Outsourcing
Outsourcing entered the business and management lexicon during the 1990's and is often defined as the delegation of non-core operations from internal production to an external entity specializing in the managment of that operation. The decision to outsource is often made in the interest of lowering firm costs, redirecting or conserving energy directed at the 1 of a particular business, or to make more efficient use of worldwide labor, capital, technology and resources. Though often used interchangeably, "outsourcing" differs from "offshoring" in that "outsourcing" is relative to the "restructuring" of the firm while "offshoring" is relative to the nation.
Overview
"Outsourcing" involves transferring or sharing management control and/or decision-making of a business function to an outside supplier, which involves a degree of two-way information exchange, coordination and trust between the outsourcer and its client. Such a relationship between economic entities is qualitatively different than traditional relationships between buyer and seller of services in that the involved economic entities in an "outsourcing" relationship dynamically integrate and share management control of the labor process rather than enter in contracting relationships where both entities remain seperate in the cordination of the production of goods and services. Business segments typically outsourced include information technology, human resources, facilities and real estate management, and accounting. Many companies also outsource customer support and call center functions, manufacturing and engineering. Consequently, a debate has insued concerning the benefits and costs of the practice as well as how to categorize it as a phenomenon.
Outsourcing, offshoring, and offshore outsourcing
Note that “outsourcing,” “offshore outsourcing,” and “offshoring” are used interchangeably in public discourse despite important technical differences. To be consistent, “outsourcing,” in a corporate context, represents an organizational practice that involves the transfer of an organizational function to a third party. When this third party is located in another country the term “offshore outsourcing” makes more sense. “Offshoring,” in contrast, represents the transfer of an organizational function to another country, regardless of whether the work stays in the corporation or not. In short, “outsourcing” means sharing organizational control with another organization, or a process of establishing network relations within an organizational field. "Offshoring,” on the other hand, represents a relocation of an organizational function to a foreign country, not necessarily a transformation of internal organizational control.
Benefits of outsourcing
The fact that many large businesses outsource and continue to outsource suggests that, in many cases, outsourcing is successful in that it increases product quality, lowers costs substantially, or both. Some economists have argued that outsourcing is a form of technological innovation analogous to machines on a car assembly line. Ford Motor Company relied heavily on workers in the past to assemble car parts. Today these workers are replaced by machines because they are cheaper in the long run, produce better quality products, or a combination of the two (the firm is trying to increase its quality to cost ratio, quality being defined by the consumer and inferred from revenue). Economists state that machines on the car assembly line must have a higher quality to cost ratio than workers because, if they didn't, there would be no 1 for the firm to replace workers with machines. Although workers’ jobs were lost from this replacement of workers with machines, the Ford Motor Company made more money by lowering costs (and increasing quality, thereby increasing revenue). Some argue that greater profits to the labor owners lead to higher consumption, which leads to further job creation, allowing those who lost jobs to gain jobs in other sectors of the economy. A firm's motivation for replacing workers with machines is identical to the motivation for outsourcing, i.e. the firm is trying to maximize the quality of its product given cost (its productivity). Because outsourcing allows for lower costs, even if quality reduces slightly or not at all, productivity increases, which benefits the economy in aggregate.
Professor Drezner reports that for every dollar spent on outsourcing to India, the United States reaps between $1.12 and $1.14 in benefits. Drezner also points out that large software companies such as Microsoft and Oracle have increased outsourcing and used the savings for investment and larger domestic payrolls.
Likewise, outsourcing can present advantages to non-Western states. "Developing" countries, such as China or India, benefit from the patronage of companies that outsource to them - in terms of increased wages, job prestige, education and quality of life.
On a political level, there are also benefits. As Thomas L. Friedman details, countries with a vested interest in their economies are much less likely to go to war, and there is virtually no possibility that they will go to war with countries that participate in their economies. Although, it is worth noting that Germany and Britain were each other's largest trading partners prior to the start of World War I.
Response to benefits of outsourcing
It is apparent that many organizations today are making the decision to outsource. In today’s global marketplace outsourcing has made itself accessible to many organizations on a National and International level. Offshore outsourcing has provided many businesses with the opportunity to harvest the benefits of lower labor costs and to exploit the value of less than par foreign currencies. Through outsourcing companies today have the ability to develop competitive strategies that will leverage their financial positions in the ever competitive global marketplace.
Some of the major advantages that today’s organizations can expect to obtain through outsourcing are:
Ability to purchase intellectual capital
Through outsourcing, today’s businesses have the ability to utilize the technological know- how of other organizations. This allows businesses to find the specific requirements they need to implement their target objectives.
Ability to focus on core competencies
Outsourcing allows businesses to delegate non-vital projects they need completed to vendors. This ultimately provides an organization with the ability to focus on distinctive core competencies which will help yield long term benefits. If an organization experiences long term advantages from well developed core competencies they are said to have achieved a sustainable competitive advantage.
