AN APPRAISAL OF THE EFFECT OF OUTSOURCING STRATEGIES ON ORGANIZATION PERFORMANCE
Several organizations have embarked on outsourcing strategies over the years but many still suffer in terms of their goal achievement; some have experienced low productivity both in terms of quality and quantity, their profitability has not been stable, and their capacities are grossly underutilized. This research work determined the effect of outsourcing strategies (back office activities, primary activities, accounting activities and supporting activities) on the performance of Small and Medium Scale Enterprises (SMEs). Survey research design was adopted in Benue State, Nigeria. Stratified random sampling technique was used in selecting respondents for a primary source data gotten through a well-designed and self-administered questionnaire. Also, secondary data was sourced from the financial records of ten (10) selected SMEs. The variables were statistically analyzed using multiple regression technique. At the end of the research, the study found that; outsourcing of back office activities (such as bookkeeping, payroll, billing, order processing, payment processing, cleaning services, security services and other administrative activities); outsourcing of primary activities (such as manufacturing, purchases, warehousing, Sales force and customer service); outsourcing of Supporting activities(such as shipping, IT services/system, training, advertising, legal services, transport services, public relations) has a significant effect on organizational profitability of SMEs whereas, outsourcing of accounting activities(such as financial reporting, tax processing) has no significant effect on performance of SMEs. This study therefore recommended that SMEs should embark more on outsourcing strategies to attain the benefits of cost savings/restructuring which results in better customer service at profit; also, outsourcing process management through follow up steps like effective communication and monitoring should be employed and taken seriously to better reap the benefits of this maintenance/growth strategy. Also, SMEs should ensure that, the costs of managing the outsourcing process is not greater than the benefits generated by the outsourcing program.
1.1 Background of the Study
Business environment in today’s world is severely dynamic (Jae, Minh, Kwok and Shih, 2000). Rapidly changing and increasingly complex business issues are creating key shift in organizations and the manner in which they do business (Sev, 2009). One fact is still certain; every organization has its goals; also, the success of an organization is measured by the level at which it attains its goals.
In order to achieve its set goals in the presence of technological advancement, sophistication of business processes, knowledge explosion and need for constant growth, an organization looks out for strategies to enhance performance (Dominguez, 2006). It therefore reflects on the capabilities of its workers (staff), its technological knowhow, business processes and so on, and answers the question of whether it can achieve its goals with what it already has on ground or look out for ways to complement (Sev, 2009; Isaksson and Lantz, 2015). In struggling to meet the demands of customers and shareholders, an organization may look out for ways that it has a comparative advantage. It therefore focuses on core competences and seeks to reduce operation cost which presents outsourcing as the right strategy (Akewushola and Elegbede, 2013).
Outsourcing is one management tool that has gained relevance among managers in addressing today’s business dynamics (Jae, et al. 2000). It entails contracting out of a business function (Jae, et al. 2000; Dominguez, 2006; Isaksson and Lantz, 2015). It is the replacing of in-house provided activities by subcontracting it out to external agents. Consequently, the management and development of innovations in outsourced activities become the responsibility of an agent external to the firm.
Outsourcing avails organizations the opportunity to concentrate her core competencies on definable preeminence business area and provides a unique value for customers Dominguez (2006; Gro¨ßler, Laugen, Laugen and Fleury, 2012). Also worthy of note is the fact that present day outsourcing is no more limited to peripheral activities such as cleaning, catering and security. As noted by Jennings (1997) and Dominguez (2006), outsourcing also includes critical areas such as design, manufacturing, marketing, distribution, information system etc.
Outside Nigeria, notable companies which have outsourced are among others Kodak Company who subcontracted its computing operations to International Business Machines (IBM); the result of which was higher quality computing system and operation at Kodak for less money than it was spending (Sev 2009). Also as noted by Hill (1997), Boeing as at 1997, was world’s largest manufacturer of commercial jet aircraft with a 60% share of the global market. Despite the large share of the market, Boeing was faced with competitors like Europe’s Airbus industries. The dog fight between the big two resulted to high operating cost which made Boeing to look out for ways to beat down cost. In 1993 Boeing undertook a companywide review of its make or buy decision. In pursuit of this decision, Boeing decided and outsourced certain components to China. Worthy of note is the fact that Boeing avoided outsourcing the production of wings because it believed that doing so might give away valuable technology to potential competitors.
