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What is industrial outsourcing and what is it useful for business?

There are a large number of definitions of the term ‘outsourcing’, which, when translated literally from English, means attracting external resources to meet one’s own needs. In business practice, this term is used when placing long-term orders for receiving necessary services from other enterprises or when transferring some production functions to a third-party company.

It should be noted the proximity and sometimes compatibility of terms such as outsourcing and subcontracting. Outsourcing is basically a stable and long-term business relationship between a customer and a contractor based on contractual agreements. In this case, the contractor adapts its production and processing facilities or scientific, technical and intellectual potential in the customer’s interests for payment, which is determined by the prevailing cost of services, and not by shares in profits. Whereas subcontracting, being a special case of outsourcing, implies limited business relationships based on contractual relationships as a part of some order fulfillment.

Intellectual and industrial outsoursing

Фото: Интеллектуальный и промышленный аутсорсинг

In general, the outsourcing market is divided into two main segments: intellectual service outsourcing (information processing; research, project development, programming, and other technical works) and industrial outsourcing. Industrial outsourcing is  performance of some auxiliary functions and operations to ensure product manufacturing  (accounting, warehousing, repair and maintenance of equipment, logistics, etc.) One of the factors contributing to  development of outsourcing is the presence of a modern, highly efficient communication environment (communications, computerization and transport), which ensures a fast and reliable exchange of financial, material and information flows, along with a high level of specialization of various enterprises in the sphere of production and services.

The level of outsourcing relations development in the global economy is characterized by the fact that their volume in 2004 reached $ 72 billion. Of this volume, 53% fell on the American continent, 44% on Europe and only 3% on the Asia-Pacific region. The financial sector of outsourcing covers 33% of all contracts and makes up 26% of their total value, the manufacturing sector – (17% and 15%) respectively, telecommunications – (13% and 12%), business services – (9% and 12%) and other services – (9% and 5%). At present, in the world practice, the segment of the provision of intellectual services is larger. However, in perspective, it is expected that the industrial outsourcing segment, which includes various administrative tasks, will grow almost three times faster than the segment of intellectual services.

The use of outsourcing in many companies is specified with a need to concentrate the main efforts on the main activity of the enterprise and to achieve competitive advantages by reducing costs while increasing production efficiency. So, according to the research company” Plant Maintenance Resource Center”,  the most important reasons for outsourcing are the desire to increase productivity while reducing costs and the desire to focus on core business. In addition, outsourcing allows you to speed up the execution of work, as well as facilitates access to new technologies and to special equipment. The effect of the use of outsourcing, according to various experts, will allow a customer to reduce operating costs by about 35% and increase the profitability of capital by an average of 6% while simultaneously accelerating income growth. According to the “Industry Week Census on Manufacturing” study, 54.9% of US companies use outsourcing in production and 43.8% –  in equipment maintenance.

The task of outsourcing is cost saving and improvement of work quality

The most important arguments in favor of outsourcing development are cost savings, a guarantee of reliability and high quality of the services provided. This is due to the fact that the contractor (outsourcer) has an opportunity to specialize in a narrow area of production or services, focusing on the best specialists, using the most modern equipment, applying advanced technologies and constantly accumulating experience in servicing a great many of clients. Combining our own and borrowed experience, the outsource provider gradually improves his quality of services provided and always offers a ready-to-use solution. With provision of service to many customers, the outsourcer distributes overhead costs and optimizes the economy of work, which makes it possible to reduce prices for services provided while improving their quality. In this case, the customer buys services without incurring costs associated with maintaining a specialized unit with qualified personnel and with sophisticated equipment. This allows the enterprise-customer to reduce costs for development, because it becomes possible to purchase the necessary services at no additional cost and at reasonable prices. An outsourcing contract gives the customer the right to receive the desired service performed at a high professional level and in many cases ensuring the outsourcer’s liability for the quality of their performance.

