GLOBAL SOURCING

WHAT IS OUTSOURCING

Definition

Outsourcing means delegating certain activities from the value chain to third-party companies.

Outsourcing is a popular business strategy that offers cost-saving benefits and increased efficiency for companies (Investopedia, 2020 [1]). Typically, businesses leverage outsourcing to acquire specialized skills and streamline operations while keeping expenses to a minimum. Ultimately, the primary motive behind outsourcing is to ensure that products are sold profitably in the marketplace. 

For instance, a European firm may seek an expert IT professional to undertake a specific project, however, limited funds prevent hiring. In such a scenario, the company may outsource the job to a worker in China, India, or the US, who can deliver the same level of performance as an in-house employee but at a fraction of the cost. 

History 

The origin of "outsourcing" dates back to 1937 when Ronald Coase, an economist, coined the term. Initially, outsourcing primarily concerned the personnel department. However, in the 1970s and 1980s, corporations conducted business operations in-house. This approach resulted in multiple levels of management that impeded the agility and streamlining of businesses, particularly in global markets (NC State University, 2006 [2]).

Eventually, large companies developed a new strategy by identifying critical processes and deciding which could be outsourced (SCRC SM, 2006) (Mulin, R, 1996 [3]).  The term "outsourcing" was first coined as a business strategy in 1989 by Rick Mullin, (NST, 2021 [4]).  but the practice had been in use for some time before that. The self-sufficiency strategy of companies in the 1970s and 1980s is contradicting since major corporations have never been and will never be fully in-house. The reason for that is that large companies need external suppliers to function and produce; take Nike as an example – although they are an American company, they manufacture in countries like Japan, Taiwan, China, and some parts of India, Thailand, and South Korea. In essence, this is a form of outsourcing, but on a domestic level. Over the course of the year’s companies have used and developed outsourcing to a point where it is readily available for businesses.

Reasons for outsourcing

Outsourcing has become a popular trend among businesses in the European Union due to several reasons. One of the main reasons for outsourcing is cost reduction. Companies outsource tasks to countries where labor is cheaper, allowing them to reduce their expenses and increase profits. Another reason is the access to a broader talent pool. By outsourcing, companies can access skilled workers that may not be available or affordable in the EU. 

Outsourcing also allows companies to focus on core competencies and strategic initiatives. By outsourcing non-core functions, companies can allocate more time and resources towards developing products and expanding their market presence. 

However, outsourcing also has its challenges, including language barriers, cultural differences, and legal issues. Companies need to carefully select outsourcing partners and develop effective communication strategies to ensure success.

Advantages

• Cost savings - Outsourcing to low-cost countries can result in significant cost savings as labor cost is often lower in these countries compared to developed countries. This can result in up to 60% savings in labor costs (Deloitte, 2016 [42]).

• Access to specialized skills - Outsourcing gives companies access to specialized skills and expertise that may not be available within their organization or country. This enables businesses to access expertise in areas such as IT, finance, and customer service.

• Improved focus on core business - Outsourcing allows companies to focus on their core business activities while delegating non-core activities to third-party providers. This can lead to increased efficiency, productivity, and profitability.

• Flexibility and scalability - Outsourcing provides companies with the flexibility to scale their operations up or down depending on their needs. This can help companies respond quickly to changes in demand or market conditions.

• Increased innovation - Outsourcing can lead to increased innovation as companies can tap into the expertise of third-party providers and leverage their knowledge and ideas to develop new products and services.

Disadvantages

• Quality and control issues - Outsourcing can lead to quality and control issues, particularly when working with third-party providers in different countries and time zones. This can lead to communication breakdowns, cultural differences, and other issues that can impact quality and control.

• Security and data privacy risks - Outsourcing can also pose security and data privacy risks as companies may have to share sensitive information with third-party providers. This can increase the risk of data breaches and other security incidents.

• Loss of institutional knowledge - Outsourcing can result in the loss of institutional knowledge as companies delegate non-core activities to third-party providers. This can impact on the organization's ability to innovate and compete in the long term.

• Hidden costs and contract management issues - Outsourcing can also result in hidden costs and contract management issues, especially if contracts are not managed properly. This can lead to cost overruns and other issues that can impact the business's bottom line.

