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The Outsourcing Game

By Nikote Etienne @02289523

Since the Industrial Revolution, companies have grappled with how they can exploit their competitive advantage to increase their markets and their profits. For most of the 20th century, companies employed the strategy of becoming large integrated ones that can own, manage, and directly control their assets. Throughout the 1950s and 1960s, this trend had developed into more of a diversification strategy whereby they attempted to broaden corporate bases and take advantage of economies of scale. By diversifying, companies expected to protect profits, even though expansion required multiple layers of management. The 1970s and 1980s then saw organizations attempts to compete globally. Subsequently, these organizations global attempts were handicapped by a lack of agility that resulted from bloated management structures. To increase their flexibility and creativity, many large companies developed a new strategy of focusing on their core business, which required identifying critical processes and deciding which could be outsourced. (Hanfield) Outsourcing can be defined as simply, the strategic use of outside resources to perform activities traditionally handled by internal staff and resources. Companies have always hired contractors for particular types of work, or to level-off peaks and troughs in their workload, and have formed longterm relationships with firms whose capabilities complement or supplement their own. However, the difference between simply supplementing resources by subcontracting and actual outsourcing is that the later involves substantial restructuring of particular business activities including, often, the transfer of staff from a host company to a specialist, usually smaller, company with the required core competencies. (Hanfield) Recently outsourcing has been attracting a lot of debates. The main reason for the ongoing debate is the emergence of service providers from various countries trying to provide services in foreign locations. To understand the growing debate on outsourcing, it is pertinent to understand the benefits and issues inherent in outsourcing.

Successful supply chain outsourcing deals allows users to realize multiple beneficial business outcomes. Firstly, lower costs can be achieved. Decreased direct cost of goods sold can be achieved through the outsourced manufacturers capability and expertise to aggregate raw, packaging and incidental material requirements across its other customers that use similar materials (Scarpati). Furthermore indirect costs, such as those associated with an in-house employee, are always higher than the cost of an outside service provider thus further reinforcing why most businesses opt for outsourcing non-core functions (Image). Additionally regulatory costs are less as well. Not only can companies pay offshore workers less, but significantly lowering regulatory costs also drive down the outsourcing price tag. Programs like Social Security, Medicare and unemployment insurance dont exist in many developing countries, which drive down outsourcing costs further. Even if an outsourced worker makes the same as his/her American or European counterpart, lower regulatory costs mean that its usually much cheaper for the business to go with the overseas employee (Scarpati). In earlier periods, cost or headcount reductions were the most common reasons to outsource. In todays world the drivers are often more strategic, and also focus on carrying out core value-adding activities in-house where an organization can best utilize its own core competencies. Another benefit of outsourcing is that it gives access to technologies that can eliminate manual processes (e.g. data analytics and reporting) and provide real-time information that enable optimized business capabilities, such as improved inventory management, demand planning and manufacturing efficiencies. Furthermore, a company can gain access to specialized skills and quality services that they may not necessarily possess in their status quo. Most third party service providers excel at the services they provide therefore businesses are assured of better quality than many in-house options give (Bucki). Additionally, the service provider would have built up specialized skills in its niche area of operation. By outsourcing to such a provider, businesses get access to such specialized skills, which may be of use in some other field of operation of the business.