In Nigeria, Sev (2009) noted some examples of companies who have outsourced their operations. The examples are Ashaka Cement Plc, which outsourced its operations and services to Blue Circle industries of United Kingdom; Dangote Cement, Gboko (Benue) plant which acquired the expertise of Pakistani who have managerial know-how and expertise to give quality services and operations. Notable also is in the banking sector. Several Nigerian Mega banking groups have outsourced their operations and services to “Experts” to enhance global competition in the international financial markets. The United Bank for Africa (UBA) plc, Access Bank plc, and other universal banks in Nigeria outsourced Automated Teller Machines (ATM) to a company called inter-switch. Similarly, most banks’ recruitment exercises are being outsourced to other human resource companies like Dragnet and Philips consulting.
All the organizations identified so far are by all standards, big organizations. It is therefore pertinent to submit here that, all forms of organizations engage in one form of outsourcing or another regardless of their size (whether small or large) (Isaksson & Lantz, 2015). Be it manufacturing, services, information technology, management services, product engineering, and research process or marketing services (Suraju & Hamed, 2013). It is usual sight to see SMEs collect contracts from their customers and rather than do it themselves turn out to subcontract them to other organizations, either small or big to execute them for them. Instances of such outsourcing in Nigeria can be seen in the outsourcing of security services from security outfits by some hotels that focus on rendering hotelier services which is their core operation.
Also, a pilot study conducted revealed that, most SMEs outsource their major accounting operations to external accounting firms instead of employing accountants. They most at times have one or few accountants whose job is to record transactions and then acquire the services of external accountants who do the computation and preparation of sophisticated accounts and also audit their operations. Other areas of outsourcing by SMEs as noted by Isaksson and Lantz, (2015) and Akewushola and Elegbede, (2013) are training of staff, advertising and other supporting activities.
The reasons for outsourcing over the years are seen as to pave way for an organization’s concentration on their core competencies thereby experiencing effectiveness and efficiency through cost savings, reduced capital investment within the firm, improved responsiveness to changes in the business environment, increased competition among suppliers ensuring higher quality goods and services in the future, reduced risk of changing technology, among others (Jae, et al. 2000; Dominguez, 2006; Sev, 2009; Isaksson and Lantz, 2015).
In line with the above established merits of outsourcing, several organizations (some of which are noted above) have ventured into outsourcing. However, as noted by Sev (2009), despite the outsourcing they have been carrying out over the years, some organizations still suffer in terms of their goal achievement; some have experienced low productivity both in terms of quality and quantity, their profitability has not been stable, and their capacities are grossly underutilized.
Based on research findings over the years also, researchers have theorized reasons and areas of outsourcing and its strategies. For instance, C.K. Prahalad and Gary Hamel advocated the theory of core competencies which insists on outsourcing of non-core areas as a best practice in utilizing of resources (Prahalad and Hamel, 1990; Jae, et al. 2000; Dominguez, 2006); yet, organizations are seen outsourcing even their primary operations which is seen as their area of competence. Also, some look at the cost of operation thereby outsourcing to minimize cost (Busi and McIvor, 2008), yet some organizations give out some operations that they can carry out in a cheaper way. The question here is that; are they looking at quality or their decisions are based on social reasons as noted by the social view theory (Jae, et al. 2000) or what?
The case of SMEs has been so peculiar here. Their outsourcing is in addition to the backup/supporting activities, more of their core areas which are before now being retained in-house (Isaksson and Lantz, 2015). This research therefore delved in the specific outsourcing strategies embarked upon by these SMEs; why their choice and the effect of various strategies on organizational performance of these SMEs.
This research work explored outsourcing activities among SMEs in Gboko, Makurdi and Otukpo metropolis of Benue State, Nigeria with emphasis on organizational operations for the recent past five years (2012 to 2016). Small and Medium Scale enterprises here are defined in line with the definition of SMEs by the National Council of Industries in Onugu (2005) as any enterprise whose total worth including working capital but excluding value of land is more than ten (10) million naira but less than one hundred million naira (N300, 000,000.00); a workforce between eleven (11) and seventy (200) full-time staff and/or with a turnover of not more than twenty million naira (N20, 000,000) in a year. The main research objective was to determine the exact effect of outsourcing strategies on the performance of SMEs, hence, the following questions are asked;
- i. How has the outsourcing of Back Office Activities affected the profitability of SMEs?
- ii. What are the effects of Outsourcing Primary Activities on the profitability of SMEs?
What are the effects of Outsourcing Accounting Activities on the profitability of SMEs?
What is the contribution of Outsourcing Support Services to the profitability of SMEs?
1.2 Conceptual framework
Just like any other concept in the academic world, outsourcing has diverse definitions. This is due to the diverse nature of the perceptions of those who use it. It is therefore not feasible for one to state in a clear cut manner a definition that is generally acceptable. However, for the purpose of this research, the definitions by Yalokwu (2006) and Dominguez (2006) are relevant and so adopted. Outsourcing is defined according to Yalokwu (2006:590), as the process of subcontracting operations and services to other firms that specialize in such operations and services that can do them cheaper or better (or both). Also, Dominguez (2006:1) views outsourcing as the practice of hiring functional experts to handle business units that are outside of a firm’s core business. She describes it as a method of staff augmentation without adding to headcount.
