How effective is offshore outsourcing[1]
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Transcript of How effective is offshore outsourcing[1]
How effective is offshore outsourcing and what critical factors should be considered when outsourcingFor: BE790.614.5D Business, Government and the World Economy
Johns Hopkins University Facilitator: Arefaine G. YohannesFebruary 17, 2007
2008
By Martye Karen Joyce2/17/2007
TABLE OF CONTENT
AVERETT UNIVERSITY.....................................................................................................0FACILITATOR:. AREFAINE G. YOHANNES.......................................................................0TABLE OF CONTENT................................................................................................1
ABSTRACT........................................................................................................................1
GLOBALIZATION TRENDS AND THREATS:...........................................................1
WHAT IS OFFSHORE OUTSOURCING?....................................................................1
DECIDING WHAT TO OUTSOURCE..........................................................................1
WHY COMPANIES SHOULD CONSIDER RELOCATION STRATEGIES...........1
NATION BUILDING THROUGH OUTSOURCING - THE IMPACT......................1
EXTERNAL CONSIDERATIONS..................................................................................1
ENERGY - A DRIVING FORCE TO OUTSOURCING..............................................1
CRITICAL FACTORS TO OUTSOURCING...............................................................1
THE THREAT OF LOST WAGES AND BENEFITS..................................................1
CORPORATE OUTSOURCING FINDINGS................................................................1
RECOMMENDATIONS / STEPS...........................................................................................1
BIBLIOGRAPHY..............................................................................................................1
APPENDIXES....................................................................................................................1
Service Outsourcing Questionnaire.................................................................................1
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ABSTRACT
This paper will provide a synopsis on the topic of offshore outsourcing in the United States.
The arguments over offshore outsourcing have been prompted by sharp drops in manufacturing
jobs. Furthermore, as hi-tech advances allow service functions to transfer overseas, a larger
segment of the U.S. workforce is faced with global competition. The current level of offshore
outsourcing of services is benign compared to the remaining job creation here in the U.S.
According to Bloomberg.com, estimates suggest that in the U.S., as many as 14-16 million
service jobs are in danger. Most of these service jobs are in the technology arena. In
manufacturing, additional areas are being impinge on by international competition.
Transferring employment opportunities abroad and critical functions, however, often raises
productivity and has a propensity to increase demand for an improved labor force. It also
lowers prices of many products at the retail level particularly benefiting lower-income families.
On an aggregate basis, data provides the U.S. with a net increase. However, there is a rising
apprehension that offshore outsourcing does not only involve transitional costs as the economy
undergoes structural change, but that it creates downwards pressures on salaries for many
corporations and individuals in competition with cheaper employment abroad. This occurs
when the jobs are identical in scope. As a result, the U.S. must intensify its focus in higher
learning and training in engineering, science, and IT. Free world trade remains a prerequisite
for globalization and the development of international division of labor. At both the federal
and at the state level of government, the trend is shifting further towards protectionism. This is
contributed to China’s dowel to the dollar and the opening of overseas markets for U.S. goods
and services.
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GLOBALIZATION TRENDS AND THREATS:
What is globalization and what is its impact?
Globalization is the process of denationalization of markets, politics and legal systems, i.e., the
rise of the so-called global economy. Globalization is also where the world experiences
international paradigm shifts. Global economic integration is one such model and is a major
concern surrounding outsourcing. Because of globalization, businesses are now are faced with
an entirely different set of rules compared to a few years ago. Global economic integration is a
continuous process that moves at different speeds reacting to changes in available resources,
economic circumstances, technology, and infrastructure (World Bank, 2001).
Therefore, it’s easy to believe that millions of jobs will shift from the most advanced
industrialized countries to low-cost countries such as India and China, while millions of others
will be created in existing and new sectors. This assertion is validated by the National
Association of Software and Service Companies (Nasscom), which claim that the total market
size of knowledge process-outsourcing business in India may rise to a staggering $15.5 billion,
up from $1.2 billion currently. Additionally, Industry experts predict that by 2015, offshoring
by the US companies will represent $135 billion in wages and 3.3 million professional jobs.
And new countries like Czech Republic, Poland, Hungary and Mexico are likely to become new
offshoring destinations this year (RTTS, 2005).
Significant amounts of growth in world trade originate in the multinational firms in both goods
and service. According to (RTTS, 2005), only 19% of U.S. businesses have an offshore
outsourcing strategy. However, the percentage skyrockets to 95% if only Fortune 1000
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companies are considered. Progressively more open markets have Fortune 1000 companies
seeking efficient use of technology to share information and control their supply chain to
fragment parts of their productions activities placing different parts of their operations in
unrelated geographically locations through the use of subsidiaries or third party suppliers.
Subcontracting permits large companies to be more flexible by transferring some of the risks
related with offshoring to their sub partners.
The consequences of this political and economic restructuring are the subject of constant and
vigorous debate amongst global organizations, governmental institutions and academic
institutions. The debate is whether this model is effective on local economies, human welfare
and the environment. At a business level, we talk of globalization when companies decide to
take part in the emerging global economy and establish themselves in foreign markets. First,
they will adapt their products or services to the final user's linguistic and cultural requirements.
