The purpose of this project is to analyse on actual facts, data, information how offshore outsourcing is important to the US economy and therefore to verify if the merits so much praised by the economic theories, were justified
Reflective commentaryReasons behind investigation and relevance of the work
By seeing on TV constant demonstrations of people against offshore outsourcing, I started thinking that the idea of outsourcing production overseas was maybe not as good as it has been depicted on books and economic theories .I couldn't understand how these people were against natural evolution of the economy :Globalisation, which has given the possibility for companies to invest where the factors of production were the most favourable , which also has improved lives of millions of people ,allowing them to access to cheap products and services wherever in the world. Globalisation gives me the possibility to travel to Russia, for instance, and still eat the same Mc Donald hamburger I used to eat back in my hometown.
Being a third year student I developed skills that helped me to make my own opinion based on deep analysis and investigation .The opportunity to use those skills came to me when ,as part of my modules, I had to write a project on a contemporary business issue. I had no hesitation to choose this topic, so I could understand why this topic raised so many debates
I decided to narrow down my scope of research to US naturally, because US have always been ahead of practising offshore outsourcing .Multinationals were first originated from US and by exporting their product or services they also exported a way of life .The proverb:"when US sneeze, the rest of the world get a cold" is not only word but it is the reality
So this project is relevant for me and my fellow students because it shows that there is a gap between economic theories we learn at the University and what actually happens in the world from all point of viewProblems encountered
I didn't have problems to find sources; the university library was rich enough to help me with my investigations. But I had problems with the structure of the project because I never wrote a project that long before. So I was very puzzled at the beginning, regarding the approach, the referencing, the lay out and appendix .But fortunately I had three meetings with the seminar tutor, and after that all my worries were gone because she helped me a lot by answering my questions, by giving me feedbacks on drafts and by showing me what was exactly expected from meBenefits gained
This project has been really useful for me because I understood why there were so much cons and worries about offshore outsourcing .and I also understood that those worries were justified
So I went from a very strong opinion in favour of offshore outsourcing to a mitigated and sceptical opinion after the project
Method of analysis
My seminar tutor advised me that, for this project I could select secondary data .So I looked for books whose theme was about offshore outsourcing , and I also looked on internet every information that gives me actual data and graphs about my topic
So the first step was the collection of all information available from the University library and Internet.
The second step was the selection of relevant information concerning the actual benefit of offshoring on the US economy in one hand, and the selection of information that concerned bad impact of offshore outsourcing in the other hand
The last step was to confront those different parts and analyse how important has been offshore outsourcing for US economy but also how damageable it has been for US
Offshore outsourcing or offshoring represents the practice of carrying out a company process outside the company boundaries and outside the limits of the original national entity where the headquarters of the company are established, in other words it is the process of moving business activities to a foreign country .A survey of 7300 senior executives around the world conducted by Agrawal, V. & Farrell, D. (2007) of Mckinsey found that four out of five executives think outsourcing is good for the global economy, in US 58 percent of the US executives were positive on the development.
The trend towards outsourcing is ever growing. The statistics revealed by Lackow (2003) on the US information technology outsourcing market in Exhibit 1 show how dramatic the growth trend is.
Inspired by classic economics, the transaction cost theory is based on the premise that firms seek to economise on transaction cost. Originally formulated by Coase (1937) this theory proposes that investments including investments in outsourcing, help reducing transaction costs and in turn, reduce the size of the firm, making it more productive.
As Exhibit 2 shows , a shift in transaction costs from "A" to "B", measured by a reduction in transaction costs from "a" to "b" results in a reduction in the size of the firm from "ac" to "bc" .
Another economic theory that applies to offshore outsourcing is agency theory developed by Laudon and Laudon (2004) .Agency theory deals with the impact of outsourcing on employees or agent, who work for the owners of client businesses. According to this theory, as a firm grows in size and its supply chains and employee interactions increase, the owners need to increase the number of employees who work as agents to support the complexity of the organisation. Thus an investment in outsourcing save the firm time improves its control over it business activities by moving activities outside the firm and require fewer employees.
As Exhibit 3 shows these agency cost reductions(from A to B) move the agency costs curve from "a" to "b", causing a reduction in the size of the firm from "ac" to "bc", principally a reduction in employee.
