than a 25% share of the
market, estimated that in 1995 the European outsourcing market for computer services was $250,000m.,
which represents 6% of total expenditures in Europe on computer services. In Spain where outsourcing
is not so extensive, expenditures are estimated to be about $540m., 2.7% of total expenditures for all
computer services. However, it should be pointed out that the outsourcing contract recently signed by
LA CAIXA with the same EDS could reach a value of $1,000m. over its 10-year life. EDS is presently
negotiating a similar agreement with CAJAMADRID. In addition, Banco Urquijo announced a 10-year
contract with IBM ISS valued at an estimated 10,000m.Pta.
The CRANFIELD project3 shows that 41% of the Spanish companies surveyed, which represent a
variety of sectors of activity, have increased their use of sub-contracting in the last three years. This
conscious decision by businessmen confirms the great future to be seen in this activity. In 1995, 72% of
companies used sub-contracting to a greater or lesser extent. Forecasts indicate a continuation, if not an
acceleration, of this trend, which is appearing in the rest of Europe as well.
3.1.2. ADVANTAGES AND DISADVANTAGES OF OUTSOURCING
Many papers on outsourcing are to be found in the literature. They make reference to the advantages and
disadvantage associated with the use of outsourcing. Nevertheless, we believe it is advisable to divide
them into two basic categories: advantages and disadvantages of a strategic nature and those of an
operational nature (see Figure 5.). This classification will permit us to simplify our study of them and to
obtain some empirical evidence of businessmen´s reaction to them.
FIGURE 5. THE ADVANTAGES AND DISADVANTAGES OF OUTSOURCING
STRATEGIC OPERATIONAL STRATEGIC OPERATIONAL
Competitive Eficiency Lost of Contract problems
advantages increase control with supplier
Reduction of further
Risks labor cost increase of Problems with
reduction cost internal
Cost reduction in the Different resources
long term quality to
Organizational final consumer
Source: Own elaboration
Annual report leaded by ESADE and by Formación Continuada Les Heures of Universidad de Barcelona which studies
trends in the Strategic Management in Human Resources in Europe.
a) Generating competitive advantages:
The use of outsourcing in a specific activity does not necessarily mean a competitive advantage will be
gained in that activity, even though it is being performed in the most efficient manner by a specialist. As
the specialist may be supplying the same service to a number of competitors and all things being equal,
every user of the service essentially maintains its same relative competitive position. The basic
advantage of outsourcing is that it allows managers to concentrate on the core areas of their business
giving them more time for key activities and freeing human, capital and management resources to be
focused on activities which form the basis of their business. The following are some of the main
competitive advantages to be obtained:
a.1) the formation of barriers to entry, as a direct result of developing core competences.
a.2) the quickest access to autonomous innovation (Chesbrough and Teece, 1996), that is, innovation which can be
introduced independently of other innovations. The supplier, in the capacity of a technological partner, may be able to
provide innovation more quickly that the firm could develop it itself resulting in shorter development times, quicker
response times, greater flexibility and better quality of service.
b) The cost reductions basically obtained through:
b.1) an extensive utilization of investment, innovation and abilities of the external suppliers of outsourcing that cannot be
duplicated internally (or if they can, at a much higher cost).
b.2) a modification of the cost structure, reducing fixed costs and making variable costs more predictable. There is a
reduction in the fixed costs of maintaining capital assets and their associated labor costs.
c) Risk reduction:
c.1) with rapidly changing technologies and markets, the joint strategy presupposed by the use of the process of
outsourcing reduces risks, shortens life cycles, reduces investment requirements and allows better response to final
c.2)in addition to the above, part of the risk that the customer assumes is transferred to the supplier, since he now also has
an investment. For example, Gallo, a major producer and distributor of wines in the United States, purchases most of its
grapes from outside sources, shifting to its suppliers the cost of land, labor problems and the risks associated with the
weather (Quinn and Hilmer, 1995, p.66).
d) Finally, outsourcing increases the organizational flexibility which allows the firm to design a smaller
more responsive organization, which is able to react more quickly to the changing business environment,
as well as providing easier access to the resources and experts needed for growth.
a) Firstly, an increase in performance of the factors used can be obtained since they are managed by
specialists in each activity.
b) Furthermore, reductions in permanent staff can be achieved. (Depending on the specific legislation in each
country, outsourcing may be a way of achieving greater staff flexibility).
