The increased competitive aspects and importance of increasing bottom line performance by the officers and directors of public as well as large corporations has caused management to seek ever increased cost-saving solutions utilizing globalization. The realities of today’s highly competitive business environment and the use of outsourcing as a solution to lower costs in specific aspects of the production and or delivery of goods and services has evolved to the point where it is an essential component in corporate cost savings. In the early 1800’s the fabric covering wagons in America and that was also used for sails on clipper ships were outsourced to Scotland and the raw materials, fabric, was imported from India (Global Envision, 2005)
It took thirty years for England’s textile industry to become competitive enough to wrest this business away from Scotland and India, indicating that bottom line costs have always been the rationale for outsourcing (Global Envision, 2005). The progress of outsourcing moved slowly in terms of it being a major business technique until the 1970’s when major companies started to contract out their payroll services for processing, and this continued into the 1980’s expanding to accounting, word processing and other forms. The indicated administrative functions does not take into account that piece work in the apparel business has historically been outsourced, as well as parts in the automotive industry and the hiring and or interviewing of employees through employment agencies. The point is that outsourcing has always been a component of business practice that has escalated as a result of increased globalization and technological innovations in software, as well as the Internet.
Today’s outsourcing has transcended the locally based efforts of the 1960’s, 70’s and early 80’s in that it encompasses the utilization of labor and resources in foreign countries half a world away, rather than those within a company’s immediate vicinity or near its border. The contribution of cost efficiencies resulting from outsourcing has increased as companies specializing in offering this service have developed in countries where the cost of labor enables them to compete in this manner.
Additionally, foreign governmental programs offering tax, tariff, land and building concessions in cooperation with foreign corporations as well as part of their own individual economic initiatives and the advent of technological advances has hastened this process. And while modern outsourcing on a large scale first gained favor in the United States with companies such as Kodak and American Standard (Bizbrim, 2005) it is now a global phenomenon that started with countries such as Mexico and China and now includes India, Russia, Vietnam, South America and Pakistan as major outsourcing locations.
On the positive side, outsourcing entails firms taking a specialized aspect of business operations, be it product parts, administrative services, customer service (call centers), and other labor intensive functions. Through economies of operation by specializing on specific areas of expertise, along with economies of scale, lower labor costs as well as reduced operational (land, facilities, taxes, etc.) the preceding translate into savings in end costs making firms more competitive, and improving bottom line results. The negative aspects include the loss of jobs in a originating country’s, increased dependency on services by companies located at a considerable distance, potential quality control issues as well as potential political and economic repercussions (Katz, 2004). The business ramifications of outsourcing entails an international perspective that is fraught with benefits as well as disadvantages in its application. The following will examine these aspects, taking into account the theoretical as well as practical areas along with supporting and opposing points of view.
A simplistic definition of outsourcing is “…a process in which a company delegates some of its in-house operations/processes to a third party”(Bizbrim, 2005). In today’s business environment this entails two forms, domestic and offshore (White & Case, 2004). Domestic outsourcing refers to those instances when the operations/processes are conducted within a country’s borders, while the other form entails the utilization of a company(s) located in another country. Offshore outsourcing, in general, consists of transferring nonproductive, labor intensive or specialized work to an outside firm that used to be conducted in-house (Economic Report of the President, 2004). As a business practice, the theoretical rationales for outsourcing are (Tagliapietra et al, 1999):
In providing any goods, product or service a company must contend with the quality, expectations of end users, pricing and market positioning of competitive firms within its business sector. Theoretically, if a company reduces its operational expenditures it will thus gain a competitive advantage in savings that it can utilize to reduce cost, increase margins, and or provide extra services or other benefits that will sway customers to its products, goods or services. The specific reasons attributable to this broad concept can vary, however the theoretical benefits of outsourcing are to accomplish this objective as one of its core essentials. Making the process work in actual circumstances means that a company must implement actions that based upon the industry, competitors and marketing conditions, derives benefits it can utilize to accomplish the foregoing. The broad practical aspects of the preceding can consist of one or all of the following examples which represent a few of the more important elements of the concept:
a. Improved operational efficiencies
Depending upon the industry sector this can entail the moving of part or all of a segment of operations to achieve this end. A study by Forrester Research (Global Envision, 2004) estimated that 3.3 million jobs in the United States representing $136 billion in payroll will move outside of the country by 2015. In Europe it was reported that during 2003 outsourcing agreements increased from $19 billion to $44 billion over 2002 and that the United Kingdom accounted for 54% of all the contracts signed in that year (Jaques, 2004). These numbers would not have been achieved unless the firms within these countries contributing to these totals believed that the gains justified the expenditures
b. Reduction in operational costs
The costs of labor, union regulations, land, taxes and facility space comprise a few operational expenditure areas that a company can realize savings in as a result of outsourcing. Lower labor costs in China as well as India, Russia and other countries explain one aspect of why there has been a tremendous growth in the utilization of outsourcing for not only payrolls and call centers, it also accounts for computer parts and or assembly such as sneakers (Nike), clothing, software and medicines. In the last instance this can entail the research and development phase or the insurance claim department handling the forms submitted by insured individuals. In 2003 the United States had a $120 billion trade deficit with China, and the main contributor to this was the outsourcing of manufacturing (Global Envision, 2005). Lower labor costs, and currency rate advantages were two of the main reasons why many American companies moved operations there.