Sources: [39] - [41]

TYPES OF OUTSOURCING

There are several types of outsourcing which can be classified depending on the company’s goals (NST, 2021 [4]). 

1. IT outsourcing: The practice of hiring external service providers to manage and deliver IT-related services and solutions, such as software development, network administration, and help desk support.

2. Business process outsourcing (BPO): Refers to outsourcing a specific business function or process, such as payroll processing, customer service, or accounting, to a third-party provider. 

3. Knowledge process outsourcing (KPO): Specialized outsourcing that involves outsourcing high-value, knowledge-based work such as research and data analysis to external providers. 

4. Recruitment process outsourcing (RPO): An outsourcing arrangement wherein an external provider takes responsibility for filling vacant positions in an organization. 

5. Legal process outsourcing (LPO): Outsourcing legal work to external providers, such as research, document review, and contract management.

Sources: [42] - [48] 

Commonly outsourced sectors

According to a survey conducted by the European Outsourcing Association, 42% of companies in the EU outsource their IT services, while 21% outsource their human resources functions. The survey also found that companies outsource to countries such as India, Poland, and Romania due to their skilled workforce and cost-effectiveness.

OFFSHORING AND NEARSHORING

Offshoring

When trying to expand business operations some companies may use the option of offshoring. Offshoring is used as a natural extension of outsourcing and implies the relocation of a business process or even the entire manufacturing facility to a foreign country. By outsourcing, a company entrusts a part of their business process to a third-party vendor, either within the same country or as a cross-border transfer. Offshoring, even though it may seem similar to outsourcing, implies performing certain production operations in another country. 

Most often, offshoring is associated with generating activity in a foreign country at a lower cost such as less developed countries. In this way another country can provide lower costs for the same services; offshoring also allows better availability of trained people and fast job completion due to an expanded scope of talent.

Depending on the company’s requirements, you can differentiate between production offshoring and services offshoring; the first one relocates the manual processes of labour to the third party - for example a less developed country -  and focuses on keeping the costs low; services offshoring means relocating different departments such as HR, finance and software development to another country. This can be useful when the company wants to expand their range of production and possibly build a subsidiary in another country. 

Because of the rapid increase of globalisation nowadays, companies decide to use offshoring as an effective business strategy to expand their business operations.

Source: [7]

Nearshoring

Nearshore outsourcing model means that a business, company or any other corporate body delegates specific tasks or entire projects to a nearby country. Examples for nearshoring would be:

• A company based in the United States outsourcing to a third-party in Mexico.

• A customer in Germany delegating work to an extended development service provider in Poland (NTP, 2021 [15]).

This has the advantage of exercising more control over the employees' performance within the EU, thus ensuring a better quality of the finished product. Additionally, countries within the European Union are less prone to cultural and social issues by supplying services or products to Western European companies (NTP, 2021 [15]).

Benefits of Offshoring - and Nearshoring

DIGITAL TRANSFORMATION

Digital Transformation and Outsourcing

Digital transformation is the process of integrating computer-based technologies into an organization's products, processes, and strategies to create new — or correct, modify and extend existing — business processes and cultures (CBI, 2022 [29]).

This term includes not only the field of customer experiences but also the experience of meeting changing business and market requirements (Siebel, Thomas M., 2019 [21]). 

In the course of digital transformation, the ways of entering into outsourcing relationships and their requirements are being reconsidered.                                        

Furthermore, the interplay between digital transformation and outsourcing provides greater availability of IT resources, and creates opportunities for the implementation of digital technologies (NTP, 2021 [15]). This aspect also influences the possibility of outsourcing, meaning what type of digitalization tools are available, if they are available at all. In addition, outsourcing brings the advantage of flexibility in changing the size and scope of any IT activity due to the digitalization (CBI, 2022 [29]). 

Home office

Working from home was introduced to ensure worker safety, but now over 70% of workers prefer to keep this option open even after the global health crisis has passed. Employees are demanding that telecommuting be included in their employment contracts. Many are even considering quitting their jobs if they can no longer continue working hybrid or telecommuting.

This means that demand for IT and IT-enabled products and services remains strong. Combining this with the growing shortage of skilled workers in Europe (see also trend: Talent shortage drives outsourcing) and the declining outsourcing threshold in general, the European corporate demand for BPO (Business Process Outsourcing) is very likely to continue and will increase significantly in the next few years (CBI, 2022 [29]).