In spite of the supposed strategic advantages emphasized by the theory; in various empirical studies (i.e.
Oraa, 1994), it can be observed that the advantages perceived by the client as a consequence of
outsourcing paradoxically are more related to operational than strategic considerations (see Figure 6.).
FIGURE 6. THE ADVANTAGES PERCEIVED BY THE CLIENTS
15 strategic advantages
To decrease the management upon information systems No-one
To improve the efficiency of the system
To decrease cost To develop core competences
Various To decrease time for implementation
Source: Adapted from Oraa, J. (1994) & our own elaboration
Among the disadvantages perceived by the customer it is worth mentioning the following:
a) Lose of Control
a.1) Relinquishing certain internal activities may result in the lose of company know-how and a valuable source of learn-
a.2) Creating excessive dependance on suppliers.
a.3) Transferring confidential customer firm information may enable a supplier to become a competitor in the future.
b) Possible Cost Increases
b.1) Costs may be higher than originally estimated. A supplier on which the firm is dependent may exact over time ever
increasing compensation specially for those activities for which there are few alternate supplier or where changing
supplier would be extremely costly.
c) Variations in Quality Given to the Final Consumer
c.1) There is a risk that the quality of goods and/or services provided by the supplier does not meet initial expectations
resulting in the final consumer being adversely affected.
a) Contractual Problems
a.1) It is not feasible to identify all potential contingencies and all but impossible to accurately estimate the probability of
an identifiable contingency occurring. Contingencies of either type could significantly alter the projected cost estimates.
a.2) Renegotiating and monitoring the contracts may be complicated and costly.
b) Staff Reduction Problems
3.2 THE PROCESS OF OUTSOURCING
According to the study done by Arthur Andersen in conjunction with The Economist, there are five
stages in the process of outsourcing4:
THE PROCESS OF OUTSOURCING
1.-The identification of the core competences
2.-The evaluating of opportunities
3.-The choice of the suppliers
4.-The organization and management of the process
5.-The control and evaluation of performance
Taking this five-stage process as tested and approved5 , we will proceed to analyze it in further depth.
3.2.1. IDENTIFICATION OF CORE COMPETENCES
One of the main problems in all processes of outsourcing is that of determining which competences are
key to the firm. As stated before, and following the lead of various authors, we can go on to identify the
key competences, thus getting a clear and realistic view of the activities which truly have a strategic
nature for any organization. Furthermore, it should be pointed out that this analysis should be as
objective as possible, keeping in mind that employees at whatever level of the organization always
consider their activity to be basic and essential to the firm.
Therefore, the best way to formulate strategies for the future is obtain in-depth knowledge of a small
number of core competences. Starting from this idea, theoretically, firms could delegate to external
outsourcings all those functions in which they have decided not to develop these core competences,
transferring said functions to other specialized organizations (see Figure 7.).
FIGURE 7. DECISION-MAKING ON OUTSOURCING
core non core
Source: Own elaboration
However, it should be kept in mind that outsourcing is not the only available alternative. A study should
be make of the various options and an examination done of improvements which could be implemented
internal at low cost before opting to sub-contract out the activity.
New Directions in Finance. Strategic Outsourcing. The Economist Intelligence Unit. Written in co-operation with Arthur
We think that we are dealing with a universally valid process since it is based on the stages of the scientific method.
There is not doubt that the process of outsourcing has been used most intensively in the area of
information technology. For this reason according to Alarcón (1992, p.83), the firm itself should analyze
its present situation with respect to the following criteria:
a) What functions are presently being carried out by the IT?
b) What are the minor tasks that have been integrated into the department and are not part of its basic function?
c) What is its real cost?
d) How is it structured and how does it operate?
e) What is present staff size, how is it made up, and what are their real capabilities, especially older personnel?
f) What is the volume of data processing done outside the department proper and what relationship does it have with the
g) How efficient is the department itself?
h) How effective is company control over the department?
