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Outsourcing is a term that refers to the business practice in which a firm chooses to buy goods or services from an outside firm rather than having an in-house department to provide those things. For example, if an insurance firm contracts with a law firm to provide legal services instead of having its own legal department, it is outsourcing. As another example, an auto maker is outsourcing when it has another firm make brake pads that it then buys and installs instead of having an in-house department that makes that part.
There are at least two main benefits of outsourcing. First, it allows a firm to concentrate on its core business. It allows it to spin off businesses that are not in its “core competence” so that it can be more efficient in doing the things that are in that core rather than wasting resources and effort on non-core activities. Second, it allows companies that have strong unions to reduce costs by shifting some activities to other companies (even in other countries) where costs are lower.
The major downside to outsourcing is that it reduces the control and certainty that a firm has. The firm is no longer in complete control of its supplier. This can lead to conflicts between suppliers and the firm that could be avoided if the firm were to keep control of the activity that it has outsourced.
Increasingly, firms are choosing to outsource as they feel the benefits outweigh the drawbacks of doing so.
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