Then, they might take advantage of the Internet revolution and establish a virtual presence on
the international marketplace with a multilingual corporate web site or even as an e-business.
The post-war era has seen a remarkable lowering of trade barriers, both through regional
arrangements like the European Union, CAFTA and NAFTA and through world trade
agreements within the GATT/WTO-framework. The collapse of communism as an economic
bloc has opened markets in Eastern Europe and in Asian countries like Vietnam. Latin
American countries have also embraced free trade while Western Europe has embarked on
implementing the single market with free movement of goods, services, capital and labor.
Many observers point to the 1994 introduction of the North American Free Trade Area,
NAFTA, linking the United States, Canada and Mexico, and to the Chinese joining of the WTO
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in 2001, as two specific watershed events profoundly affecting American manufacturing.
Additionally, CAFTA and the anticipated entry of Russia into the WTO continue to affect
American’s manufacturing and offshoring strategies.
(OECD, 2004) contends that increasing competition, on the demand side, in global and budding
markets are driving companies to sharply focus increased cost-cutting rather than on revenue-
enhancing opportunities. Many underdeveloped countries on the supply side have made
education a major charter and, as a result, have created a huge skilled and educated workforce
of young professionals. The U.S. is concerned with China and India graduating well over three
times more engineers and scientist with bachelor’s degrees than our university system. In fact,
India educates more engineers than most developed countries combined. Moreover, the vast
majority of Americans seeking degrees in math, IT, science and engineering are American
immigrants who do not qualify for employment in drastically needed areas and agencies such as
in intelligence agencies and NASA where clearances require U.S. citizenship (Friedman, 2005).
The globalization of manufacturing has been boosted by repeated improvements in
infrastructure that have brought down transportation cost: railways, container ships, airfreight,
etc. However, until recently the service sector in general had been protected from outsourcing
for two reasons: 70 per cent of the service sector was based on direct customer contact (nursing,
retail, etc.) and the remainder was protected by the lack of infrastructure to make global
competition possible (Kroll, 2003).
The biggest threat to service employment was the increased use of technology, making often
tedious and repetitive service jobs as obsolete as corresponding jobs in the manufacturing
sector. With the competitive pressure from abroad being for the most part absent, productivity
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gains in the services sector as a whole have been weaker than in the manufacturing sector. This
has resulted in prices for services increasing at a rate higher than for those products faced with
international competition.
The advances of broadband technology and the use of the Internet have sharply reduced the
technological barriers to trade in services and have, as a result, opened a new area to overseas
competition. This is true for both lower value-added services like call center support and more
demanding areas like back-office functions and medical analysis and testing.
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WHAT IS OFFSHORE OUTSOURCING?
There is no official definition of what constitutes outsourcing, offshoring or offshore
outsourcing. The terms are used interchangeably to describe the way some American firms
relocate some of their domestic operations abroad or replace American production with foreign
imports. Webster's Universal Dictionary loosely defines "Outsourcing" as: A company or
person that provides information; to find a supplier or service, to identify a source". In lay
man’s terms, it is a pure contracting transaction whereby one company purchases services from
another while retaining ownership and responsibility for the underlying processes; the clients
tells the provider what they want and how they want the work performed. At this juncture, the
client authorizes the provider not only to own and operate, but also redesign underlying
processes, to reap even greater cost and efficiency benefits. Accordingly, moving along the
continuum from client to provider control of non-core processes can create distinctive value,
especially in a trusting, long-term relationship (OffshoreITOutsourcing.com, 2005).
To be more precise, outsourcing is the relocation of a function to a third party producer
domestic or abroad. A more complex explanation defines offshoring as the relocation to an own
affiliate abroad, whereas offshore outsourcing is the relocation to a third party abroad. In
manufacturing, the automobile industry is a prime example of offshore outsourcing, where
technology, parts, software, design, etc. come from a variety of countries, often making an
American car more of a global product than a domestic one, (WTO, 1999). In services, it can
be a software programming company moving to a subcontractor or an own subsidiary in India
or it can be the back-office functions in financial institutions.
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The optimal strategy for any corporation should include well thought out plans combining trade
and investment. Many companies are currently outsourcing a function having substituted a
domestic supplier with an overseas supplier. When an overseas partner is selected for an
offshore joint venture or subsidiary instead of the U.S. parent fulfilling the product or service
need internally, the original investment choice has long-term implications for U.S. workers even
if the impact on jobs initially was small. Choosing a blended approach between transferring of
operational functions and locations to explore are critical corporate considerations.
DECIDING WHAT TO OUTSOURCE
Business Process Outsourcing (BPO) is a strategy that executives utilize to help them focus on
their core competencies and achieve more than just cost savings. BPO has today received high
accolades for enabling organizations to meet a diverse set of objectives ranging from tactical to
strategic, such as, enabling consistent management practices through global operations,
accessing new sources of revenue and catalyzing organizational changes (Janko, W. & Koch, S.,
2005).
