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CHAPTER 2

LITERATURE REVIEW

2.1 Introduction

This chapter summarizes the literature review done for this study and presents in five sections. The first section discusses on the history and rise of outsourcing. The second section reviews the reasons to outsourcing and problems arises from outsourcing. In third section, risks faced by the contractor to adopt outsourcing concept will be discussed. Benefits and effect of Outsourcing in terms of cost efficiency, productivity and profitability will be explained in section 4 and the last section will include the factors to a successful Outsourcing. All the information that are collected and discussed are factual and based on previous study and research.

2.2 History / Rise of Outsourcing

As this dissertation is concerned with the outsourcing culture in Malaysia construction industry, therefore its necessary to define what outsourcing is.

Basically, outsourcing refers to the act of transferring work, responsibilities and decision rights to someone else. Companies decided to source out work because there are third parties who can complete the work with a cheaper price, faster, and better quality. (Power et al., 2006) Outsourcing is the allocation of risk and responsibility for performing a function or service to another entity. (Ashley E, 2008) According to Brown and Wilson (2005), outsourcing is “the act of obtaining services from an external source”.

Outsourcing involves the delegation of tasks or jobs from internal production to an external entity (such as a subcontractor). It means purchasing goods or services from external firm instead of providing or producing them in-house. Outsourcing is not exactly a new innovation but is a shift that has happened recently due to the trend of the industry. Data-processing industry was the first industry that done outsourcing and the trend of outsourcing has spread to other areas. (Sople, 2009)

Since the Industrial Revolution, companies are struggling to introduce a strategy to exploit their competitive advantage in order to expand their markets and increase profits. The model for most of the 20th century was a large integrated company which able to own, manage and direct control its assets. (SME, 2018) Diversification was the rallying cry in the 1950s and 1960s. Companies intended to take advantage of economies of scale and broaden their corporate bases. In 1970s and 1980s, companies attempted to compete globally and to increate flexibility and creativity, a new strategy was developed to focus on the organization's core business, which required identifying critical processes and thinking what can be outsourced. (SME, 2018)

The outsourcing trend has been taken as a positive strategy for the organization to conquer and important in increasing profitability. According to Holcombe (2016), outsourcing practices have long constituted an important part of competitive business strategy. This outsourcing trend is now increasing worldwide. There are number of evidence indicates that in U.S.A, 82% of the companies are depending on IT outsource services from India as the country is providing high quality services. (Muncaster, 2007)

According to Trunick P (2018), a survey was conducted in year 1998 and it shows that a slightly large number of respondents said that third party logistics(3PL) services was bought to replace in-house functions. The others used it for tactical purposes to enter new market or to introduce new products. A decade later, logistics outsourcing became a key enabler for strategic sourcing and global marketing strategies that provide companies with the agility to adjust to the market condition which is changing rapidly.

Dr. C. John Langlet Jr. of Georgia Institute of Technology notes that 82% of the respondents in the 12th Annual State of Logistics Outsourcing study (which is a total of 1287 individuals) has recognized heir organizations are participating in 3PL services. The study was split among four major regions of the world evenly, it can be concluded as the outsourcing trend is on the rise on a global scale. (Trunick P, 2018)

2.3 Types of Outsourcing

There are many similar terms in meaning to outsourcing. Some of the similar terms are discussed in this literature review chapter.

a) Outsourcing: Outsourcing is the activities / services undertaken by an exteral supplier / or service provider to take care of transfer of activities and possibly assets from a company that had been previously in-house. (Domberger, 1998)

b) Out Tasking: Out tasking are being called subcontracting as well, it refers to hiring an external services provider for a period of time for supplementing resources. E.g: design and delivert of a training activities. (Friedman, 2006)

c) Consulting: Consulting helps organizations in giving information about ‘how to do' something, on the other hand, outsourcing is about someone “does it” on behalf of you. (Friedman, 2006)

d) Off shoring: Off shoring is defined as outsourcing across national boundaries. In the other word, it means doing outsourcing internationally. (Adler, 2003)

e) Contingent workers: According to Domberger (1998), it means leasing people to a firm / service seeker by a company that supply Human Resource services.

These different definition for various type of outsourcing were used by various researcher to suit their particular research context. However, there may be some overlap of activities in each of these definitions. These definitions of outsourcing, implying resources procurement from third party agency to run the internal operation of the firm, do not capture the true strategic nature of this issue. It is way beyond the sourcing decisions of the firms. Undeniably, all companies actually do purchase and procure things to keep their operation running smoothly. (Outsourcing: Literature Review, N.D.)

