Outsourcing: Definitions and Analysis

Alexandre Dolgui (1) and Jean-Marie Proth (2), *

(1) Ecole des Mines de Saint-Etienne, UMR CNRS 6158 LIMOS, 158 cours Fauriel
42023 Saint-Etienne, France, e-mail: [email protected]

(2) Research Director/Consultant, 22, rue du Colombier, 57420 Pouilly, France, e-mail:
[email protected]

* Corresponding author: [email protected]

Abstract
The objective of this paper is to provide the classical vocabulary on the topic, a short
analysis of the state of the art of global outsourcing to the late 2000s (e.g. China that is a good
example of an emerging country in the early 70) and a review of the advantages and
disadvantages of outsourcing over the medium and long term. We do not seek to define how
to outsource, but to show the possible consequences of such a decision. This paper was
written at a time when many questions arise on the subject.

Key words: Supply chain, Subcontracting, Outsourcing, Off-shoring, Offshore

outsourcing, Pro outsourcing, Cons outsourcing, Perspectives.

1. Introduction
The first question that arises when a new production (a new service) is decided is: what
should we make indoor and what could be entrusted to external sources? A possible answer to
this question is the following: make internally everything that uses the core competencies of
the production system and outsource other tasks. It remains to define the set of core
competencies of the production system under consideration, and identify external sources to
which assign the remaining tasks.
Another important question requires an answer: what are the risks of outsourcing, and how
to minimize these risks? Specifically, the question is: how external sources will be integrated
into the production strategy and make achievable production targets?
To avoid confusion in the explanations, it seemed useful to clarify the terminology used in
the field of outsourcing: this is the purpose of Section 2.
In Section 3, we offer a brief chronology of outsourcing. This timeline shows how a phased
strategy came to undermine a well established economic system.
In Section 4, we list the main arguments used by firms in favour of outsourcing as well as
the arguments of those who oppose outsourcing. This section contains two subsections. The

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first one is devoted to the study of the benefits of outsourcing. We recall the classical
arguments in favour of this type of decision. However, we also mention the side effects that
may cause adverse effects. They are of two types: the emergence of high unemployment in
countries that outsource and the transfer of core competencies from developed countries to
developing countries. We may also mention that outsourcing may also be negative in
countries of vendors by being an argument for keeping employees at a low living standard.
Many research studies have been done to promote outsourcing. Works concerning in
particular offshore outsourcing, which is increasingly criticized for the poor quality of some
of its achievements and for delivery delays, are the most interesting. We present some of these
works. These are mostly serious works well documented. Unfortunately, they are either
qualitative or they are only interested in a part of the problem, or some assumptions are
unrealistic. We will present some significant publications.
The second sub-section of Section 4 focuses on additional arguments that oppose
outsourcing. We present the four arguments that we place among the most important. The first
one is the dilemma of competition that explains the process by which, in certain
circumstances, the vendor may become the master of the game. The second and third
arguments put the reader on guard against outsourcing in one hand showing how the initiative
of the buyer may be paralyzed and how its activity can escape to the vendor. The last point of
the statement shows that offshore outsourcing can disrupt the global economic balance.
Section 5 does not purport to be a definitive conclusion, but simply the reminder of the
main questions to ask when thinking about outsourcing.

2. Terminology related to outsourcing

To avoid confusion, we devote this section to clarify the terminology used in the field of
outsourcing (Simchi-Levi et al., 2004).
Outsourcing is defined as the act of obtaining semi-finished products, finished products or
services from an outside company if these activities were traditionally performed internally.
In the previous sentence, the word "product" may be replaced by "service". The company that
out sources is called "buyer" whereas the company that provides the service is known as the
"vendor". Note that outsourcing leads to a significant rapprochement between the vendor and
the buyer. An important flow of technical and organizational information inevitably occurs
between the protagonists. We shall see later that this can lead to significant problems.
Confusions are frequent between "outsourcing", "offshore outsourcing", "off-shoring" and
“subcontracting”.
We speak of "offshore outsourcing" where the vendor is located in a country different from
that of the buyer. Therefore, only the location of the seller differentiates the two concepts.
When a company is fully relocated to a country other than his home country, we speak of
"off-shoring". This situation is relatively rare because it is risky.
Managers sometimes confuse "outsourcing" and "sub-contracting". The latter concept
means that part of the work is transferred to another company that has special skills or
resources that allow it to perform tasks clearly specified in better conditions. In other word, a
subcontractor works for the buyer in specific limits, while a seller cooperates with a buyer.
Subcontract involves only the transfer of the specifications of the product or service.
We still will use the term "core competencies."  This concept was first introduced by
Prahalad and Hamel (1990) and used by many authors including Dekkers (2000). According
to the authors, the "core competencies" can be defined as the collective knowledge of the
production system concerned, in particular knowledge of procedures and how to best integrate
and optimize them. More simply, one could say that the concept encapsulate the expertise of