POPULAR OUTSOURCING AND OFFSHORING DESTINATIONS IN EUROPE

Eastern Europe

As for offshoring, most of it occurs in Eastern Europe (50.3%). This is mainly due to the fact that Romania, Poland, Bulgaria, Czech Republic, Slovakia and Hungary have rapidly changed their economic structure and production after the collapse of the Soviet Union. Accession to the EU accelerated the development of infrastructure and attractive conditions for investment in these countries (N-ix, 2021 [26]).

Popular IT outsourcing destinations in Europe

Taking into account the growing demand for outsourcing in the fields of IT and software development, it is worth introducing popular European countries for IT outsourcing separately from attractive countries for outsourcing according to other parameters (N-ix, 2019 [23]).

Ukraine

It is again eastern European countries which turn out to be the most attractive for IT outsourcing, with Ukraine coming out on top with a variety of attractive factors:

•   Cost-efficient.

• One of the fastest growing European countries in the software development sector.

• A vast IT talent pool: over 192,100 IT professionals in the year 2019 (around 60% of software developers are employed in software development outsourcing and outstaffing companies) who provide extensive expertise.

• Strong technical education and 16,000 graduates in information and communications technology every year.

• More than 100 R&D subsidiaries of international companies from various industries, including software, gaming, telecommunications and e-commerce are located in Ukraine. Research and development centers of such global companies as Apple, Microsoft, Samsung Electronics, Apple, Boeing, eBay, Skype, and IBM are located in Ukraine (N-ix, 2019 [23]).

On the left - Average Software Developer Salary in Ukraine [10], on the right Average Software Engineer Salary in Germany [11].

Poland

However, other countries are trying to keep up in this industry as well, for example Poland is offering: 

• 750 vendors providing software outsourcing services.

• More than 295,300 IT specialists, although this is not automatically an indicator for a good outsourcing destination, as only 32 percent of them work for outsourcing companies (Keytotech, 2021 [9]).

• Polish developers are currently ranked 7th in the world for their skills, following Ukraine, which is 6th.

• Poland is rated as a country with high proficiency in English skills and currently holds 14th place among the 35 European countries which provides appropriate communication when outsourcing (Raconteur, 2016 [14]).

Romania 

ranks third, offering:

• 144,000 IT quality experts.

• A growing IT industry with an annual growth rate of 14.3%, which is a significant part of the country's economy (about 6% of the country's GDP is accounted by IT-related activities).

• Proficiency of IT experts not only in English, but also in other European languages: French, German, Italian, as Romanian is close to these languages, which facilitates not only communication within the company, but also the best customer support.

• 7,500 graduates in information and communications technology annually.

• Minimized barriers for business travel due to favourable geographical location (Relevant, 2021 [13]).

EXAMPLE OF AN OUTSOURCING COMPANY

L’Oréal - Who are they?

L’Oréal is the world's largest cosmetics company and has developed activities in the fields and aspects of hair colour, skin care, sun protection, make-up, perfume, and hair care (Collin, 2021 [22]). 

L’Oréal operates in over 130 countries in continents such as Asia, America, East, and West Europe through 25 international brands. One may wonder - where does the success of L’Oréal lie? It is hidden in the fact that the company succeeded in reaching out to the customers of different countries of the world - no matter different income ranges or cultural patterns; giving customers the appropriate product that based on their slogan they “are worth it”. The area of expertise of L’Oréal being that it succeeded almost in every country that it entered. The strategies of L’Oréal were varied and diverse enough to help, adjust and stop itself from restricting itself to a single country  (Collin, 2021 [22]).  

Based on articles and marketing materials, L'Oréal sold its product based on customer demand and country preferences, rather than keeping the product identical worldwide. They expanded the company to include a variety of brands that helped appeal to a wide spectrum of the global market, rather than generalizing the brand. As a result, L'Oréal became acceptable in many cultures and established itself as a product in the local market  (Collin, 2021 [22]). 

