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Insourcing, offshoring, outsourcing, near-shoring: The confusing terms crop up frequently but aren't always well-defined. What do they mean in practical terms? Should small-business owners sign on to these oft-promoted business models? Do they really deliver on promised cost-savings? Smart Answers columnist Karen E. Klein recently posed these questions to Phil Bloodworth, a partner in PricewaterhouseCoopers' advisory performance-improvement practice. Edited excerpts of their conversation follow:
Q: Let's start with some definitions. We hear the term all the time, but what's really meant by "outsourcing"? A: Outsourcing is allowing any third party to take on a function in your organization. The general idea has been around forever in the form of companies like ADP (ADP), which is a payroll provider.
What's new is something called "business-process outsourcing," which has come about in the past 5 or 10 years. This means outsourcing something that's a functional area within your organization, like accounting, human resources, manufacturing, product development, and even elements of production. These are things that used to be considered the core values of a company. Now, we have whole companies that are basically shells and outsource every aspect of what they do.
Q: What about "insourcing"? A: Insourcing means establishing shared service centers within your own company. So you're grouping together a core competency to save money. For instance, one of my clients is an architectural firm with offices on both coasts. They have had two redundant finance units, and now they are combining them into one group that will bill the units for the costs they incur. The benefits are cost savings, standardizing processes, streamlining projects and reporting, reallocating resources into one location, and gaining efficiency.
Q: Is this a new idea? A: No. The idea has been around a long time, but it often hasn't been done well. People are finding it now as an alternative to outsourcing.
Q: And "offshoring"? A: Offshoring is moving any business process to a foreign location. It isn't necessarily the same thing as outsourcing, by the way. You could still own that process and offshore it. The best example here is the automotive companies, which have been offshoring for years. For instance, GM (GM) builds cars at plants all over the world. Some of the Japanese auto manufacturers have plants here in the U.S., so they're offshoring production to us.
Offshoring can also be an option connected to outsourcing. Typically, what happens is that you find a U.S. vendor, and they sell you an outsourced solution. So, you're hiring a U.S. company, but the actual taxable work is done in a foreign country -- typically India, Eastern Europe, China, Vietnam, or Korea.
By the way, another option is happening now, and that's "multishoring." In this model, you outsource to a U.S. company, but the majority of the work is done in India. Because costs are on the rise there, however, the Indian team may outsource some of its technology to Vietnam. So, your company might be in Dallas, while some aspect of your business is being kicked to India, but they've got infrastructure and technology running in Vietnam, where the cost is lower. That's multishoring.
Q: How does "near-shoring" differ? A: It's offshoring, but to a country that geographically touches you. For instance, GM building cars in Canada or Mexico is near-shoring.
Q: The general belief is that outsourcing is cheaper than doing anything in-house, but you say that's not always the case. Why? A: Business owners tend to underestimate the related costs of outsourcing, and they underestimate what it takes to manage. You can't flip a switch with outsourcing and have everything be hunky-dory -- and especially not if you're outsourcing overseas. Also, you can never outsource total responsibility for a company function or process. For instance, if you outsource something that's going out to print, you still need a proofreader in-house to look it over.
Another cost-related issue is that the outsourcer may have an up-front price, but you find that there are a bunch of add-ons that you didn't think through or put into the contract that come up later and cost more. Maybe you're used to running down the hall and having your in-house employee spit out a special report at no charge -- but that won't be possible for the outsourcer.
The bottom line is, if done right, all these processes we're talking about can free up your company's capital to do product development and all the other things you need to do. Also, you may want to outsource a problem area that your company does not have the skills, people, or bandwidth to do properly.
Q: How can you make sure you're doing things right if you pursue one of these models, particularly as an entrepreneur? A: Everything revolves around the contract. If you don't personally negotiate the contract, you may not even be sure where the work is going. Get all the details straight out front. And don't lowball too much. The outsourcers have to deliver at a cheap unit rate, but you don't want your outsourcers starving to death, you don't want them to fail, and you don't want to be a low priority for them.
As a small-business person, you have to step back and make an honest evaluation of your company, how you do things, and what your total cost of ownership really is. Think about how much it costs you to do a process in-house -- and make sure you include the benefits and resources of doing it yourself. I get so many calls from companies -- big and little -- that say they want to outsource because "everybody's doing it." But that's not the way to go into it.
Understand what's driving your need to outsource. Do you want to provide better service? Then don't be shocked if it costs you more -- not less. Sit back and assess what outsourcing will really be like.
Small businesses do a lot of great things. Most of them have a good handle on their finances and their operations. A lot of small-business owners are very hands-on -- they like to know what's going on in their companies. Do you really want to send part of that business 10,000 miles away? Are you ready for that?
Q: How does a small-business owner go about finding an outsourcer? A: They'll find you, if you put the word out that you're interested. Before you do that, though, develop the metrics that you expect delivery on. Understand what you're looking for (or else the vendors will tell you what you need). And, by the way, that will always dovetail really nicely with what they offer.
Also, understand that [choosing an outsource partner] is a months-long process. Don't rush in quickly. Qualifying a candidate firm, matching proposals, due diligence, contract negotiations: This isn't something that you do over a weekend. You've got to ensure that it's a win-win situation for both sides, or else it'll never work.
Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues
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