Outsourcing vs. insourcinghttps
Outsourcing and insourcing are unequal siblings: in order to describe one, you also have to deal with the other. This fact is gaining in importance, especially because European companies have been returning to their own competencies for some years now. An increasing number of companies are doing more and more themselves, irrespective of the potential cost benefits of outsourced production parts. In order to evaluate the potential of both corporate philosophies soberly and without prejudice, it is necessary to look in both directions. And that is why this insourcing guide also deals in detail with outsourcing.
Outsourcing and insourcing – contradictory and harmonious in one
There are good reasons for both outsourcing and insourcing process steps and production parts. The fact that insourcing is increasingly becoming a winning strategy does not mean that outsourcing is fundamentally and in every case the wrong decision. One goal of this insourcing guide is to identify the strengths and weaknesses of both methods and to relate them to each other.
Interestingly, the approach to the topic is already worth mentioning. Even the order of the elements to be described is significant when it comes to the best understanding of the two contrasting business strategies. Which should be described first: Outsourcing or Insourcing?
The obvious answer would be: order doesn’t matter, the main thing is correct information. But this is only partially true, because a closer look reveals: In most cases, one is the consequence of the other. In other words, insourcing is often the consequence of previous outsourcing. Insourcing is therefore often a corrective strategy to dampen the negative consequences of unsustainable outsourcing or, ideally, to eliminate them altogether.
This insourcing guide therefore proceeds chronologically. First, there is a look at outsourcing, followed by a look at insourcing. Finally, there is a discussion of both methods, with an assessment of when it makes most sense to use which strategy.
Outsourcing: using external expertise
Don’t do everything yourself – that’s the basic philosophy behind outsourcing. In business management terms, the term means the transfer of corporate tasks and, in some cases, corporate structures to a third party, usually a production or service company.
The aim is to obtain a service previously provided by the company itself from an external provider. The definition of outsourcing also contains a socio-political implication: particularly in Germany, it is associated with the relocation of jobs abroad, in some cases also to the company’s own subsidiaries.
In the early days, outsourcing was mainly used in the IT sector. Companies began to outsource parts of their IT infrastructure or computing-intensive processes to external service providers. Since about the 1960s, outsourcing has gradually spread to companies in many other industries.
Outsourcing can have different reasons
The reason why a company decides to outsource strongly determines how sustainable the chosen strategy is. The effectiveness of the corporate decision in turn determines whether the need for insourcing arises after a certain period of time.
Over the years, this area in particular has seen painful erosion in quality management and discrepancies in operating cultures between the company’s own workforce and the contracted companies. Especially after outsourcing for reasons of personnel cost savings, there is now an increasing trend towards insourcing.
Where outsourcing can make sense
Particularly in the service and e-commerce sectors, many use cases can be found where outsourcing can be used to create optimal operational processes. Here is an example:
Four professional interpreters, two of whom have completed marketing training, would like to jointly found an online translation service. The four founders can take on a number of tasks themselves: producing translations, recruiting and training additional translators, and marketing their own company.
However, there are a number of other tasks involved in implementing this business idea:
An online service needs a powerful and appealing website. Although all four founders have rudimentary knowledge of web design, this is by no means sufficient for professional execution. They outsource the web design and ongoing maintenance of the website to a creative and competent web design studio.
Fast and competent support is the be-all and end-all for growth and customer loyalty. The four founders could do this themselves – but that would leave far too little time for the actual entrepreneurial tasks – the ones that bring in the profits. Outsourcing to an external call center solves this problem.
And finally, there’s accounting. Hiring your own accountant is an extra burden that doesn’t pay off in the long run – especially given the option of outsourcing accounting to an office that specializes in it, often in combination with tax advice.
Is there potential for later insourcing in this example? That may well be the case. If the company develops in the expected way, it may be worthwhile from a certain size onwards to employ your own accountant and support staff.
The different forms of outsourcing
Outsourcing can – as already mentioned – have different reasons and objectives. Accordingly, different types of outsourcing have developed. In many cases, combinations of these are also used. Here are the most important types:
The outsourcing types described are merely examples. There is no official classification and categorization. The terminology is also not binding. You may well come across a category that describes one of the types listed here under a different name
Insourcing: Bringing back competence and autonomy
When companies bring previously outsourced areas back into their own corporate environment, there must be good reasons for doing so. After all, the previously decided outsourcing should lead to cost savings and conservation of own resources. So why take the step back?
This insourcing guide deals with this question in particular. If outsourcing brings such substantial benefits – why should companies go back on it? There seems to be only one answer to this question: Expectations were not met. This can mean different things:
- The saving effect on own resources is lower than desired
- The cost savings fall short of the set targets
. Either the utilization was not as high as estimated, even in the outsourced operation, or the outsourcing itself creates new demands on the resources, which partially or completely nullify the savings effect.
