Outsourcing Core Functions: What Businesses Should Do?

Businesses are giant machines that run because of small cogs -- and those cogs are processes.

Simply put, businesses are only as effective as the combined effectiveness of their individual processes.

Most business leaders believe that BPOs and IT are the only two ways to understand the outsourcing ecosystem. This belief is seen in the generic statistic that 64.3 percent of all global outsourcing comes under the umbrella of IT; whereas 24.6 percent comes under business processes.

Outsourcing is bigger than just BPOs and IT functions. In order to make outsourcing a more effective process, those undertaken by a business should be bifurcated into core functions and non-functions.

Many generic categorizations would have marketing, finance, accounting, and manufacturing together as the core functions of a business that cannot be outsourced. The rationale for this is that these functions carry sensitive information that cannot be disclosed to anyone except the business’ top management.

A simple way to protect this information is by using a Non-Disclosure Agreement and encrypting sensitive data. There is no need to keep something in-house to protect the data, especially if the business cannot handle it efficiently.

Therefore, in order to see whether certain things should be outsourced or not, business leaders should focus on the very definition of core functions.

A core function is a business process that:

1. Can give the business a significant edge over the competition, if it becomes the business’ long term competency.

The focus here is on getting a significant edge over the competition, not an incremental one. Financial analysts call this a ‘moat,’ which cannot be replicated by the competition. A moat refers to a defensive barrier built around a castle to stop enemies from entering.

Thus, for a business function to be called a core function, it should give a huge edge to the business and not be replicable.

2. Has a direct impact on the current and future performance of the business:

The function should have a significant impact on the overall performance of the business, both in the long and short term. If the function is crucial in the long run, it becomes a strategically important function. Such a function should be taken in-house, even if it that incurs higher costs. 

The higher cost is because an important long-term function should be able be properly executed by the business itself. Initially, there may be high costs as a result of running it internally, but over time, the business’ learning curve will cause costs to decrease.

An example of this is the tech giants Facebook and Amazon. Initially, both businesses were dependent on external service providers for web hosting. As time went on, they brought their hosting needs in-house and now their server storage spaces are so huge that both Facebook and Amazon have an alternative source of income from renting those spaces.

3. If not taken care of, can have a domino effect on all the other business processes:

This criterion is based on the importance of a business function as per its interdependency on other business functions. If the success of the function has a direct correlation with the success of other functions, it becomes a core function.

Anything that does not satisfy all three of these criteria is a non-core function and can be readily outsourced. In fact, it should be outsourced.

This might sound radical to many businesses, but the rationale for such bifurcation is to make it leaner and more efficient.

This categorization goes against the popular belief that certain functions have to be handled in-house because that is how it was always done. For instance:

a. Manufacturing is said to be a core function for a business.

The motivation to keep manufacturing in-house is that it handles quality levels. Contrary to this belief, Apple, one of the best electronic brands around, outsources the majority of its manufacturing. Apple clearly gains a huge advantage by doing so -- their costs are lowered because the process is executed by someone who specializes in it. At the same time, Apple can focus on its own core functions, like designing and marketing products.

b. Similarly, it is said that marketing should be done in-house because it shapes the brand.

Unilever and P&G, two of the largest consumer brand houses today, outsource most of their marketing communications to creative agencies who are entirely focused on this. By outsourcing marketing, these businesses can get effective results, and can devote themselves to their core functions, like product planning and brand management.

d. Accounting is the language of the business, but it is not necessary for all businesses to pay for a full-fledged accounting team from day one.

Last week, I was talking with Tim Chavas from Zipbooks, and he said, “Publicly-listed companies are legally obliged to have an in-house accounts team handling all the primary paperwork.

Additionally, all the companies are supposed to get their books of accounts authorized by the public accountants as well.” That being said, many companies offer services like handling the majority of the accounting needs of small businesses.

For instance, the big four of accounting - PWC, Deloitte, KPMG and EY - started their services as tax consultants and external accountants. There are many smaller firms that can act as outsourced accountants. Additionally, with an automated billing process, outsourcing becomes a simple data transaction.

c. Start-ups, in their initial stages, do not need CFOs. 

Most of the work relating to finances is so small that it only requires attention occasionally throughout the year. Therefore, many successful start-ups hire CFOs on a contract or project basis. This is one way of outsourcing the finance function so that the start-up can conserve resources that it would’ve otherwise spent while searching for and hiring a full-time, in-house CFO.

At the end of the day, businesses resort to outsourcing for these top four reasons:

a. Cost cutting.

b. To be able to focus on core competencies.

c. To solve capacity issues.

d. To enhance service quality.

When the business keeps its core functions, as defined earlier, in-house; they automatically take care of these four goals in the long run. Businesses should focus on understanding strategy and defining core functions, so they know which functions can be outsourced and which cannot.