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The Perceived Impact of Outsourcing on Organizational Performance

Dean Elmuti, Eastern Illinois University

Introduction

In todays world of ever increasing competition, organizations are forced to look for new ways to generate value. The world has embraced the phenomenon of outsourcing and companies have adopted its principles to help them expand into other markets (Bender 1999). Strategic management of outsourcing is perhaps the most powerful tool in management, and outsourcing of innovation is its frontier (Quinn 2000).

Outsourcing is a management strategy by which an organization delegates major, non-core functions to specialized and efficient service providers, or as Corbett (1999). President of Michael F. Corbett and Associates asserts, Outsourcing is nothing less than the wholesale restructuring the corporation around our core competencies and outside relationships. The traditional outsourcing emphasis on tactical benefits like cost reduction (for example, cheaper labor cost in low-cost countries), have more recently been replaced by productivity, flexibility, speed and innovation in developing business applications, and access to new technologies and skills (Greer, Youngblood, and Gary 1999; Bacon 1999).

The market for providers of outsourced services of all types is growing rapidly. In 1996, American firms spent over $100 billion in outsourced business activities (Casale and Overton 1997). Other estimates place the total U.S. market for outsourcing at more than $300 billion by the year 2001 (Dun and Bradstreet 2000). Globally, outsourcing usage grew 35 percent in 1997 and the total market for outsourced services is expected to increase to $200 billion by the year 2001 (Greer, Youngblood, and Gray 1999). A recent study was conducted by Yankelovih Partners indicated that two-thirds of companies world-wide already outsource at least one business process to an external third party. This practice appears to be most common in the U.S., Canada, and Australia, where 72 percent of outsourcing is being sought (Goldstein 1999; Bacon 1999).

Successful implementation of an outsourcing strategy has been credited with helping to cut cost (Bowersox 1990; Gupta and Zeheuder 1994; Greer, Youngblood and Gray 1999), increase capacity, improve capacity, improve quality (Lau and Hurley 1997; Kotabe, Murray and Javalugi 1998), increase profitability and productivity (Casale 1996; Sinderman 1995), improve financial performance (Crane 1999), lower innovation costs and risks (Quinn 2000), and improve organizational competitiveness (Lever 1997; Steensma and Corley 2000; Sharpe 1997). However, outsourcing does generate some problems. First of all, outsourcing usually reduces a companys control over how certain services are delivered, which in turn may raise the companys liability exposure.

Companies that outsource should continue to monitor the contractors activities and establish constant communication (Guterl 1996). Another big problem with outsourcing comes from the workers themselves as they fear loss of jobs (Malhorta 1997). According to a recent survey 55 percent of outsourcing relationships fail in the first five years. Of these that do manage to stay together, 12 percent are unhappy with their arrangement and regret ever making the deal (Foster 1999).

This study was designed to explore why companies are undertaking outsourcing projects and identifies factors that my facilitate or impede outsourcing projects. This article also examines the relationships between outsourcing strategies and organizational performance. The paper is organized in the following manner: the next section reviews the outsourcing literature and develops the questions this paper seeks to answer; the third section presents the method used in the study; the fourth section highlights overall results of the study; the fifth section presents detailed results in answer to specific questions; and the final section summarizes company improvements in performance.

Literature Review

The significant level of outsourcing programs used across all business sectors is well documented in the literature (Bender 1999; Quinn 2000; Dun and Bradstreet 2000; Klaas, McClendon and Gainey 2001). Past research has progressed along several paths. First, some researchers have focused on motivations and reasons for outsourcing activities (Conner and Prahalad 1996; Greer et al. 1999; Sinderman 1995; Mullin 1996; Grant 1996; Frayer Scannell and Thomas 2000). According to this perspective, the global imperative for outsourcing accelerates as firms evolve from sellers of products and services abroad to setting up operations in foreign countries and staffing those operations with host countries or third party nationals (Greer et al. 1999). Most corporations believe that in order to compete globally, they have to look at efficiency and cost containment rather than relying strictly on revenue increases (Conner and Prahalad 1996). As companies seek to enhance their competitive positions in an increasingly global marketplace, they are discovering that they can cut costs and maintain quality by relying more on outside service providers for activities viewed as supplementary to their core businesses (Mullin 1996; Grant 1996).

