If I were you, I would eliminate the second option. Contracting services means spending money, and this was never an effective process. What I understand from your question is that you need to cut costs, which is reflected in your first option - "reduction of staff." Should you choose the first option, you need to do the following:
• You need to stop recruitment.
• You need to profile all the jobs to understand the value these positions and the people holding them add to the business.
• You need to have a very attractive compensation scheme to persuade the people you decided to make redundant to accept. "Make them an offer they cannot refuse." This requires a budget. There are various offers you can make, such as giving them 12 months' salary upfront and letting them go to find a job, keeping them in the organization for a period until they secure a position elsewhere, or going the extra mile by helping them find jobs elsewhere.
• You need to have another budget to spend on training employees who will replace those who have been made redundant. This will be shown during the job profiling process to determine what training is required.