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Outsourcing and HRM
Brian S. Klaas
The Market or the Organization


When outsourcing is used, firms are
relying on a market-based form of
governance to ensure they receive
quality goods and services
When firms keep processes in-house,
they are relying on organizational
governance
What Outsourcing Offers

Outsourcing offers benefits that flow
from increased economies of scale,
the potential for high-powered
incentives, and the ability to respond
quickly to supply and demand shifts
One Problem With Outsourcing

Exposes firms to greater risks from
opportunism by the vendor or
supplier
When Outsourcing is Good


Off-the-shelf products or services are
generally viewed as more
appropriate for outsourcing
arrangements
The company can benefit from
economies of scale when limited
customization is necessary
When Organizational Control is
Good


When the product or service
demands substantial customization
The firm must make an asset
specific investment to use the vendor
Contracts Don’t Always Work

Where substantial uncertainty exists
regarding what will be needed from
the vendor, it is difficult to
completely specify all relevant
contingencies within the outsourcing
contract
Why Has Outsourcing Become So
Popular


Globalization and labor arbitrage
Technology
Globalization and Labor Arbitrage


Within developing economies,
investment in human capital and in
production capacity has expanded
dramatically
The wage differential between
developed and developing economies
is substantial
Globalization and Labor Arbitrage
Continued

The wage differential is now so great
that firms may be willing to accept
the risks associated with vendor
opportunism
Technology


With developments in technology, a
wide range of service activities can
be readily outsourced
When combined with vendors
operating globally, it allows for
increased speed in terms of product
development
What Should be Outsourced?


Activities or processes that might be
viewed as off-the-shelf
Activities that require an asset
investment when the labor arbitrage
potential is great
Core Competencies

Allow firms to gain competitive
advantages and relate to a collective
knowledge or understanding within
organizations about how to perform
complex and inter-related sets of
activities
What Not to Outsource


Core competencies that offer the firm
a competitive advantage
Core competencies are rarely
compartmentalized within specific
parts of the firm
What Not to Outsource Continued


Activities that involve high levels of
uncertainty or asset specificity that
may make the firm subject to vendor
opportunism
Activities that the firm is particularly
good at and that rely on implicit
knowledge within the firm
Managing the Outsourcing
Relationship


Specify within the contract of the
tasks, performance metrics, and
penalties for non-performance
Engage in regular benchmarking of
the services available from
alternative vendors to ensure that
contractual terms allow the firm to
switch vendors without undue
difficulty
Managing the Outsourcing
Relationship Continued

Assess resources and skills
possessed by a firm, relying on
information available within the
marketplace to assess vendor
capabilities
Outsourcing in an Uncertain
Environment



Typically requires an asset
investment
Involves a degree of uncertainty
Can be profitable when companies
take specific measures
Measures to Take in an Uncertain
and Complex Environment

Developing personal ties with the
vendor helps in the following ways:
• Limits the vendor’s willingness to
engage in opportunistic behavior
• Increases the reputational cost of
violating the contract
Specific Approaches to Improve
Business Relationships


Align the interest of the vendor and
firm via gainsharing mechanisms
that allow both parties to benefit
from improved performance and
efficiency
Tie vendor compensation to broader
measures of client performance
Moderating Factors of Outsourcing
Arrangements


Activity
Firm size
The Nature of the Outsourced
Activity


Outsourcing for the global firm
reduces IT infrastructure costs
through economies of scale and by
spreading the costs among vendors
The global firm saves through wage
differentials
The Nature of the Outsourced
Activity Continued


Outsourcing arrangements are
designed to help improve and
standardize business processes as
they relate to transactional HR issues
Allow firms to establish metrics that
let them monitor and control the
quality of services being provided
Outsourcing Executive Search

Market governance mechanisms
might be effective for search firms:
• The level of investment pales in
comparison to the investment required
to build the network of relationships
that is used in conducting the search
Outsourcing Executive Search
Continued

Other market mechanisms include:
• Reputation of the search firm if they find
a weak candidate
• Quick and effective feedback regarding
vendor performance is likely to emerge
in this setting
Firm Size


For many smaller organizations, gaining
access to HR expertise when there is no
internal HR staff member is likely to
require some form of an outsourcing
relationship
For many small organizations, their
outsourcing decision is at least in part
determined by the value associated with
professional HR expertise
Building Relationships

For small and medium firms, building
relationships with vendors can
reduce uncertainty and opportunism
Summary
In this chapter we have examined:
 Reasons for the growth in
outsourcing
 Why firms outsource
 Managing relationships
 The nature of the activity
 Firm size