Other researchers have identified several outsourcing issues, trends and strategies that companies take in establishing and effectively managing their outsourcing activities (Sinderman 1995; Carney 1997). The trend is for outsourcing relationships to function more as partnerships. Outsourcing providers are taking increasing responsibility in realms that have traditionally remained in-house, such as corporate strategy, information management, business investment, and internal quality initiatives (Sinderman 1995; Carney 1997). A survey of U.S. CEOs shows that 42 percent of communication firms, 40 percent of computer manufactures, and 37 percent of semiconductor companies rely on global outsourcing (Faber 1995). According to another survey conducted by Duncan and Groves-Rowan (1997), more than 65 percent of banks surveyed indicated that they were already involved in at least one type of outsourcing function. The five most commonly used outsourcing functions in banking were taxes, bankruptcy/foreclosures, systems, cashiering, and insurance (Jennings 1996). Personnel expenses were the primary reason behind banking outsourcing; however, it also improves operating efficiency and reduces service costs.

On the other hand Kotabe (1998) argues, that there could be negative long-term consequences of outsourcing resulting from a companys dependence on independent suppliers. Such reliance on outsourcing may make it inherently difficult for the company to sustain its long-term competitive advantages without engaging in the developmental activities of the constantly evolving design and engineering technologies. Other researchers have examined the outcomes of technology-sourcing partnerships from the sourcing firms point of view (Steensma, Kevin and Corley 2000; Mowery, Oxley and Silverman 1996) found that, in general, equity-based alliances were more effective than contract-based outsourcing. Steensma, Kevin and Corley (2000) suggest that the outcomes from technology partnerships for sourcing firms depend on the interaction between technology attributes and the interdependence between source and sourcing firms.

Other researchers have focused on outsourcing strategy effectiveness and its impact on organizational characteristics (Frayer, Scannell and Thomas 2000; Klaas, McGlendon and Gainey 2001). Frayer et al. (2001) suggest that in order for an out-sourcing strategy to work effectively, companies must proactively manage their outsourcing strategies by establishing top management commitment, global sourcing structures and processes, and global sourcing business capabilities. In addition, they suggest that companies that have not raised their sourcing approach to global, strategic level may already be behind in terms of quality, cost, delivery, technology, performance, and customer service. Klaas et al. (2001), suggest that the influence of organizational characteristics was highly contingent, suggesting that organizational characteristics have different effects on various types of outsourcing activities outsourced. As such, it appears that many factors such as pay level, promotional opportunities and demand uncertainty should be considered when deciding to outsource functions or activities.

Other researchers have focused on outsourcing performance measures (Kotabe, Murray and Javalagi 1998; Goldstein 1999; Malhorta 1997; Carney 1997). For example Kotabe et al. (1998) identifies three types of performance measures as necessary components in any outsourcing performance measurement system: strategic measures; financial measures; and quality measures. Other studies use additional dimensions of market performance such as costs savings, cycle time, customer satisfaction, and productivity to measure the effectiveness of outsourcing strategy (Goldstein 1999; Malhorta 1997; Carney 1997).

From a different perspective, obstacles such as poor choices of sourcing partners, inadequate planning and training/skills needed to manage outsourcing activities and poor organizational communication have also been identified as impacting the success of outsourcing projects (Lau and Hurley 1997; Guterl 1996; Foster 1999; Laabs 1998).

How is successful outsourcing performed? Literature identifies high-level approaches to outsourcing (Heywood 1994; Jennings 1996; Bender 1999; Corbett 1999; Carney 1997; Foster 1999), but not detailed methodologies. Further there is little empirical research investigating outsourcing performance implications (Klepps and Jones 1999; Kotabe and Murray 1998). Additionally, while consultants identify the success of their approach, they do not identify the failures or problems of their approach as readily (Lever 1997; Crowley 1999). Fewer studies have examined the outcomes of outsourcing activities. Lau and Hurley (1997) find a significant relationship between outsourcing and profitability margin where they found that Chryslers profit margin is four times as high as that of GM due to effective outsourcing through strategic alliances. Frayer, Scannell, and Thomas (2000) suggest that companies are increasingly viewing outsourcing strategies as a means of reducing costs, increasing quality, and enhancing a firms overall competitive position.