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the company with regard to its "strengths", that is to say, the activities that make that the
company is ranked ahead of the competition.
In their article, Quinn and Hilmer (1994) give a more detailed definition of the "core
competencies" concept. In their view, the "core competencies" are defined as follows:
- Have a range of expertise that crosses traditional functions horizontally,
- Have the capacity to adapt to changes in long-term demands of clients,
- These "core competencies" must be limited in number (as a matter of effective
management),
- Dominate the competitors with regard to these skills,
- Being close to customers in order to be recognized as a leader,
- Finally, be able to continue and even improve the domination of the competitors.

3. A brief chronology of outsourcing in an emerging country

The chronology we now set out applies to China, but could also apply to other emerging
countries towards which companies offshore. In the book (Dolgui and Proth, 2010), we stated
the following chronology:
- In the seventies, outsourcing activities concerned low added value products such as
textiles, consumer electronics (TV sets for example), toys, etc.
- In the eighties, outsourcing incorporated car parts and even full assembly of cars.
- In the nineties, more and more outsourcing requirements concerned products with high
added value such as software, semiconductors (for IBM, Intel, Texas Instruments, …),
medical equipment, to mention a few.
- Since the middle of the nineties, outsourcing to China concerns higher added value
products and services: research and development (R&D), key auto parts (for Ford, Daimler-
Chrysler, and Volkswagen), key airplane components (for Boeing), machinery, and so on.
Since China’s vendors are involved in value added products and services, the related
technologies migrate from Europe and the US to China. The reason is that outsourcing usually
occurs through joint venture, equity stakes and co-production agreements, which leads to
sharing know-how and, in addition, makes the buyers more and more dependent on the
vendors.
Most of the US and European giant companies outsource currently in China. We can add to
the companies already mentioned above Philips Electronics, Thomson, Siemens, Airbus,
General Motors, Renault, etc.
This evolution has resulted in a financial domination of China over Europe and the US.
This situation is sometimes summarized by saying: “China supports developed countries as
the rope support the hanged person”.
We summarize this evolution until the late 2000s in Figure 1. We note that, at least in some
areas, China is on track to overtake Europe and the United States in terms of technology and
innovation.
We will return to chronology to highlight the risks it open to U.S. and European
economies.

4. Is outsourcing good or bad strategy?

We are in a period in which some companies that had previously decided to outsource part of
their production are backtracking on their decision. It is also during this period that we find in
the literature more and more communications that take for granted the positive aspect of
outsourcing, to the point of not even ask the question that introduced this section (see for
example the following sentence in (Yao et al., 2010): ” While outsourcing may enhance a

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client’s firm’s value in several ways, such access core competency, current research finds that
cost reduction ranks the highest among other outsourcing benefits”.
Added value

Increasing flow
of technical
information and
technology to
China.fut que le

High added value products

and services (R&D, etc.)

Car parts and car assembly

High added value products

Low added value products

Years
Seventies Eighties Nineties 2000s
Figure 1: Evolution of Outsourcing to China

Our goal is to give voice to the supporters and opponents of outsourcing in order to
have a balanced perspective on this key issue.