One of the reasons for the spread of outsourcing is complication of business processes that create an extraordinary overload of companies caused by the need to further promote the increasing flow of goods or services to the market with limited resources in the context of dynamic changes in market conditions. This has led to the widespread adoption of computer and information technologies in the field of business and in the management of enterprises. At the same time, the complexity of information systems being introduced has increased and, accordingly, the saturation of enterprises with hardware and software has increased, which has led to an increase in the number of specialists in their support. As a result, it turned out that it is more efficient to ensure operation of such systems by implementing the complete transfer of IT infrastructure to external services, and this was the basis for the active development of the IT outsourcing market. The IT services market is developing rapidly around the world and, as economic reforms advance, it has many areas of application in business. This is due to an increase in business activity and an increase in the speed of response to changes in the market situation. In this regard, the role of online reference and information services and electronic business relations systems (e-commerce, partner search, advertising, etc.) is increasing. The IT-outsourcing companies, thanks to the global Internet, have the opportunity to penetrate the markets of other countries. Thus, many foreign IT companies are already working steadily on the market; In turn, national IT-outsourcers have the opportunity to expand actively their activities in the markets of the CIS countries and countries of Eastern Europe.

Along with the development of IT outsourcing, there has been an increase in telecommunications outsourcing, within which maintenance of communications equipment, network administration, leasing of servers, storage resources and database support are carried out. National enterprises have so far been cautiously using outsourcing when servicing communication infrastructure, since beware of leaking sensitive data from their information systems. This is due to distrust of third-party contractors, the quality of the services they perform and the reliability of their service. However, the expansion and complication of business is increasingly compelling market participants to turn to telecommunications outsourcing.

Currently, the most active consumers of production and economic outsourcing are large enterprises of the fuel and energy complex, metallurgical, chemical and transport. Moreover, these enterprises are interested in integrated services, so the trend towards the provision of a package of services is gradually becoming apparent in the activities of an increasing number of outsourcers. Describing the trends of further reform and development of large enterprises, it can be assumed that in order to optimize the use of investment resources, large companies will withdraw non-core funds in favor of improving and developing key production processes that provide the main competitive advantages. For example, the “Lukoil” company allocated its units for drilling wells to the specialized association “Lukoil Drilling”, and the “BP-TNK” company intends to sell its service division.

Similar trends occur in mechanical engineering. For example, some association abandoned its own production of printed circuit boards using outdated technology in favor of the third-party suppliers that ensure high quality products. One of the well-known enterprises sold its low-profit blacksmith and machine shops and now buys similar products on the side. An equally well-known tractor factory liquidated its unprofitable workshop for metalware production, which was loaded only by 10%, and began to buy metalware from a specialized third-party company. In the field of light industry, a well-known company has acted as follows: producing women’s clothing under the “OGGI” brand, it independently develops models, prepares production, purchases materials and accessories, and also sells ready-made clothes. However, the production of the clothing itself is carried out on the terms of outsourcing and subcontracting with many small and medium-sized enterprises of light industry. Assessing the situation in the outsourcing market, it is necessary to understand that the majority of existing large enterprises are associations of largely obsolete industries, closed to the production of the main product and representing an industrial variety of subsistence economy. Under the conditions of the emergence of the national economy, with the gradually developing infrastructure of industrial services, the need of large enterprises for a wide range of own production, auxiliary and functional divisions is reduced. It is known that in order to increase the economic efficiency of a number of large enterprises, they are restructured and a number of non-core units are removed from them (transport, repair, construction, tool and a number of other workshops, including many support services). Their functions on the terms of outsourcing can more effectively be performed by a number of third-party small specialized enterprises.

However, the wide development of outsourcing relations is still hampered by a very weak level of development of small business in the provision of industrial and scientific and technical services. Moreover, in the small business sector itself, suffering from a lack of financial resources, outsourcing relations are developing much more slowly than among large and medium-sized enterprises. This is also due to the fact that small enterprises often do not have any opportunity to analyze a feasibility of outsourcing certain functions. In this regard, experts recommend basing on the distribution of business functions of an enterprise in accordance with the principle: “I keep for myself only what I can do better than others, I will transfer to an external contractor what he does better than others.” This approach allows the enterprise-customer to optimize its organizational structure, to reduce production costs while improving quality and to focus on strategic issues of improving the efficiency of the enterprise, entrusting the execution of secondary and supporting functions to third-party enterprises. Gradually, among small businesses, it begins to gain recognition for outsourcing in the field of IT services, office equipment service, vehicles, and even when providing accounting services. This allows small businesses to solve many problems of accounting and taxation more successfully and efficiently. The presence of examples of successful outsourcing experience in our country testifies to the prospects for the further development of this form of business relations, especially in conditions when enterprises have an acute shortage of necessary knowledge and specialists. Outsourcing allows comprehensive involving of highly skilled professionals for high-quality development and quick implementation of projects (technological, informational, administrative, managerial, etc.), as well as purchasing services (accounting, logistics, marketing research, equipment repair, etc.). The development of outsourcing relationships contributes to the gradual optimization of the structure of large, medium and small enterprises operating in the real economy, bringing them certain benefits.