Another benefit is that of flexibility through effective capacity management. With uncertainty surrounding todays global economy, companies need the ability to expand or downsize quickly (Scarpati). There may be times when the non-core function may need additional hands to meet deadlines. Unfortunately, thats not always possible with todays labor laws, as employee lawsuits are at an all-time high. However, if the function is outsourced, the headache of meeting the deadline is the service providers (Image). Strategic outsourcing allows companies to take that risk away, allowing businesses to adapt more quickly to rising or slowing demand. One example of this is in a companys decision to outsource traditional data storage to a cloud service provider (CSP) instead of keeping it in house on a corporate server. In using a CSP, a company can react quicker to changes in data storage needs by simply making a call and increasing or scaling down its storage in a few minutes. If this were managed in house, the IT department would have to source the necessary IT equipment, procure it, and then install it, which could take a number of days and much more resources. One more benefit that arises is more efficiency. A key strategic reason companies choose to outsource is to free up time to focus on core business processes. Without having to run an accounting department or an IT operation, companies are able to direct their scope to work on what really matters inside their business, thereby increasing work flow and allowing managers to finish projects faster (Scarpati). For example, there can be faster introduction of new products and accelerated innovation of existing products due to redirection of resources to focus on product innovation, research and development, sales and marketing, and customer service. Global outsourcing also presents significant benefits for developing countries by opening up new export, growth and employment opportunities in various tradable service activities. In a more dynamic sense, the trade induced growth in income levels in developing countries will have further positive feedback effects for the rest of the world in terms of rising exports and increased tourism

inflows. This is the age old global wealth creation story which is a win-win game. There are already signs of this happening with rapid growth in China and India leading to sharp increase in imports by these countries as well as increases in outbound tourism from them. On the other hand, there are several disadvantages associated with outsourcing. The main one is that there is a loss in managerial control. Whether the company signs a contract to have another company perform the function of an entire department or single task, you are turning the management and control of that function over to another company. Furthermore, the outsourcing company may not be driven by the same standards and mission as the main business (Bucki). They will be driven to make a profit from the services that they are providing to the company and other similar businesses. Also there are threats to security and confidentiality. The life-blood of any business is the information that keeps it running. If you have payroll, medical records or any other confidential information that will be transmitted to the outsourcing company, there is a risk that the confidentiality may be compromised. If the outsourced function involves sharing proprietary company data or knowledge (e.g. product drawings or formulas), then this risk must be taken into account. A company needs to evaluate its outsourcing partner carefully to make sure data is protected (Bucki). Another issue is that of quality problems. The outsourcing company is mostly motivated by profit and since any contract will fix the price and quantity, the only way for them to increase profit will be to decrease expenses (Bucki). These decreased expenses often come at the expense of a loss in the quality of product or service provided. As long as the outsourcing company meets the conditions of the contract, they are obligated to be paid and thus the burden of the inferior products is forwarded on towards the end customers. A good example of this is what happened with Boeing last year. The company was forced to ground all of their 787 Dreamliners for a few months due to malfunctions causing billions of dollars in losses. Company engineers blamed the problems on the 787s outsourced

supply chain, saying that poor quality components were coming from subcontractors that operated largely out of Boeings view. The last disadvantage of outsourcing is the most controversial of them all. Outsourcing brings about many ethical issues about social responsibility. There is no question that every job moved offshore is a job lost on-shore, and as long as employers can get quality resources for a fraction of US salaries, the income towards local resources will continue to fall. There is a groundswell of backlash against this current trend toward exporting jobs outside the US. This backlash can cause negative publicity for the company in question leading to boycotts and hence market share losses. Typical outsourcing areas include IT services, customer service, call centers, administration services, financial services, and indirect production. Looking at the global services market, one can see a highly dynamic environment whereby selecting the best outsourcing location for a companys operations can have a significant long-term impact. One of the most comprehensive online databases of outsourcing country statistics developed to aid in decision making is compiled annually by SourcingLine. SourcingLine is an independent research company that specializes in the IT industry. Looking at Appendix 1, we see the top 30 IT outsourced countries in the world. Each country has been scored across dozens of key statistics which fall into three broad areas of Cost Competitiveness, Resources & Skills, and Business & Economic Environment. India, ranked first in the survey, provides the best mix of factors, but it is not a leader across all dimensions. It is still a highly cost competitive location, but recent wage inflation has impacted its position relative to other countries. India also has a massive resource and skill base, but educational challenges are impacting the skills of graduates and the business & economic environment can prove taxing. Other leaders in the survey include numerous other countries from Asia, but also Latin America and Europe.