4.1 Pros of outsourcing

4.1.1 Outsourcing: the forecasted benefits and some negative consequences

The arguments quoted here are common in the literature. The reader can especially see
Chapter 3, Section 3.5 in (Dolgui and Proth, 2010) to find most of these arguments:
- Cost saving, which requires choosing a vendor that performs the outsourced function
more efficiently than buyer could.
- Reduce staff, or minimize the fluctuations in staffing due to changes in demands.
- Free employees from tedious tasks in order to allow them to concentrate on core
activities.
- Gain benefit by taking advantage of external expertise or outsourcing non-core activities.
- Achieve greater financial flexibility by selling assets that were formerly used in the
outsourced activity in order to improve company’s cash flow.
- Gain access to external skills and technologies. Of course, this is only true if the "vendor"
brings new skills and innovative technologies and not only workforce.
- Vendors are assumed to provide quality activities: paying for service creates the
expectation of performance (in costs, quality, flexibility, etc.). The previous remark still
holds.
The arguments presented above are theoretically in favour of outsourcing. However, we
noted that some of them may, in certain circumstances, be arguments against outsourcing.
This is the case of the reduction of staff and costs which may have a negative impact on the
social environment for buyers. We also observed that obtaining greater financial flexibility
through the sale of assets may have a negative impact on future developments of the buyer.

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Finally, we noticed that the accession of new skills and new technologies through outsourcing
is not obvious, and therefore may have a negative impact.
We summarize these observations in Table 1.

Table 1: Main objectives and side effects

Desired objectives Possible adverse consequences

Search for a vendor whose prices are as low - Unemployment in the country of the buyer
as possible - Permanence of a low social status in the
vendor's country
- Risk of quality problems if the vendor is
involved recently in this type of product
Reduce staff in the buyer’s company Unemployment in the buyer’s country
Taking advantage of external expertise This is only possible if the vendor has a high
technological level, but in this case the prices
it offers are probably less interesting.
Free employees from tedious tasks Unemployment in the buyer’s country
Improve financial flexibility by selling assets The sale of assets reduces the possibility of
that have become unnecessary as a result of future extensions of the buyer. This is a
outsourcing strategic constraint that the buyer applied to
himself. In addition, he/she becomes
dependent on the vendor.
Gain access to external technology This is an advantage only if the technology is
used occasionally. If the need for this
technology is permanent, then this may
favour the vendor who becomes dominant
partner.
Vendor provide quality activities Unwarranted assertion

It is perhaps why, in recent years, researchers who expressed their support of outsourcing
alter their explanations. They use a lot less traditional arguments like "cost savings" or
"enable the buyer to focus on their core competencies."
Sometimes, their argument boils down to an assertion such as, for example in Wu et al.
(2005): “While outsourcing has become an indispensable part of an enterprise’s core business
and its benefits are widely recognised…” However, as it is increasingly difficult to ignore the
problems caused by outsourcing, the authors continue their sentence by writing: “the risks
associated with outsourcing must be clearly understood and assessed, as far as possible, in a
quantitative manner.”
We also note that the scope of the arguments in favour of outsourcing has grown
considerably. It now includes strategic considerations that become paramount, as in the article
mentioned above: “Long-term performance requires more emphasis on the strategic aspects of
competitiveness.” Unfortunately, while extending the scope of arguments at the strategic
level, analysts are often forced to abandon the quantitative approach to adopt a qualitative
approach, which is much less convincing.
Sometimes the following arguments are used: “A long-term outsourcing policy may
initially need to be more defensive, but when confidence in the integrity and honesty of
suppliers has been well established, a more relaxed approach may be adopted.” For our part,
we would like to be clearly defined terms "integrity" and "honesty" in the business world. If it
is just to satisfy the constraints set out in the contract, we agree with the authors. But we ask
the following questions:

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 - Is it “honest” to take advantage of low social level of a country to make employees work
for ridiculously low wages? Note moreover that this process is endless. For example, China
has long been an appreciated vendor due to the cost of its workforce, which has long remained
very low compared to Western countries and the United States. However, average wages have
increased in China. The result was not long in coming: some Chinese companies currently
outsource in Ethiopia where the cost of labour is three or four times lower than in China.
- Where is “integrity” when a country uses the exchange rate of its currency to increase its
competitiveness?
Many other questions could be asked about it.
In their paper, Yang et al. (2012) emphasize the importance of a hybrid form of
governance, the legal contract enriched by adapting informal relationships between buyer and
vendor. In other words, the contract sets the measurable criteria of cooperation, while
informal adaptation introduces flexibility in the relationship between buyer and vendor. This
flexibility is particularly essential for supply chains are complex structures that require
adaptive management.
The literature offers many other papers that consider outsourcing as a process that requires
permanent intervention of human intelligence. This process can not be reduced to the
application of an algorithm, even that of an expert system.
This observation shows the difficulty of assessing the impact of outsourcing and in
particular the relationship between the effects of outsourcing and the results that are often
qualitative.
To conclude, we note that, while remaining conducive to outsourcing, many researchers
take a step back with regard to this concept. This trend manifests itself in different ways:
- A shift towards a perspective both more strategic and qualitative of the concept of
outsourcing.
- The explosion in the number of special cases treated in the literature, and therefore a
drastic reduction of general conclusions.
- An increase in the number of communications that are interested in outsourcing risk, see,
among others (Weerakkody and Irani, 2010).

