Understand the Advantages and Disadvantages of Outsourcing

Outsourcing is an increasingly common way for companies to do business, with the market growing by around four percent per year. Whether you’re looking to supplement your in-house expertise, develop new products and services, or you want to outsource specific functions in your business—it could be the answer for you. 

Like many things in business, there are pros and cons to outsourcing. It’s important to understand both sides before deciding if it’s right for your business. 

In this article, we’ll share the advantages and disadvantages of outsourcing, along with what you can do to ensure outsourcing goes smoothly.

A Quick Definition of Outsourcing

Let’s start by exploring what outsourcing is:

  • Almost exclusively used by businesses and organizations.
  • Involves hiring a business or freelancer outside your organization, and asking them to carry out work for your organization on a contractual basis.
  • Outsourced businesses typically perform services or create goods that you do not have the resources, expertise, desire, or time to carry out internally.
  • Terms of engagement with an outsourced business will be defined in a contract and other agreements.

Examples of Outsourcing

Now that we’ve defined it, let’s look at what outsourcing looks like in practice. Here are some examples of the functions and roles that businesses could outsource:

  • IT support and maintenance to a managed IT service provider.
  • Advertising and strategy to a marketing agency.
  • Promotional design to a freelance graphic designer.
  • Customer support to a call center.
  • Content production for SEO to a freelance writer.
  • Parts or products manufacturing to an external supplier.
  • Product images to a freelance photographer.
  • Operational processing to a specialist business.
  • Project management to a program and project management consultancy.
  • Application building to a software development agency.
  • Creative and knowledge work to freelance designers, writers, and other experts.
  • Distribution of goods to a third-party logistics provider.

The Advantages of Outsourcing

When managed properly, outsourcing provides significant benefits:

Bringing in Skills, Resources, and Functions You Don’t Have In-House

Hiring new people is time-consuming and expensive, and sometimes you don’t want to build out or replace functions within your business. Outsourcing provides you with the flexibility to take on external resources, skills, and expertise as required. Even if you’re a small business, outsourcing to expert freelancers can significantly expand the skills you have access to.

Providing Specialized Support for Time-Limited Initiatives

Some businesses might use outsourcing to replace operational functions, while others will take on external expertise for defined programs and projects. If you need to deliver a specific initiative, but don’t want overheads when the project completes, then outsourcing can be a great choice. You can take on individual freelancers as subject matter experts, or get entire outsourced teams for your project needs.

Controlling How You Work with an Outsourced Business Through Contracts and Agreements

You should have a contract and agreements in place that clearly define how you and an outsourced business or individual will work together—it’s a good idea to talk to an attorney or another professional about your contract. Be sure to set terms, conditions, and expectations around several important areas:

  • The scope of services that you expect.
  • How those services will be billed.
  • The speed, quality, and other aspects of the scope of service provided.
  • Escalation, resolution, and complaint procedures.
  • How the outsourced business will treat your employees, business data, systems, and various other aspects of your organization.
  • Incentives and penalties for meeting or missing what you’ve defined in your agreements.

Understanding and Managing Your Budget

Once you’ve defined what you need from an outsourced business, you’ll have a clearly defined budget. This gives you greater control over your “Total Cost of Ownership,” and can be easier to understand and manage than in-house resources and functions.

The Disadvantages of Outsourcing

Although outsourcing provides plenty of advantages to businesses, it’s also important to understand the potential pitfalls, so you can take steps to avoid them.

Losing Direct, Close Control Over Outsourced Functions

An outsourcing contract (and the agreements and statements of work that go along with it) gives you control over the “big picture”—it does not give you control over day-to-day operations and functions. You’re relying on the internal management of your outsourced functions to provide the right skills, expertise, accuracy, and efficiency to produce high-quality goods and services. If you’re working with individual freelancers, this process does get easier, as you can carefully direct them to produce the services you need. 

Not Having Incentives, Escalation Routes, and Penalties in Place

An outsourcing contract needs to give you leverage and influence with the business you’re outsourcing to. If you don’t have incentives and penalties in place, you’re limiting the control you have over the services you receive. You’ll also need to think carefully about notifying and escalating potential issues in a consistent way, so you can get them resolved quickly. If you’re managing larger outsourcing partnerships, you will need good relationship managers in your business to handle interactions with your outsourced services. If you’re mainly working with freelancers on limited initiatives, then you can likely handle the relationship management yourself.

Lacking Internal Business Institutional Knowledge

Employees and functions within your organization build up a wealth of knowledge about the why, what, and how of your business operations. Moving to an outsourced solution means you lose that institutional understanding, as it now resides with the outsourced business. That means if you ever change outsourced providers, you’ll have to build up that institutional knowledge from scratch. Of course, if you’re using freelancers and other individuals to produce work with a limited scope, this won’t be as much of an issue. 

Managing Areas Like Cybersecurity and Data

One of the biggest issues with outsourcing business functions is a lack of control over the information and system access you’re sharing. The rise of data breaches and security lapses means it’s incredibly important to get tight controls and strong protection in place, which can be more difficult when outsourcing. 

Tips to Enhance Outsourcing Practices

Here are some good starting points for getting outsourcing right:

  • Everything flows from the contract: As we’ve discussed above, you need to get a watertight contract in place that defines all the key aspects of what you’re outsourcing.

  • Define clear SLAs and SOWs: If you don’t define absolutely everything in your contract, be sure to have strong supporting service level agreements (SLAs) and statements of work (SOWs) that clarify expectations.

  • Get samples and reviews ahead of time: If possible, try to understand the quality of a provider’s work before signing up with them. If they’re a manufacturer, review actual samples, if they’re a consultant, talk to other businesses about their quality of service, if they’re  a freelancer, look at their portfolio of work.

  • Create a strong review process: Have your relationship managers carry out periodic reviews of the services you’re receiving, including talking to internal teams and external customers about their experiences.

  • Focus on integration with your business: Relationships between the outsourced function and your employees are central to making outsourcing work. As you begin to outsource your functions, be sure to involve the staff “on the ground” to make those relationships, communications, and business practices easier.

Is Outsourcing Right For Your Business?

Outsourcing can provide your business with greater flexibility and specialized expertise—but it’s not always the right fit for every business. To understand if it’s right for yours, use these tips to understand the advantages and to help mitigate any risks, gaps, or shortfalls. 

For more information on outsourcing and other practical small business advice, we invite you to explore our resources section and reach out to organizations within our lending community.

Webinar: Writing a Business Plan

If you are applying for financing, a solid roadmap becomes especially important as it is the best way for a lender to get a feel for you and your business.

Disclaimer:  the information provided on this page is meant for general informational purposes only and may not reflect the most current resources and recommendations available. Please consult with your financial, tax, legal, and other relevant advisors when making decisions about your small business.