The Bureau of Labor Statistics states that approximately 15 million Americans are unemployed. According to Outsaurus, the estimated amount of outsourced jobs is 10.5 million. Literally millions of jobs could have existed had outsourcing not become a national norm and the national unemployment rate would have remained low (Arslan). Global outsourcing has clearly made the structure of international competition and consequent labor market adjustments more intense. However, it is not a new phenomenon. Rather, it is a continuation of the process of globalization that began in the 1950s and 1960s which has led to net wealth creation globally. While it is not a zero-sum game, there are multiple benefits as well as inevitably adjustment costs and job losses that need to be addressed in a timely and effective manner by all countries involved in the international division of labor.

Appendix 1
Overall rank
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 India Indonesia Estonia Singapore China Bulgaria Philippines Thailand Lithuania Malaysia Jordan Chile Egypt Hungary Czech Republic Poland Vietnam Sri Lanka Latvia Argentina Costa Rica Mexico Romania Russia Jamaica Ukraine Ghana Israel South Africa Kenya

Country

Overall outsourcing index


7.1 6.7 6.6 6.5 6.4 6.4 6.3 5.9 5.9 5.8 5.7 5.7 5.7 5.6 5.6 5.6 5.4 5.4 5.4 5.4 5.3 5.3 5.2 5.2 5.2 5 4.9 4.7 4.6 4.5

Cost competitveness index


8.3 8.6 7.5 6.4 7 8.8 9 8.2 7 7.9 7.6 7.2 9 6.9 6.9 6.8 7.4 8.3 7 7.5 7.3 6.9 6.8 6.4 6.2 6.3 7.5 3.8 6.9 6.7

Resources & skills index

Business & economic environment index

6 4.3 5.2 5.7 5.6 2.9 2.8 2.3 3.9 2.2 2.7 3 0.9 3.4 3.2 3.6 2.5 1.2 2.7 2.5 2.3 2.8 2.7 3.4 3.7 3.2 0.9 5.5 0.6 1.3

4.2 4.4 6.9 9.4 5.6 5.2 3.9 5.9 6.5 6.9 5.7 6.9 4.3 6.3 6.5 5.5 4.5 4.3 5.6 4.4 4.8 5.3 5.2 4.7 4.7 3.8 4.3 7 6.3 3.6

Source: http://www.sourcingline.com/top-outsourcing-countries

References
- Hanfield, Robert. "Supply Chain Management, SCM, SCRC Supply Chain Resource Cooperative, Poole College of Management, North Carolina State University." A Brief History of Outsourcing. North Carolina State University Poole College of Management Supply Chain Resource Cooperative, 1 June 2006. Web. 07 May 2013. http://scm.ncsu.edu/scmarticles/article/a-brief-history-of-outsourcing

- Scarpati, Kevin. "Outsourcing ." Outsourcing. Digital Supply Chain, 30 Nov. 2011. Web. 07 May 2013. http://www.supplychaindigital.com/outsourcing/top-10-reasons-to-outsource

- Image Source Magazine. "A Case for Outsourcing: Pros & Cons." ImageSourceMag. Image Source Magazine, 12 Sept. 2011. Web. 07 May 2013. http://www.imagesourcemag.com/ismarticle/a-case-outsourcing-pros-cons

- Bucki, James. "Top 6 Outsourcing Disadvantages." About.com Operations / Technology. About.com, n.d. Web. 07 May 2013. http://operationstech.about.com/od/outsourcing/tp/OutSrcDisadv.htm

- Arslan, Andrew. "10.5 Million American Jobs Have Been Outsourced." Intellectualyst RSS. Intellectualyst, 12 June 2012. Web. 07 May 2013. http://intellectualyst.com/10-5-millionamerican-jobs-have-been-outsourced-643/

- Rajan, Ramkishen S., and Sadhana Srivastava. "Global Outsourcing of Services: Issues and Implications." Harvard Asia Pacific Review. Harvard Asia Pacific Review, n.d. Web. 04 May 2013. http://www.hcs.harvard.edu/~hapr/winter07_gov/rajan.pdf