The first step towards making this wonderful resource work for any organization is first
deciding what functions should be outsourced. For this, it should be remembered that all
functions are not alike. While certain core functions such as decision-making, are not the right
candidates for outsourcing, others such as HR administration, finance & accounting and
payment services provide strategic advantages when outsourced.
In short, Globalization is concerned with the application of business practices, processes and
resources to take a business or a product globally. Additionally, globalization refers to the
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process of internationalization, which can be adapted to various languages and regions without
engineering changes and the localization of products and services.
WHY COMPANIES SHOULD CONSIDER RELOCATION STRATEGIES
Cost is a critical factor for companies’ considering to offshore or offshore outsourcing
production. A recent survey conducted by The Economist (2004) points to the reduction of
labor costs and direct material costs as the most important factor leading to offshore
outsourcing. Additionally, access to distinctive materials, services and R&D assets as well as
market presence and diversification play vital roles. This is chiefly significant for investments
in other industrial nations. Wages found in countries with lower earnings are frequently a mere
fraction compared to developed countries, (chart 1) even when factoring in a nominal salaries
expansion in these countries of 8 per cent compared to 2.5 percent in the U.S. (Bie, 2005).
.
While low wages is an important consideration, it is not enough of a factor for an attractive
investment destination; other factors such as a country’s infrastructure, security and availability
of skilled workers must be considered. If low wages were the only criterion for foreign
investment, Africa would be flooded with foreign direct investments. Over the last 30 years, the 9
countries in Southeast Asia have been successful in combining low wages with an aggressive
strategy of promoting stability, investment protection, rule of law and a generally hospitable
environment (e.g. through tax incentives). Together with high investments in education and
infrastructure, these elements of good governance have gained increasing attention in
assessments of successful development strategies (Bie, 2005).
Any cross-border outsourcing transaction raises a host of potential legal issues; in addition there
is an emerging body of "global sourcing" legislation in the U.S. It is important to note that
while there is considerable risk not reviewing and weighing all factors collectively for
determining an outsourcing function. For example, there exist a consensus both in China and
the West that rule of law is a good thing, however, this is not a universally accepted truth.
Some communist governments, including China have been at least partially negative toward the
idea of rule of law, arguing that it interferes with class struggle and their infrastructure.
Furthermore, the rule of law is opposed in many authoritarian and totalitarian governments.
The explicit policy of those governments, as evidenced in the Night and Fog decrees of Nazi
Germany, is that corporations should carefully review and weigh how they leverage themselves
in the global arena (Wikipedia 2006).
Additionally, cultural variations and personal preferences create huge and often miscalculated
problems. As a general rule, the less complex the function (e.g. phone service vs. network
design), the more labor costs will be in the overall evaluation. Many businesses will assess the
overall cost/benefit analysis incorrectly and make sub-optimal decisions, either through
overemphasizing the offshoring or by over-investing in capital at home as a result.
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Another concern is that a race to relocate offshore could also lead to unanticipated expenses,
from issues such as liability laws and high training costs due to labor turnover.
(Arora & Gambardella, 2004) asserts that language is a vital requirement (but not an adequate
condition alone) for relocating to a country with re-exports of the service function. India,
Ireland and Israel have a huge labor pool of English-speaking professionals, while investments
in China and Brazil mainly are aimed at the local market. It is important to note that the
Philippines, Malaysia, South Africa and other countries with strong English-speaking traditions
are also seeking shares of the future stream of offshore outsourcing activities. For the identical
rationale, French investments in back-office/call-centre services are being directed towards
French-speaking North and West Africa. In the Nordic countries, customer support is often
pooled outside, but by default has to be manned by Nordic speakers. This results in having to
raise the relative cost of providing a service there considerably.
NATION BUILDING THROUGH OUTSOURCING - THE IMPACT
Many companies surveyed referenced that beyond merely IT outsourcing, offshoring and
inshoring infrastructure services is the next big thing. Inshoring is the process where foreign-
headquartered multinationals contribute to U.S. economic growth, security and raising U.S.
living standards through their operations that are insourced, thus, creating American jobs
(Slaughter, 2005). The complexity of such interdependent relationships stretches far beyond
cost saving and entering into new markets.
One example of how involved outsourcing and offshoring can be is exemplified by the
relationships between U.S. military forces, international allies and contractors on the battlefield
in Iraq. This example in nation building is a case in point of how many multinationals
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coooperate with governments to produce opportunities to perform offshore services. Thus,
offshoring and outsourcing is often explored to create opportunities to expand abroad as well as
for national security and for creating cost reductions (Bartholomees, 2004).
Several other key drivers are shifting suppliers’ requirements from remote management to one
of introducing offshore outsourcing into the solution. Quite often, private contractors play a
huge role in basic government work—mostly out of public view. One such example is the
controversy over the U.S. outsourcing the management of six U.S. ports by the United Arab
Emirate. This example, at the forefront of the offshoring debate, challenges how far
outsourcing should go. Several congressmen have vowed to block the sale of British port
operator P&O to Dubai Ports World of the United Arab Emirates, a staunch U.S. Gulf ally,
citing security concerns. The U.S. Congress needs to debate this position in order to create
greater transparency in certain U.S. and global counterterrorist organizations such as The
Counterintelligence Field Activity Agency, which is buried deeply within the intelligence
community. With the U.S. Congress in the midst of an election year, public fear of Arab
nations could potentially threaten their reelection chances (FSSI, 2006).