For example, the high quality Apple Computer is assembled in China. And the UK’s HSBC bank moved 6,000 jobs to India and China to reduce operational costs (Rediff, 2004). In 2004 the United Kingdom’s trade deficit with China ran at 17.1 billion euros while Britain’s trade with China totaled 24.0 billion euros (Freeman, 2005). The European Union member states ran a deficit of 70.8 billion euros that same year compared to 55.5 billion euros in 2003 and in 2002 that figure was 47.6 billion euros (Freeman, 2005).
c. Just in time delivery
One of the other large corporate areas for savings is in inventory. The cost for materials and warehousing finished items is an additive that is reflected in the final price. Just-in-time delivery was developed in the 1970’s in Japan to meet consumer demands and to aid the Japanese economy (Mariathasan, 1999). The outsourcing of parts, processes and systems in today’s global business arena entails Internet B2B order processes that project when finished units are needed and where, based upon sophisticated modeling programs that predict consumer demand as well as economic conditions. The costs saved through reduced warehousing costs as well as finances that would be otherwise tied up in finished inventory awaiting shipment to various delivery points throughout the globe represents a huge business savings.
All of the preceding practical outgrowths of the theoretical advantages derived from outsourcing to “gain or maintain a competitive advantage” are dependent upon an individual company’s ability to implement a successful outsourcing strategy that solves the multitude of logistical problems inherent in doing business in varied countries with outsourcing suppliers.
Theoretically, depending upon the product(s), goods or services a company is engaged in, access to new markets/countries as well as the ability to improve the position in those markets is based upon being able to effectively and efficiently service that country. The theoretical advantage inherent in outsourcing is that when the proper supplier is selected the necessary expertise to accomplish the preceding can be found within a firm that has vast experience in the laws, culture and policies that accompany entry into new markets and countries. To work, this theory has to be put into practice. Company management must investigate the positive as well as downside aspects of utilizing a third party source as opposed to internal methods. This entails an understanding of the diverse elements, laws, customs, regulations, currency fluctuations, market conditions, competition and associated areas that accompany a new markets entry and the ongoing monitoring of the preceding.
Management’s responsibilities entail exposing the company to new markets of opportunity to increase the potential consumer or client base thereby enabling it to sell more products, goods and services which aids in reducing per unit costs. When key operational segments such as customer service, shipping, warehousing, production and allied operations are spread throughout differing countries the company faces massive duplication of processes and employees, thus adding to overhead costs. Application of outsourcing techniques can permit a company to gain access to a new market by significantly reducing the learning curve required to operate there. The savings in administrative functions, a functioning customer service or support department, inventory management and delivery, as well as other areas reduces the risk exposure and lessens new market entry cost breakeven exposure. Some of the other practical benefits resulting from the utilization of outsourcing in entering new markets are:
a. Organizational flexibility
b. Improved operational efficiencies
c. Reduction in operational costs
d. Economies of scale
e. Increased competitiveness
f. Reduction in capital investments
The preceding all contribute to the objective of:
a. Improving a company’s profitability
b. Enhance its competitiveness and
c. Increase its ability to respond to change.
The utilization of outsourcing theoretically permits a firm to marshal its internal management and other resources to allow it to concentrate on its core competencies. Hamel et al (1990) describe this as “…the collective learning and coordination skills…” of a company’s products. They explain that core competencies represent the source of a company’s “…competitive advantage…” Hamel et al (1990) and that this is the method by which the company can introduce new services and products. The importance of this corporate theory cannot be over stated as it represents management and the company focusing in on what it does best, and then doing that to the best of their ability.
In a practical sense this has been the approach of China, India and other outsourcing locations as they understand that their competency lies in lowered labor costs thus providing them with an advantage in luring business operation segments in manufacturing, services, and other areas. And while trade articles and sources discuss the outsourcing of jobs to India, China is the emerging power in this field as it has the raw numbers in population and is projected to lead global outsourcing by 2015 (Minevich et all, 2005).
Regardless of the product, goods or services the element that makes any of these areas work is people. Even industries that are non labor intensive are in effect labor intensive from the standpoint that it takes people, abet less of them, to make it work and run. India reigns as the prime outsourcing locale for software and service exports to the United States as a result of such lower costs. During 2003 through 2004 this total was estimated as 8.5 billion USD in outsourced services (Krishnadas, 2003). The United States economy by outsourcing to India was projected to save between $10 and $11 billion (Krishnadas, 2003).
