To Outsource or Ally - What is the Difference?

by Bradley Morgan [Published on 28 June 2006 / Last Updated on 23 Jan. 2013]

A current and increasing trend in business is to engage in relationships with external entities in order to achieve strategic goals or obtain synergistic benefits. Two of the more dominant expressions in modern business literature relating to this intermingling of enterprises are outsourcing and strategic alliance.

TO OUTSOURCE OR ALLY: WHAT IS THE DIFFERENCE?

A current and increasing trend in business is to engage in relationships with external entities in order to achieve strategic goals or obtain synergistic benefits.  Two of the more dominant expressions in modern business literature relating to this intermingling of enterprises are outsourcing and strategic alliance.  These two practices are becoming ever so common among the business community, and although the distinction between them is becoming increasingly blurred, they have distinguishing traits, which bear consequential benefits and risks.

It has been said that the practice of outsourcing should be looked upon not as a simple customer-vendor relationship, but rather as a partnership where the engaging parties mutually benefit from their agreement.  While this may be a sound management practice, and while outsourcing shares many of the same characteristics with strategic alliances, outsourcing should be recognized as its own distinctive tactic.  Outsourcing is the contracting of services via monetary means in order to minimize or limit the resources that would normally be required to perform business functions internally, thus reducing costs.  A strategic alliance, on the other hand, does not necessarily involve monetary payment from one firm to another, or a binding contractual agreement between two companies.  Rather, it is a partnership in which business entities collaborate with one another in order to bring about mutual benefits.  This partnership can range from a loose and informal one, to more formal joint ventures, which involve legal measures to set parameters.  Strategic alliances might include practices such as the partnering of manufacturers and retailers in order to reduce logistics costs, or the engagement of hardware and software development firms to create competitive advantage through synergy.  Indeed, there are almost infinite ways in which strategic alliances can be formed.  The point here is that outsourcing and the formation of strategic alliances, while similar in some ways, are normally used to achieve different outcomes and involve different methods of binding between the participants.

Outsourcing Strategic Alliance

Relinquishment of Control of Asset(s)

Monetary Investments

Primary Driver: Reduce Costs  

Retained Control of Asset(s)

Non-monetary Investment

Primary Driver: Acquire Skills and Capabilities

Table 1: Distinguishing characteristics of outsourcing and strategic alliances

Like any investment, outsourcing and strategic alliances convey benefits and risks, many of which are shared.  The gains are numerous and highly significant, which explains the increasing popularity of the practices.  Cost reduction is the number one reason for companies to engage in outsourcing, with an average of 20% savings in operating costs for domestic outsourcing and an even greater reduction for offshoring (Lucas, 2004).  Strategic alliances, on the other hand, are primarily driven by the need to obtain skills that are too costly to incubate in-house[1].  It should be noted that these are merely the primary drivers for each practice.  Often times both outsourcing and strategic partnering can result in cost savings and skill acquisition.   Not only do both practices facilitate the reduction of monetary costs, they also free up time and resources.  If a firm relinquishes control of a particular area of operations, such as in the case of outsourcing, it is now free to re-allocate the once dedicated resources to other functions.  Similarly, a strategic alignment might allow a firm to focus its concentration on areas of more importance outside the expertise of its partner.  Other benefits include risk reduction, expansion of business models, and increased opportunities.

It seems that friction will always be generated when dealing with the interaction between any business entities, whether it be consumer-to-business or business-to-business.  In the latter case, one must always be aware of cultural differences.  Like the marriage of people, differences in schools of thought on things like politics, discipline, and management philosophies will affect the strength of the relationship.  Corporate culture must be taken into account when businesses engage in partnerships.  In some cases, differences will be obvious and in some they may lie below the surface only to be exposed later.  Businesses should make careful observations about the interaction between the employees of businesses in the early evaluation stages of outsourcing and partnering in order to avoid a potential incompatibility.  This is true for both outsourcing agreements and strategic alliances.

