Outsourcing involves moving some of the internal activities of a firm to outside provider(s). The supplier replaces some internal capacity and production through a binding agreement defining the terms, costs, and duration for the procurement. The means of production are transferred to the supplier, which can be a benefit but is also subject to risks.
The main rationale for outsourcing is mainly related to the ability to find lower input costs for the good or service, which is particularly relevant when they are standard and easy to replicate. This allows for a better level of cost control and frees up internal resources that could be used more effectively for core activities that are the most valuable. In other cases, outsourcing allows accessing capabilities that otherwise are not internally available, particularly when it involves specialized goods, parts, or services.
There are three sectors where outsourcing dominates:
- Services. Administrative, engineering, research, development, or technical support processes.
- Manufacturing. Fabrication, assembly, and customization.
- Distribution. Transportation, packaging, and warehousing, services that can be provided by third-party logistics firms.