Outsourcing vs. Offshoring

Business / By / January 31, 2023

Outsourcing is used by companies to contract specific tasks or processes out to a third party.

Offshoring, on the other hand, is the process of moving tasks or processes overseas that were once performed in-house.

In truth, there are a few different outsourcing strategies and offshoring is one of them.

Both practices are similar in that the work is assigned to a third party that operates externally.

Both also increase productivity, reduce costs, and provide access to specialist labor or knowledge.

Despite these similarities, there do exist a few differences. These are explained below.

Understanding Outsourcing

In essence, outsourcing refers to the practice of contracting work out to individuals (freelancers) or companies in another country.

These entities are not considered part of the organization and usually have the freedom to work as they please under the proviso that deadlines are met and adequate results are produced.

Outsourcing benefits

In a 2020 global survey on why companies outsource, Deloitte found that the following reasons were most popular: 

  1. Cost reduction (70% of respondents). Hiring in-house specialists increase overheads.
  2. Flexibility (40%). This pertains to shorter, more flexible contracts and the commoditization of services.
  3. Speed to market (20%). This is influenced by the microservice architecture which enables the continuous deployment of complex applications.
  4. Access to tools and processes (15%), and
  5. Agility (15%).

Outsourcing risks

Companies are sometimes forced to share proprietary information with third parties during their relationship.

To minimize the chances of theft, prior due diligence on a contractor is vital. 

There may also be communication issues that arise from differences in time zone, culture, or language.

Understanding offshoring

Offshoring is perhaps a more substantial initiative where crucial business processes or operations are moved to another country.

Unlike outsourcing, where work is performed by external entities, offshoring operations remain under the control of the company.

Offshoring benefits

Many companies use offshoring to reduce manufacturing costs, but there are other important benefits such as:

  • Less stringent rules and regulations – with fewer impediments to production, the company can increase revenue and profit.
  • Incentives – some countries offer incentives to companies willing to establish a presence there. In the wake of COVID-19, India and some countries in Europe and Africa are offering various tax deductions, subsidies, and cash grants to lure foreign investment.

Offshoring risks

The risks of offshoring are similar to those that are present in outsourcing – particularly if either operation is conducted in a vastly different culture or region.

Organizations that move core operations overseas sometimes suffer reputational damage as employees lose their jobs in the domestic market.

They can also be subject to various geopolitical risks, with labor unions in the United States actively lobbying Congress against offshoring.

Other states in the USA are considering legislation to avoid working with firms that offshore to developing countries with cheap labor.

Key takeaways:

  • Outsourcing is used by companies to contract specific tasks or processes out to a third party. Offshoring is the process of moving tasks or processes overseas that were once performed in-house.
  • Offshoring is one of a few different forms of outsourcing, which means they share similarities. Both involve work assigned to a third party that operates externally and both share similar cost reduction benefits.
  • The key difference between offshoring and outsourcing is that in the former, operations remain under the control of the company in question. Offshoring also tends to be used for core operations such as manufacturing, while outsourcing is popular for smaller tasks and services that help a business remain flexible and agile.

Connected Business Concepts And Frameworks

Supply Chain

supply-chain
The supply chain is the set of steps between the sourcing, manufacturing, distribution of a product up to the steps it takes to reach the final customer. It’s the set of step it takes to bring a product from raw material (for physical products) to final customers and how companies manage those processes.

Data Supply Chains

data-supply-chain
A classic supply chain moves from upstream to downstream, where the raw material is transformed into products, moved through logistics and distribution to final customers. A data supply chain moves in the opposite direction. The raw data is “sourced” from the customer/user. As it moves downstream, it gets processed and refined by proprietary algorithms and stored in data centers.

Distribution

whats-distribution
Distribution represents the set of tactics, deals, and strategies that enable a company to make a product and service easily reachable and reached by its potential customers. It also serves as the bridge between product and marketing to create a controlled journey of how potential customers perceive a product before buying it.

Distribution Channels

distribution-channels
A distribution channel is the set of steps it takes for a product to get in the hands of the key customer or consumer. Distribution channels can be direct or indirect. Distribution can also be physical or digital, depending on the kind of business and industry.