What is difficult for the U.S. population to discern, through all of the white noise, is the critical
importance of nation building and dispelling the awful perception of intolerance towards all
Arab-speaking nations following the events of 911. This deal is about D.P. World, a holding
company, managing only the terminal operations – which schedules and unloads ships. Local
port authorities will still run the ports themselves. D.P. World responsible with terminal
operations will not address port security; they are simply accountable for writing the paychecks.
Customs and Border Protection (CBP) and the U.S. Coast Guard are responsible for all aspects
of security. This agreement is critical with the Middle East flow of money and points directly
12
back to the Iraqi Government’s banking procedures with managing oil revenues coming out of
the Iraq (FSSI, 2006).
Some of the rhetoric would have people believe that U.S. ports are being sold to foreign
governments; the ports are controlled by the local port authority and the security – the most
important part – is not going to be changed one bit by D.P. World taking over this contract
(Worthen, 2005).
Suggesting that U.S. ports outsourced being a security threat is a chance for the U.S. to view
this agreement as a significant opportunity to broaden our nations security and further
participate in the paradigm shift occurring with the global economy. This reallocate of
resources should be examined thoroughly addressing the impact on U.S. jobs, union
participation, emerging technologies, trucking operations, emerging supply-side constraints
with industrial nations as China, India and unrefined resources from such countries as Saudi
Arabia, Nigeria, and other mineral rich nations. These shifts will ultimately result in a chain of
renegotiated agreements that will influence relationships worldwide.
Furthermore, the threat of Russia’s infiltration within the Middle East by collaborating with Iran
to develop a facility for enriched uranium and talks with HAMAS potentially compromises the
U.S.’s position within the Middle East. The U.S. must also pay critical attention to our closest
allies in and around the Middle East such as Israel by urging calm, preserving trust, and not
permitting any distance between our two nations (FSSI, 2006).
Another example of how multinationals collaborate with government in creating outsourcing
initiatives is the recent development of nuclear energy cooperation agreement between the U.S.
and India. This agreement too will allow multinationals and subcontractors involved with the
13
Department of Energy and other energy sensitive agencies focused on research and
development of nuclear science to share and to explore emerging technologies. Additionally,
this strategy is a critical opportunity to further nation building in areas where China may be
attempting to develop similar back door relationships.
EXTERNAL CONSIDERATIONS
Beyond the factors and the potential impact of outsourcing addressed earlier are many other
external factors driving multinational corporations and nations here and abroad; (Powell, 2004)
describes them as:
Excessive Corporate Taxation –Despite the bush tax cuts of 2002, the U.S. continues to have
one of the highest corporate tax rates; however, numerous tax breaks and exemptions exist for
targeted sectors, which include large multinationals. The latest tax reform package from
October 2004 was originally meant to benefit exporters of manufacturing goods, but it has also
proven to lavish tax breaks on numerous other businesses, including importers of Chinese
ceiling fans.
Escalating Costs Of Health And Pension Benefits – U.S. businesses are more exposed to costs
of benefits like healthcare, workmen’s compensations and pensions than most of its major
competitors abroad. In 2003, employer’s expenditure on health insurance for employees alone
reached over 8 per cent for total compensation. Daily there are rising tensions concerning the
strains of supplying pensions benefits to U.S. workers in the transportation and manufacturing
industries suggesting that pensions will be obsolete due high cost and tough global competition.
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Escalating Costs Of Actual Or Threatened Tort Litigation - In 2001, the costs of the U.S. tort
system reached $205 billion, over 2 percent of the GDP. Comparable international data are
limited, but estimates suggest that tort costs are much more common in the United States
compared to their largest trading partners.
Escalating compliance costs for regulatory mandates - This particularly true for regulations
related to workplace safety, pollution abatement, and corporate governance.
Additionally, according to The Office of Management and Budget’s, (OMB, 2004)
Report to Congress on the Costs and Benefits of Federal Regulation, real expenditure for
administering and enforcing regulations nearly doubled from $13.7 billion to $31.9 billion from
1990-2005 (in real terms). In terms of compliance, three areas of regulation are hit particularly
hard: consumer safety, workplace safety, and environmental protection. The manufacturing
compliance costs were 147 billion dollars in 1997 (OMB, 2005).
One interesting model to offset the challenges facing many multinationals is a nearshore
outsourcing solution. A nearshore solution is a model used in international waters or with
bordering countries that do not have the restricted burdens of regulations and compliance
experienced in the U.S. The U.S SeaCode, a nearshore outsourcing solution, is one such
creative approach to circumventing U.S. regulations and compliance issues. Seacode has
created a solution with hybrid outsourcing creating new high-end jobs for U.S. engineers - even
bringing back jobs that had already left the country. They have achieved this by combining the
skills and experience of our U.S.-based engineers and program managers with unique ship-
based offshore engineering capabilities. As a result, they are able to deliver to clients a
combination of American engineering talent and reduced blended cost (SeaCode, 2005).