How L’Oréal and Nestlé cases are connected

It is not obvious, but L’Oreal is also a part of Nestlé company. However, in December 2020 it was announced that Nestlé would remove its amount of ownership from L’Oréal. Nestlé SA said it would cut its stake in L’Oréal to about 20% by selling shares worth 8.9 billion euros ($10 billion) back to the French cosmetics brand, moving to reduce the weight of the beauty giant on its books for the first time in 7 years” [24]. However, it does not mean that there is no connection between L’Oréal and Nestlé left. Both brands still should care and present similar values towards climate change, inclusivity, fair production and more.

Due to demands for higher wages and rising production costs, large companies have opted to outsource production units to offshore centers in India, the Philippines, China and Malaysia, which have a well-trained and technically skilled workforce at lower labor costs.

Nestlé thus made the decision to outsource logistics, raw materials and equipment abroad to minimize costs while adapting more quickly on the ground. By involving local groups in the Néstles production chain, the firm lived up to its corporate social responsibility (CSR). The success of Nestlé's business management approach was even rewarded with the company being voted one of the most admired companies in America in 2008 (ZME Science, 2021 [18]).

However, oversight of outsourcing centers is often driven by programmatic approaches. In North America, Nestlé faced challenges because its bottled water subsidiaries were damaging the environment and water sources of local communities without including the people who live there with employment or other compensation in the process. This, however, strongly contradicts Néstle's statements that they wanted to involve local people as well as respect the environment. Sadly, however, this is not an isolated case. Cosmetic brands are also repeatedly called upon to take more sustainable measures in their production and to comply with them. As Packaging-Gateway reports: “Multinational beauty brand L’Oréal Paris has committed to reducing the amount of packaging used for its products by 20% by 2030. The commitment is part of the company’s latest set of targets for the decade,which it announced under its ‘L’Oréal For the Future’ sustainability programme”. For L’Oréal in order to increase recyclability and prevent plastic pollution, the company aims to use fully recycled or biobased plastic in its packaging by 2030 (LiveKindly, 2021 [25]). 

To reduce problems with outsourcing and have better oversight of their international operations and quality standards, Nestlé have integrated web platforms like EProcurement, an online eMarketplace portal to expand their supply chain network.

As we can see, Nestlé outsources much of its services and production, which is to be expected given the size of the company and all the brands associated with the group. Nestlé is proud of the CSR it implements, but when companies outsource, they often lose control of the entire production process, so there are always violations of environmental regulations and working conditions in production. Sometimes, things go too far wrong and trigger a scandal. However, in order to avoid such scandals directly and thus prevent damage to their image, companies must develop a strategy to gain better control over outsourced production steps (Ivy Panda, 2020 [16]).

THE NEGATIVE SIDE OF OUTSOURCING-OUTSOURCING SCANDALS

THE OUTSOURCING TRENDS AND PREDICTIONS

Post COVID-19 Influence

The rise of Remote Work

Remote work has seen a significant increase during the pandemic and is likely to continue even after it ends. This rise in remote work contributes to the growth of outsourcing, as companies are now more willing to hire remote teams and outsource certain functions at a lower cost. In Europe, remote job opportunities peaked at 19.9% in October 2021 but gradually decreased to 9.1% by February 2022. The United Kingdom dominated remote job opportunities, accounting for 29.4% across the continent (ZTS, 2023 [32]).

Rearranging priorities

The major shift that has transformed the way organizations understand outsourcing is the switch from delegating small tasks towards outsourcing more core functions. Besides recognizing the numerous financial benefits of outsourcing, businesses have started to assign more essential tasks and areas to reliable third-party partners. By outsourcing high-end processes, companies achieve more (Morphnetworks, 2020 [19]).

People before finances

In 2021, focusing on processes and people is far more significant than the price. Price-driven partnerships are a thing of the past. The trend for 2021 was staying in touch with employees’ and customers’ real necessities. Outsourcing companies alter their approach and stir their work by emphasizing the processes and the people participating (Morphnetworks, 2020 [19]).

Quality before quantity

One of the most frequently mentioned disadvantages of outsourcing was focusing on the quantity and being strictly profit-oriented. Now, results and quality play a more valuable role. Concentrating on high-standards and optimal results is the new aspect that defines the value of outsourcing trends (Morphnetworks, 2020 [19]).