Vertical Integration

vertical-integration
In business, vertical integration means a whole supply chain of the company is controlled and owned by the organization. Thus, making it possible to control each step through customers. in the digital world, vertical integration happens when a company can control the primary access points to acquire data from consumers.

Horizontal vs. Vertical Integration

horizontal-vs-vertical-integration
Horizontal integration refers to the process of increasing market shares or expanding by integrating at the same level of the supply chain, and within the same industry. Vertical integration happens when a company takes control of more parts of the supply chain, thus covering more parts of it.

Horizontal Market

horizontal-market
By definition, a horizontal market is a wider market, serving various customer types, needs and bringing to market various product lines. Or a product that indeed can serve various buyers across different verticals. Take the case of Google, as a search engine that can serve various verticals and industries (education, publishing, e-commerce, travel, and much more).

Vertical Market

vertical-market
A vertical or vertical market usually refers to a business that services a specific niche or group of people in a market. In short, a vertical market is smaller by definition, and it serves a group of customers/products that can be identified as part of the same group. A search engine like Google is a horizontal player, while a travel engine like Airbnb is a vertical player.

Entry Strategies

entry-strategies-startups
When entering the market, as a startup you can use different approaches. Some of them can be based on the product, distribution, or value. A product approach takes existing alternatives and it offers only the most valuable part of that product. A distribution approach cuts out intermediaries from the market. A value approach offers only the most valuable part of the experience.

Backward Chaining

backward-chaining
Backward chaining, also called backward integration, describes a process where a company expands to fulfill roles previously held by other businesses further up the supply chain. It is a form of vertical integration where a company owns or controls its suppliers, distributors, or retail locations.

Market Types

market-types
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.

Market Analysis

market-analysis
Psychosizing is a form of market analysis where the size of the market is guessed based on the targeted segments’ psychographics. In that respect, according to psychosizing analysis, we have five types of markets: microniches, niches, markets, vertical markets, and horizontal markets. Each will be shaped by the characteristics of the underlying main customer type.

Decoupling

decoupling
According to the book, Unlocking The Value Chain, Harvard professor Thales Teixeira identified three waves of disruption (unbundling, disintermediation, and decoupling). Decoupling is the third wave (2006-still ongoing) where companies break apart the customer value chain to deliver part of the value, without bearing the costs to sustain the whole value chain.

Disintermediation

disintermediation
Disintermediation is the process in which intermediaries are removed from the supply chain, so that the middlemen who get cut out, make the market overall more accessible and transparent to the final customers. Therefore, in theory, the supply chain gets more efficient and, all in all, can produce products that customers want.

Reintermediation

reintermediation
Reintermediation consists in the process of introducing again an intermediary that had previously been cut out from the supply chain. Or perhaps by creating a new intermediary that once didn’t exist. Usually, as a market is redefined, old players get cut out, and new players within the supply chain are born as a result.

Coupling

coupling
As startups gain control of new markets. They expand in adjacent areas in disparate and different industries by coupling the new activities to benefits customers. Thus, even though the adjunct activities might see far from the core business model, they are tied to the way customers experience the whole business model.

Bullwhip Effect

bullwhip-effect
The bullwhip effect describes the increasing fluctuations in inventory in response to changing consumer demand as one moves up the supply chain. Observing, analyzing, and understanding how the bullwhip effect influences the whole supply chain can unlock important insights into various parts of it.

Dropshipping

dropshipping-business-model
Dropshipping is a retail business model where the dropshipper externalizes the manufacturing and logistics and focuses only on distribution and customer acquisition. Therefore, the dropshipper collects final customers’ sales orders, sending them over to third-party suppliers, who ship directly to those customers. In this way, through dropshipping, it is possible to run a business without operational costs and logistics management.

Consumer-To-Manufacturer

consumer-to-manufacturer-c2m
Consumer-to-manufacturer (C2M) is a model connecting manufacturers with consumers. The model removes logistics, inventory, sales, distribution, and other intermediaries enabling consumers to buy higher quality products at lower prices. C2M is useful in any scenario where the manufacturer can react to proven, consolidated, consumer-driven niche demand.