Recently, the incentive to use outsourcing has spread to other functional areas, especially the financial
function. The most striking case of financial outsourcing is, without a doubt, the recent agreement
between Sears and Andersen Consulting. This consultant will take over the administration of financial
and accounting operations management for Sears, which is one of the largest department stores and
distribution companies in London. The agreement signed by the two companies has a value of up to
$500m. over the ten-life of the contract and will mean transferring 900 Sears employees to the
Andersen Consulting is presently handling the external operations and has integrated them into the
overall management of the company in such a way that the customer can keep a close eye on the
operation it has transferred without being involved in them. This permits them to focus on other
strategic core areas of their business.
3.2.2. EVALUATION OF OPPORTUNITIES
Measuring the effects of outsourcing on organizations is not easy. All suppliers agree that there are two
complementary approaches to analyzing the effects of implementing the process of outsourcing: the
economic effects and the strategic effects.
Looking at economic benefits, there is a general consensus for the need to use certain analytical
techniques, such as, Cost-Benefit Analysis or Mapping Planning, to determine future cost savings to the
organizations planning to use this type of process. This is the only way that firms are able to decide
whether it is in their interest to externalize some of their non-basic activities. A few cases give a clear
view of the large savings which can be obtained by using the process of outsourcing. British Petroleum
Exploration, one of the major users of outsourcing, has managed to reduce its exploration costs by
approximately 30% (Cross, 1995).
Nevertheless, it is important to realize that the main source of advantages from outsourcing is not to be
derived for the most part from future cost savings. The advantages come rather by making more time
available for other types of strategic decision-making, which logically have an impact on improving the
competitiveness of the firm in the future. This was the belief of 18% of the executives surveyed in the
case of firms with a moderate growth rate. This percentage increases to 31% when executives from
firms with high growth rates were surveyed (EIU, 1995).
Along with economic advantages, all the suppliers emphasized the strategic benefits to be gained from
using outsourcing, which furthermore they considered to be the most important, because the
organization is freed of tasks which take time away from activities that truly generate added value within
As empirical evidence we show some cases of a variety of organizations which have already adopted the
process of outsourcing. They are summarized in Table 1. which appears below.
FIRM PROCESS OF OUTSOURCING IMPLEMENTED
GENERAL *Process of outsourcing of the information technology system
It went from having an over-sized department incurring large expenditures to using an external
supplier who extended better service with and better quality at lower cost. To accomplish this,
it bought Electronic Data Systems (EDS) which at that time was the market leader in computer
software services in the United States. Now, after being spinned off by GM, it is the world's
leading supplier of computer services.
BRITISH *First used outsourcing in the area of information technology
PETROLEUM (IT) and later extended its use to financial administration systems
B.P.X. Mr. Goodwall, Chief of Staff, Exploration Europe, summaries the B.P.X. results as follows:"In
1990, we were around 8,500 people, figuring we needed about $25 a barrel to make a living,
today we are around 2,800, and we are delivering a 30% return at $14. The reason for this great
success is that the company is now highly focused on its core business processes. Outsourcing
is one means to aid that focus." (Arthur Andersen, EIU, 1995).
MICROSOFT *Processes of outsourcing in a wide range of areas from catering and
maintenance to production and distribution
The sub-contractors have, in fact, become a very important part of the model? of the business.
A.C. *Process of outsourcing almost all its activities
What was in the beginning a very flexible and successful company, with time began to have
A manufacturing and problems, as a result of numerous customer complaints about quality and late deliveries. The
distribution company of extent of these problems forced it to reconsider its entire system of outsourcing and to carry out
bicycle tubes and tires the operations internally in order to have greater control.
I.B.M. *Processes of outsourcing the hardware, software and distribution
It was able to drastically reduce investment and the time required to enter the market. Four
years after its implementation it was the world leader, overtaking by a wide margin Apple, the
pioneer in the sector?. It had gained a 41% market share and was the standard setter in the
industry. However, those same factors which brought it success (the use of outsourcing) have
been the cause of its later? more recent problems. As a result of yielding so many activities to
suppliers, it found it difficult to maintain its competitive advantage, because there was
insufficient back-up in key activities controlled by IBM. As a result IBM today has only 7.3%
of the market, behind the new market leader COMPAQ, which currently has 10.5% of the
market. Furthermore, the largest part of the profits earned in this market have gone to its
suppliers firms, such as Intel and Microsoft, who in realty are those who have controlled its
investment? (Chesbrough and Teece, 1996,p.68).
