Opinion: Outsourcing: What You Don't Know Can Hurt You

Michael H. Zack

November 28, 2007 (Computerworld)

Outsourcing — contracting with outside parties to supply and manage services that companies and organizations have typically provided for themselves — is becoming a universally accepted way of doing business. But in deciding to outsource, are companies asking themselves the most relevant questions?

In most cases, the key concerns driving the decision to outsource are cost and capacity. What's been neglected in weighing the benefits and risks of outsourcing are the issues of knowledge transfer and organizational learning. Companies can increase the advantage and reduce the downside of outsourcing when they evaluate it from a knowledge-based view.

Organizations learn mostly as a by-product of performing activities — so-called learning-by-doing. Outsource an activity and you outsource the learning that comes with it. Therefore, if you outsource activities that provide an opportunity for strategically important learning, you may be creating a significant competitive threat to the company.

When a company outsources, it essentially is transferring the opportunity to learn about an activity to an outside provider. The provider gains knowledge about the activity being farmed out, often making improvements or even radically restructuring the way the activity is done. The client company relies on the provider for the outcome of that activity, but there's a risk that through outsourcing a company's understanding of these key activities may erode. And transferring the knowledge and learning back to a client company that no longer understands the old activity let alone the new and improved version, can be difficult at best, and in many cases impossible.

Few companies recognize the potential slippery slope of outsourcing. Outsourcing renders the company less familiar with its outsourced activity, creating an even greater need to continue the outsourcing arrangement. The company enters a cycle of increasing dependence on the outside provider. If the activity and its underlying knowledge are strategically important, then the dependence could pose a significant strategic risk.

This risk can be mitigated to some degree by the provider transferring the knowledge and learning back to the client. Even though this is not always in the best interest of the provider, most have been willing to implement knowledge transfer as part of their service contract. But it's surprising how many client firms choose not to take advantage of this opportunity.

Knowledge transfer is never easy and never complete. The effectiveness of transferring the knowledge back from the provider to the client company depends on the nature of the activity and the outsourcing arrangement being used. The more that's known about an activity, the easier it is to specify, document and transfer. Highly mature and specifiable processes therefore make the best candidates for outsourcing, since few opportunities for learning will be foregone, and what learning does take place is easier to transfer to the client. Accounting, simple financial analyses and well-specified maintenance programming are examples of good outsourcing candidates.

Activities that offer a company the potential for strategic innovation and learning, such as customer service and new product development, represent a possible risk to the company when outsourced. The learning associated with these activities is difficult to transfer back to the client; therefore, they are less attractive candidates for this practice. For example, I observed a small telecommunications company that outsourced the design and development of its strategically unique provisioning software application — essentially the guts of it business. It ended up knowing very little about how the software operated, let alone how to improve it.

The second issue that should be addressed when considering outsourcing is proximity. Distance between the outsourcing company and its provider creates many knowledge transfer barriers, including time, culture, language, need for mediated communication, and legal constraints on information flow. Geographic immediacy offers the ability to meet frequently face to face and engage in the rich interaction needed to transfer knowledge more effectively. An alternative to using an independent overseas outsourcing provider would be to perform the activity offshore but in-house. This increasingly popular arrangement mitigates some of the knowledge transfer issues, while offering protection against strategic knowledge leaking out of the company.  With outsourcing becoming increasingly widespread, its implications for knowledge and learning are critical to a company's ability to compete in the knowledge economy.

Michael H. Zack is an associate professor of Information, Operations and Analysis at the College of Business Administration at Northeastern University in Boston. He can be reached at m.zack@neu.edu.