Ability to better anticipate future costs
Organizations that choose to outsource have the ability to determine exact future costs. Prior to the contract development of any outsourcing agreement, the outsourcing company develops a request for proposal (RFP) document which highlights the major requirements and scope of the project which is to be outsourced. Through bids vendors have the ability to make offers to perform the outsourcing for the given project. When a bid has been accepted the organization has an exact figure illustrating what the expense will be to outsource the project.
Ability to lower costs
Overall outsourcing is viewed by many organizations as a strong business tactic that ultimately is a superior economical approach to developing products and services.
Criticisms of outsourcing
Quality of service
Criticisms of "outsourcing" from both managment and consumers often focus on a central question: is the performance or quality of the outsourced service on par with the expected standards of managment and consumers, or, how does outsourcing a service effect its quality as opposed to "in-house" work? A common specific criticism from the U.S. customer is that overseas workers communicate in broken or incomprehensible English (see http://www.cfo.com/article.cfm/4390954/c_2984406/?f=archives). In response to consumer criticisms, some companies have attempted to train overseas workers to speak with American accents and/or familiarize themselves with American culture, especially American holidays, sports, and entertainment, in effort to ease the tensions arising from cultural differences that appear to affect the quality of service or raise the number of customer complaints, rather than bring the service back "in-house" (questions remain on the ease to bring outsourced services back in-house-on whether or not "outsourcing" has become institutionalized) or send it to a country more in sync with the customer's culture. In another example, hospital services, such as radiology, outsourced overseas raises the following questions from both management and consumer: "Are the radiologists qualified? Is communication as good when the radiologists are so far away? Can an overseas doctor be held accountable when something goes wrong? Is anyone ensuring that properly trained and licensed radiologists are actually doing the work? Is patient privacy being protected? "Hospital Services Performed Overseas: Training, Licensing Questions Raised". Washington Post, reviewed online: http://www.washingtonpost.com/wp-dyn/articles/A12392-2005Apr23.html)".
Work, labor, and economy
The 2004 U.S. presidential election campaign focused on outsourcing to some degree. This debate did not center on problems of declining quality of customer services but on the threat to U.S. jobs and work. Democratic U.S. presidential candidate John Kerry criticized firms that outsource jobs abroad or that incorporate overseas in tax havens to avoid paying their fair share of U.S. taxes during his 2004 campaign, calling such firms "Benedict Arnold corporations," in reference to the infamous traitor Benedict Arnold. Criticism of outsourcing, from the perspective of U.S. citizens, by-and-large, revolves around the costs associated with transferring control of the labor process to an external entity in another country. A Zogby International poll reports that 71% of American voters believe that “outsourcing jobs overseas” hurts the economy and another 62% believe that the U.S. government should impose some legislative action against companies that transfer domestic jobs overseas, possibly in the form of increased taxes on companies that outsource. The poll of over 1,000 Americans was conducted in August 2004.
Outsourcing appears to threaten the livelihood of domestic workers and, in the United States, the American Dream. This is especially true for high-tech workers who were promised the “jobs of tomorrow”- a phrase Bill Clinton iterated in 1994 to justify his conservative position on the North American Free Trade Agreement (NAFTA). Outsourcing appears to work contrary to the claim that “free trade” will create the “jobs of tomorrow” in America when high-tech or high paying white collar jobs are transferred to or created in foreign countries. Thus, outsourcing may be representative of a specific historical moment where the United States government fails to mediate business-labor relations in a way conducive to prevailing values that places the American middle class worker as a central priority. At a more general level it represents a new threat to labor, contributing to rampant worker insecurity, and reflective of the general process of globalization culminating in Western societies as a whole (see Krugman, Paul (2006). "Feeling No Pain." New York Times, March 6, 2006).
In the UK, it is argued a malicious implementation of the Higher Education Role Analysis (HERA) may force Higher Education administrative and support staff to prematurely retire or seek for new employment in other organizations, thus freeing of staff many departments which could then be effectively outsourced. Outsourcing departments like Accounts, Payroll and Procurement is now common practice, as seen in August 2005 at the University of Portsmouth.
Policy solutions to outsourcing are also criticized. One solution often offered is retraining of domestic workers to new jobs. However, some of these workers are already highly educated and already possess a bachelor's and master's degree. Retraining to their current level in another field may not be an option due to years of study and cost of education involved. There is also little incentive given that the jobs in their new field could also be outsourced as well. Proportions of workers trained for Science, Technology, Engineering, and Mathematics (STEM) fields fields in developing nations are viewed to outstrip traditional technology leaders such as the U.S. Thus jobs considered previously to be protected from international competition may not continue to be so.