As previously mentioned, the lack of skills available for a business is an obvious reason to seek external assistance.  Businesses who choose to outsource solely for this reason should weigh their options carefully.  The return on investment for third party expertise is not as rewarding as investing in internal expertise.  In non-exclusive outsourcing deals, the skill sets of the vendor''s employees are applied to all of their clients, preventing any real competitive advantage from being captured.  In this case, also, the resources provided by the outsourcing party contribute to the organizational knowledge of the outsourcee, which is more valuable as an internal asset.  Although the desire to retain this knowledge may be irrelevant to the outsourcing firm, it is a by-product of their investment, which they cannot capture.  Often times, skill acquisition can be achieved with less risk through strategic alliances.  Because strategic alignments do not normally involve the exhange of money for services, or complex contractual relationships, the return on investment is higher.

The issue of control constitutes a major divergence between outsourcing and strategic alliances.  When outsourcing, control over assets and\or capabilities is relinquished.  The risks here are numerous.  Can the oustourcee be trusted?  Is the company sound? That is, will it survive throughout the terms of the contract?  Can it deliver the level of service and features that are required (Clyman, 2004)?  The list goes on.  In the case of strategic alignments, these risks are significantly reduced.  In such partnerships, control is not normally an issue.  Control over internal capabilities and assets is retained, and therefore will not pose the same problems.  The ability to control a partner''s capabilities and assets is not possible, but if the agreement is mutually beneficial for all participants, the behaviors of the external entities involved will be favorable.

One of the obvious concerns of management when engaging in relationships with external entities is that of security.  The leakage of sensitive information into the wrong hands could prove quite costly to a business, especially if the protection of the information is crucial to the core competencies or strategic direction of the firm.  Issues such as the trustworthiness of the service provider''s staff, the transfer of data between organizations, and infrastructure must all be considered.  "Security and privacy are critical issues, and companies without the resources to make a direct investment in personnel to have a physical presence at the outsourcing partner''s place of business need to take this into consideration" (Lucas, 2004).  The privacy of a business'' employees is also important, especially when engaging in human resources-related outsourcing projects.  This risk is amplified when dealing with offshore outsourcing.  "Privacy is a big concern for outsourcing, and when a file leaves the building in another country, there can be difficulty enforcing privacy laws in the courts" (Lucas, 2004).  In strategic alliances, the exchange of sensitive information will most likely be at the discretion of the participants at any point in time, so the risk is no greater than it would be under normal operating circumstances.

The practices of forming strategic alliances and outsourcing each offer similar benefits, with varying degrees.  Outsourcing businesses may undertake increased risk along with the long-term, highly binding contractual agreement between themselves and the outsourcing party, but also may experience more valuable gains.  Strategic alliances, because of their less-binding nature, allow more flexibility for participants, thus reducing much of the risk inherent in outsourcing.  However, the benefits gained from such partnerships will not normally be as great.  When seeking partnerships and agreements with external businesses, managers should determine the degree of cost reduction or skill acquisition that must be obtained, as well as the amount of risk that can be incurred.

References

Applegate, L., Austin, R., & McFarlan, W. (2003) Corporate Information Strategy and Management (6th ed.). Boston, MA: McGraw Hill.

Clyman, John. (2004, Oct. 19). Business IT: Rent or Buy?. PC Magazine, 129. Retrieved April 19, 2005 from LexisNexis.

Lucas, Peter. (2004, Dec.). Outsourcing: The Good, the Bad, & the Ugly. Collections & Credit Risk, 22, 9-12. Retrieved April 19, 2005 from LexisNexis.

Footnotes

[1] Older outsourcing agreements were often formed for this purpose, but more recently have been used to shed non-core business functions.  Because skill acquisition can be achieved via strategic alliance with less overhead, outsourcing for this reason has waned in popularity.

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The Author — Bradley Morgan

Bradley’s fascination with computers and technology dates back to the days of the Atari 800. His interest in security was sparked at a young age, when a hacker with a copy of the infamous “Stoned” virus crashed his system through a vulnerability in his WWIV BBS, forever ingraining a trepidation in his psyche. Morgan is currently employed in two capacities as a Multimedia Technician and a Technologist, and holds a Masters degree in Management Information Systems. He is Network+ and Security+ certified and has over 15 years of experience in all aspects of computing, with a primary forte in web development.

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