Base on the above definitions, outsourcing can be comprehensively said to be the contracting and/or subcontracting of operations and services whether they are outside of a firm’s core business or not to other firm(s) that specializes in it and can do it better or cheaper (or both). This definition supports the fact that organizations have their areas of specializations. An organization that performs its administrative and business services and operations may not perform all of them efficiently. This may lead to low quality products/services. When an organization focuses on areas that it has advantage comparatively and outsource those it performs minimally this would lead to efficiency and high quality productivity. The emphasis of this research however, is on the outsourcing strategies of SMEs, their implementation and contributions to organizational performance.
Outsourcing strategies have been classified by different scholars in different ways. Some of the classifications are here reviewed and a choice made at the end.
- i. Classification according to Jennings ( 1997 )
According to Jennings (1997) as reported by Sev (2009), outsourcing strategies can be categorized into the principal type and the common type. The principal type entails traditional outsourcing: Here the routine jobs or task that the staff of the organization does not perform are identified and the service providers aired for the job and Greenfield outsourcing: Without hiring the service provider the organization can directly hire an imminent company which can execute their business which was not done in the organization internally (Sev, 2009). The common type on the other hand includes: Information technology (IT) outsourcing, Call centre, Payroll, Finance functions and activities, E- publishing, Book-keeping service, Accounting, Human resources and Computer Aided Design (CAD) service (Sev, 2009).
This classification however, is not quite explicit to be used in defining the outsourcing strategies of SMEs. Also, most outsourcing is perceived as human resource management strategy, as such listing human resource outsourcing as a strategy amongst others which obviously entails the use of human resource without adding to head count is rather confusing.
- ii. Classification according to Harward (2010)
According to Harward (2010), there are four (4) outsourcing strategies at an organization’s disposal. These four types of outsourcing strategies or what some call engagement models for sourcing are largely grouped into two. The first two are considered business process outsourcing (BPO) engagements, and the other two are considered out-tasking models. The BPO models are comprehensive and selective. And the out-tasking models are licensing and contracting. The four sourcing strategy model is shown diagrammatically in Fig. 1;
A common question is “what is the difference between BPO and out-tasking?” The easiest way to explain it is to look at an organization as an integrated group of business processes that must be managed by someone (Harward 2010). In small businesses, the business processes can be grouped into four functional areas of; administration, content, delivery, and technology. The number of processes a supplier manages, the complexity integrating those processes, and the duration of time a supplier is expected to manage those processes all help define the differences in outsourcing strategies.
BPO refers to those engagements that are most complex, longer in duration, integrated across functional process areas, and considered most strategic to the business whereas, out-tasking refers to the models that are less complex, fewer processes and limited to one functional area, more tactical, and more labor oriented (Harward 2010). These four types of outsourcing strategies are briefly differentiated below:
- 1. Comprehensive BPO – this is the most complex, strategic, long term, and demanding relationship you can have with a supplier. A comprehensive outsourcing deal means that you are engaging with a partner for a multi-year period to strategically manage a comprehensive set of processes across all four functional process areas of your organization (Harward 2010). Both parties are willing to commit dedicated resources to the deal which means you are both committing people and finance over an extended period of time. Comprehensive does not imply that the supplier does everything associated with task for your company. Even in a comprehensive engagement, you as the buyer still must manage some processes like client relationship management or strategic planning. The idea that you give away all responsibility to the supplier is actually a myth, and never happens in real life.
- 2. Selective BPO – this is also a very complex engagement, but somewhat less than a comprehensive deal because of the reduced integration of functional processes. In selective outsourcing, you engage a partner to manage multiple processes within one functional area (administration, content, delivery, or technology) but not process across functional areas (Harward 2010). Here you may contract with a supplier for the next three years to manage all custom content development activities for product e-learning courses. But the supplier would not deliver any courses, manage registration or admin services related to the transaction, nor host or support the courses online. Contracts for selective BPO deals are similar to those of comprehensive BPO but they are somewhat less complicated because there are fewer processes involved.
- 3. Licensing Agreement – these engagements are forms of out-tasking and used when sourcing a tangible asset, such as a technology or real estate. Licensing agreements for technology usually take the form of software as a service (SaaS) contracts (Harward 2010). When the cost of implementation and set-up are high, these deals are often times multi-year. This allows the client to amortize costs over longer periods of time. When these costs are low, deals often take the shape of month to month. Contracts for license agreements are generally purchase orders with defined terms and a unit price in the form of price per time.