. Either the savings potential through outsourcing is lower than calculated, or outsourcing itself generates new costs that reduce the savings.
The cost savings are associated with unforeseen quality deficits. Contrary to promises made, the external companies and service providers do not adhere to the agreed standards. This may be due to cultural or managerial reasons. In the end, the damage caused by quality losses is greater than the benefit in terms of cost reduction and resource conservation. The motto in such cases is therefore: we’d rather do it ourselves again. In many cases, insourcing means a reassessment of internal company parameters – away from resource and cost dominance and towards quality-oriented strategies geared to product culture. Marketing experts like to call this the “Steiff effect“. The well-known soft toy manufacturer with the famous button in its ear was one of the best known to outsource significant parts of its domestic production to low-wage regions. In the case of the traditional German company, production capacity went to China, then the land of low wages and plagiarism champions. About 50 employees lost their jobs as a result. That was in 2004, but the dream of low-cost mass production only lasted four years – then came the famous headline in Focus magazine: “Steiff brings the teddies home”.
The stuffed animal producer made the typical insourcing experience: quality is not a commodity. The world-renowned quality of Steiff products in the German tradition of craftsmanship cannot be smoothly outsourced through standards frameworks and execution protocols. In order to transfer the high quality standards of one’s own corporate culture to other producers, the latter must internalize the traditional quality awareness of German companies in addition to many years of experience.
An industrial culture geared to mega-growth, mass consumption and short product lead times suits traditional German companies like Daimler suits Chrysler – as both companies painfully discovered. Another example of successful insourcing was provided by car manufacturer Opel in 2008. 180 new jobs were created in Germany by abandoning the outsourcing of parts of production and services – especially for the Insignia model.
Similar experiences were made by the building block manufacturer Lego, which brought its outsourced production back home from the American company Flextronics. Lego’s reasons are astonishing: According to company spokespersons, the targeted savings and synergy effects can best be achieved by insourcing into the company’s own operations.
Insourcing is gaining in importance
During the research for this insourcing guide, it became clear that companies that outsource abroad are increasingly turning to the locational advantages of their own country. However, this initially preferred variant of outsourcing – mainly spurred on by the low wage levels in the target countries – entails special risks and challenges. Risks that ultimately caused many companies to fail, and not only in the area of small and medium-sized enterprises.
According to a study conducted by the Fraunhofer Institute for Systems and Innovation Research (ISI) in Karlsruhe on behalf of the Otto Brenner Foundation, for some time now only around 15 percent of German companies have been relocating production parts to third countries. However, the insourcing rate is even more striking: within four to five years from the start of outsourcing, 20 to 25 percent of companies decide to bring back outsourced areas.
The reasons for the return are usually identical: negative experiences with the foreign partners are just as much a part of it as unpleasant developments in the target countries – both in the economic as well as in the political area. However, this often plays only a subordinate role. The main problems usually stem from inadequate situation analysis and planning of the project and from a strategy designed for too short a time horizon: short-term cost savings do not justify costly and long-term outsourcing campaigns.
Of course, there are still areas where outsourcing is the right answer to operational optimization issues, such as IT. In the meantime, the turnover of outsourced IT services has exceeded the 17 billion euro mark. By way of comparison: in 2003, the figure was still 10 billion.
The numbers speak for insourcing
Another insight of this insourcing guide is revealed by the statistics. Outsourcing is still a widespread strategy for saving costs in addition to conserving resources, mainly by reducing wage costs. But it is precisely this cost advantage that is visibly shrinking, caused by wage increases in the supposedly low-wage countries in Eastern Europe and Asia.
A 2008 survey of Eastern European countries by the German Federal Statistical Office already revealed considerable rates of increase at that time:
Bulgaria: around 19 percent
Estonia: around 13 percent
Latvia: around 21 per cent
Lithuania: around 15 per cent
Poland: around 10 percent
Romania: around 21 percent
Slovenia: around 11 percent
Hungary: around 8 percent
The growth rates in the Asian region are lower, but also significant.
These figures are particularly meaningful when compared with the figures in Germany and Europe for the same period: labour costs rose by 2.8 per cent in Germany and by 4.1 per cent in Europe. The signals are unmistakably pointing to insourcing.
A common misconception about outsourcing is one aspect that this insourcing guide also uncovers. The hope of many companies that outsourcing operational processes to external providers would lead to optimised cost control and greater transparency is unfortunately nothing more than an illusion. Management consultant Johanna Joppe explains more about this in her book “Die Outsourcing-Falle: Wie die Globalisierung in den Ruin führen kann” (amazon.de). In it, she explains how cost transparency tends to worsen rather than improve as a result of outsourcing to third-party companies. In addition to the resistance that already arises in one’s own company during cost analysis, there are also the imponderables of a cost policy in external companies, into which the outsourcer usually has no insight – not to mention any possible influence.