But the most famous theory that supports offshore outsourcing is the theory of "comparative advantage "Hall and Soskice (2001). According to this theory if an external outsourcing provider firm, regardless of its geographic location, can perform work activities more productively than the client firm ,the client firm should allow the external outsourcing provider to do the work .This allow the client firm to focus on what they do better .Countries that have benefited from international outsourcing, such as India, China, and Russia have made it a government priority and have set up agencies to support the easy transition of foreign -based clients firms into their outsourcing markets. Therefore, countries in the developed world have a technology advantage, while other countries, such as India and China, have an advantage in the cost labour. Since these advantages cannot be easily transported, countries tend to use their advantages to specialise in the production of goods that can be produced with their relative advantages.
So overall according to the economic theories, offshore outsourcing increases the profit of firms that practise it and therefore increase the national revenue of the country where firms are from .
Findings and analysis
The practice of offshoring or offshore outsourcing is not a new phenomenon. It has been utilised and hotly debated for many years and has only seemed to pick up momentum from both sides as the concept of globalisation spreads. As Mary K. Coulter (2005) describes "Potential markets are found all the way from small villages in China to Johannesburg to Moscow to Mexico City, and all points in between." Globalisation knows no borders. Businesses large and small are now able to compete with one another in the world market. Coulter goes on to point out that globalisation not only means that businesses are able to expand their product reach, but they are also able to access vast "financial, material, human and knowledge resources" and that they "should be acquired wherever it strategically makes sense to do so." The business activities that are offshored have changed in the course of the history. Despite the fact that IT offshoring is the most popular form of offshoring, today the importance of other forms is increasing. All this business activities shifted away from US have raised lot of concern among Americans, because it can imply poor customer service, creates a complex infrastructure, has hidden costs, and it can cause a loss of jobs.
The purpose of the analysis will be to assess to what extent offshoring has been positive to US and understand why offshoring is being criticized
Before developing points of criticism in the second part I will first expose the benefits of offshoring for USOffshoring is essential to US Economy Microeconomic opportunities for U.S
By enabling businesses to conserve costs, growth and have access to a large pool of talent, offshoring is essentially securing the stability of US economy by securing the vitality of businesses. In order to remain or become competitive in today's economy, US based companies must outsource jobs to foreign countries. The cost savings that can be derived from hiring employees in underdeveloped countries such as India or China are astounding. According to Agrwa and Farrell (2007), for every dollar of spending on business services that moves offshore, US companies save 58 cents, mainly in wages. According to the Report on Salary Surveys of McAvoy (2006) the average salary for low level finance positions in 2006 is $58,500. By performing a calculation, we discover that by hiring offshore for low level finance positions, US based companies will save approximately $33,390 per employee. For Jean Paul Vellotti (2006), a typical offshore IT setup includes one technical lead, two senior programmers and two junior programmers. If the salaries of these five positions are added together, they equal approximately $100,000 a year. This amount is the same as the salary of one senior programmer in the United States. In a 2005 survey conducted by the Financial Executives Research Foundation, 71% of businesses who sent jobs offshore did so for the cost savings [(Sennett, (2006)].
The differential in wages alone exaggerates the potential economic benefits. Though the wage-saving is substantial, additional costs are incurred in terms of telecommunications and the management of the offshore facility. Nevertheless, once these costs are taken in account, there is at least 45 to 55 percent saving in the cost base. (Exhibit 4). Reengineering the process design can further increase this potential saving to 65 to 70 percent of initial costs.
If a company were to choose China for their offshore location, they would have no employer healthcare costs because the government of China provides social medicine for its citizens. Employer sponsored healthcare coverage is one of the highest priced benefits an employee received.
Value potential accrued to U.S.
Value potential to the U.S. from $1 of spend offshored to India 2006
The most innovative companies in the world, while very different in service and style, share one common factor. They all outsource jobs to foreign countries. According to an ongoing survey from the Offshoring Research Initiative, growth is rapidly gaining on costs savings as the most common reason companies outsource. Growth is the goal of all companies. Growth creates profit, and profit creates more growth. For example, Apple saw stock returns of 24.6% between 1995 and 2005 and their margin of growth in that same timeframe was 7.1%. [McGregor, (2006)]. At IBM' s innovation themed leadership forum in April 2007, a man named Sunil B. Mittal gave a speech explaining how he created growth in his telecom company by outsourcing all functions with the exception of marketing and customer management.