On the other hand, outsourcing is a fundamental decision to negate the vertical integration of an activity within an organization. In this way, it is a strategic in nature and has a long lasting effect on the overall functioning of the organization. (Gilley & Rasheed, 2000) According to the Outsourcing Institute (2001), “Outsourcing is a management strategy undertaken by a firm to outsource major, non-core functions to specialized service provider that work efficient.” In order to show the strategic significance of outsourcing, it is defined as “Sourcing of goods and services which was previously produced internally within the sourcing organization from an external supplier”. (Cooke et al., 2005)

2.4 Reasons to Outsourcing

The major reason for a company to implement outsource decision in their organization strategy planning is to increase value for money. A decision to outsource is largely assessed based on where it is more economical to appoint an external service provider (also known as subcontractor)to execute the work rather than provide them from internal sources and evaluate whether the anticipated benefits from outsourcing outweigh the cost of outsourcing in order to achieve a higher level of profitability for the organization. (Spencer, 2000)

According to Spencer (2000), following the decision to outsource, any benefits are achieved through a number of different avenues, which can have effects on the economy, and change the overall performance of an organization or department. In addition, the results of a survey done by Peter Embleton and Philip Wright in 1998, concluded 18 major benefits arising from outsourcing. (Embleton & Wright, 1998)

The benefits of outsourcing are as follows:

Advantages Description

Cost savings Companies can benefit from economies of scale

Time savings Project can be done more efficiently, thus save time

Hidden costs Outsource helps in discovering hidden cost of an organization

Core activities Allow organization to focus on their core activities

Cash infusion Certain assets can be sold for cash infusion if a process is outsourced

Talent availability Outsourcing provides access to talent that not available in-house

Re-engineering Outsource partner allow managers to re-evaluate their business process

Greater flexibility Management has flexibility in human resource allocation

Wall Street Stock performance is enhanced, as investors expect cost reductions

Corporate culture Firm may adapt to different corporate culture of their outsourcing partner.

Accountability Commercial supplier bound by contract, internal department do not always control expenditures.

Labour peace Outsourcing certain key areas lead to labour peace

Free in-house staff In-house staff can be freed up for more interesting tasks

Access to specialists Specialist skills can be gained from outsourcing firms

Greater productivity Outsourcing can be used to increase productivity

Geographical Outsourcing helps in handling problems with geographical distance

Quality Outsourcing improve the quality of work

Distractions Outsourcing relieves management of the distraction of managing another staff function

Table 1: Outsourcing Advantages (Embleton, 1996)

The above advantages are the finding of the survey conducted by Embleton, who has listed the following flow of benefits arising from outsourcing. The Outsourcing Institute of North America has conducted another survey on the 10 major reasons for an organization to adopt outsourcing in their strategy planning. (Outsourcing Institute of North America, 1998)

The list of advantages is being discussed below:

• Reduce & control operating costs

• Improve company focus

• Gain access to world-class capabilities

• Free internal resources for other purposes

• Resources are not available internally

• Accelerate reengineering benefits

• Function difficult to manage/out of control

• Make capital funds available

• Share risks

• Cash infusion

(Outsourcing Institute of North America, 1998)

According to a research from an Australian perspective done by Axio Outsourcing. Axio Outsourcing is an Australian firm that provide specialized in facilitating outsourcing partnerships for Australian business has list down several advantages from outsourcing.

Axio Pty. Ltd. (1998) has list down the following advantages of outsourcing:

o To focus on core activities

o To mitigate future losses

o To reduce costs & improve efficiencies

o To effect organizational changes

o To enable transition to a new environment

o To improve service levels

o To avoid or escape operational gridlock

o To acquire new skills

Closer examination of the above statement has suggested that the economic advantages arising from outsource activates can be categorized into four board categories. (Spencer, 2000) The advantages achieved from outsourcing include:

1. Cost Effectiveness – Cost savings can be achieved through competitive tendering.

2. Responsiveness and Control – Transfer / risk sharing with an outsource partner.

3. Improve efficiency – Work is executed by specialized therefore higher efficiency can be achieved.

4. Flexibility – Able to cope with changes in demand for services.

These benefits involve many considerations including quality and access to specialist knowledge and expertise, therefore its important to discuss each of the category in detail.