Security
There are also security issues concerning companies giving outside access to sensitive customer information. In April of 2005, a high-profile case involving the theft of $350,000 from four Citibank customers occurred when Indian call center workers in Pune, India, acquired the passwords to customer accounts and transferred the money to their own accounts opened under fictitious names. Citibank did not find out about the problem until the American customers noticed discrepancies with their accounts and notified the bank.
Outright fraud is also a concern. In 2005, Intel discovered and fired 250 Indian employees after they faked their expense reports. The firings followed from Intel's internal Business Practice Excellence program of expenses claims. The report concluded that fraudulent practices such as "faking bills to claim your allowances like conveyance [and] drivers’ salaries" were some common malpractices in India. Intel would not put up with such fraud. NASSCOM, which is a forum of IT and ITeS companies, has attempted to address these fraud concerns in India by creating the National Skills Registry. That database contains personal and work-related information, enabling employers to verify a staff member's credentials and allowing police to track the background of workers.
Opponents often dismiss these reports, saying that fraud and corruption exist everywhere. However, it is disingenuous to therefore insinuate that fraud and corruption is uniform from nation to nation. Corruption is in fact measured for comparison by Transparency International, through their Corruption Perceptions Index. Popular outsourcing destinations such as China (3.2/10) and India (2.9/10) rank low on the index, meaning high levels of corruption.
That being said, security related issues, such as falsifying expense documents, or compromising client financial information, are rare when taken in to account the number of offshore personnel and projects they are associated with.
Furthermore, even if there is variation in corruption level or perceived corruption level among countries there is also high variation in corruption within countries. Government banning an American firm from outsourcing to India may prevent a potentially beneficial alliance between a non-corrupt American firm and a non-corrupt Indian firm. It may encourage a potentially harmful alliance between a non-corrupt American firm with a corrupt American firm.
Responses to criticism
Work, labor and economy
International outsourcing, which has been the type of outsourcing that has received greatest political attention, is a form of trade. As such, mainstream economists argue that the basic principles of comparative advantage and the gains from trade apply. The 'threat' to overall employment or the economy is thus no more valid than the so-called 'threats' from imports or migration.
Economist Thomas Sowell from the University of Chicago said “anything that increases economic efficiency--whether by outsourcing or a hundred other things--is likely to cost somebody's job. The automobile cost the jobs of people who took care of horses or made saddles, carriages, and horseshoes.” Walter Williams, another economist, said “we could probably think of hundreds of jobs that either don't exist or exist in far fewer numbers than in the past--jobs such as elevator operator, TV repairman and coal deliveryman. ‘Creative destruction’ is a discovery process where we find ways to produce goods and services more cheaply. That in turn makes us all richer.” Nationally, 70,000 computer programmers lost their jobs between 1999 and 2003, but more than 115,000 computer software engineers found higher-paying jobs during that same period. However, economists do concede that labor is not always perfectly mobile and that some workers may have difficulty getting new jobs. Some economists suggest that government training programs be provided. There is also some evidence that openness to trade with developing countries has increased inequality in developed economies (largely by increasing the premium on high skilled work whilst exposing low skilled workers to cheap competition).
Quality of service
One criticism of outsourcing is that product quality suffers. But the outsourcing firm has freedom to move a firm department or division back home if its profits are suffering as a result of poor quality. In fact, many American companies like Dell have moved customer service divisions back to America as a result of poor quality. The decision to outsource is like any other business investment decision in that there is risk. Critics of outsourcing often talk about outsourcing failures without mentioning instances of outsourcing success. The decision to outsource is like the decision to expand a business overseas, to incorporate computer technology, or to hire new workers. If the company does it correctly, it benefits from higher profits. Proponents of outsourcing believe that arguing that outsourcing leads to lower product quality is pointless because if it were true, consumer demand will force firms to shift back to producing the good or service in-firm rather than out-firm.
The ability to influence the quality of outsourced production depends on the relationship of power between consumers and producers. If producers have market power, e.g. if they are a monopoly they can reduce the quality of their good without suffering a major drop in sales. For example, many individuals do not make their own food. Instead, they outsource the task to restaurants and fast-food firms like McDonald's or Hungry Jacks. Suppose McDonald's and Hungry Jacks are the only fast-food firms. McDonald's competes with Hungry Jacks to win consumers in the fast-food market. However, if Hungry Jacks goes out of business, McDonald's is a monopoly and can reduce the quality of its food (e.g. to reduce costs) without suffering as high a drop in revenue because consumers now cannot switch to Hungry Jacks. Institutions are set up to promote competition. E.g. in Australia the ACCC (Australia Competition and Consumer Commission) regulates businesses to prevent abuse of market power and to promote competition. In the United States the FTC (Federal Trade Commission) takes on this role.
Sometimes poor quality goods and services must be accepted by consumers because accountability systems regarding consumer or user feedback are limited. In order to increase quality or maintain a high level of quality, many offshore outsource firms also employ quality management models, such as Taylor, Lean, and Six Sigma. Differing firms have varying levels of implementation success. |