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ENERGY - A DRIVING FORCE TO OUTSOURCING
Rising Energy Costs, Particularly Natural Gas – While energy reserve estimates for oil,
natural gas, and coal are very difficult to develop, globally there is concern with the available
energy sources. The result is worldwide there has been a major spike in the cost of energy. One
such example of the impact of rising energy cost is where General Motors and Ford Motor and
its shareholders finally received the bad news On May 5, 2005, where Standard & Poor's
downgraded their debt of both carmakers to junk status (Welch, 2005).
This is due in part to US consumer’s steady march into Asian car companies' dealerships
seeking more fuel-efficient vehicles in the quake of escalating gas prices. The National
Association of Manufacturers introduces an effective cost index to measure the effects of the
burden of the above-mentioned problems. The overall additional or hidden costs faced by
American manufacturers are estimated to 22 per cent of the raw cost index (Davis, 2005).
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Energy resources fall into two broad categories: renewable and non-renewable. Ultimately,
the planet’s energy comes from three sources: the sun, energy of radioactivity of Earth’s
creation material, or momentum energy of objects in the solar system. In the very long term,
none of this energy is unlimited. Except for the purposes of human use, incident solar
energy in its various forms such as biomass, hydro, photovoltaic cells, wave power and wind
power can be considered sources of renewable energy, as can geothermal energy from hot
radioactive creation material and tidal energy from the momentum of the Earth/Moon/Sun
system. The major non-renewable energy sources are hydrocarbons – oil, natural gas and
coal – which can be regarded as stored solar energy from photosynthesis of millions of years
past, and nuclear materials such as uranium. At present, most of the world’s energy comes
from non-renewable sources. In 2001, according to the Department of Energy’s Information
Administration the global energy split is as follows:
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Table 1 Sources of Global Energy – 2001Source Percent
Oil 42
Natural Gas 23
Coal 23
Nuclear 6
Total Non-Renewable 92
Hydro 7
Other 1
Total Renewable 8
Source: US Energy Information Administration
OFFSHORING vs. OUTSOURCING?
Relocating functions offshore to an affiliate or outsourced to a third-party can have significant
implications. The advantage of outsourcing a function is that companies can focus on their core
businesses and exploit cost-cutting measures. Additionally, outsourcing provides the
originating firm with enormous flexibility should problems occur, lower risks from business
cycles and less burden with increasing costs on benefits such as healthcare and retirement
programs. Also, relocating involves little capital investment.
Some disadvantages from outsourcing are the loss of control and an increased level of effort
essential when integrating responsibilities from third parties in the internal operating structure.
The more complex and integrated various services or processes are, the greater the probability
that outsourcing will occur.
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(Bie, 2005) asserts that in the early days of moving operations abroad most firms chose to
outsource the activities to other, often local, companies. It was easier, quicker and required less
investment capital (hence risk). (Mann, 2004) argues that a significant slowdown in American
manufacturing foreign direct investments in low-cost countries (down from 12 billion dollars in
1999 to 1.3 billion dollars in 2005) may be attributed to increased use of offshore outsourcing.
However, as foreign direct investments around 1999 were at an all-time high, the majority of
the decline in investments is most likely attributable to the 911, general weak economic growth
and global anxieties.
Offshoring and inshoring has now become a standard operation and a core component of the
financial services business model, an increasing number of businesses choose to offshore,
thereby retaining control. In this way, the initial commitment is greater, but the company has
the advantage of remaining in control and thus integrating sensitive services in core businesses.
This is perceived as the model for the future.
Other options include joint ventures and acquisition of an existing firm. However, investment
decisions are often subject to specific restrictions depending on the country in question. In
addition to being alert to specific challenges, (Bie, 2005) advises manufacturers to keep
essential production technology at home in order to avoid copying of product or subassembly.
This is critical given the trend in countries such as China where Chinese businesses are
aggressively filing patents and claiming other intellectual property rights to the counterfeits
locally, in effect becoming the legal owners (Spurgeon, 2004).
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CRITICAL FACTORS TO OUTSOURCING
For a company contemplating relocating production, the primary objective is to ensure that the
perceived benefits from a low-cost environment are achieved. This list highlights factual data
gathered from real-world experiences I have personally encountered working on client sites
developing and revising business processes and from published articles relating to this subject.
Besides the relative labor costs, other factors such a barriers to entry (regulatory access to
market) relocation costs, integration in production chain and the availability of quality labor are
among the factors that companies have to face. Following is a highlight of such factors for
consideration:
Infrastructure (physical access to market) because many offshore countries lack the
network bandwidth for fast communication and many experience intermittent electrical
outages.
Security - Not all foreign countries have the high-level concern or the laws, such as
those for privacy or intellectual property, to protect organizations or nations assets.
Skill Set/Quality - encountering poor or unacceptable quality of work in test automation,
regardless of the CMM level touted or other defined universal methodologies for S/W, H/W
or infrastructures.