The increasing use of outsourcing arrangements, as well as the unfamiliar complexity, suggest the need to know more about how to effectively utilize this strategy. Consequently, more information is needed to understand successful outsourcing and problems encountered in outsourcing activities and its impact on overall organizational performance. The claims by proponents of outsourcing strategy suggested four research questions that guided this investigation of the relationships between outsourcing programs and organizational performance:

  1. To what extent does the degree of familiarity and utilization of the outsourcing strategy vary across a variety of settings?
  2. Why do organizations undertake outsourcing projects?
  3. Do outsourcing programs achieve their stated objectives of improving organizational performance, productivity, marketshare, and quality?
  4. What factors are associated with the success or failure of outsourcing programs?

Method

To answer the above questions, a survey of outsourcing strategy was developed and distributed to 1500 organizations throughout the United States. The names of the firms were generated randomly from a computer database known as Compact Disclosure and Association for International Research Inc. in 1999. These firms were randomly selected among several types of industries, unionized and nonunionized, and across a variety of settings. Survey respondents were Presidents/Vice-presidents, General Managers, Project Managers (in charge of outsourcing activities), Functional Managers, and Supervisors in these selected organizations. A total of 430 questionnaires were returned for a response rate of 28 percent. Twenty-eight questionnaires were not acceptably completed, thus reducing the response rate to 26 percent. The remaining 402 were usable questionnaires and these responses were analyzed in this study. The respondent organizations were spread relatively evenly throughout the United States and ranged in size from 50 to 50,000 employees. The following industries were represented: manufacturing (28%), oil (10%), banking (12%), information technologies (26%), and insurance and professional services (24%).

Measures

The four-page questionnaire was divided into three parts. The first part consists of items dealing with outsourcing familiarity, reasons for implementing outsourcing strategy, duration of an existing program, the extent of interest in establishing a new program, improvement of an ongoing program or discontinuation of the present outsourcing strategy. The second part consisted of items dealing with the perceived factors that may have contributed to the success or failure of outsourcing programs among survey respondents. Finally, the third part consisted of items dealing with measures to assess the performance of outsourcing strategies from the perspective of survey respondents.

To measure organizational performance, we used Likerts Profile of Organization Characteristics because, unlike other potential measures, it allowed additions to be made to the questionnaire in order to assess overall performance with specific new programs or initiative (Likert 1973).

The Likert instrument has been shown to have acceptable levels of reliability and validity across a variety of settings. It is based on a scale of 1 – 5 (a Likert 5 type rating scale), with 5 as the most effective level and 1 as the least effective level. A reliability test was conducted for indices of organizational performance to enhance their credibility. The coefficient alpha for this study was above 0.76. Most researchers consider an alpha at .70 to be an acceptable criterion for adequate scale reliability. In addition to the scales described above, basic demographic questions including gender, age, job status, industry type, size of the firms by number of employees, and annual sales were included in the survey. Several variables were identified as being significant for the purpose of this study. First, there were the elements used to measure the independent variables outsourcing strategy with measures (derived from Casale 1996; Lever 1997; and Duncan and Groves-Rowan 1997) that included outsourcing dimensions such as types of activities or functions outsourced. Outsourcing involves a long-term contractual relationship for business services from an external provider and differs from other forms of contracting in several distinguishing ways. It is not a situation that firms enter lightly or want to renegotiate frequently (Lever 1997). The second variable focused on the elements used to measure the dependent variableorganizational performancethat included productivity (cost savings, efficiency, cycle time), quality (customer service and percentage of defects), satisfaction and market performance (marketshare, return on investment, return on sales). These measures of performance are used by several authors (Kotabe, Murray and Javalagi 1998; Goldstein 1999; Likert 1973; Gupta and Zheuder 1994).

