Outsourcing Product Business

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LITERATURE REVIEW - Concept of Outsourcing

Outsourcing is subcontracting a process, such as product design or manufacturing, to another company, (Overby, 2007). An outsourcing decision is often made in the interest of cost reduction, or to make more expeditious use of labor, capital, technology and resources. Outsourcing became part of the business term during the 1980s.

According to Okonkwo (2007) outsourcing is contracting with another company or person to do a particular function. In recent times more and more organizations outsource the activities within their company in various ways. Most of the time activities that are regarded as non-core to the business of the company are usually outsourced to other companies. A few reasons company outsource are innovations in technology, economic and competitive pressures for cost reduction. For example, a bank might outsource its cleaning operations to a firm that deals mainly in cleaning and maintenance of organizations' environment, as this kind of activity is not related to the bank's daily activity of servicing customers. These outside firms that provide organizations with outsourcing services are referred to as third-party providers or service providers.

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Outsourcing is a practice that organizations usually engage in, and commonly used in recent times to carry out different functions for organizations and in essence reducing the bulky work load of an organization. Some of the functions that organizations outsource are accounting, payroll. According to Stein (2005), these processes could be done more expeditiously through other companies who have the wherewithal in terms of trained personnels, the facilities required, and therefore save money.

Business process outsourcing according to Stein, (2005) includes human resources, finance and accounting, and customer services. An outsourcing contract usually involves a lot of money and the activities of the service provider are carried out over a long period of time, meaning that outsourcing is a long term agreement. Sometimes firms fish for labor directly on a contract basis to carry out duties for the organization on behalf of the service provider, and therefore become employees of the service provider. Some well known outsourcing service providers in the outsourcing of business and information technology are Accenture, KPMG, IBM and many more.

Some active companies that are short on time and money, such as start-up software publishers, apply multi-sourcing - using both internal and service provider staff - in order to speed up the time to launch. They hire a multitude of outsourcing service providers to handle almost all aspects of a new project, from product design, to software coding, to testing, to localization, and even to marketing and sales.

The process of outsourcing consists mainly of four stages, namely:

  • Contract development: to work out the legal, pricing and service level agreement (SLA) terms.
  • Evaluation and selection: to decide on the appropriate outsourcing projects and potential locations for the work to be carried out.
  • Strategic thinking: to develop the organization's philosophy and knowledge about the role of outsourcing in the activities of the organization.
  • Outsourcing management or governance: to refine the ongoing working relationship between the client and outsourcing service providers.

In most case, the success of outsourcing depends on three main factors which are executive level support of the organization with regards to the activities that they plan to outsource; good and substantial communication amongst the employees that are involved in the outsourcing project; and the organizations ability to manage its service providers properly. The outsourcing professionals in charge of the work on both the client and provider sides need a combination of skills in such areas as negotiation, communication, project management, the ability to understand the terms and conditions of the contracts and service level agreements (SLAs), and, most of all, the willingness to be flexible as changes come into the business.

Concept of Productivity

Productivity is a term that is most commonly talked about by everyone, but still means a series of different things to different people. The meaning of productivity can range from effectiveness to efficiency, to rates of turnover, to output measures, to consumer or client satisfaction, to the intangible things such as job satisfaction, morale, disruption in workflow and loyalty.

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The definition of productivity is very vast and can also be complex because it is a technical and managerial concept. Productivity is term that matters very much to most organizations including government bodies, and social institutions. Productivity is the efficiency with which output is produced by a given set of inputs, which is measured by the ratio of output to the ratio of input. An increase in ratio indicates an increase in productivity. Conversely a decrease in output or input ratio indicates a decline in productivity (L. Scott, 2003)

According to Iyaniwura and Osoba (1983), the least controversial definition of productivity is that it is a quantitative relationship between output and input. This definition is more generally accepted for two related reasons. First, in the context of an enterprise, an industry or an economy the definition has suggested what productivity is. Secondly, regardless of the type of production, economic or political system, this definition of productivity remains the same as long as the basic concept is the relationship between the quantity and quality of goods and services produced and the quantity of resources used to produce them (Oyeranti, 2001).

Oyeranti, (2001) defined productivity as a ratio of some measure of output to some index of input used. In other words, productivity is nothing more than the arithmetic ratio between the amount produced and the amount of any resources used in the course of production. This conception of productivity goes to imply that it can indeed be perceived as the output per unit input or the efficiency with which resources are utilized (Samuelson and Nordhaus, in Oyeranti, 2001).