The relationship between the United States and India on IT outsourcing is reflected by the fact that for each $1.00 that is spent by a corporation in the United States on India outsourcing, 67 cents actually returns in the form of savings in cost, repatriated profits and new exports thus resulting in a net 33 cents that remains in India (Bartlett, 2004). He goes on to state that the outsourcing equation does not end there as the gains from productivity is estimated to add an additional 45 to 47 cents in value to the United States economy. The net resulting economy gains to the United States represent an estimated $1.12 to $1.14 for each $1.00 invested.
Interestingly, the United States in 2002 was the largest global exporter (outsourcer) of computer services at $60 billion. This contrasts with India’s total that was less than $20 billion that same year and China slightly exceeded $10 billion (Amiti et al, 2004). The United States ran a trade surplus in outsourcing during 2002 that amounted to $22 billion USD, more than it paid to other countries for this service (Amiti et al, 2004). The gains in productivity in the United States enabled it to maintain its trade advantage in this area and this offset the lower payment scales of their India counterparts.
The labor cost savings that are blamed for the exodus of jobs to outsourcing locales such as India, China and other destinations has been found to have no permanent or long-term job loss effects on the United States economy (Garner, 2004). As outsourcing represents a cost saving strategy for manufacturing, the development of products, customer service and support, IT, records retention and other areas it is a bottom line additive that contributes to increased profitability, competitiveness, and enables a company to offer goods and or services at lowered prices with more features and benefits. Realistically, those firms which do not maintain pace with the cost cutting measures of their competitors are looking at reduced market share and business decline. But rather than being viewed as a must do alternative firms in all industry sectors, by and large, view outsourcing as practical (Hanel, 2005). He advises that there are four steps in the process of selecting as well as establishing an outsourcing relationship:
1. Development of specifications that define the selection criteria,
2. Evaluation of potential partners against these criteria,
3. Design of a structure encompassing the relationship which consists of the objectives and an agreement defining the terms and level of performance,
4. And lastly, the management of the association through formal and informal means as an ongoing process.
As outsourcing is a viable business strategy that aids in either keeping pace with or maintaining an advantage over competitors, management attitudes are positive. The Garner Group’s study on this area indicated that 80% of the boards of American companies have discussed the issue of outsourcing and 40% have actually completed either a pilot study or implemented it for segments of their operations (Ezrati, 2004). He points out that historically those individuals whose jobs were displaced by outsourcing found employment in differing industries and that there are and have been cases of hardship on the part of a percentage of these individuals. Ezrati (2004) also points out that the companies that implemented outsourcing policies in response to or as a result of industry sector trends managed to maintain or increase growth thus resulting in a net gain in jobs, although the displaced positions were permanently lost.
Ezrati (2004) indicated that on an historical basis the jobs displaced by outsourcing mirrors developments in the 1950’s and 60’s when lower cost European labor threatened the American steel industry. He adds that the foregoing forced innovations in productivity, and that this same underpinning exists today. Ezrati (2004) states that innovation has created an 80% growth in management jobs over the past 20 years and the standard of living has risen with a 175% gain in per capital income since 1960, 58% from 1980 and more recently just under 20% from 1996. These figures reveal that the present heated climate of outsourcing represents another cycle in business than seeks to maximize cost outlay against productivity that benefits all concerned.
The global context of business in today’s technologically based environment creates a climate whereby the utilization of outsourcing is a viable and constructive management technique. The ills attributed to its use such as loss of jobs are the same arguments utilized in the 1960’s and 70’s in the exodus of manufacturing in the United States to Mexico and China, yet industry not only survived it increased productivity as a result. And that is the core around which outsourcing revolves, cost cutting measures that increase internal operational efficiencies to permit companies to compete in a fast paced business environment where customers and clients expectations continue to demand more for their money.
From an historical perspective the theoretical approaches and arguments for outsourcing weigh heavily on the positive side as its purpose increases shareholder value through improved operational costs and thus bottom line performance. In terms of the net effects to individual national economies, outsourcing has put countries such as India, China, Pakistan and others on the economic map in the same manner it did for Japan.
Outsourcing permits companies to focus their attention on their core business as well as obtain skilled labor at cost savings to improve returns. It also aids in improved technology that is made available to companies at lowered costs thus providing an underpinning to compete with self contained larger multi-national corporations on a more level playing field. Outsourcing is a technique that weeds out the unproductive elements in a businesses operation, replacing it with a more cost effective means to accomplish the end objective. When equating the global effects of outsourcing one must take into account that it has served to bring technology and innovation to developing economies such as India, China, Pakistan and other nations.
The transfer of technology, plant, software and other skills that form the foundation of the outsourced functions serves to upgrade the standard of living for workers in those sectors. The question of job loss in the countries of origin represents segments of corporate operations that needed cost containment in order for the company to remain competitive, grow and thus eventually add additional jobs. As an important segment of business operations and cost control, outsourcing historically has permitted companies a means to contain costs as well as remain in business, and this continues to be the case.
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