3.2.3. CHOICE OF A SUPPLIER
If an evaluation of the practical value of implementing a process of outsourcing gives a positive result,
we need to look at the second step of the process of outsourcing, which is that of choosing a supplier.
Because of the specific nature of the process of outsourcing (the transfer of confidential information, the
delegation of responsibility, the lose of control of one's activities, the length of the contracts, etc.), the
choice of a supplier will be a conditioning factor within the firm for a long period of time. Therefore, the
extent of the gains to be realized will depend to a great degree on the ability of one's supplier to fulfill
his commitment. It should not be forgotten that all suppliers do not deliver the same level of quality
when offering their services. Many of them overly depend on a transfer of "human assets" from the
customer firm in order efficiently carry out this process.
However, the attributes of the supplier will vary as a function of the type of activity subject to the
process of outsourcing. In the extreme, an organization can find two basic types of tasks suitable for the
use of outsourcing which will determine the kind of relationship with supplier.
Simple process Complex process
Non-basic activity (functional) Basic activities (quasi-strategic)
Weak relationship with the supplier Strong relationship with the supplier
As for the simple type, any organization should be capable of outlining a basic process of outsourcing at
the first preliminary stage. In the case of the complex, the organization needs the services of a supplier-
consultant to help in the planning and development of the whole process. Because of the low cost of this
type of service, it is recommended that organizations consult with a supplier-consultant who has more
time, ability and experience to assist in this task, which otherwise may prove to be rather complicated.
Furthermore, supplier-consultant rarely have high fees for this preliminary service, since they expect to
earn significantly higher profits with the implementation of the process of outsourcing.
3.2.4. ORGANIZATION AND MANAGEMENT OF THE PROCESS
After the process of choosing a suitable supplier, the only thing remaining to do is to start the transition
to outsourcing. This is not an easy task. The great challenge facing the organization that of ensuring that
all goes forward in the most efficient manner possible. This objective can be met only if the organization
pays special attention not just to the technical aspects of outsourcing, but also more importantly to the
human aspect. In both these areas, it is important to be able to rely on an experienced supplier.
With respect to the technical aspects, as we mentioned earlier, it is essential to conduct the range of
analyses to determine the future profitability of the project. On the other hand, it is obvious that impact
on the personnel in the organization will be of a broad, varied and, not always, desireable nature. Many
of the employees in the organization will be affected in one way or another as a result of implementing
the process of outsourcing. Some of those affected will stay within the organization and even may
improve the quality of their work, other will transfer to work for the supplier of outsourcing, and the
least fortunate may not even be re-trainable for work with other employers.
3.2.5. MANAGEMENT AND EVALUATION OF THE GROWTH? OF THE PROCESS OF
Signing the contract and implementing the process does not end, the relationship between the supplier
and the customer. This is precisely when process of evaluation and control of results should commence
to ascertain how well stated objectives are being met. In spite of this, many customers of outsourcing do
not know how to proceed with this phase, although it is just as important as the rest.
There are two fundamental points which should be monitored after the signing of the outsourcing
contract: the economic and the professional perspective.
A) From an economic point of view, several aspects should be examined:
1.) On the one hand, cost saving should closely reflect the forecast estimates of the initial stages of the
study produced by the supplier (except for major contingencies). If no strict controls are in place, it may
permit unjustified deviations in the service provided by the supplier.
2.) Furthermore, if the customer firm foresees that there may be future contingencies regardless of their
nature, the supplier should be required to include in the contract clauses clearly stating the costs which
will be incurred if these contingencies should arise.
B.) From a professional standpoint, the customer should make certain that the supplier is providing the
same standard of service as is specified in the contract. By so doing, the customer firm will ensure a
minimum level of quality of service from the supplier for the final consumer.
In the following section, we will make a more in-depth analysis of the complexity which the process of
outsourcing presents to an organization implementing it.
4. PROBLEMS OF OUTSOURCING
The main advantages of outsourcing are based on the importance of the firm concentrating its efforts on
the maintenance and development of its core competences, which today is a universal business concept.
