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Companies have always "out-tasked," that is, hired special contractors for particular jobs or to level-off peaks and valleys in their workload. They have always partnered — forming needed relationships with firms whose capabilities complement their own; companies have always contracted for shared access to resources that were beyond their individual reach — whether it be buildings, people, or technology. Indeed, none of these concepts are new, yet, none of them represent what we today call outsourcing.

Outsourcing applies to every facet of today's corporation and at every level. It is a central management tool for the fundamental redesign of America's businesses. Many believe that outsourcing must be embraced by corporations if they are to compete successfully in today's global economy. It is a rethinking of what an organization is and must do itself to deliver all of its promises to customers.

Rethinking Traditional Organizational Structures

An understanding of the importance of the outsourcing megatrend in the U.S. starts with a reexamination of the traditional U.S. view of a "company," which is rooted in the post-industrial-revolution model defined by giants such as General Motors and DuPont in the 1920s and `30s. On the basis of this model, a company is generally thought of as a large, vertically-integrated, self-sufficient organization — that is, as an organization that directly owns and manages most, if not all, of its required resources. Under this model, business success was traditionally seen as synonymous with owning and directly controlling the factors of production.

Over the years, as organizations became more complex, their resources were further specialized and directed toward various aspects of the company's operations — product design, engineering, manufacturing, human resources, information technology, distribution, and sales, just to name a few.

Viewed strategically, outsourcing fundamentally challenges executives to rethink this notion of the traditional vertically integrated firm in favor of a much more flexible organization. The factors of production have given way to the primary of the intellectual capabilities of the firm that tie the factors of production together. An organization where internal investments are made in a more focused way on the organization's core competencies with mutually beneficial longer-term outside relationships used to source many, if not most, of these ever increasingly specialized sub-disciplines.

The reality is that in the U.S. this traditional vertically integrated firm is not the only, nor necessarily the best, way to create value — especially in today's ferociously competitive, highly volatile global economy. Almost any organization can gain access to resources and factors of production. What differentiates companies today is their intellectual capital, their knowledge and their expertise, and their ability to leverage the capabilities of others— not just the size and scope of the resources they directly own and manage.

As a result, outsourcing has been adopted by firms from across the corporate spectrum as well as governments at all levels and not-for-profits. No organization is too large or too small to be examining outsourcing. Preeminent organizations, such as those on the FORTUNE 500® list of America's largest corporations, are adopting outsourcing as a cornerstone of their efforts to sharpen market focus, capitalize on global opportunities, and energize operations. At the same time, smaller, rapidly expanding companies are using outsourcing as a way to match the capabilities of a large firm without the expense and delay of directly acquiring and managing each new resource needed.

What is Outsourcing?

What is outsourcing? Outsourcing is more than purchasing, and it is more than consulting. It is a long-term results-oriented relationship for a whole business activity over which the provider has a large amount of control and managerial discretion. Outsourcing is the use of outside business relationships to perform necessary business activities and processes in lieu of internal capabilities. The term outsourcing describes a number of situations.

· A pharmaceutical firm hires a contract manufacturing organization to manufacture a product

· A computer chip maker hires a staffing company to monitor and manage all of their non-exempt hiring

· A university hires an information technology company to manage all of it's desktop PC's and staff the user help desk

Those who provide outsourcing are often referred to as outsourcing partners, suppliers and providers. On Firmbuilder.com we use the term service provider for convenience. Those who are purchasing the outsourcing services are called buyers or users. What defines outsourcing is more the circumstances of the relationship than the nature of the work performed—that is why the label `outsourcing' is applied to a lot of situations.

Outsourcing vs. Suppliers

Outsourcing relationships are characterized by replacing or substituting the services of an external provider for internal capabilities. Importantly, outsourcing applies to an activity an organization did do or would have done itself. A bank doesn't say that it's "outsourcing" the production of mops, brooms and chemical cleaners when it buys cleaning materials for its janitorial staff from a supply service. That same bank may `outsource' cleaning services, or even outsource purchasing, but the difference is that cleaning and purchasing are things a bank would reasonable do, manufacturing and transporting mops, brooms, and chemical cleaners are not. Outsourcing is not about "supplying" commodities or totally unrelated products or services.

Outsourcing vs. Consulting

The difference here is both difficult and easy to see. The difficult part is that many firms simultaneously position themselves as offering consulting and outsourcing services, they don't clearly distinguish the two, and in the process they confuse the situation. It's easier when you think clearly about what the differences truly are. Consultants advise us on how to do something. Outsourcing providers actually do it. Sometimes a consultant will deliver a business service or product, and that's when they are acting like a provider, and other times an outsourcing provider will advise, but generally the distinction is easy to see. Most professional services firms fall into one of three categories. There are the consultants. There are the providers. There are the hybrids. The reality is that many firms are both consultants and providers, but play different roles with different clients and at different times.

Outsourcing vs. Jobbing and Out-Tasking

Outsourcing relationships are high value-add, durable and on-going—they are not a one-time only deal. Hiring a provider to set up your technology, or a manufacturer to handle production when demand exceeds capacity, or using FEDEX to deliver overnight packages is not outsourcing. Outsourcing relationships are high level, contractual relationships for a fixed period of time, usually measured in years, but they are assumed to be continuous. Provider and user often work to define the service delivered. There is frequent interaction between user and provider and a lot of communication. The outsourcing service is customized to the needs of the user.

All of the elements of outsourcing combined are what make it a unique management practice. Outsourcing providers are partners, given significant managerial discretion for how to deliver the service, who manage the day-to-day delivery of that service. The value they create is based on being a long-term partner who understands the business, can deliver on the requirements of the relationships, and look ahead to how they can better service client firms.

The redefinition of the organization from the outside in continues to gain momentum. It offers enormous potential for achieving unprecedented levels of business performance and shareholder wealth. Understanding these changes, harnessing their power, and applying them to the organization you lead is the single, most pressing issue faced by managers and executives today.

Worldwide, the use of outside specialized firms for everything from basic custodial work in hospitals in Italy to the most sophisticated parts of a bank's business processes in Australia is accelerating. Study after study finds growth rates in outsourcing spending of 25-30% annually ormore.

The bottom line is that organizations both in the U.S. and increasingly around the world are redefining themselves through outsourcing. This transformation of businesses from vertical to virtual is profound and impacts the future success and expectations placed on each and everyexecutive.

Outsourcing has become the de facto model for today's modern organization. To savvy executives the real question is no longer should we outsource, but how best to ensure success in this new outsourced world.

This means that executive thinking is shifting. It's moving from the need to justify outsourcing to the need to justify the use of internal resources. Executives are increasingly asking themselves how best to concentrate their limited internal resources. And, where can outside relationships be best used to create unique value for customers and competitive advantage for the firm. All of this presages a re-alignment in how we think and how we manage. Every executive and manager, not just a single centralized executive, needs new skills for this increasingly virtual business world.

At the same time, commercial, not-for-profit, and governmental organizations are under ever relentless pressures to do more with less, to focus on the limited set of activities that bring the most leverage to the marketplace, and do it all faster and with greater competitive differentiation.

It all adds up to a business environment that demands that external solutions be considered right alongside the use of internal resources. Turning to an outside provider may deliver important advantages. Outside organizations that specialize in a particular activity or process may be more cost effective, but increasingly, their contributions come more from their ability to help clients drive shareholder value and transform their businesses. Specialized providers can bring innovative solutions, enhanced flexibility, accelerated process redesigns, a greater range of services, continuous improvement, and sophisticated performance measurement procedures — like balanced scorecards.

Published: Prior to January 18, 2001

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