Competency& Objectivity is your offshore partner performing your development and
your testing? Will they keep your best interests at heart (and provide adherence to
functional, performance, reliability and usability testing standards) when it conflicts with
meeting their deliverable date?
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Geopolitical Climate -While recent events have proven that the US is not immune to
terrorism, Asia and other underdeveloped areas experience instability caused by unstable
government, political unrest, terrorism, etc.
Culture Cultures are different - It is possible to insult offshore partners inadvertently or
simply experience miscommunications. Business conduct, greetings, forms of address,
gestures, value systems and punctuality vary widely around the globe.
Language Barriers - Unquestionably many offshore resources provide communication
challenges, especially over a forum that does not allow you the ability to view facial
expressions - and e-mail can be worse.
Time Zone Clash - Many of the firms in Asia have as much as a 10-hour time
difference. The outsourcing firms try to spin this as a "good thing" for you. Is it good to not
be able to have your team discuss issues with their team as they arise?
Difficulty Visiting Their Site - Because of the cost and length of travel (as much as 20
hours each way), visiting your partners with any frequency becomes much more unrealistic.
Also, foreign ground transportation is not like that in the US.
Difficulty Bringing Resources Here - There are possible Visa issues and heavy
expenses with bringing your partners to where you do business.
Increasing Price Trends - Many offshore providers that have been successful are
increasing their prices due to fact that competition for local human resources is pushing up
the cost of labor.
Labor Backlash - There is a groundswell of backlash against the current trend toward
exporting jobs outside the US. This backlash may cause negative publicity for your firm.
According to (Bie, 2005), risks associated with offshore outsourcing for financial entities fall
into four categories: operational, reputation, legal and country-specific. The operational risk is
21
the income loss resulting from an internal failure in the business model or from external events.
With regard to operational risk, the bank argues that the transfers of managerial responsibility to
a third party (as is the case with the outsourcing of a service) introduces uncertainties and lessen
control of the overall exposure.
The reputational risk arises when the way by which services are performed by third parties
reflects badly on the originating firm. Consequently, even if the originator is not legally
responsible for the event, the firm can incur a monetary loss from loss of credibility. Especially
for financial firms, the breach of confidentiality concerning customer financial information can
cause significant damage. The transfers of information itself as well as imperfections in the
service provider’s control environment are specific areas of risk.
The legal risks arise as offshore outsourcing is based on binding contractual arrangements.
Besides small print problems, risks can arise when specific contractual details become
detrimental to the financial firm’s business strategy, for example if the contract is of long
duration, but the service in question reflects outdated business realities.
The above-mentioned risks are common to all outsourcing arrangements, but moving the
service offshore, which tend to lessen direct influence or at least increase the supervisory
burden, exacerbates the risks. Additionally, moving functions offshore creates country-specific
risks, which might include changes in foreign policy as well as political, social, economic, and
legal conditions.
In response to the increasing use of outsourcing, the Joint Forum, established by the Basel
Committee of Banking Supervision and other international supervisory bodies, issued nine
22
principles for the financial sector with regard to outsourcing. According to the principles, firms
should have a number of policies in place before entering an agreement, for example regarding
the attainment of direct responsibility and the establishment of a comprehensive risk
management system. The specific outsourcing arrangements should be on clear legal footing,
identifying rights and responsibilities of all parties.
The financial institution should also be vigilant in assuring that the service provider protects
customer confidentiality. Furthermore, financial supervisors should take into account a firm’s
outsourcing arrangements and make it an integral part of the monitoring exercise. Additionally,
supervisors should be certain that an offshore outsourcing arrangement does not hamper the
supervisory work, for example by reducing access to relevant material (BIS, 2004).
THE THREAT OF LOST WAGES AND BENEFITS
While outsourcing is inevitable, the requirement to understand the underlying implications of
outsourcing is important. The threat of job loss, deleted benefits, and lower wages are at the
forefront of this debate. Provided is a short table from a variety of sources and reports
comparing job loss estimates and projections due to outsourcing. The disparity in the numbers
shows the uncertainty and the difficultly in measuring these numbers. The total size of the U.S.
Labor Force is 140 million jobs (Outsourcing Statistics in Perspective, 2004).
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Jobs Lost to Date* Projected Job Loss Jobs at Risk
300,000-995,000 3.3 million-6 million 14.1 million
300,000-500,000(Goldman Sachs)
3.3 million over 15 years(Forrester Research)
14.1 million(UC Berkeley)
400,000-500,000(Business Week)
6 million over 10 years(Goldman Sachs)
995,000(economy.com)
TRENDS IN OFFSHORE OUTSOURCING AND TRADE SUBSTITUTION
As trade barriers are removed and new technologies integrate the global community, firms have
the ability take advantage of relative strengths on the micro level and optimize manufacturing
operations. This development is also reflected on the macro level in the trade statistics.
Overall, exports have enjoyed stronger growth rates than most GDPs for a long period of the
postwar era, thereby increasing the overall economic interdependence, (WTO, 2005). For
America, the external balance and the relationship with the surrounding world has become a
major focus of attention as the trade balance has continued to deteriorate. For 2003, the deficit
reached nearly 550 billion dollars, and the deficit on 2004 is on track to become even larger.