In this manner, the structure of the firm is freed from those of its activities which are carried out by
external specialists, while leaving a small responsive organization to focus on those activities which
maintain its nucleus of competences.
In theory, this is the fundamental reason put forward in the current literature and by the firms using
outsourcing and the supplier firms.
This theoretical approach does not reflect, however, the importance of the problems arising from the
practical application of outsourcing. Although the philosophy of the firms advocating the use of
outsourcing is that of concentrating on their core competences, in practice often the main advantage
obtained is from its use as a tool to get around rigidities imposed by labor laws in many countries and
thus to acquire greater flexibility in the area of human resources and to gain short-term cost savings.
These problems associated with the process of outsourcing can be analyzed from two angles, the
external, fundamentally to be found in the relationship with the suppliers and the internal, associated
with the possible repercussions on the human resources of the organization.
4.1 EXTERNAL PROBLEMS
Theoretically, the best system for economic relationships is the market. In our case, it is the supplier-
customer relationship resulting from the use of outsourcing. So that, this is the firm's justification for
externalizing all activities except those in which the firm has a competitive advantage and as such is
beneficial to keep them internalized. In practice, however, there are market utilization costs, so-called
transaction costs which make its use costly. The search, the negotiations, the drawing up of contracts,
and afterwards the administration, monitoring and the control procedures of the contract are among
In many cases, the existence of these costs can justify carrying out the activity within the firm, in spite
of whatever economic reasons there may be for sub-contracting it. The question which this poses is not
new in the business economics. What is it today that makes market costs, including transaction costs,
generally lower than the co-ordination costs of an activity performed within the firm?
The basic reasons from our point of view are, on the one hand, the dynamics of technological changes
which require earlier investment in capital goods increasing the internal development costs to a degree
which may be difficult to assume for those organizations whose main activity is in another strategic
field. On the other hand, the use of the new information technologies makes co-ordination between
firms easier, gradually reducing costs and associated difficulties. In many cases, it is not only a cost
problem, but the fact of greater competitive pressure which forces the firm to develop alliances and co-
operative relationships in order to be able to meet the changes in the marketplace. Experience gained
through these relationships lets a firm establish new co-operation relationships such as outsourcing. In
this case, the lasting nature of the relationship involved in outsourcing means that the transaction is not
just arm’s length, and therefore, there is increased interest in co-operation in search of not, only short-
term, but also long-term gains.
In spite of these reasons, we believe that the costs and risks associated with the relationship between the
firm and the supplier become one of the principle problems posed by outsourcing. More specifically,
one must take into account a series of difficulties related to the nature of the suppliers, the consequences
of the established relationship and the limitations of the contract.
4.1.1. NATURE OF THE SUPPLIER
The prime supporters of the concept of outsourcing are the suppliers themselves, who in practice are
basically the seven consultants. Along this line, we think that one should be aware of the contradiction
that exist in the supplier-consultant extolling the virtues of a lean flexible organizations with a reduced
staff, while they increase theirs by absorbing personnel of the customer through the outsourcing con-
tract, creating their own structures which in the long-run will be less flexible and more costly. An impor-
tant question is what happens to the transferred worker when the agreement ends. This is especially
critical if the life of the contract is not very long and the customer decides not to renew the contract , to
change supplier or to revert to its original structure, i.e. re-internalize the activity.
On the other hand, it is understood by the very nature of outsourcing that the firm is limited in its choice
of suppliers. The idea is to choose a supplier of the highest trust and professional reputation who will be
a long-term partner of the organization.
4.1.2 CONSEQUENCES OF ESTABLISHED RELATIONSHIPS
A long-term, close relationship, in practice, can present the same rigidities and disadvantages as carrying
out the activity within the firm and lacks the flexibility of market relationships. On the other hand, if the
contract is very open and short-term, it is difficult to create a relationship of mutual trust which could
lead to co-operative gains.
In continuation, we feel it possible to outline some specific problems:
- An overly-dependent relationship may be created which firmly ties the firm to the supplier, resulting in
exorbitant cost increases, reductions in quality and acceptance of out-dated technology. As we will
illustrate below, these problems can be averted by anticipating them in the contract.