Outsourcing Familiarity and Usage

The questions were designed to measure outsourcing strategy familiarity and duration of existing outsourcing programs among the surveyed respondents. Outsourcing strategy generally refers to determining which production units will serve particular markets and how components/goods/services will be procured. While traditional importing involves a passive role in procuring merchandise, outsourcing requires proactive decisions about where, when, what, how much, and from whom to buy (Kotabe 1998). About 95 percent of the organizations surveyed reported that they were familiar with outsourcing strategy. About 25 percent of the respondents (102 organizations) reported that they did not have an existing outsourcing program. The remaining 300 organizations reported the duration of their outsourcing programs to be: 60less than one year, 80less than two years, and 160three years. These organizations have adopted an outsourcing strategy in part to include the area of manufacturing, transportation, payroll, inventory, human resources activities, information systems, and others.

Why Outsourcing Projects are Undertaken

Why do organizations take the risk of outsourcing? To examine this question, data was collected in three areas: (1) the reason outsourcing was initiated; (2) the activities or the functions organizations outsourced; and (3) the specific goal of the outsourcing project. The top reasons for undertaking outsourcing projects identified by the survey results were to: reduce costs, improve quality, improve delivery and reliability, gain access to materials only available abroad, establish a presence in foreign market, use resources not available internally, reduce the overall amount of specialized skills and knowledge needed for operations, make capital funds available for more profitable operations, and focus on core competencies of the corporation. These findings complement previous studies (Bowersox 1990; Crane 1999; and Quinn 2000) and suggest that outsourcing is undertaken for purposes that have a large impact on the organizations bottom line, although more tangential purposes such as strategy, profitability, and competitive advantage may have been the rationale for the more direct reasons. Table 1 shows the results of this inquiry. The total number of responses is greater than 300 organizations because respondents were asked to check all reasons that applied to their decision to begin outsourcing.

Type of Activities Outsourced

Second, outsourcing projects target specific types of activities or functions (see Table 2). Organizations were asked to identify the types of activities that they outsourced or were attempting to outsource. The top activities or functions identified were: information technology (such as application development, contract programming, data entry and simple processing), management services, manufacturing of components for the final product or the whole product, product design, engineering projects, distribution, and sales of products or services. These findings support recent studies on outsourcing activities (Corbett 1999; Buss 1995; Jones 1997; Bender 1999; Greer, Youngblood, and Gary 1999).

Projected and Attained Goals of Outsourcing

Finally, outsourcing strategy should have a specific goal an objective with a measurable outcome. Organizations were asked to identify their most specific goals or projected benefits and to indicate both the projected and the actual percentage of improvement achieved as a result of the outsourcing effect (see Table 3). The survey choices included: performance, cost-savings, productivity, cycle time, customer service, market share, and quality as the primary goals of outsourcing efforts, which were suggested by several authors (Jennings 1996; Quinn 1999; Beuder 1999). Table 3 shows the results of this inquiry and also shows the number of respondents who indicated that they achieved some improvement in attaining the primary goals. A majority (54%) of these respondents indicated that they achieved 10 to 20 percent improvement in performance, 10 to 15 percent in cost savings, 5 to 10 percent in improvement in productivity, less than 10 percent improvement in cycle time, 5 to 10 percent improvement in customer service, less than 10 percent improvement in market share. Fewer than half (44%) attained 10 percent in improvement in quality. This suggests that while organizations are not getting the projected or the promised magnitude of improvements ascribed to outsourcing they are achieving significant improvement in the activities.

Relationships Between Outsourcing Strategy and Overall Performance

Further evaluation of the relationships between outsourcing strategies and organizational performance, was accomplished by using multiple regression analysis to evaluate the dependence of measures of organizational performance on outsourcing strategy dimensions. This analysis determines the proportion of variance in organizational performance scores explained by outsourcing program scores. Multiple regression analysis was also used in this study to determine the strength of the dependancy relationship between the outsourcing programs and organizational performance. Two major variables were identified as being significant for the purpose of this study: (1) the elements used to measure the independent variables and the mean scores of all outsourcing dimensions such as functions and outsourced activities, and (2) the elements used to measure the dependent variable organization performance that included productivity, quality, satisfaction, and performance. The results of this analysis are presented in Table 4.