The increasing shortfall combined with significant employment elimination in the
manufacturing sector has shifted focus on corporate decisions to move production abroad, and
hence the individual decision on offshore outsourcing. This shift has amplified the spotlight on
China and its fixed exchange rate with regard to the dollar, as the Chinese trade surplus with the
United States has increased significantly to 124 billion dollars in 2003, or 23 per cent of the
total U.S. trade deficit in 2004. One explanation for the increasing deficit could be that U.S.
multinationals increasingly use foreign affiliates rather than direct exports to satisfy foreign
demand. Profits from foreign affiliates of U.S. multinationals are much higher than in the U.S.
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parent and contribute overall to half of the total profits of the multinationals, but only with one-
third of the sales. For this reason, capital inflows (royalties and repatriated profits) are
increasing more rapidly than direct exports (Bie, 2005).
Furthermore, according to the Bureau of Economic Analysis, outsourced jobs outnumber
insourced ones by 3.4 million and in 2005 alone, total 2005 exports of $1,271.1 billion and
imports of $1,996.9 billion resulted in a goods and services deficit of $725.8 billion (BEA,
2006).
From a general perspective, the most significant development of the direction of America trade
is the increasing trade with Canada and Mexico since the NAFTA-agreement came into force in
1994, chart 3.
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CORPORATE OUTSOURCING FINDINGS
Most U.S. organizations will require some type of nearshore or offshore element in virtually
every large outsourcing contract during 2006.
For an example, IBM Global Services reported that 100 percent of its requests for
outsourcing support include an economical international sourcing alternative. Additionally,
organizations that already use offshore partners or offshore resources, but have a large
number of vendor staff performing duties locally, will eventually move this staff offshore in
order to benefit from greater profits.
As global outsourcing/ consulting firms, such as Accenture, BearingPoint, Northrop
Grumman and CSC increase their presence in India their strategy is to: (1) compete with the
primary Indian solutions providers and (2) accommodate organizations that are challenged
with their bottomline. With India as a primary offshore destination allows U.S. companies to
take full advantage of their strategy rather than merely focusing on a cost containment
strategy, resulting in quality and output benefits being realized. Organizations should apply
quality a stringent quality improvement program as an integral part of all Indian outsourcing
activities.
Large system integrators will continue to replace small local contractors with offshore or
nearshore vendor support. As organizations transfer to remote ADP programming models,
they usually replace external contractors before considering replacing internal staff.
Furthermore, company’s intention is not to eliminate their internal staff. Their objective is
to cut down on external contractor spending thus, freeing up internal resources to focus on
mission-critical work.
India will dominate as the preferred offshore country for IT services and China
continues to dominate the electronic and manufacturing market. Their vendors will
continue to lead the offshore marketplace. While these countries remain the best option for
North American organizations, vendors are seeking to develop shops in other low-cost
countries, in such countries as Brazil, Czech Republic, Hungary, Indonesia, Malaysia,
Mexico, Poland and Pakistan.
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Out of the 66% of the participants who are currently outsourcing, 40% are focused on Business Process Outsourcing, 23% on Applications Management, and 38% on IT Operations.
75% of the participants indicated that an effective outsourcing relationship could transform an enterprise on a strategic level.
Out of the 70% of the participants who are currently considering leveraging offshore resources as a component of their outsourcing decision, 34% indicated they are making their decision now, 34% in 6 months, 5% in 9 months, and 27% in 12 months or more.
CONCLUSION AND RECOMMENDATIONS
Strategically, organizations must examine the structure of the agreement. Beyond examining
price, the assessment should include: maturity, business processes, deployment capability,
security, long-term maintenance costs, management costs, service levels and the value chain.
These critical processes of any effective outsourcing proposition can’t be performed merely
with a worksheet approach and requires options analysis and a business-case format. In
addition, there are a number of sequences to consider that are provided in the following steps:
Recommendations / Steps
Evaluate all risks and quantifying them when measured with probability. Review
alternative options e.g. (near-shore, partial offshore) and other combinations of services.
Review the value of the partnership and its critical importance to your organization.
Obtain the expertise of an independent organization have them assess, measure and
manage the process of outsourcing.
Assess the readiness of the organization (requirement management processes, level of
engineering specification, etc) for all aspects of outsourcing and offshore specifically.
Organizations who finally decide to explore global opportunities should at initially
decide the model they are most at ease with, and then set their strategic direction. Most
importantly, they should not allow outsiders to drive the model.
Finally, the analysis and process should be done by and independent and non-biased third-party
organization who offers the objectivity necessary in assessing organization capabilities, business
processes and those of outsourcing partners.
