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Mark Herman has been helping friends with financial questions since serving as an Army helicopter pilot.

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Updated January 9, 2021

What Is Outsourcing? 

Outsourcing is a business strategy that includes transferring work from a company’s employees to an external party. Many companies outsource their services and the creation of goods with the goal of decreasing costs such as employees, overhead, equipment, and technology. 

Outsourcing work or production to other countries may further decrease costs and allow a company to focus more heavily on its critical operations. However, to preserve domestic jobs, companies may also outsource within their own country.

What Are Some Common Terms for Outsourcing?

Outsourcing may be used interchangeably with the terms contracting-out and externalization. 

Are Outsourcing and Subcontracting the Same? 

Outsourcing and subcontracting are similar, but the level of control held by the company in each case is different. 

For instance, outsourcing delegates an entire project or department’s operations to an unaffiliated individual or business. Subcontracting may only assign part of a project temporarily, and each task is mutually agreed upon on a contractual basis.

Outsourcing vs. Offshoring 

While outsourcing refers to any shifting of work to a third-party, offshoring refers to outsourcing work to a third-party in a different geographic area. Offshoring can save money for companies on products and services while also providing jobs for workers in developing countries.

Examples of Outsourcing

Companies can outsource many of their operations in an effort to reduce costs, save time, and earn more money. It may even give them a competitive advantage in their industry. 

Common outsourcing examples include:

  • Manufacturing

  • Distribution

  • Shipping and logistics

  • Research and development

  • IT Services

  • Bookkeeping or payroll

  • Marketing

  • Sales

  • Administrative tasks

  • Human Resources

  • Customer Service

Famous Companies That Outsource 

Companies which outsource their employees include (but are certainly not limited to):

  • Apple

  • Nike

  • Cisco Systems

  • Walmart

  • IBM

  • Ford Motor Company

  • American Express

  • Microsoft

Common Outsourcing Models & Pricing 

There are eight common outsourcing pricing models, including:

Staffing Model 

A service provider handles a project for a specified period. During this time, the client has full control and is given the necessary equipment and workspace to complete the work.

Fixed Price Model

A service provider sets a standard rate for the services to be provided monthly or annually. This includes charges for equipment and workspaces.

Cost Reimbursable Model

A service provider limits the number of expenses they will accrue before adding a percentage for profit.

Time and Materials Model

A service provider will bid on a project by providing the potential client with a proposal of time needed and cost.

Consumption-Based Pricing Model

A service provider charges their client based on actual usage.

Profit-Sharing Pricing Model

A service provider receives a percentage of profits from the client.

Incentive-Based Pricing Model

On top of their normal rate, the service provider receives bonuses or commissions for their work, based on performance.

Shared Risk-Reward Pricing Model

A service provider will share the risk and reward with the company. In addition to their normal rate, they receive compensation based on company performance. If the company experiences challenges, however, their additional compensation may decrease or not exist.

Is Outsourcing Good or Bad? 

Outsourcing has advantages and disadvantages that need to be considered. It can be both good and bad, depending on the company’s situation, motivators, and goals. Outsourcing work may be beneficial for one company while unsuitable for another.

Advantages of Outsourcing 

There are many pros of outsourcing, including:

  • Reduced costs such as overhead, staff, equipment, and technology

  • Work may be less expensive than hiring staff members

  • May have greater access to experts in the field

  • Tasks may reach completion more quickly

  • Companies can focus on revenue-driving work

  • Assistance in planning and mitigating against potential risks

  • Ability to take on more projects that work towards the company’s mission and goals

Disadvantages of Outsourcing

There are many cons of outsourcing, including:

  • Complex contracts between companies with possible hidden costs

  • Access to confidential data can cause security threats or data breaches

  • Communication challenges that cause project delays and slower turnaround time

  • Language and cultural barriers

  • Time zone differences

  • Little control over quality from the originating company

  • Less knowledge of the industry or domain

  • Public backlash or moral dilemmas

How Does Outsourcing Affect the US Economy? 

The effects of outsourcing on the US economy can be viewed from multiple lenses. Outsourcing enables companies to lower their production costs and the savings can be passed on to consumers who will make more purchases. Outsourcing helps US companies be more globally competitive. 

However, outsourcing can also hurt the US economy if many people lose their jobs. Individuals and families without stable incomes aren’t as likely to make discretionary purchases.

Are Outsourcing and Globalization the Same?

Globalization refers to the interdependence of various countries in terms of economies, cultures, jobs, products, information, technology, and populations. Global outsourcing is just one factor that causes globalization.

How Outsourcing Affects Developing Countries 

When companies outsource their work to developing countries, it can have an overwhelmingly positive impact on economies and workers alike. The creation of jobs enables people to afford basic necessities as well as make discretionary purchases. Outsourcing has the potential to improve the standard of living in developing countries and has helped to create the middle-class in nations like China and India. 

Negative Effects of Outsourcing on Developing Countries

Workers are understandably typically drawn to cities that have larger outsourced industries and promises of higher earnings. As people seek out higher-paying roles that aren’t critical to their nation’s development (e.g. call centers, assembly lines), this exodus creates a large hole in farming and cottage industry communities. 

Due to a cheap and replaceable labor force, some employers may exploit employees by enforcing longer working hours and unsafe conditions. Because developing nations also tend to have more lax environmental standards than those in developed countries, factories may cause more pollution (in order to create cheaper goods). 

Ask an Expert about Outsourcing
At InvestingAnswers, all of our content is verified for accuracy by Mark Herman, CFP and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Outsourcing .

Can Outsourcing Work for Small Businesses? 

Outsourcing can work well for small businesses and start-up companies since it enables owners to focus on their most critical tasks. It also limits the number of team members companies need to onboard, thus increasing efficiency. According to the Small Business Association, more than one-third of small businesses outsource a portion of their operations. The internet has made it easier than ever to outsource all types of tasks and projects quickly and at a reasonable cost, from virtual receptionists to IT services and marketing.

Mark Herman has been helping friends with financial questions since serving as an Army helicopter pilot. Since then, he’s gained valuable experience in the corporate world before moving on to become a CERTIFIED FINANCIAL PLANNER™.

If you have a question about Outsourcing , then please ask Mark.

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