The multiple regression values in this table indicated that 40 percent of the variance in productivity, 31 percent of the variance in quality, 14 percent of the variance in satisfaction, and 32 percent of the variance in performance is explained by linear regression on the outsourcing strategy dimensions. The F-ratings indicate, with more than 95 percent confidence, that these linear associations are statistically significant. These findings complement previous studies (Casale 1996; Jennings 1996; Quinn 1999; Lau and Hurley 1997; Steensma, Kevin and Corley 2000), that found a positive relationship between outsourcing activities and performance.

The Degree of Success or Failure of Outsourcing
Strategies

Another primary intent of this study was to examine the degree of success or failure of outsourcing strategy among organizations that have an outsourcing program in their establishments. Firms considered their outsourcing projects successful when the benefits generated by the outsourcing strategies were greater than the costs of developing the required resources and capabilities through internal development or acquisitions. On the other hand, firms considered their outsourcing projects unsuccessful or failures, when the costs of managing the links between outsourcing partners were greater than the benefits generated by the outsourcing program. This finding is consistent with previous studies on alliances success and failure (Heywood 1996; Foster 1999; Laabs 1998).

However, 173 of the 300 firms (58%) classified their effort as successful and reported that they were achieving at least 5 to 15 percent improvement in each of their strategic outsourcing goals. Although, the actual percentage of improvement is less than the projected percentage of improvement, they considered their efforts successful. One way to explain this finding suggests that the stated goals were unclear or expectations from outsourcing projects too high. Furthermore, the firms reported that the outsourcing strategies in their organizations were making a huge contribution to overall organizational performance. They indicated that the dollar savings and indirect benefits generated by the outsourcing programs were greater than the costs of developing the required resources and capabilities through internal development. Outsourcing strategies were believed to help improve performance, increase access to international markets and leading edge technologies, enhance responsiveness to customer needs, and contribute to organizational goals of increased productivity, efficiency, reduced costs, reduced cycle time, and improved quality of the goods and services in their organizations.

Factors Associated with the Success or
Failure of Strategic Alliances Strategies

To examine the success factors, respondents were asked to identify their opinions concerning the degree of usefulness of fourteen possible factors associated with outsourcing strategies (on a scale of 1 very useful to 5 not useful). The responses were translated into means and ranks to make the analysis more meaningful to the readers and are presented in Table 5.

Successful firms identified the clear objectives and expectations of outsourcing activities as the most useful and contributing factors to their outsourcing effort. Outsourcing must be done carefully, systematically, and with explicit goals and expectations. Sensible reasons to consider outsourcing include both strategic and tactical concerns on both a department and organizational level (Casale 1996; Corbett 1999). A good choice of outsourcing partners was the second most useful and contributing factor among successful organizations. Outsourcing partners should be selected based on their expertise in the operation being outsourced and their cultural fit with the firm. The third factor is providing adequate training skills needed to manage outsourcing activities and to negotiate a sound contract. Providing managers with skills that will enable them to adapt to other cultures and work with other managers may be very important to ensure the success of outsourcing (Sinderman 1995). Developing a comprehensive plan outlining detailed expectations, requirements, and expected benefits during all phases of outsourcing activities may be the key to successful sourcing efforts (Guterl 1996).

Effective communication among cross-functional areas reduces the negative effects of outsourcing projects on the morale and performance of the remaining employees. Management must step in and rebuild trust among the workers, and jobs may need to be reevaluated and expanded or changed to fit the new organization. This can be achieved through support and involvement of top management and by providing incentives to employees and vendors who meet and exceed the contracted performance expectations (Jones 1997; Foster 1999). Another factor is to acquire the right people, with the right skills involved in all phases of outsourcing activities. Early in the evaluation, persons must be identified as to who will take leadership responsibility, perform the analysis, and make the decisions. Adequate supporting infrastructures, commitment by top management, and development of objective performance criteria were among the factors contributed to successful outsourcing projects. Properly defined performance criteria for an outsourcing engagement are objective, quantifiable, and collectible at a reasonable cost, and should be metrics which can be benchmarked against performance of other organizations and providers (Ramarapu, Parzinger and Lado 1997; Kleepes and Jones 1999). Other factors identified among the top priorities in successful firms include adequate performance feedback, emphasis on both short and long-term benefits, anticipation of change for both good and bad times and accommodation of cycles of demand that require an adjustment in services.

