Sunday, January 8, 2012

Supply Chain Analysis of Off-Shoring and Outsourcing

“Outsourcing,” the purchase of a value-creating activity from an external supplier, can refer to work provided by companies in the U.S. or in other countries.  It may be viewed as a strategy by which a firm achieves desired results by collaborating with other firms.  “Offshore outsourcing” (off-shoring) is a special case of outsourcing in which a firm sends an activity to be performed by a business in a foreign country.  The authors describe outsourcing as “the result of a deconstruction of the value chain” that was developed in the 1990s by researchers to explain  strategies used by successful companies to achieve competitive advantage, whereas off-shoring is described as based on the idea of comparative advantage, a nineteenth century concept related to specialization within a country.  With the digitalization of production, a process by which a firm can break jobs into smaller pieces, outsourcing may also be based on comparative advantage.

Outsourcing is a business practice used to lower costs by many Fortune 500 companies, such as Microsoft, IBM, Hewlett-Packard, and AT&T.  Firms also undertake outsourcing because they do not have the resources and capabilities of carrying out all activities better than competitors.  By outsourcing those activities in which they do not have a competitive advantage, firms can concentrate on building core competencies to achieve a strategic advantage over competitors in delivering new products and services.  Dell, for example, outsources most of its manufacturing in order to concentrate on online sales, an activity in which it has a core competency.  Software giant Microsoft and Netscape Communications Corp. have outsourced “rote work” everywhere from Ireland to India (Madigan, K. & Mandel, M., 2003). 

Today, with the pervasiveness of new technologies and reduction in telecommunications and transportation costs, almost every function or activity in a firm’s value chain can be performed at various worldwide locations.  For many companies, only a few jobs may need to be done on-site.  This has led to a sharp increase in outsourcing and off-shoring of manufactured goods as well as of certain types of business services such as information technology, accounting, technical/customer support, medical billing, and human resources functions that are routine in nature.  Factors leading this increase have been the opening of a number of developing countries, worldwide improvements in productivity, and a fall in the costs of logistics and of the transaction costs of exchanging information with other entities.  For manufacturing, China has emerged as the clear leader in attracting off-shoring activities of foreign companies, while India is currently the leader in the case of services.

Despite outsourcing’s overriding benefits of lowering a firm’s cost structure and enhancing its ability to achieve a competitive advantage in an intensely competitive global marketplace, much fear about the effect on the U.S. economy of lower wages and the loss of jobs to off-shoring  has been generated by critics.  In response, the authors state that “fears about job losses may be somewhat exaggerated.”  They point out that most job losses from 2000 to 2004 were due to a recession, not off-shoring, and that according to government statistics, off-shored jobs are responsible for well under one percent of official unemployment statistics (qtd. from The Economist, Mar. 13, 2004).   Additionally, studies in 2003 and in 2004 are cited to support the claim that off-shoring could result in a net gain for the U.S. economy.  In reviewing more recent studies, I found that the above data is outdated in light of the rapidly accelerating pace of off-shoring and thus merits further study.  Nonetheless, living standards around the world are rising, in part, because of offshore outsourcing:  overall, workers in emerging and in developing nations are gradually obtaining new and higher-paying jobs, while U.S. consumers are able to buy products  and services that are cheaper than if they were made or provided domestically.

Copyright 2012 James L. Alyea. All Rights Reserved.


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