4.1.2 Initiatives in favour of outsourcing

Researchers who believe that outsourcing is a positive approach worked diligently in different
directions to strengthen their approach. We discuss here some works that we feel are
important in this context.
In their research work (Yao et al., 2010) have focused on the selection of outsourcing
contracts, after finding that existing works were descriptive and therefore of limited use. Their
work is based on the three most popular outsourcing contracts, that is to say, fixed-price, cost-
plus and gain-sharing. They fill a gap in particular:
- By explaining the difference between these types of contracts in the USA and France,
- By explaining how to deal with the problem of information asymmetry.
The authors readily admit that their work is limited to the search for cost reduction for the
client. They note that the cost reduction is often the major criterion to make an outsourcing
decision and suggest that research should continue considering other criteria, such as the use
of up-to-date technology, improving core competencies, improving quality and productivity,
etc.
In his work, Schoenherr (2010) conducted a survey in 15 countries on the subject of
outsourcing. He received 806 responses which allowed him to sketch the process of decision
making. This study provides insights for researchers and practitioners. It also provides the
most important suppliers of the respondents and the reasons for outsourcing to these suppliers.
The importance of this work comes from its size and quality of the links between the different

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concepts. Thus, it allows the user to locate its outsourcing decisions in relation to a wide
range of previous experiences.
Narasimhan et al. (2010) discuss the mediating role of ISMP (Integrative Supply
Management Practices) on outsourcing performance. Two types of supply management
practices are examined: practices to avoid failures and practices with the goal of improving
performance. In addition, these two types of practice play a role in performance related to
outsourcing. The authors propose a conceptual model. This paper provides some interesting
ideas for further development. However, it remains very qualitative and difficult to exploit
with the assurance of an unequivocal result.
The article of Wang et al. (2010) proposes a linear programming model with fuzzy
multiple objectives to analyze the effectiveness of vendor selection in terms of costs. The
approach is interesting and seriously conducted. However, the authors admit that the proposed
method is insufficient for decision making. According to the authors, a method of investment
analysis is required. We will add that key aspects of outsourcing are absent from the model,
for example, the increase in unemployment in the developed world and the impoverishment of
these countries because of the transfer of technology to developing countries. In summary,
this work is serious and shows how the use of fuzzy sets can assist in the analysis of complex
systems. Unfortunately, the seriousness of that work masks the fact that essential aspects of
outsourcing are not taken into account.
Weerakkody and Irani (2010) studied the policies of four vendors. The study is empirical.
The authors identified different models that relate to offshore outsourcing. As we noted
above, the authors emphasize that offshore outsourcing now involves high level IT activities.
They also emphasize that the transactions are in areas of limited risk and low value in terms of
production of the buyers. The authors suggest vendors to develop outsourcing strategies of
low cost, focusing on high-value contracts, avoiding new risks. The authors believe that this
approach will facilitate the choice of buyers.

4.2 Cons of outsourcing

Some arguments that could have let the reader sceptical about the value of outsourcing have
crept in the previous sub-section. We will now supplement, showing the risks when a
company out sources.
We will consider four special risks. In our opinion, they are pivotal:
- Dilemma of the competition.
- Loss of initiative by the buyer.
- Migration of production and services to vendor’s country.
- The harmful aspect of offshore outsourcing strategy.