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BIBLIOGRAPHY
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Bardan, A. & Kroll, C. (2003) The New Wave of Outsourcing; Fisher Center for Real Estate & Urban Economics, University of California, Berkeley Retrieved, Wednesday, February 1, 2006 from: http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1025&context=iber/fcreue
Bartholomees, B. (2004) U.S. Army War College Guide to National Security Policy and Strategy, Retrieved, Saturday, September 17, 2005 from: http://www.au.af.mil/au/awc/awcgate/ssi/policy_strategy.pdf
BEA (2006) U.S. International Trade in Goods and Services December 2005 U.S. Census Bureau and U.S. Bureau of Economic Analysis Retrieved, Friday, February17, 2006 from: http://www.bea.gov/bea/di/1001serv/intlserv.htm
Bie, U.H. (2005) Offshore Outsourcing: Consequences and Challenges for U.S., Retrieved, Wednesday, May 25, 2005 from: http://www.nationalbanken.dk/C1256BE9004F6416/side/6F842029134F8271C1256F8500478A06/$file/wp_22.pdf
BIS, (2004) The Bank for International Settlements; Basel Committee on Banking Supervision, Retrieved online Monday, February 13, 2006 from: http://www.bis.org/speeches/sp040203.htm
Center for American Perspective (2004): Outsourcing Statistics in Perspective March 16,
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Friedman, T. (2005) The World Is Flat, A Brief History of the Twenty First Century, First Edition, Farrar, Straus and Giroux, New York, New York.
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(RTTS, 2005) Statistics Related to Offshore Outsourcing, Retrieved, Saturday, January 14, 2006 from: http://www.rttsweb.com/services/outsourcing/stats.cfm
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Slaughter, M. (2005) Insourcing Jobs, Making the Global Economy Work For America, Retrieved, Saturday, January 14, 2006 from: http://www.ofii.org/insourcing/insourcing_study.pdf
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Spurgeon, B. (2004) The New Chinese Counterfeit Game By Brad Spurgeon International Herald Tribune, Retrieved online Monday, February 13, 2006 from: http://www.iht.com/articles/2004/11/14/business/chiip.html
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Wikipedia (2006) Off Shoring and the Rule of Law, Retrieved, Saturday, September 17, 2005 from: http://en.wikipedia.org/wiki/Rule_of_law
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APPENDIXES
Appendix A: Service Management Service Outsourcing Questionnaire
Company Name: _
Address: ______
Reference Name:Reference Activity:
SIN(s): _________________________________________________________________________
NAICS Code(s)___________________________________________________________________
Brief description of services/products provided: ____________________________________________________________________________________________________________________________________________________________________________
1. If you outsourced a process, did you incorporate a change management plan?
2. If you are a financial services provider, would you consider outsourcing your technology functions, such as Security, S/W or H/W support or a portion of that function?
3. If you are planning to outsource your sales/services function, what is most critical to your decision?
4. If you are a buyer, which of the following has been the primary reason for considering a sole source approach?
5. When considering a BPO versus an IT agreement, is your organization more or less likely to consider a sole source approach?
6. Has your organization ever had an unsuccessful outsourcing relationship?
7. Has your organization attempted to outsource any of the following?
8. What type of outsourcing is your company contemplating? Has your company engaged offshore?
9. What organizations are you or have you used as an out sourcing resource?
10. If you have implemented offshore outsourcing, in which country is your service provider located?
11. What is your perception of offshore outsourcing?
12. Where are you from? Where does your organization and its stakeholders originate?
13. What is your interest in outsourcing based on?
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P.O. Box 16813P. 703-338-7118
P/F: 703-579-6444www.fssincorporated.com Always Customer
Driven
14. If you are a foreign based company, where are planning to outsource this year?
15. If you are a foreign-based company, what are you planning to outsource this year?
16. If you are a foreign-based company doing business with the US federal government, have you established a proxy board?
17. What are you planning to outsource this year?
18. What is your title in the company?
Ratings: Please summarize the contractor’s performance and circle in the column on the right the letter that corresponds to the performance rating for each rating category. Please see the attached rating guidelines for a description of the rating scale.
Factors Rated Key Questions Comments: (continue on additional sheets if desired)
Rating
Timeliness of Performance:
1. How would you rate the contractor’s ability to deliver a particular service or product on time?
E A U
2. How timely was the completion of the order according to the terms negotiated?
E A U
Quality: 3. How would you rate the quality of the contractor’s product or service?
E A U
4. How would you rate the contractor’s application of internal quality control or review systems during order performance?
E A U
Value: 5. How would you rate the value of the products or services provided compared to the price paid?
E A U
Business Conduct:
6. How would you rate the contractor’s ability to resolve problems without extensive guidance from company counterparts?
E A U
7. How would you rate the contractor’s professionalism in responding to and completing your order?
E A U
Customer Satisfaction:
8. How would you rate the responsiveness and cooperation of the contractor’s customer service organization?
E A U
9. How would you rate the contractor’s willingness to work with you to address special requirements (e.g., changes to requirements, urgency, etc.)?
E A U
10. How would you rate your level of satisfaction with the effectiveness of their performance?
E A U
Overall Satisfaction:
11. How would you rate the likelihood that you would use the contractor again, and why?
E A U
RATING GUIDELINESPlease summarize contractor performance in each of the rating areas. Assign each area a rating of E (Exceptional), A (Acceptable), or U (Unacceptable).
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