We outsource a lot of things, in business and in life. How do we decide what to outsource, and what to do ourselves?
In the 1990s, outsourcing became all the rage, particularly in the IT industry, where I was working. But the principles behind outsourcing have their roots in the economic theory of comparative advantage, which was first proposed by David Ricardo over 200 years ago.
Comparative Advantage is the underpinning principle of the whole global trade regime, and it’s the reason I’m an advocate of global flows in trade, capital, labor, and intellectual property. It’s sad to see this principle under fire from the current wave of national protectionism.
The theory basically says that you should do the things that you’re best at, and others should do the things that they’re best at. That way, goods are produced at the greatest efficiency and lowest cost. Then, everyone simply trades the goods and services they need from the most efficient source of production.
There are a few exceptions to this principle, of course. Sometimes, despite your own lower efficiency, you may not want to lose control of your supply chain. Other times, even though something might be done more efficiently elsewhere, it’s a core piece of your competitive advantage. And, yes, sometimes, the global supply chain isn’t ethical, and cost advantages are built through human rights violations.
How, then, would you go about making an outsourcing decision in your company?
For a start, work out exactly why you want to outsource. What are you trying to achieve? Are you trying to reduce your costs? Are you trying to free up management bandwidth that would otherwise be wasted on non-core activities? Do you need more consistency and predictability in your processes? Are you looking for greater flexibility of resources, so that you can scale more easily to meet shifts in demand? Do you require access to specialist expertise you don’t have in-house? Maybe it’s a combination of these.
The answer to this question should frame how you approach the market.
The second thing is to understand your cost structures. You need a good baseline for how much it’s actually costing you to produce that product, or deliver that service now.
To do this well, you need to identify and attribute costs to the people who actually do the work, the people who support the work, the assets that you’re using for that work… even the management bandwidth required to make the work happen.
How much of that will disappear once you outsource? It’s really important that you understand the delta. Only then can you truly identify the relative efficiency and cost of a market-based, outsourced solution.
Before you go to market, it’s important to establish the selection criteria. What criteria are you going to use as the basis for deciding which supplier to choose?
Setting the criteria up in advance will guard against you becoming starstruck with suppliers whose sales people just talk a good game. It’ll help you to sort out the dogs from the fleas, as you’ll be able to clearly see which companies really meet your criteria.
Just remember the suppliers who turn up to the outsourcing table do this every single day. You do it extremely rarely. A gap between the promise of the marketing spin, and the reality of the service delivery is inevitable, but you want to make that gap as small as you possibly can.