Emerging Risk of 2015: Outsourcing

Outsourcing has been a boon to profits, but the cost savings carry risks if they come through low safety standards, poor quality control, etc.

Outsourcing might just be the most common business management earnings booster of the past 10 years. Which means that it is also a top candidate for becoming a major emerging risk in the near future. The idea of outsourcing is an extension of the fundamental logic of capitalism: specialization. Processes are good candidates for outsourcing when there are other firms that can perform the same service at a significantly lower cost. Cost Advantages When you start looking at a potential outsourcing situation, you need to understand the source of the cost advantage. There are several possible drivers:
  • Higher efficiency
  • Lower wages paid to the people performing the outsourced work
  • Lower overhead for the outsourcing partner
But there are other ways that a cost advantage might come about that are not as desirable:
  • Lower safety and health standards
  • Lower spending on quality control
  • Lower amount of slack resources that can be available when a machine breaks or a key person gets sick
  • Lower-quality source materials
How to Control Risks of Outsourcing If an outsourced process is not only out of sight but also out of mind, this emerging risk may become a current problem. There are two basic ways of controlling the risks of outsourcing: by specifying standards at the outset of the arrangement and by inspection of the process and output on a continuing basis. But with the explosion of outsourcing over the past 10 years, even firms that had set down extensive and clear standards at the time of the original agreement and that have allocated the needed resources for inspection of the processes and outputs are at risk from the complacency that comes from the the passage of time without serious incident, the changing individuals on both sides of the agreement and the changing pressures on both organizations. An outsourced process is out of sight. If it also becomes out of mind, then it will likely move out of the emerging risk category into the current problem category. This article first appeared on WillisWire.

Dave Ingram

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Dave Ingram

Dave Ingram is a member of Willis Re's analytics team based in New York. He assists clients with developing their first ORSA (own risk and solvency assessment), presenting their ERM programs to rating agencies, developing and enhancing ERM programs and developing and using economic capital models.


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