Case Scenario:
Is Outsourcing Good or Bad for Firms?
Outsourcing by U.S. firms has increased significantly in recent years as a way to lower costs and improve their focus on their capabilities. However, firms are now outsourcing professional jobs done by white-collar workers (engineering and software development jobs); most previous outsourcing involved blue-collar manufacturing jobs. Because it is affecting a large number of all types of jobs, outsourcing has become a political issue. However, some argue that outsourcing, such as in the automobile industry, will lead to production and sales in foreign countries with growing demand, such as China. In fact, China is the top automobile producer in the world, primarily for export through outsourcing, but also because of the expanding domestic demand. More broadly, some argue that trade with foreign countries such as China has fostered moves away from past political repression toward more economic freedom. Thus, as discussed next, most of the focus of outsourcing is to improve efficiency and effectiveness, but political ramifications must also be considered.
Even though outsourcing to low-cost manufacturers has been common for some time, software development, programming, and even high-technology professional activities such as interpreting medical X-rays are more recent examples of work activities being outsourced. For example, AstraZeneca, a large U.K. pharmaceutical firm, has contracted much of its drug production and even some of its R&D to manufacturers in China and India, which will come online in the coming decade. One executive indicated that “manufacturing is not a core activity for the company” and “that there are a lot of organizations that are better at manufacturing.” However, he also pointed out that “it will never make sense for a major pharmaceutical company to outsource 100 percent of its manufacturing requirements.” In fact, the decision will be based on keeping knowledge of important products and processes in-house to protect intellectual property, as well as basic supply (sourcing and transportation), financial, regulatory, and restructuring considerations. However, another analyst noted: “Emerging markets are being seen as a prominent driver of topline growth by the pharma majors. It is in this environment that R&D activities too are becoming increasingly global.”
Outsourcing professional activities means that higher paying jobs are going overseas and may become a political liability for organizations doing such outsourcing. Yet businesses argue that outsourcing is necessary to remain competitive in global markets. In fact, managers suggest that outsourcing important activities not only saves money (by reducing costs) but also increases quality in some cases because those doing the outsourced work are specialists. Still, drawbacks are a factor. Outsourcing firms lose the capability to perform the activity when they outsource it, meaning that it will be difficult and costly to redevelop that capability at a later date, if desired. Additionally, even though outsourcing provides flexibility that is important in a dynamic competitive landscape, firms must be careful not to outsource key areas. Managers must also ensure that the firm does not lose a core competence or an activity important for supporting a core competence because of their outsourcing decisions. Additionally, outsourcing may involve risks to reputation and even legal liability problems if work is done poorly. For example, Delta and United Airlines brought back their outsourced customer service operations to North America when they started to experience a lower rate of satisfaction from more sophisticated conversations with customers. Often, voice-based processes that are combined with knowledge-based activities are not good candidates for outsourcing to offshore or even near-shore vendors. Onshore vendors may be more suitable to mitigate such risks.
The outsourcing trend has reached Japan and Europe. However, the cost of outsourcing in Europe is more expensive. For example, in Denmark, although firms have more flexibility to decide to outsource than most European companies, workers can receive up to 90 percent of their wages for six months as severance paid by the company before they receive any unemployment payments from the government insurance program. By law, they also receive up to six weeks of retraining to facilitate movement into new jobs. However, the reverse trend toward outsourcing to higher-level capabilities is evident. For example, many U.S. financial service firms expect to receive significant levels of outsourcing by sovereign wealth funds (national governments that often have funds due to trade surpluses, such as Saudi Arabia) to provide expertise in portfolio management.
Many arguments are made on both sides about the costs and benefits of outsourcing. Firms must decide whether outsourcing is positively linked to performance, what to outsource, and to whom to outsource. They may have to fend off politicians who provide incentives not to outsource. In addition, legislation may be introduced that calls for a tax to be levied on imported goods or services that have been developed through outsourcing. The problems managers face related to outsourcing are complex, and the solutions many not be simple.
Question 1. From the perspective of strategic management, what are the costs and benefits of outsourcing?
Question 2. As a manager, what type of information would you gather and what analyses would you conduct to decide whether to outsource an activity?
Question 3. How do you predict that outsourcing from U.S., Japanese, and European firms to China, Taiwan, and India will affect the economies and firms in the three sourcing countries?
(700 words total, not including questions...with references)