Changes in current economic situations such as dynamic markets, constantly changing customer preferences, new structure of production and work, etc. are leading to a rethinking of the concept of productivity. Productivity is mainly viewed as an efficiency concept (amount of outputs in relation to efforts or resources used), productivity is increasingly viewed as an efficiency and effectiveness concept, effectiveness being how the enterprise meets the dynamic needs and expectations of customers (buyers/users of products and services) i.e. how the enterprise creates and offers customer value. Productivity is seen to depend on the value of the products and services (utility, uniqueness, quality, convenience, availability, etc) and the efficiency with which they are produced and delivered to the customers.

The broader conception of productivity is incorporating wider definitions of what the outputs and inputs are of the production-distribution process. The social and ecological impacts are now increasingly considered as outputs of the production process in addition to the traditional physical and value measures of outputs. Similarly, the social and ecological costs are now also being recognized as inputs in the equation of productivity. With increasing concerns on the social and ecologic impacts of the operations of enterprises, the definitions of inputs and outputs are changing. Social and ecological inputs and outputs are increasingly being factored-in in the efficiency and effectiveness performance of the enterprise.

Productivity improvement must now focus on value creation rather than on minimization of inputs, (Tolentino, 2004). Higher customer value is created when the products and services meet customer needs for utility, timeliness, esteem, service, etc. This is what customers buy and pay for. With the rapid growth of information technology and more and more access to information, expectations of customers are constantly changing and becoming more demanding. Therefore, for long term productivity and competitiveness, organizations must always be ready for innovation from time to time, coming up with newer ideas to better and develop their products and ways of doing things, be flexible and agile, respond rapidly to the increasingly sophisticated customer demands which are constantly changing, and be able to anticipate and adjust to the very dynamic market conditions.

Outsourcing and its impact on productivity

Baumol (1967) argued that one of the major reasons for the growth of the services sector could be linked to services outsourcing in the manufacturing industries (ten Raa and Wolff, 2001). The fact that manufacturing industries to an increasing extent could outsource their less efficient service activities, and focus on their core competences, led to significant productivity gains in the industry, and increased the already existing productivity gap between the manufacturing industry and the service sector - a phenomenon that was later called “Baumol's disease”. Not all services sectors, however, are affected similarly by ICT services sometimes noted as an example of a sector that may contribute to improved productivity growth, (Wölfl, 2005).

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In the 1990s, the United States went through a large economic expansion and an increase in productivity. It was argued that this was mainly as a result of large information technology investments facilitated by falling hardware prices, and the change in economic activities that these investments brought. Mann (2003) argues that although technical change is the most important driver of IT hardware price declines, international trade and the globalization of IT hardware production also played a major role. More specifically, she estimates that over 1995 to 2002, the international fragmentation of IT hardware manufacturing led to a price decrease between 10% and 30% of IT hardware. This translated into a higher productivity growth of 0.3 percentage points per year corresponding to an accumulated USD 230 billion in additional GDP. Moreover, IT capital deepening and IT diffusion are now fuelling an increasing demand for IT services and software, which has allowed new business areas and economic activities to emerge., the potential increase in productivity could even be greater than it was in the 1990s.

Some of the earliest attempts to estimate the effects of fragmentation on plant productivity using micro-data include Görzig and Stephan (2002), and Girma and Görg (2002, 2004). However, while both studies focus directly on outsourcing as an explanatory factor of productivity, non of them made any distinction between domestic and international outsourcing.

Görzig and Stephan (2002) examine a panel data set of about 43 000 German manufacturing companies over the period 1992-2000. They estimate firm performance measured by both the returns per employee, which could be interpreted as productivity, and the return on sales. Three different measures of outsourcing are employed, and are all related to internal labor cost. The first is “material inputs” which reflects make-or-buy decisions by the firms and therefore resembles material outsourcing to external suppliers. The second is “external contract work” meant to reflect subcontracting, and the third is “other costs not related to production” capturing outsourcing of services.

Generally, Görzig and Stephan discovered a considerable effect of all three measures of outsourcing in the way a firm carries out its activities, measured against individual employees. This effect is more effective for material outsourcing, but not very effective for services in the short run. Moreover, they found that increased subcontracting and outsourcing of services reduces the profitability of the firm, whereas firms engaging in material outsourcing tend to do better than those that do not outsource. Based on this they conclude that, on average, the level of subcontracting and outsourcing of services that firms have engaged in is above the optimal level. Despite the significance of these results, it should be noted that most of the variation in performance across firms can be attributed to firm-specific characteristics, and therefore remains unexplained. Previous research has not been comprehensive on the effect of outsourcing on productivity, hence the need for this study