- On occasion, competences not considered basic may contain information of a confidential nature. This
type information when transferred from customer to supplier may be leaked and so facilitate entry of
new competitors including the outsourcing supplier. Guarding the confidentiality of information
provided to the supplier may present additional costs in the short term which may have a negative
impact on total savings, or safe-guarding it may simply not be possible. In reality, the theoretical
evolution of the process of outsourcing should take the opposite direction, producing an interdependent
relationship which grows over the life of the contract. Trust in the supplier can only be achieved through
a stable continuous relationship during which his ethics and professional ability can be ascertained.
- If a firm transfers an activity, and therefore, loses current know-how, it may be unable assess the cost
and the quality of the services provided. Furthermore, the organization should be aware of the
technological setback it would face if it were forced to re-internalize an activity at a future date.
For activities which have been externalized, it is essential for the firm to maintain staff capable of
monitoring and controlling these activities. To assist in carrying out these supplier control functions, the
customer should use a process of benchmarking to compare costs and service received with those
provided by "best in class" and to demand the same performance from its supplier.
4.1.3. CONTRACT LIMITATIONS
Some of the above-mentioned problems, arising from the supplier-customer relationship, can be averted
by drawing up a detailed contract which deals with any foreseeable contingencies (EIU, 1995).
Contracts can require the supplier to meet minimum standard with respect to dynamism,
competitiveness, efficiency, state-of-the-art technology and consumer orientation. Contracts of this type
should include the following types of clauses:
- contract extensions conditioned on an exhaustive analysis of the service provided in the first years of
the relationship between the customer and the supplier.
- escape clauses applicable in the first months of the contract if the supplier does not meet set goals.
- a reduction in costs to the firm after the supplier has amortized its initial investment.
However, what suppliers may not appreciate is that the contract, although important, cannot encompass
everything. A co-operative relationship based on mutual trust and interests is difficult to maintain, but
which nevertheless today is a necessity in the competitive environment in many sectors.
These relationships of trust can be stimulated according to the nature of the suppliers, who are normally
consultants. They are interested in maintaining their reputation in order to ensure the extension of their
outsourcing contracts and to increase their goodwill in order to gain new contracts.
All the risks of the relationship with suppliers are the traditional justification for internalizing activities.
Therefore, we think that outsourcers must be tightly controlled to make establishing an outsourcing
relationship worthwhile. As a result, the closer the activity is to the nucleus of competence, the greater
the care which must be exercised in choosing and controlling a supplier.
4.2. INTERNAL PROBLEMS
From an internal point of view, the main problem is the relationship with the employees, because
outsourcing normally results in a reduction in staff. However, it is very possible that one of the greatest
advantages that the firm sees in outsourcing is the formation of new labor relationships in an
environment highly regulated and characterized by trade union inflexibility. As a matter of fact, there is
a greater propensity to use the process of outsourcing in Europe than in the United States, because of
stricter European labor laws (see the survey in Figure 2.).
The present trend to downsize organizations has produced major changes in labor relations of firms,
especially in the area of job responsibility. The old idea that a job was a means of earning a living in
exchange for eight hours of work, where the worker saw no relationship between his performance and
the financial results of the firm, is currently disappearing. A growing number of workers are being hired
on a short-term basis, with the renewal of their contracts dependent on their performance. Furthermore,
workers with tenure contracts have seen their wage structure modified paying them on the basis of
performance. Nevertheless, labor laws in many countries do not give firms the staff flexibility that they
From this perspective, we should ask ourselves if the present model of outsourcing does not represent a
phenomenon of opportunity where current legislation is being liberalized to meet the needs of firms
which require more flexible organizations and more professional and more motivated employees. Thus,
we perceive that outsourcing can be used by firms as a simple tool to free themselves of permanent
employees by transferring them to the outsourcing firm, which can enter into a less binding relationship
with them and if necessary in the medium-term lay them off at low cost.
Certain cases, as observed in the multinational IBM, seem to point to the fact that outsourcing is used to
reduce staff and eliminate fixed costs. In Spain, as in other countries, depending on the labor laws and
the strength of the trade unions, multinationals have used an indirect approach to obtain staff flexibility.