4.2.1 Competition dilemma

Suppose that an international company (called "buyer") wishes to outsource part of its activity
to a company that has the appropriate skills, but works in a nearby area. We also assume that
the "vendor" is of a good technical level and its reliability is widely recognized.
The collaboration between the two entities will create links between both. We will witness
the birth of a flow of information between "buyer" and "vendor." This flow of information
transfer technical data, and possibly data on the know-how that will enable the vendor to
perform the necessary tasks to the satisfaction of the buyer.
Of course, the buyer will take precautions so that core competencies can not fall into the
hands of the vendor. But it will be difficult to maintain a tight barrier between the buyer and
the vendor, especially if the collaboration continues and if the vendor is well organized in the
collection of data. In particular, the vendor may exert pressure to access to core competencies.
Furthermore, this collection can be complemented by indirect means, mainly if the technical

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and technological level of the vendor is high. It is therefore possible that the vendor
appropriates all the skills of the buyer. The vendor will become a competitor of the buyer in
the medium term. We summarize this in Figure 2.

Outsourcing

Organizes
Buyer Vendor data

Pressure for Ready for competing

further information with the buyer

Figure 2: The competitive dilemma

In conclusion, when the buyer uses a vendor of a good standard, the risk is that it becomes
a competitor in the medium term, especially if it is located in a country where wages are low
and people have a good education level.

4.2.2 Loss of initiative by the buyer

The existence of a vendor necessarily exerts a number of constraints on the buyer. Following
are the main constraints:
- Freedom of the buyer is reduced. In particular, all activities that include a vendor can not
be changed without a rebalancing of the organization. This rebalancing could be complex. It
may even require a renegotiation with the vendor,
- The investment opportunity of the buyer may be eroded by the costs incurred by the
vendor,
- As to the vendor becomes important in the organization of the buyer, the freedom of the
latter can be significantly reduced.
We will therefore keep in mind that outsourcing a part of the activity of a buyer reduces its
degree of freedom. This phenomenon is even more important when the choice of the buyer
was partly motivated by the benefits offered by the seller's country (incentive tax policy, for
example), because in this case, the pressure on the buyer are stronger.

4.2.3 Migration of production and services to vendor’s country

The flow of investments from the developed to the developing countries due to outsourcing is
huge. If we limit ourselves to China, the figure of 0.5 trillion during the 2000s was cited.
Developed countries were not content to outsource the work; they have also outsourced
research, especially in areas where competition is played (IT, top service, aviation,
automobiles, etc.). In other words, developed countries have built in developing the tools that
allow them to compete with, in addition, the advantage of low wages and often a currency
widely undervalued.
The argument for outsourcing is motivated as follows: it is in the developing countries that
will arise the future markets, it is thus necessary to settle there. Yes, but it might be good to
answer the following questions:

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 - Does the current strategy induces the risk of killing American and European industry and
related sectors of research and development before a sole market opens in a developing
countries?
- Is the preceding argument the result of an accurate analysis or, more clearly, the desire of
some investors to make money at any price, including destroying the industry, research and
development, in developed countries?
One example among many others shows the danger of outsourcing, even when it does not
occur to a developing country. The French company Renault has decided some years ago to
develop a low-cost brand in Romania. The pretext used was to allow former communist
countries to develop auto industry. It was also stated that this brand would never be developed
in Western Europe and the United States. The result is the following. Dacia sales exploded in
Western Europe. The event was predictable.
So we will keep in mind that the current strategy of the developed countries leads to the
migration of production and services to developing countries. In addition, we know that
developing countries have, for some of them, massive amount of currencies they can invest by
buying foreign companies with their technology and know-how and develop their own
research and development centres. Added to these advantages a growing number of skilled
engineers trained in the country or abroad. All conditions are met for the developing
countries catch up and surpass developed countries in the short term, especially as
competitiveness factors that characterize them disappear very slowly.

4.2.4 The harmful aspects of offshore outsourcing strategy

4.2.4.1 General comments

In this sub-section, we provide general comments about offshore outsourcing and we examine
if we should follow, or not, the “unique thought” that claims that outsourcing is the salvation
of the manufacturing sector of developed countries.
In the previous section, we saw that production and services migrate to developing
countries. Two additional drawbacks should be noted:
- Among employees whose employment has been outsourced, only a part of them found a
job at a level of competency and salary that are equivalent to the previous ones,
- Jobs outsourced generally lead to higher number of jobs in the host country (developing
country). The explanation is to be sought in the competence of the engineers who generally
take advantage of outsourcing to enrich and adapt the features.
Finally, the question to answer is simple: How harmful is offshore outsourcing to developed
countries?

