CIMA E1 Syllabus D. Shape And Structure Of The Finance Function - Outsourcing - Notes ^{8 / 9}

Outsourcing

Outsourcing means contracting out aspects the work of the organisation previously done in-house to specialist providers. 

Outsourcing carries commercial and reputational risks. 

Therefore, an organisation should outsource their threshold competences (things that an organisation must be good at), but they should not outsource their core competences (things that an organisation does that drives its competitive advantage). 

Advantages of Outsourcing

• Cost reduction - outsourcing can deliver economies of scale through standardised processes.

• Radical transformation - outsourcing can enable broad structural change.

  Low value, non core activities can be moved to the external provider allowing the organisation to shift internal resources from operations to innovation.

• Access to superior capabilities and resources of the specialist provider

• Business partnering

Disadvantages of Outsourcing

• Loss of control due to dependence on the external provider

• The organisation will need to develop expertise and invest time and money in managing the outsourced services.

• Outsourcing will cause disruption and may result in significant resistance to change.

• Risk of loss of confidential information. for e.g. outsourcing suppliers working for multiple competitors could lead to loss of confidential information

• Erosion of internal knowledge and skills

• Finality of the decision -  once a service has been contracted out it may be difficult to reverse the decision (due to a loss of in-house expertise)

Service Level Agreements

Service level agreements are legal agreements between the supplier and customer regarding the level of service that should be provided, this can minimise the disadvantages of outsourcing.

Transactions Cost Theory

The transactions cost theory approach is based in the economics of Ronald Coase and Oliver Williamson

They suggest that organisations choose between two mechanisms to control resources and carry out operations, either hierarchies or markets.

• Hierarchy solution

  Here, management decides to own assets and uses policies of the firm to control their use and performance.

• Market solution 

  Here, management decides to buy in the use of the assets or staff from outside companies under the terms of a contract. 

  Outsourcing is a contemporary example of increased reliance on the market.

  If the market solution is chosen, then there will be transaction costs

What are transaction costs?

Transaction costs are costs that are not seen outright when outsourcing.

• The cost of searching for the supplier

• The cost of bargaining with the supplier until the SLA is agreed

• The cost of enforcing