Affected personnel have been at the intermediate or senior level of the labor pyramid, generally in the
over-fifty age group. Termination of employment is negotiated, with compensation decided in the
courts, breaking all ties with the firm and giving the ex-employee the right to unemployment benefits.
However, at the same time, they contract some of these employees on an individual basis as free-lance
employees in a service company called Skillbase, S.A., whose main activity consists of sub-contracted
work from IBM, which is part owner. In this way, former senior employees, now outside the structure of
IBM, continue working, but on Skillbase, S.A. projects, in the same office with the same secretaries as
before, but now in the capacity of employees of the outsourcing company. Thus, IBM continues to
utilize the know-how of these senior employees in on-going projects without any future commitment to
them. At the same time, junior staff is being trained, but in a much smaller and more flexible personnel
For us, it appears clear that the implementation of outsourcing, regardless of the objective being sought,
obviously causes major problems with the personnel affected, which may reach such magnitudes that
the firm may have to reconsider its decision. There is even talk of insourcing, as in the case of
Volkswagen, which is considering once again internalizing operations that had been externalized as a
result of offers from their own workers competitive with those of external suppliers.
In fact, when an activity traditionally carried out in the firm is externalized, the workers in that area lose
their reason for being. As a result, there is a re-organization of the affected staff in which they may be
given a new position in the firm, they may be transferred to another company, or they may even lose
their jobs. Every firms solve the problem of surplus staff differently. Nevertheless, the effects on the
workers of outsourcing an activity can be grouped as follows:
1.- Remain in the customer firm in the same area of activity.
2.- Remain in the customer firm in a different department, area, or function.
3.- Transfer to the supplier company.
4.- Take part in an outplacement program.
5.- Be laid-off, normally with an incentive plan.
Of these alternatives, usually the greatest percentage is represented by those workers transferred to the
supplier company, especially if happens to be a large firm, as was the case with Sears.
Joining a new company may be viewed by the workers as an opportunity to be part of a major company,
whose main activity is related to their area of expertise. On the other hand, it may be accompanied by a
feeling of insecurity and worry about their future.
This brings up the question of loyalty to the original company, just as much for the transferred workers
as for those who remain. The first group will probably continue providing service to their old firm
through the sub-contractor. The usual and necessary practice of integrating staff and managers from the
customer firm into the supplier company can be especially beneficial to the customer firm if during the
transition process a sense of continuing loyalty can be instilled in the transferred employees. On the
other hand, there may be motivational problems if the process if carried out against the will of these
Whatever the case, they will have to go through a process of adaptation to their new employer. This
means becoming accustomed to a new culture, new work procedures, and different financial conditions.
If the transferred employee does not adapt to the new organization, failure is almost assured. However,
the new employer and the new employee need each other. Therefore, it is advisable to set up a period of
dialogue in which to exchange experience and discuss work procedures. Dialogue of this type can be
mutually beneficial by heightening the level of understanding of both parties.
Likewise, the moral of the workers who remain behind may also be affected as they become aware of
the uncertainty of keeping their jobs. Nevertheless, if the process of outsourcing causes no trauma and is
well accepted by the workers, the latter, on seeing themselves freed from performing non-basic activities
in the firm, may improved their quality of work, and better using their work time resulting in improved
competitiveness for the firm and in greater job satisfaction for the workers.
In conclusion, the ability of the organization to handle the staff affected directly or indirectly in the
transition of externalizing the activity will be the determining factor in the success or failure of
outsourcing. Therefore, firms involved in changes of this nature should be aware of the importance of
human resources in order to minimize the risks arising from a poorly managed change.
The majority, if not all of those involved one way or another in these processes, agree that there should
be an involvement of human resources in the transition process, with a process of communication
between workers and management. However, there is no consensus on the level, timing or duration of
this communication process.
Thus, while some managers feel that members of the organization should be informed from the
beginning of what is occurring and where it will lead to; while, others are of the opposite opinion stating
that a firm planning to externalize certain activities should put off as long as possible giving out
information with regard to their future plans in this area.