More focus on Customer Experience

In 2021, customers became more demanding. Thus, companies continuously come up with new tactics and solutions to provide excellent customer care. However, this vital segment will require even more attention and dedication in the following years and must invest in their customer support teams. It is no secret that a satisfactory customer experience leads to happy customers, which more are likely to recommend one's brand and ease customer acquisition. They boost visibility and reliability by leaving positive reviews and testimonials.

Secondly, content customers who had an outstanding experience when interacting with brand's representatives are more loyal. Thirdly, outstanding customer experience increases Customer Lifetime Value and leads to significant long-term gains (Morphnetworks, 2020 [19]).

Discovering new promising regions

The regions and countries organizations typically picked to find suitable outsourcing business partners are changing. The increase of the new talents is helping to connect new businesses, fields, and economies. The best countries to outsource to and more successful business partners to meet are now located in the closer than ever.

The European market is booming, diverse, and prosperous. Outsourcing to a European country brings on board talent with a strong work ethic and culture. Highly proficient and educated experts, excellent English skills, and a fantastic quality-to-price rate make Europe the prime location for creating business relations (Morphnetworks, 2020 [19]).

There is a growing inclination towards outsourcing in Eastern Europe specifically, presenting a multitude of opportunities alongside certain challenges. The conflict instigated by Russia in Ukraine has significantly altered the region's driving factors, yet its resilience remains steadfast. Prominent IT hubs such as Ukraine, Poland, Romania, the Czech Republic, and Estonia have emerged as favoured destinations for outsourcing software development, aiming to propel the outsourcing market to a value of $578.30 billion by 2027.

Eastern Europe boasts a considerable pool of highly educated individuals possessing advanced IT skills. Combined with the allure of a lower cost of living compared to Western countries, this creates an appealing business environment. Governments in the region have undertaken effective measures to bolster their outsourcing ecosystem, further enhancing the attractiveness of these locations (Agiliway, 2023 [33]). 

The IT Outsourcing

As technology becomes more complex, companies find it challenging to handle all their IT needs internally. IT outsourcing allows one to focus on its core competencies while leaving other tasks to a third party so that you can maintain the competitive edge needed in today’s marketplace.

According to Statista, at the same time in 2013, Skype had up to 70 million users, making it a market leader in the online video space. A significant outsourcer, Skype chose Estonia (East Europe) as a talent pool and hired multiple developers to work on the product. As time went on and these engineers’ showed success, Skype hired them as partners, further solidifying the bond between the two parties. Skype's business plan was successful, as Microsoft acquired the company in 2011 for $8.5 billion Statista, 2013 [34]).

Outsourcing beneficial strategy for start-ups

Outsourcing used to represent a privilege owned by enterprises and well-established brands. Now, there’s a new wave. Surveys have shown that in 2019 there were more than 50% of small businesses that planned to outsource. More and more early-stage companies consider collaborating with a third-party team to prevail over operational deficiencies and enhance their time to market. Starting from scratch usually entails having to be extra cautious regarding many matters keeping a budget friendly approach in mind.

Businesses are focused on structuring and conducting hiring processes, defining, and strengthening the employer brand, keeping the employees happy, and finding new clients or customers. Concentrating on all these responsibilities can convert into an impediment when delivering a high-quality product or outstanding service. In-house teams wouldn’t be able to achieve it all without some external assistance and additional competence (Morphnetworks, 2020 [19]).

N-iX is a leading European outsourcing firm with 20+ years of experience and a team of over 2,000 tech experts. With R&D centres in various countries including Poland, Ukraine, and Bulgaria, they offer software development and tech consulting services across multiple industries like manufacturing, logistics, fintech, and more. N-iX has built long-term partnerships with over 50 clients from the US and Europe, earning recognition as a top software development company in Europe and receiving the European IT & Software Excellence Award (N-ix, 2023 [35]).

THE FUTURE OF OUTSOURCING

Increased focus on artificial intelligence

Artificial intelligence enables companies to make data-driven decisions and automate processes. AI can help businesses deliver the best possible services in less time with fewer errors and lower costs. With companies spending more and more money to stay ahead of their competition, it is no surprise that they have started investing heavily in AI technology. As a result, global AI market revenue is expected to reach US $ 51.27 billion.

