Outsourcing and HRMOutsourcing and HRM

Brian S. KlaasBrian S. Klaas

The Market or the OrganizationThe Market or the Organization

When outsourcing is used, firms are When outsourcing is used, firms are relying on a market-based form of relying on a market-based form of governance to ensure they receive governance to ensure they receive quality goods and servicesquality goods and services

When firms keep processes in-house, When firms keep processes in-house, they are relying on organizational they are relying on organizational governance governance

What Outsourcing OffersWhat Outsourcing Offers

Outsourcing offers benefits that flow Outsourcing offers benefits that flow from increased economies of scale, from increased economies of scale, the potential for high-powered the potential for high-powered incentives, and the ability to respond incentives, and the ability to respond quickly to supply and demand shifts quickly to supply and demand shifts

One Problem With OutsourcingOne Problem With Outsourcing

Exposes firms to greater risks from Exposes firms to greater risks from opportunism by the vendor or opportunism by the vendor or supplier supplier

When Outsourcing is GoodWhen Outsourcing is Good

Off-the-shelf products or services are Off-the-shelf products or services are generally viewed as more generally viewed as more appropriate for outsourcing appropriate for outsourcing arrangements arrangements

The company can benefit from The company can benefit from economies of scale when limited economies of scale when limited customization is necessarycustomization is necessary

When Organizational Control is When Organizational Control is GoodGood

When the product or service When the product or service demands substantial customizationdemands substantial customization

The firm must make an asset The firm must make an asset specific investment to use the vendorspecific investment to use the vendor

Contracts Don’t Always WorkContracts Don’t Always Work

Where substantial uncertainty exists Where substantial uncertainty exists regarding what will be needed from regarding what will be needed from the vendor, it is difficult to the vendor, it is difficult to completely specify all relevant completely specify all relevant contingencies within the outsourcing contingencies within the outsourcing contract contract

Why Has Outsourcing Become So Why Has Outsourcing Become So PopularPopular

Globalization and labor arbitrageGlobalization and labor arbitrage TechnologyTechnology

Globalization and Labor ArbitrageGlobalization and Labor Arbitrage

Within developing economies, Within developing economies, investment in human capital and in investment in human capital and in production capacity has expanded production capacity has expanded dramatically dramatically

The wage differential between The wage differential between developed and developing developed and developing economies is substantial economies is substantial

Globalization and Labor Arbitrage Globalization and Labor Arbitrage ContinuedContinued

The wage differential is now so great The wage differential is now so great that firms may be willing to accept that firms may be willing to accept the risks associated with vendor the risks associated with vendor opportunism opportunism

TechnologyTechnology

With developments in technology, a With developments in technology, a wide range of service activities can wide range of service activities can be readily outsourced be readily outsourced

When combined with vendors When combined with vendors operating globally, it allows for operating globally, it allows for increased speed in terms of product increased speed in terms of product development development

What Should be Outsourced?What Should be Outsourced?

Activities or processes that might be Activities or processes that might be viewed as off-the-shelf viewed as off-the-shelf

Activities that require an asset Activities that require an asset investment when the labor arbitrage investment when the labor arbitrage potential is greatpotential is great

Core CompetenciesCore Competencies

Allow firms to gain competitive Allow firms to gain competitive advantages and relate to a collective advantages and relate to a collective knowledge or understanding within knowledge or understanding within organizations about how to perform organizations about how to perform complex and inter-related sets of complex and inter-related sets of activities activities

What Not to OutsourceWhat Not to Outsource

Core competencies that offer the firm Core competencies that offer the firm a competitive advantagea competitive advantage

Core competencies are rarely Core competencies are rarely compartmentalized within specific compartmentalized within specific parts of the firmparts of the firm

What Not to Outsource ContinuedWhat Not to Outsource Continued

Activities that involve high levels of Activities that involve high levels of uncertainty or asset specificity that uncertainty or asset specificity that may make the firm subject to vendor may make the firm subject to vendor opportunismopportunism

Activities that the firm is particularly Activities that the firm is particularly good at and that rely on implicit good at and that rely on implicit knowledge within the firmknowledge within the firm

Managing the Outsourcing Managing the Outsourcing RelationshipRelationship

Specify within the contract of the Specify within the contract of the tasks, performance metrics, and tasks, performance metrics, and penalties for non-performancepenalties for non-performance

