550 Week 8 Final Draft
SHOULD YOU OUTSOURCE?
You pick up the phone to call customer service. When the line connects, you hear someone with a distinct foreign accent who introduces himself with a distinctly American name. Before you know it, you are telling “John” in customer service precisely what it is you need, and he is attending to those needs quickly and efficiently. The thing is, “John” isn’t named John at all — and he’s probably talking to you from a massive call center located somewhere in Mumbai or some other location overseas. “John” is one of many such outsourced workers, the use of which has allowed many companies in the United States to obtain the goods and services they require at lower rates than they would pay by producing these in-house.
Simply put, outsourcing is the transfer, to external suppliers, of activities that have traditionally been internal. Outsourcing is the act of taking advantage of another firm’s specialties and economies of scale, whether that firm is domestic or international.
Companies of all sizes may choose to outsource. For example, Apple chose to focus on its core competencies (such as creativity, innovation, and product design), and outsources its manufacturing globally (such as to a major technology manufacturer, Foxconn Technology Group, in China). Small “mom-and-pop” businesses often outsource too, obtaining their accounting, payroll and tax preparation externally.
OFFSHORING
Outsourcing internationally (also called offshoring) gained popularity several decades ago as companies searched for a cost advantage in manufacturing in countries with lower wages. Since then, outsourcing has evolved beyond manufacturing to include engineering, software development, logistics, customer service, information technology (IT), human resources, accounting, tax, and other professional services.
In the early years of business-process offshoring, companies outsourced highly standardized, repetitive, low-skill, and labor-intensive business processes to low-wage countries in pursuit of lower costs.
BEYOND COST BENEFITS
Today, outsourcing is undertaken for various reasons beyond just cost. These reasons include the ability to exploit economies of scale and scope offered by vendors, to mitigate technological risk and uncertainty, and to improve the company’s focus on its core competencies.
Technological advances have made working across geographically dispersed locations feasible. As governments in emerging economies invest in infrastructure and education, pools of untapped talent and highly educated, skilled workers are “brought online” and become accessible to companies worldwide. Many executives are now citing the desire to access high-quality talent globally as one of the reasons for offshoring.
Today, many companies are not just look at outsourcing simply to reduce costs. They are looking to attract and develop external talent and create local assets that benefit their firms. Often this local talent can bring fresh diversity of thought to the company while helping to determine the local needs of the market.
Other reasons for outsourcing are economies of scale and minimization of risks. Specialized companies have higher volumes and highly developed expertise because their entire focus is on the specialized activity. Outsourcing sterilization in the medical device field is one example. Sterilization is a specialized activity requiring safety controls and expert training. This type of work is often outsourced to minimize both costs and risk to the company.
OUTSOURCING TO ENTER NEW MARKETS
Entry to new markets is another reason to outsource. Activities are outsourced to a local factory or partner located in a particular region to gain access to that market, for example, in countries (such as China) where it is notoriously difficult to enter without local partnerships. Companies can outsource part of the manufacturing process or finishing of product to these partners to ensure easier access to the local market. This is, in fact, one key advantage of outsourcing.
RISKS OF OUTSOURCING
There are various risks associated with outsourcing. These include poor quality, political instability, infrastructure issues, potential loss of intellectual property, and the need for increased buffer stocks.
Poor Quality – The risk of sub-standard quality controls is significant in outsourcing. The outsourced supplier may reduce controls after a contract is signed to maximize profit margins. These shortcuts could result in major quality issues that could adversely affect the company. We have all seen the various safety recalls caused by poor quality controls employed by outsourcing partners.
Political Instability – Another risk of outsourcing to a lower-cost geography is the potential for political instability in that country. These political issues can change the landscape very quickly, making suppliers unreliable.
Infrastructure – The risk of infrastructure problems is very real in some outsourcing locales. This risk may offset any benefit realized in lower labor costs, because the company must invest in setting up or upgrading the existing infrastructure. This includes back-up power where the electrical grid is reliable, security for employees, etc.
Loss of Intellectual Property (IP) – The risk theft of IP in all its forms is high, especially in China. Many countries lack the IP protections enjoyed in industrialized Western nations. Corruption, local laws, and bureaucracy often leave the company with little legal recourse.
Buffer stocks – Low-cost locations are usually far from the primary markets. This means the company must hold more inventory (buffer stock) to allow for transportation lead time. Missed shipments and customs and excise difficulties can result in failure to supply customers on time.
MAKE OUTSOURCING DECISIONS STRATEGICALLY
Business leaders must consider carefully where they are going and what they will get from an outsourcing venture. Each outsourcing decision is one that should be made strategically. This week, we have two very interesting readings on outsourcing: one on the offshoring of high-value services, and the other on domestic outsourcing.
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