4.2.4.2 The harmful effects of offshore outsourcing to countries

We illustrated the explanation with the example of the car manufacturer Renault which has
implemented a low-cost brand in Romania. This brand is currently invading Europe, causing a
significant decline in sales of brands already established (including Renault!) and indirectly
causing the closure of factories, especially in France.
It is possible that the same process recurs in the aviation industry. Indeed, the European
manufacturer EADS has outsourced part of its production, with the corresponding technology
in China. The argument was, this time, that outsourcing was a condition of the purchase of
aircraft by China. It remains to observe closely the evolution of the situation.
It is easy to understand that offshore outsourcing can also be harmful for countries that are
neither "buyers" nor "vendors". Take the example of Dacia. This low-cost product is also
exported to such countries. As a result, retailers' margins are shrinking and unemployment
rises, causing economic problems.

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 The next question is worth to be asked (Dolgui and Proth, 2010):
“Is it better not to outsource offshore sensitive technology and risk losing a market or to
outsource, winning a market on the short term, but in the end losing all markets, including the
home market?”

4.2.4.3 The harmful effects of offshore outsourcing to the world

The consequences of offshore outsourcing are well known of citizens of developed countries.
These consequences are unemployment, declining living standards, deindustrialization, to
quote only a few. But the pivotal (and probably lasting) damage is deeper and less visible
globally. The reason is that a basic knowledge of economic theory is needed to understand.
The explanation given by Deardorff (2006) is clear. It is reproduced below:
“The first answer to this (question) should be that offshore outsourcing cannot harm the
world as a whole if there are no distortions anywhere in the world economy. We know from
elementary general equilibrium theory that, in the absence of distortions (externalities, taxes,
and the like) perfectly competitive markets maximize the value of world output as constrained
by world factor endowments and technology. The introduction of the ability to do offshore
outsourcing only adds to what it is technologically possible to do in the world economy, and
it thus relaxes that constraint. It can therefore only increase or leave unchanged the value of
world output.
But of course the world does have distortions, lots of them. And in that case, as with free
trade, examples abound in which the new opportunities make all distortions worse. In another
place, Deardorff (2005), I have again suggested a couple of examples of how this might
occur”.
Thus, it seems possible that offshore outsourcing to developing countries, which introduce
important price distortions (Deardorff, 2001), may hurt world economy.

5. Conclusion
When considering the consequences of outsourcing (especially offshore outsourcing), it is
surprising to see the enthusiasm of researchers for this management tool and, at the same time
that their studies ignore important criteria. Among the criteria systematically ignored, we find
in particular:
- The negative impact of offshore outsourcing on employees of the vendor and buyer
companies,
- The negative consequences of outsourcing to the vendor company in the medium and
long term,
- The global economic imbalance that can occur in the case of distortions in the economic
system, which always occurs in practice (advantageous export or import taxes granted by the
vendor's country, distortion of currency values, distortion in wages, etc.).
Ignoring the above criteria has the effect of penalizing the well-being of employees, pose a
significant risk to the future of the buyer, and risk creating chaos (chaos extra) in international
trade.
The disadvantages of offshore outsourcing usually cited in the literature are too often at
issue: problems of quality of services and products, delivery problems, risk of fraud, etc. The
literature suggests, as we have seen, solutions to these problems. However, these solutions
concern either specific problems or some aspect of more general problems. On the other hand,
they are limited to general guidelines or propose algorithms whose assumptions are
questionable. The latter situation occurs when trying to use at any price known mathematical
tools (e.g. linear programming) and that reality refuses to adapt to the theory. In this case, the

10
investigator is tempted to introduce simplifying assumptions that can drive the model apart
from reality.
Unquestionably, offshore outsourcing often leads to low production costs, but to avoid
problems it is best to outsource only products or services:
- Low-tech,
- Whose production is already mature.
These remarks do not apply where the vendor is highly technical. By cons, in this case, the
risk is that the vendor becomes competitors in the medium term.
The main question that arises can be stated as follows: are we sure that if we consider all
parameters of outsourcing, it is still advantageous to outsource? Subsidiary question: should
we not accept outsourcing only when the vendor is comparable to the buyer in terms of social
level, taxes, etc.?

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