Engage in regular benchmarking of Engage in regular benchmarking of the services available from the services available from alternative vendors to ensure that alternative vendors to ensure that contractual terms allow the firm to contractual terms allow the firm to switch vendors without undue switch vendors without undue difficulty difficulty

Managing the Outsourcing Managing the Outsourcing Relationship ContinuedRelationship Continued

Assess resources and skills Assess resources and skills possessed by a firm, relying on possessed by a firm, relying on information available within the information available within the marketplace to assess vendor marketplace to assess vendor capabilities capabilities

Outsourcing in an Uncertain Outsourcing in an Uncertain EnvironmentEnvironment

Typically requires an asset Typically requires an asset investmentinvestment

Involves a degree of uncertaintyInvolves a degree of uncertainty Can be profitable when companies Can be profitable when companies

take specific measurestake specific measures

Measures to Take in an Uncertain Measures to Take in an Uncertain and Complex Environmentand Complex Environment

Developing personal ties with the Developing personal ties with the vendor helps in the following ways:vendor helps in the following ways:• Limits the vendor’s willingness to Limits the vendor’s willingness to

engage in opportunistic behavior engage in opportunistic behavior • Increases the reputational cost of Increases the reputational cost of

violating the contractviolating the contract

Specific Approaches to Improve Specific Approaches to Improve Business RelationshipsBusiness Relationships

Align the interest of the vendor and Align the interest of the vendor and firm via gainsharing mechanisms firm via gainsharing mechanisms that allow both parties to benefit that allow both parties to benefit from improved performance and from improved performance and efficiency efficiency

Tie vendor compensation to broader Tie vendor compensation to broader measures of client performance measures of client performance

Moderating Factors of Outsourcing Moderating Factors of Outsourcing ArrangementsArrangements

ActivityActivity Firm sizeFirm size

The Nature of the Outsourced The Nature of the Outsourced ActivityActivity

Outsourcing for the global firm Outsourcing for the global firm reduces IT infrastructure costs reduces IT infrastructure costs through economies of scale and by through economies of scale and by spreading the costs among vendorsspreading the costs among vendors

The global firm saves through wage The global firm saves through wage differentialsdifferentials

The Nature of the Outsourced The Nature of the Outsourced Activity ContinuedActivity Continued

Outsourcing arrangements are Outsourcing arrangements are designed to help improve and designed to help improve and standardize business processes as standardize business processes as they relate to transactional HR issues they relate to transactional HR issues

Allow firms to establish metrics that Allow firms to establish metrics that let them monitor and control the let them monitor and control the quality of services being providedquality of services being provided

Outsourcing Executive SearchOutsourcing Executive Search

Market governance mechanisms Market governance mechanisms might be effective for search firms:might be effective for search firms:• The level of investment pales in The level of investment pales in

comparison to the investment required comparison to the investment required to build the network of relationships that to build the network of relationships that is used in conducting the search is used in conducting the search

Outsourcing Executive Search Outsourcing Executive Search ContinuedContinued

Other market mechanisms include:Other market mechanisms include:• Reputation of the search firm if they find Reputation of the search firm if they find

a weak candidatea weak candidate• Quick and effective feedback regarding Quick and effective feedback regarding

vendor performance is likely to emerge vendor performance is likely to emerge in this setting in this setting

Firm SizeFirm Size

For many smaller organizations, gaining For many smaller organizations, gaining access to HR expertise when there is no access to HR expertise when there is no internal HR staff member is likely to internal HR staff member is likely to require some form of an outsourcing require some form of an outsourcing relationship relationship

For many small organizations, their For many small organizations, their outsourcing decision is at least in part outsourcing decision is at least in part determined by the value associated with determined by the value associated with professional HR expertise professional HR expertise

Building RelationshipsBuilding Relationships

For small and medium firms, building For small and medium firms, building relationships with vendors can relationships with vendors can reduce uncertainty and opportunismreduce uncertainty and opportunism

SummarySummary

In this chapter we have examined:In this chapter we have examined: Reasons for the growth in Reasons for the growth in

outsourcingoutsourcing Why firms outsourceWhy firms outsource Managing relationshipsManaging relationships The nature of the activityThe nature of the activity Firm sizeFirm size