To examine risk factors, respondents were asked to identify the seriousness of fourteen risks facing outsourcing projects (on a scale of 1not a problem to 5a serious problem). Their responses were then recorded in three categories: 1not a problem, 2 and 3a problem, 4 and 5a serious problem. The responses were also translated into means and ranks to make the analysis more meaningful to the reader and are presented in Table 6.

Unsuccessful firms identified the fear of change, including fear of job loss as the most serious problem facing their sourcing efforts. Dealing with these fears through communication and honesty is important to managing this factor (Jones 1997; Quinn 2000). A poor choice of sourcing partners was the second most serious problem facing unsuccessful organizations. Establishing strategic supplier alliances and adoption of the philosophy that the firm is a partner with the suppler may help alleviate this problem (Lau and Hurley 1997). The third factor was not providing enough training/skills needed to manage outsourcing activities. The individuals responsible for managing the outsourcing relationship should receive specific training that includes a complete understanding of the business goals of the contract, the specific performance criteria agree to, and individual roles. This training and communication can also help reduce resentment or resistance (Foster 1999). Inadequate comprehensive plans outlining detailed expectations, requirements, and expected benefits of outsourcing efforts was the fourth factor identified by unsuccessful firms in their outsourcing projects.

The effects of outsourcing projects on the morale and performance of the remaining were among the most serious obstacles to outsourcing success. Keeping people informed every step of the way and working out a deal perceived as fair for them is important because an organization trades more than its physical assets to the vendor in any outsourcing arrangement it often gives away its people as well (Bender 1999).

Somewhat surprisingly, given the nature of outsourcing activities, the following obstacles were ranked lower than other problems in respondents outsourcing efforts: inadequate control systems over how certain services are delivered (which in turn may raise the companys liability exposures, Guterl 1996), and hidden costs and risks such as travel costs, license transfer fees, exchange rates, and foreign taxes on products and services (Ramarapu, Parzinger, and Lado 1997). Also significant was that unsuccessful organizations did not generally consider lack of high-level management support to be a serious problem, which probably means there was support and involvement by top management in these organizations.

Other problems identified including poor organizational communication, cross functional political problems, unclear expectations, lack of flexibility, keeping contracts short, and taking a tactical rather than an strategic approach to outsourcing activities (Laabs 1998; Mullin 1996; Grant 1996).

Conclusion

The attitudinal results presented in this study provide support for the claims of outsourcing proponents that outsourcing allows companies to enhance expertise, improve service quality, reduce staff, streamline the process, lower costs and reduce the administrative burden and saving time. Outsourcing in this sense, is beneficial to organizational performance (Casale 1996; Crane 1999; Quinn 2000). In addition, this study identified current outsourcing strategy trends and practices for randomly selected firms in the United States. One of the important contributions of this study is the revelation that organizations generally considered themselves successful at outsourcing. However, while they achieved significant improvement in organizational performance, they have not reached the magnitude of improvements ascribed to outsourcing strategies.

A number of organizational strategies were also identified as key contributors to outsourcing success. These included strategies with clear objectives, right outsourcing partners, adequate skills, adequate planning, effective communication, and cooperation and collaboration throughout the organization. These strategies are thought to improve quality, deliver, and performance.

Limitations

This exploratory empirical investigation into outsourcing provides tentative avenues for increasing the probability of success of outsourcing projects and raises many issues for further study of the outsourcing phenomenon. This study is limited by its small sample across a wide range of business sectors and organizations sizes. In addition, a survey methodology was also used, which is susceptible to both misinterpretation and common method variance. Despite these limitations the research contributes to developing an understanding of outsourcing in identifying areas that need further research. First, the study indicates that in many cases, one of the primary risks to firms is the effect of outsourcing on employee morale and performance. However, more must be learned about the specific changes made to human resources, how these were successfully implemented, and how they contributed to the outsourcing effort. Second, the study found that organizations with different levels of success at outsourcing identified different factors as problems in the outsourcing project. These factors need to be explored in more depth to identify those that must be managed to ensure the highest level of success of an outsourcing project.

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