The increased focus on artificial intelligence and automation technology is a great opportunity for outsourcing providers. It is possible that businesses will also start to rely more heavily on outside vendors with expertise in this field. Instead of developing their own tools and strategies for AI and AI-powered automation (which could take years), many companies will instead outsource this function to a third party NTP, 2021 [15]).

German firm KONUX transforms railroad operations with the help of artificial intelligence (AI) and the Internet of Things (IoT). They use AI-based analytics and smart sensors to give real-time information for infrastructure monitoring. KONUX assists businesses like Deutsche Bahn in streamlining operations and cutting costs by continuously evaluating crucial switch components like the trackbed and frog. Their AI-powered solution enables data-driven automation and decision-making, which has a huge positive impact on the railway sector's efficiency (KONUX, 2018 [36]), (AI magazine, 2022 [37]).

Growing demand of Blockchain services

The blockchain is a distributed ledger where all transactions are recorded. This technology has been around for years, but it was Bitcoin that brought the idea to mainstream attention when this cryptocurrency became the first to use the blockchain as its underlying platform. Since then, many other companies have started using similar platforms to offer their own services and products. Experts predict that this trend will only heat up over the next few years, as more and more businesses discover how they can incorporate blockchain technology into their own business (Maxinai, 2021 [20]).

Cyber security

According to the European Union Cyber ​​Security Agency (ENISA), cyberattacks have continued to grow, not only in number and type but also in terms of their impact. This upward trend is also expected to continue until 2022. Three months into the year, cyberattacks against telecommunications networks in Portugal, government servers in Poland, and oil facilities in Germany, Belgium, and the Netherlands have already made headlines.

With the increasing frequency and complexity of cyber threats, accelerating Europe's transition to a digital-first economy and rising cybersecurity requirements in European legislation, the need for skilled cybersecurity personnel has never been greater. At the same time, according to the latest Digital Economic and Social Index (DESI) report, 55% of companies continue to report difficulty recruiting ICT specialists, as revealed in the latest ENISA report. The lack of cyber skills is even more pronounced (Microsoft, 2022 [30]).

Growing need for cybersecurity specialists

The popularity of cloud computing, mobile devices and "Internet of Things" (IoT) has brought a lot of new possibilities to the market. However, it has also exposed companies to unprecedented security threats that were unheard-of just a few years ago.

Hacking, cyberattacks and data breaches are now commonplace in today’s digital world. In fact, the number of connected IoT devices has increased by 9%, reaching a total of 12.3 billion worldwide. This enormous number makes it difficult to protect these devices from hackers and creates an ever-growing need for cybersecurity professionals who can keep up with this fast-paced industry (Maxinai, 2021 [20]).

Inflation

There are many trends affecting the European Business Process Outsourcing (BPO) and International Trade Organization (ITO) market. There are general trends that justify raising the price of products and services, such as inflation and skills shortages. Technological trends include the growing importance of IoT and big data solutions, and the popularity of Virtual Reality (VR), Augmented Reality (AR), and Marginal Revenue (MR) solutions. There are also trends shaping the way business is done in the ITO and BPO sectors, such as the emergence of green IT, open talent platforms and impact sourcing, but we also see the importance of value over price and the impact of geopolitical conditions increase (CBI, 2022 [29]).

Annual inflation more than doubled from March 2021 to March 2022. This has many implications. One of them is that it can increase the price of outsourced services. Maybe even for your existing contract.

Reasons for high inflation in Europe:

• Increasing energy bills;

• Supply problems (of physical products);

• Higher shipping costs;

• Talent shortage;

• Spiralling attrition rates (people leave companies quicker)

Inflation has its two sides, the employee side and the employer side. Employees need higher wages as they struggle with the rising cost of living.

Operating costs as an employer have also increased. Gas and electricity costs are rising, and while ITO and his BPO sector are not the most vulnerable sectors when it comes to rising commodity prices, so are costs. ITO and BPO providers are increasingly looking to pass on additional costs to their customers. Can they do it in the same way retailers do? A study by Everest Group found that 43% of service providers are aggressively raising prices on existing contracts. 12% got a raise and 11% declined a raise. Globally, prices charged by service providers have increased by an average of 6%. If possible, it also provides an opportunity to (temporarily) compete on price (CBI, 2022 [29]).

REFERENCES

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