According to Johanna Joppe, at most 20 percent of all outsourcings actually produce the targeted savings effects – both in the case of domestic and foreign outsourcings. Around 40 percent result in significantly lower savings or none at all. In view of these facts, it is not surprising that the trend towards insourcing continues.
Discussion: Outsourcing or insourcing – which makes sense?
As mentioned at the beginning: The growing return to insourcing does not necessarily mean that outsourcing is fundamentally the wrong decision. As a result of a thorough situation analysis, careful planning and in a sensible application scenario, outsourcing can lead to optimal results. As I said: if the parameters are right.
Outsourcing is the most suitable method when the main objective is to free operational resources from secondary processes and thus allocate them to processes that serve the actual creation of value. This is often the case when tasks are involved that lie outside the company’s core competencies. In some cases, cost savings can also be a valid criterion for outsourcing – namely when service providers offer competencies that would first have to be acquired in-house at great expense in terms of time and money.
External service providers for special competencies deliver constructive cost saving potentials that have a lasting effect. Through them, the company can avoid expenses for employee training and operational adjustments and also derive tax advantages. The disadvantage of this strategy is the permanent dependence on the service provider. If problems arise with the service provider, in many cases they also become problems for the client.
A typical example is just-in-time logistics, as used in many manufacturing companies in the automotive industry or by high-tech producers. If the processes are faultless, components arrive at the plant at precisely the moment they are needed for installation. If problems occur at the logistics provider, this can bring the company’s entire production chain to a standstill. Dramatic loss rates can be the result.
Insourcing is the process of integrating previously outsourced areas or processes back into the company. The main reason for this strategy is to intercept and ideally reverse negative developments and disadvantages that have resulted from outsourcing.
The benefit comes from ending negative effects that the company has put up with in anticipation of the outsourcing benefit. For example, if a firm decided to outsource parts of its production, it was usually aware of the increased effort involved in cooperating with the supplier – both in terms of time and logistics. The insourcing of outsourced production is the result of a factual weighing of benefit and effort: If the benefit has not proven to be as high as expected, the disadvantage of the increased time and logistical effort outweighs it.
Once production has been reintegrated into the company’s own operations, all additional logistics requirements are eliminated. The time required for coordination with the other operational processes also drops abruptly, and the dependence on an external supplier ends.
On the other hand, the company again faces higher personnel and production costs – the reasons why the decision to outsource was made before. However, in view of the negative experiences during the outsourcing phase, a new assessment of the previously negatively perceived aspects can now take place: The disadvantage of higher costs is put into perspective in view of the improved quality management, the streamlining and optimization of operational processes and the accumulation of in-house know-how through the now intensified employee training. An example of a successful insourcing project:
The manufacturer of exclusive leather goods outsourced parts of its production to a subcontractor in Singapore. Over time, it turns out that the transport costs of raw materials and intermediate products between Asia and the headquarters are considerably higher than originally calculated. Also, the time schedules cannot be planned as precisely as hoped. In addition, the subcontractor has priorities that were not known when the contract was signed: For example, he repeatedly favors larger incoming orders from American customers, which leads to severe delivery delays for the German company.
The German designer leather goods producer concludes that the envisaged cost and resource advantages do not justify the problems that have arisen. The ecological footprint caused by the company’s outsourcing strategy is also not justifiable in the long run, neither in front of the customers, nor in front of the
The company decides to insource the outsourced production capacity and thus kills several birds with one stone: The CO² balance improves abruptly. At the same time, the production processes can be better coordinated and the dependence on an unpredictable supplier is eliminated. A loss of the company’s image
due to the outsourcing measure can be averted in good time before negative viral effects set in.
What are the reasons for outsourcing?
Saving resources, purchasing competence, saving personnel costs, limiting risks
What does insourcing mean?
Insourcing is the reintegration of previously outsourced processes and functions into the company. Other names for insourcing are therefore also backsourcing or reinsourcing.
Is insourcing the better solution
No, both have their advantages and disadvantages, just because insourcing is the one when you return from outsourcing does not mean that insourcing is the better of the two.
In many cases it is not possible to foresee in advance whether outsourcing certain business areas is the right decision or not. Quite often the planned figures speak for it, but the lived reality paints a completely different picture. If it turns out that outsourcing does not achieve the desired results and possibly creates additional problem situations, insourcing is the best solution to make the best use of the experience gained and possibly create a situation that is better than in the period before outsourcing.
Do you have any more questions?