The following factors contribute to the development of outsourcing:

  • possibility of reducing overhead costs by eliminating unprofitable workshops, sites and divisions occupied by minor, periodically performed works (repair and construction work, equipment repair, territory cleaning, etc.);
  • reduction of production costs by transferring the manufacture of blanks, hardware and components to third parties;
  • the need for temporary use of special industrial, technological, testing and laboratory equipment, warehouses, vehicles and building machinery;
  • placing orders for the products manufacturing or provision of services during peak loads (seasonal demand or fluctuations in market conditions) with a shortage of own capacities;
  • safety net in case of breakdown of own equipment, so that in these circumstances it was possible not to stop the shipment and not to lose in revenue, but to switch to production on the side.

Outsourcing, as a form of attracting external resources, reduces the need for investments in non-core funds and reduces overhead costs (cost of jobs, employee training, information support, etc.), avoiding staff expansion.  Along with the obvious benefits of using outsourcing in various industries, there are serious factors hindering its development. Among the main reasons hindering the development of outsourcing in the domestic economy are the lack of highly skilled managers who are able to analyze accurately the situation and assess the benefits of outsourcing in the current conditions of development of market relations; reduction of efficiency in solving production and technological issues with an insufficient level of development of communication systems and logistics chains; a limited number of alternative producers and service providers in a given region or within the radius of allowable transport costs, which makes it difficult or impossible to select optimal or economically advantageous partners for interaction on the terms of outsourcing.

All this causes fear in entrepreneurs to lose the control over the enterprise and unwillingness to trust a third-party organization with certain information about their activities necessary to ensure effective interaction between the customer and the outsourcer. Indeed, when outsourcing, the customer to some extent loses the ability to control the transferred part of the company’s activities. Therefore, in some cases it is advisable that the customer has his own controller at the outsourcer, who will evaluate the effectiveness of the work and the compliance of the level of services provided to customer’s requirements. It should be particularly noted that the customer entering into an outsourcing contract should include a description of the conditions for withdrawing from the agreement without loss. If the customer transfers the personnel, equipment and property to the outsourcer, the conditions for terminating such an agreement should allow them to be returned to the customer’s company or provide an opportunity to conclude an alternative agreement.

It is possible to protect against poor-quality outsourcing services and minimize risks when transferring business functions to a third-party structure, provided that the Service Level Agreement (SLA) is correctly entered into. This contract defines the professional liability of the parties and establishes the obligations of the contractor in ensuring the proper quality of services and the reimbursement of possible losses. On the basis of such a contract, you can force the outsourcer to correct their mistakes and pay damages. However, most outsourcing companies do not have sufficient assets to compensate for possible losses from poor-quality work, so service contracts are subject to insurance of a number of legal, consulting, accounting, auditing, IT services, etc. Companies that successfully use outsourcing, seek to secure the fulfillment of their own obligations and expect their suppliers to maximize openness to establish reliable partnerships.

In conclusion, it should be noted that the slow development of outsourcing relations among various business entities, in turn, hinders the process of clusterization of the economy, and thus limits the possibilities for accelerated socio-economic development of our country. As the national market develops, with the growth of sustainability and efficiency of small enterprises specializing in supplying subcontracting relationships, large companies will increasingly begin to focus on the development of outsourcing, as is the case, for example, in the global automotive industry, where small enterprises such as suppliers of workpieces, parts and assemblies are rather the main production unit, than the large automotive concerns. Considering the need to accelerate the development of national small business in the industrial and scientific-technical sphere as one of the most important conditions for sustainable economic growth in the country, it can be assumed that outsourcing relations will be the basis for small business interaction with large and medium-sized enterprises in many areas of activity, among which the most promising are research and implementation of experimental work, the provision of information, marketing, analytic maintenance, administrative and other services, cleaning of territories and premises (production and office), carrying out repair work on equipment, buildings, structures, making simple products (billets, hardware, component parts), cleaning up industrial waste and recycling them for subsequent disposal, modernization or disposal of obsolete equipment, local logistics, etc.


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