- 4. Contracting – the second form of out-tasking engagements and the most common form of outsourcing in the small business industry is contracting. Some refer to it as a ‘labor for hire’ engagement (Harward 2010). It’s where we pay a contractor by the hour/day/week/month to perform a task. Contracting is commonly used when we source a supplier to manage a project, and we compensate them when the project is completed. The project can be consulting, instructional design, delivery of a course, etc. It is a tactical engagement when your objective is to limit the complexity and breadth of processes you expect the supplier to manage. It is transactional, which means the relationship ends when the activity is complete. It is the most flexible, least risky and easiest to manage relationship for the buyer. It limits your obligations to a supplier and allows you to easily terminate a contract when things are not going well. Contracts are generally purchase orders with defined terms of activities for a unit price for each deliverable. Unit prices are usually in price per time or price per project terms.
This classification according to Harward (2010) is also seen as not being explicit enough. The two groups of strategies (Business Process outsourcing strategies and out tasking strategies) are so inter related such that the last two (contracting and licensing) are seen as been sub of the first two (Comprehensive and selective). Also, while the first two measure the extent of outsourcing, the last two measure but the area of outsourcing.
1.3 Conclusion and recommendations
Base on the above findings, this research concludes that just like large scale organizations, small and medium scale enterprises outsource. They have over the years embarked on outsourcing strategies such as back office activities (such as security services, cleaning services, order processing, others); primary activities (manufacturing, purchases, warehousing, sales force, customer service, others); accounting activities (such as financial reporting, tax processing, others) and support activities (legal services shipping/ transportation, IT services/system, training, others). These outsourcing activities have over the years led to their increase in profitability.
Also, base on the findings of this research, this research concludes that, Most SMEs outsource more of their primary activities than others which are backup, or supporting in nature. This act is unlike the large organizations which outsource more of their non core activities. However, not every SME outsource. Also, some which outsource have not being managing it effectively. Worthy of note here is the fact that, some which outsource do so without much consideration of their area of operation thereby not utilizing fully the merits of this strategy.
The researcher therefore recommends that;-
- i. SMEs should embark more on outsourcing strategies to attain the benefits of cost savings/restructuring which results in better customer service at profit.
- ii.Outsourcing process management should be taken seriously to better reap the benefits of this maintenance/growth strategy. Follow up steps through effective communication and monitoring should be employed.
Also, SMEs should ensure that, the costs of managing the outsourcing process is not greater than the benefits generated by the outsourcing program.
- iv.Record keeping is a very vital aspect of business operations. However, base on the responses captured above, it is clear that SMEs attach less value on its record keeping. This research therefore submits that, owing to the unqualified imperativeness of accounting function in today’s business word, SMEs should take this function with all seriousness and thus outsource it to competent vendors who can carry out this function better or at a cheaper rate than putting accountants on their payrolls.
Contribution to knowledge
Issakson and Lantz (2015) carried out a research on outsourcing strategies and their impact on SMEs performance in Sweden and realized through regression results that, all the four strategies have no effect on financial performance of SMEs as measured in terms of Returns on Equity (ROE) and Return on Assets (ROA).
This research has taken a step to replicate their research here in Nigeria; focusing on profitability as a measure of performance and realized that, three of the strategies (Back office, Primary activities and Support activities) have significant effect on the profitability of SMEs except outsourcing of accounting activities whereby, there is a high indication that most don’t even outsource here in Nigeria.
This research adds to the literature on outsourcing strategy and Small/medium scale business operations. It fills a gap by providing local evidence as to the effect of various outsourcing strategies on the organizational performance of small and medium scale businesses in Beenue State, Nigeria. Also, it will be quite useful for proceeding researchers who may use it as a background for further research.
Limitations of the study
Aside the common but less strong limitations to a research such as time constraint, lack of resource materials, financial constraint, others, this research is constrained by;
Lack of records: Ordinarily one would have preferred to present and analyze financial records of all these organizations to arrive at the implication of their outsourcing practices but due to the presence of insufficiently and so skeletal records, this research has depended more on the responses of the SMEs owners/Managers to arrive at the financial implication of their outsourcing practices. This is a threat to this research as a common error or misinformation by the respondents can mar the truism of its findings.
Limited scope: This study is limited by its small sample across a wide range of business sectors and organizations. Here, only 233 SMEs are sampled among the almost uncountable SMEs in Nigeria. The scope here is also Makurdi metropolis which is a feint representation of Nigeria.
Suggestions for further studies
The research by Issakson and Lantz (2015) and this research, notwithstanding, there is need for a research to ascertain effects of these outsourcing strategies on other non financial performance measures such as SMEs customer satisfaction; employee job satisfaction; employee commitment, others.
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