Transloading

transloading
Transloading is the process of moving freight from one form of transportation to another as a shipment moves down the supply chain. Transloading facilities are staged areas where freight is swapped from one mode of transportation to another. This may be indoors or outdoors, depending on the transportation modes involved. Deconsolidation and reconsolidation are two key concepts in transloading, where larger freight units are broken down into smaller pieces and vice versa. These processes attract fees that a company pays to maintain the smooth operation of its supply chain and avoid per diem fees.

Break-Bulk

break-bulk
Break bulk is a form of shipping where cargo is bundled into bales, boxes, drums, or crates that must be loaded individually. Common break bulk items include wool, steel, cement, construction equipment, vehicles, and any other item that is oversized. While container shipping became more popular in the 1960s, break bulk shipping remains and offers several benefits. It tends to be more affordable since bulky items do not need to be disassembled. What’s more, break bulk carriers can call in at more ports than container ships.

Cross-Docking

cross-docking
Cross-docking is a procedure where goods are transferred from inbound to outbound transport without a company handling or storing those goods. Cross-docking methods include continuous, consolidation, and de-consolidation. There are also two types of cross-docking according to whether the customer is known or unknown before goods are distributed. Cross-docking has obvious benefits for virtually any industry, but it is especially useful in food and beverage, retail and eCommerce, and chemicals.

Toyota Production System

toyota-production-system
The Toyota Production System (TPS) is an early form of lean manufacturing created by auto-manufacturer Toyota. Created by the Toyota Motor Corporation in the 1940s and 50s, the Toyota Production System seeks to manufacture vehicles ordered by customers most quickly and efficiently possible.

Six Sigma

six-sigma
Six Sigma is a data-driven approach and methodology for eliminating errors or defects in a product, service, or process. Six Sigma was developed by Motorola as a management approach based on quality fundamentals in the early 1980s. A decade later, it was popularized by General Electric who estimated that the methodology saved them $12 billion in the first five years of operation.

Scientific Management

scientific-management
Scientific Management Theory was created by Frederick Winslow Taylor in 1911 as a means of encouraging industrial companies to switch to mass production. With a background in mechanical engineering, he applied engineering principles to workplace productivity on the factory floor. Scientific Management Theory seeks to find the most efficient way of performing a job in the workplace.

Poka-Yoke

poka-yoke
Poka-yoke is a Japanese quality control technique developed by former Toyota engineer Shigeo Shingo. Translated as “mistake-proofing”, poka-yoke aims to prevent defects in the manufacturing process that are the result of human error. Poka-yoke is a lean manufacturing technique that ensures that the right conditions exist before a step in the process is executed. This makes it a preventative form of quality control since errors are detected and then rectified before they occur.

Gemba Walk

gemba-walk
A Gemba Walk is a fundamental component of lean management. It describes the personal observation of work to learn more about it. Gemba is a Japanese word that loosely translates as “the real place”, or in business, “the place where value is created”. The Gemba Walk as a concept was created by Taiichi Ohno, the father of the Toyota Production System of lean manufacturing. Ohno wanted to encourage management executives to leave their offices and see where the real work happened. This, he hoped, would build relationships between employees with vastly different skillsets and build trust.

Jidoka

jidoka
Jidoka was first used in 1896 by Sakichi Toyoda, who invented a textile loom that would stop automatically when it encountered a defective thread. Jidoka is a Japanese term used in lean manufacturing. The term describes a scenario where machines cease operating without human intervention when a problem or defect is discovered.

Andon System

andon-system
The andon system alerts managerial, maintenance, or other staff of a production process problem. The alert itself can be activated manually with a button or pull cord, but it can also be activated automatically by production equipment. Most Andon boards utilize three colored lights similar to a traffic signal: green (no errors), yellow or amber (problem identified, or quality check needed), and red (production stopped due to unidentified issue).

Read Also: Vertical Integration, Horizontal Integration, Supply Chain.

Read More:

Read next: 

More Resources

About The Author

Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
Scroll to Top
FourWeekMBA