The advantages of communicating with all levels of the organization are derived from the benefits
produced by having a better climate of consensus which will ease the transition. Thus, the feelings of
anxiety which may be caused by a lack of information or by a flood of rumors, can be minimized. On
the other hand, the disadvantages of an over-abundance of information are centered on later problems
which might occur when affected personnel resort to sabotage by distorting and altering the process of
analysis undermining the reliability of the final results.
According to Grover Wray6, it is preferable to restrict information related to the process of outsourcing
to a small number of staff. His reasoning is that if the firm decides not to proceed with outsourcing the
firm's image will not be damaged in the eyes of its employees. In summary, it is wise to be prudent with
respect to future strategies, so as not upset the smooth functioning of the organization.
The contemporary relationship of firms to their business surroundings are conditioned by the changes in
technology and the economic environment. Firms face these alterations to their surroundings by making
qualitative change in the way that they perform their activities and structure their organization. In this
respect, the key concept is that of flexibility, defined as the premise of rapid adaptation to any kind of
change in demand so as to maintain and expand the competitive position of the firm. The new
organizational models integrate this flexibility through mechanisms such as outsourcing, which give rise
the existence of new organizational such as the " Irish shamrpock" model proposed by Handy.
The trend towards virtual corporations based on the relationship of co-operation among several firms
starts with the identification and exploitation of the concept of core competences, in such a way that
new advantages are obtained from specialization and that the customer receives added value superior to
the levels previously offered.
Strategic outsourcing is at the center of the process of organizational change tending towards the
flexibility of the business structure. In this respect, these processes may be preceded by radical changes
which lay the ground work for process re-engineering.
Outsourcing has a series of advantages and disadvantages, which can be divide for analytical purposes
into those of a strategic and of an operational nature. The main strategic advantages are the creation of
competitive advantages, the reduction of risks, an improved long-term cost structure and an increase in
organizational flexibility. In summary then, from a strategic standpoint, outsourcing allows the firm to
concentrate its efforts on consolidating and expanding its core competences. On the other hand, among
the operational advantages, we find an increase in efficiency as a result of activities being carried out by
specialized firms and reductions in permanent staff, which then become variable costs related to the
level of activity.
As for the disadvantages of a strategic nature, the most important are the lose of control of activity done
through outsourcing, the transfer of sensitive information, the possibility of exorbitant price increases
by the supplier at a future date, along with fluctuations in quality. The operational problems we have
observed are difficulties related the making of the contract and arising from the effects on human
Nevertheless, we think that from a practical point of view, the problems associated with outsourcing can
be studied from an external perspective (found basically in the relationship the customer of outsourcing
has with its supplier) and an internal one (staff repercussions).
The main points of interest in the external area are related to the nature of the supplier -they are mainly
large consulting firms who offer outsourcing as one of their many services- consequences of the
established relationships (with the contradiction between an extremely detailed relationship which could
lead to rigidities similar to those which existed before outsourcing and a looser one which could under-
mine the trust between the two parties), and the limitations inherent in the contract (which to a certain
Director of Human Resources for Contract Services for Arthur Andersen.
extent can be overcome by the desire of the supplier to maintain a level of trust in order to preserve his
reputation in the marketplace).
With respect to problems of an internal nature, we have seen have how certain firms have turned to
outsourcing as a short-term solution to avoiding the rigidities caused by labor laws. These firms may
limit themselves by viewing outsourcing merely as a simple way of freeing themselves of permanent
staff. From this perspective, outsourcing could represent a phenomenon of opportunity, while labor
legislation is being in accordance with the needs of firms for more flexible organizations and more
professional and more motivated workers.
The aspects related to the management of human resources are of crucial importance to the success of
the organization. Therefore, detailed planning is imperative to the process of outsourcing, maintaining
strict secrecy up until the moment that it is decided to put it into effect. From that moment on, a fluid
means of communications must be set up with the staff being affected. This has a multiple objective: to
guarantee the outsourcing of an activity has a smooth transition -identifying practical difficulties and
proposing solutions- to set up and consolidate co-ordinating mechanisms between the customer and the
supplier, to settle the problem of sharing information between organizations, and to maintain those
aspects of the labor climate associated with employee moral.
In summary, outsourcing facilitates the transition to the new flexible organizational models leading to
the virtual corporation using a process which is not free of some uncertainties which affect its conceptu-
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