2.4.1 Cost Effectiveness

According to Kakumanu and Portanova (2006), cost reduction has become the core drive for companies to outsource. The practice to outsource has many areas that can help in minimizing the operation cost of a firm. Another study conducted in UK has concluded that high wages of employees are directed induce outsourcing, they suggested that the number one factor of outsourcing should be cost saving. (Girma and Gorg, 2006)

Cost effectiveness can be achieved by adopting outsourcing as business strategy plan through competitive tendering of services. Tenders submitted by various organizations with the relevant expertise will be evaluated and the work will then be awarded to the lowest tenderer. (Spencer, 2000) Contracting the work out is often cheaper especially if opted for off-shore development because workers are hired only for executing specific works. In addition, outsourcing creates value for shareholders by minimizing the cost and commitments to fixed capital and working capital. Also, outsourcing helps an organization to create competitive advantages towards its competitors by focusing on its core business. When an organization only specialized / focus on certain area, this may provide a significant cost savings for the company. (Sople, 2009)

The primary reasons behind the decision of adopting outsourcing for companies because it helps in minimizing operational and labour costs. Outsourcing may lead to a defining impact on the revenue of a company and it can deliver significant savings to a company. ("Top 10 Reasons to Outsource - Flatworld Solutions", 2018)

In addition, outsourcing also provide the benefits of cost optimization. One of the most significant factor affecting the decision to outsource is due to the cost factor. Cost efficiency is the most important factor for an organization to improve the balance sheet of the company. Most of the companies' major goal is to achieve “Lower cost, Quality Product”. According to a survey conducted recently by London School of Economics (LSE), nearly 70 percent of the company route for outsourcing is to reduce the cost of operation. (Ltd.,2018)

Moreover, outsourcing provide lower cost for businesses is the major reason why many firms decide to outsource. By adopting outsourcing, the work can be done for a fraction of the price. Organization also benefits from skipping the cost of employees benefits. Organization does not need to bear for the cost to pay for their in-house employees health insurance and even vacation pay. Many firm choose to outsource their work because they receive a better quality work at a much lower price. According to research, a firm can save up to average 60% in their operational cost by implementing outsource as one of their business strategy. (Rampton, 2012)

2.4.2 Responsiveness and Control

Other than cost effectiveness, outsourcing also beneficial when a firm is needed to deal with increasing specialization or to keep pace with their competitors. (Livermore, 1999) In addition, many of the researcher findings also concluded that outsourcing also bring the advantages of transferring of risk to the outsourcing partner.

Adopting outsource as one of the company strategies enable the access to specialist expertise, final product quality improvement and the minimize the risk level.

The decision of outsourcing made by firm helps to create a significant impact on its work quality. The reasons behind this is simple because outsourcing generally involves in transferring activities to an external third party. The external providers usually have more specialized experience in the particular area. Besides, the external party equipped with a better purchasing power and has superior skill of management. (Rimmer, 1998)

Furthermore, competitively tendering the outsourced work allows the customer to introduce more opportunities than have been available from internal reosurces. The most obvious of these is the risk management. Within the framework of the outsourcing contract, the risk can be allocated appropriately between the parties of the contract, this is the fundamental advantage of outsourcing. (Domberger, 1998)

According to Rampton (2012), when a project is being outsourced, the liability and risk can be given away to the outsourced partner associated with the task. Payroll management is a good example. Company can gain the freedom to focus on other core activities of business by outsourcing the work to a payroll service provider. This helps in saving money on the amount of liability insurance that required firms to pay and the risk of being sued.

Risk Management is another main reason why companies outsourcing. A hidden advantage arising from outsource is that if a firm is facing problems due to natural calamities, technical crisis or fluctuations on the market. The work can still carry on by the offshore outsource partner as the work is usually executed by the outsource partner once the project is being outsourced. ("How Does Outsourcing Reduce Cost? (Benefits of Outsourcing)", 2018)

2.4.3 Improved Efficiency

The Turnaround Time (TAT) for an outsourced company is usually much lesser on a project, this is because of they are handling high outsourcing projects. Therefore, equilibrium between the cost & time has garnered by the outsourced company to complete the projects. Hence, the outsourced company has expertise in such a way to get the work completed before the deadline and meanwhile without compromising on the quality of work. (Ltd, 2017)

Figure 1: Advantage of outsourcing

Moreover, outsourcing the work also lead to a faster result. As there are a lot of things that required attention and the organization is doing everything in house, this might reduce the efficiency of the firm. On the other hand, when work is outsourced to an outsource partner, everything become easier as portion of the work is burdened and shared by the outsource partner. Quick and fast development can be achieved. The project delivery time able to be minimized and helps the firm to get involved into the competitive market. ("How Does Outsourcing Reduce Cost? (Benefits of Outsourcing)", 2018)

Cheaper labour from outsourcing able to improve efficiency of a firm. Outsourcing enhances productivity and efficiency because it allows business / organization to stay competitive in the face of rising labour cost. By outsourcing, corporation able to find workers that are well trained, yet unable to move to the primary location of the corporation. In a case that a firm can minimize their labour cost, productivity can be improved by spending the company capital in other place such as employing additional workers, equipment update, or lowering prices.  ("Outsourcing: Does outsourcing enhance efficiency and productivity?", 2018)

2.4.4 Flexibility

One of the major advantages of outsourcing is flexibility. It can be a lot easier to cut back on a vendor than an employee. (Sople, 2009)

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