How to outsource: A decision-making guide for entrepreneurs
Should I outsource or not? All business owners are likely to ask themselves this question at some point. Outsourcing can take many forms and has both pros and cons. One thing is certain: if you decide to move forward with outsourcing, you need expert knowledge on how to go about it.
Here are five questions to demystify outsourcing.
1. What is outsourcing?
Outsourcing is when a company subcontracts part of its operations (e.g., producing a good, completing a manufacturing step or providing a service, such as transportation or payroll processing) to a third party.
Outsourcing often brings to mind moving production to countries like China and Mexico. But you can also outsource a single stage of production, like painting, to a local partner
Rather than investing in their site and expanding upon reaching maximum capacity, some companies outsource their storage needs.
2. What are the advantages of outsourcing?
Outsourcing is prevalent in one form or another because it offers several advantages when resources are limited.
Companies often choose to outsource part of their operations to reduce costs. For example, a part can be produced by a supplier at a more affordable cost than if the company invested to manufacture it in-house. It can also clean up their balance sheet by eliminating assets and stabilizing cash flow.
It’s often a question of volume. If the volume is too low, it’ll be more advantageous to outsource the operation, even if it means bringing it back later, when the volume greater. Whether or not outsourcing is appropriate should always be re-evaluated as the company grows.
Without hard numbers, it’s difficult to determine whether there’s a real benefit to outsourcing.
To determine whether subcontracting is advantageous, you need to know your operating costs and have hard numbers.
Access to expertise
Many companies also choose to outsource because it gives them access to expertise or cutting-edge technology that they do not have or that they do have but in limited capacity.
For example, if a company can’t afford to purchase a very advanced technology, it can still benefit from it by choosing a specialized supplier who uses it. With this specialized expertise, it’s possible to produce a better-quality product, often at a lower cost.
Strategic use of resources
Outsourcing also allows companies to add resources during peak periods or even reserve them for high-value-added tasks. To do this, you need to think about your company’s core mission and whether it is relevant to continue certain operations.
This is the case not only for physical resources, but also for human resources. For example, outsourcing can be a helpful tool in the current labour shortage. You have to ask yourself if you’re deploying your workforce as strategically as possible at a time when it’s so difficult to recruit and retain workers. In addition, outsourcing is a way to help meet one-time or seasonal needs, without the company having to hire employees, with the annual salary and benefits that come with that
Quick market adjustment
Companies may also decide to outsource when the market is moving quickly and they do not have the time to familiarize themselves with a new field in the short term. A good example is the immense popularity of e-commerce and the sudden volume of orders to be processed. To seize these business opportunities, many entrepreneurs decide to turn to outsourcing because they lack the knowledge or the human resources to process and ship their orders.
There is a cost associated with market responsiveness. That is why it can be advantageous to do business with a specialized supplier that can offer a product or service more quickly.
The main advantages of outsourcing
- Cost reduction
- Access to expertise
- Strategic use of resources
- Quick market adjustment
The main disadvantages of outsourcing
- Risk of dependency
- Loss of expertise
- Sharing insider information
3. What are the disadvantages of outsourcing?
Outsourcing is not always the answer, however, and it is important to be aware of the associated risks.
Risk of dependency
Transferring production or a stage of production to another company can create a form of dependency. You also need to avoid spreading yourself too thin by dividing the work among different subcontractors because that could dilute the benefits, like economies of scale, and make management more complicated.
By being aware of the risk of dependency, you can nevertheless protect yourself by signing an agreement with the supplier.
Loss of expertise
Outsourcing an operation also results in a loss of expertise within the company.
The team that used to do the outsourced task is reassigned to other operations. The team can obviously resume that operation later and regain their expertise, but there is always a readjustment period.
Sharing insider information
You need to be aware that, for outsourcing to work well, you must share insider information with your supplier. For example, details of new products will be in the hands of this partner company’s employees.
It is therefore important to take the time to choose a trusted supplier and to include confidentiality clauses in the agreement you sign with them.
4. How to outsource?
After a preliminary analysis, if you decide that outsourcing could be beneficial, the next step is to define the exact work to be outsourced and how this will be done. There are several things to examine to ensure that the process goes well.
Choosing a supplier based on a needs analysis
The choice of supplier should be based on several criteria, not just the best price offered.
- Does the supplier have sufficient experience in your industry?
- Is the supplier able to meet your expectations in terms of quality, turnaround times, reliability, and technology?
- Does the supplier have the flexibility to adapt to your changing needs?
- Does the supplier have the necessary skilled labour to do the job properly?
- Are the supplier’s ethical and environmental practices aligned with yours?
- Will the supplier be able to integrate well into the supply chain?
You have to solicit bids, and it’s recommended that you prepare specifications to make the selection easier. You need to have your list of priority needs in hand and decide, for example, where you’re willing to pay a little more for a higher level of quality. You have to look at the solution as a whole.
Including performance indicators in the agreement
It is perfectly normal to have several expectations regarding the work carried out by your subcontractor, and you must make sure to include them in the agreement signed by both parties.
You can include objectives related to quality, production capacity, stock levels, or delivery times; it all needs to be there. It’s reassuring for both companies to have clear objectives and measures because it avoids misunderstandings.
Partnership: real teamwork
You need to ensure that key stakeholders will invest the necessary information-sharing and collaborative efforts to make outsourcing a success.
To make things easier, why not consider joint training between your and your supplier’s employees? This makes it possible to establish a work methodology.
It may also be a good idea to have your employees connect with your supplier’s employees. Some companies even end up considering their suppliers’ workers as part of their own team, and this dynamic fosters continuous improvement.
Start small and test the waters
Before giving a large amount of work to a subcontractor, it’s better to start with a pilot test and then prepare a transition plan.
Giving a small amount of work to a subcontractor gives everyone the chance to adjust and ensures that everything is running smoothly before you increase quantities.
The golden rule: do not transfer your inefficiency
Companies will generally outsource the part of their operations that is not particularly productive. That is no reason to transfer this inefficiency to a partner, however.
For example, if the pallets you send to your subcontractor are labelled incorrectly and they have to spend an hour sorting them, you’ll pay more for the service. Bear in mind that you will be billed for this lost time, and make sure you work to reduce waste.
5. How does technology facilitate outsourcing?
While managing outsourcing used to be complicated because information was processed manually, technology has greatly simplified and accelerated exchanges. If there is a change to a drawing for a part, for example, the updates can be shared among the different teams, commented on and corrected in real time.
Management systems also provide a wealth of information for monitoring production in real time. It is also possible to access order status and stock levels. This increases efficiency, and it can be reassuring to have access to this information.
It is also recommended that you be transparent with your subcontractor, for example by giving them a solid overview of the work ahead. If you expect a large volume of work, you’ll need to give them time to prepare, invest accordingly and consequently be better able to meet your needs. The more you share the right information, the easier you make life and the more likely you are to avoid mistakes and delays. Everybody wins.
In conclusion, outsourcing is not a magic fix-all, but it can be an interesting option to explore depending on your company’s context and specific objectives.
Optimize your company’s performance
Discover how to identify wasteful practices in your business, set new key performance indicators and build dashboards by downloading our free guide for entrepreneurs: Create a Leaner Business.