Now that the initial exodus of manufacturing jobs has all but ended, the next wave of offshoring will take place in companies who want to expand their business, but would not have the capital to do so within the United States. Lewin and Peeters (2006) of the Harvard Business Review stated, in the current wave of offshoring, which includes far more innovation and product development than the first wave did, the ratio of jobs created offshore to jobs eliminated in the United States is 13:1 consistent with growth. This means that for every 13 jobs created offshore, only one job is lost in the United States as a result. The idea behind offshoring for growth is that companies can hire several offshore associates to handle more routine tasks while their existing, higher paid, associates in the United States are free to take on those tasks that have the possibility of creating more growth. In his article, Pros and Cons of Offshoring, Velotti (2006) tells the story of a company that manufactures plastic knobs, dials and pointers for other devices. This company decided to offshore because they were recording an overall annual loss of $750,000. By offshoring the manufacturing type positions, this company was able to create jobs in other, higher paying divisions of this company, two of which were sales and marketing. Because the talent pool in the United States is so small, it is almost always necessary to train your employees after they are hired. This training is costly, and is usually an investment that rarely generates a return, as the average longevity of any worker, lower than a senior manager, is approximately two years. With a talent pool as large as China an employer can choose a candidate with all the requirements they desire, thus eliminating further education costs. Even if some education is required, the cost of that education will be much less than one obtained in the United States. If a company chooses to hire employees from underdeveloped countries where there are substantially more workers than available jobs, they are almost guaranteed to achieve the level of longevity they desire. If an employer pays their associates in foreign countries even $100 more a year than their competitors pay in that country, they can create the kind of loyalty existing in this country 50 years ago.
When you are paying your workers, whether they live in the United States or not, more than your competitors, you usually find that the morale of those workers is in turn higher. Lewin and Peters(2006) explain that a survey of companies that offshore their labour, conducted by Duke University and Archstone Consulting, revealed that the majority of firms who outsource are surprised by the quality of work completed in foreign countries. They frequently enter into an offshoring arrangement with the expectation that they will give their foreign associates the ideas created by their US associates and have them create the product. According to the article by Lewin and Peeters (2006), they will often find that not only do the foreign associates do extremely well at completing the tasks they are given but they are quick to suggest creative new ways of doing things and eventually create ideas of their own. Since these ideas come from their daily lives and perspectives, they generally provide the US based company with an opportunity to create business in the foreign country that houses their labour force.Macroeconomic opportunities for U.S
So offshoring creates wealth for U.S. companies and consumers and therefore for the United states as a whole: that is why companies choose to follow this course .Offshoring is an example of the innovation that keeps U.S. companies at the leading edge of competitiveness across multiple sectors. If it did not benefit U.S. businesses, they would not offshore. The more companies innovate, the more competitive they become and the more benefits are passed on to consumers. Thus , offshoring not only captures every bit of economic value, dollar for dollar, that exists in the U.S. economy prior to the decision to offshore, but it also creates a net additional value for the U.S economy that did not exist before . In fact the U.S. economy will capture economic value through several different channels: reduced costs, increased revenues, repatriated earnings, and the redeployment of additional labour .(Exhibit 5)
- Reduced costs: because cost savings represent the largest form of economic value capture. For every dollar of spend offshored, 58 cents are captured as net cost reduction to businesses even as they receive an identical level of service to investors .
- New revenues: for every dollar of spend offshored, offshore services providers buy an additional five cents worth of goods and services from the U.S economy, thereby creating exports and extra revenue for the U.S. economy. Providers in low-wage countries require U.S. computers telecommunication equipment, other hardware and software. In addition they also procure legal, financial, and marketing services from the U.S.
- Repatriated earnings: Several providers serving U.S. offshoring market are incorporated in the U.S. These companies repatriate their earnings back to the U.S., which amounts to an additional 4 cents out of every dollar of spend offshored
- Redeployed labour : As low value-added service is sourced from overseas, U.S. workers previously engaged in providing those services are freed up to take other jobs .If redeployment continues at the rate it has over the past two decades, then for every dollar of spend offshored , the economy will capture an additional 45 to 47 cents for every dollar spend offshored
Already imports from the U.S. to India have grown to $3.8 billion today from less than $2.5 billion in 1990 .Data collected from McKinsey quarterly January (2007)
So far from being bad for the U.S., offshoring creates net additional value for the U.S. economy that did not exist before, a full 12-14 cents on every dollar offshored . If we consider data revealed by Mckinsey Quarterly, January (2007), of the full $ 1.45 to $1.47 of value created globally from offshoring $1.00 of U.S. labour cost, the U.S. captures $1.12 to $1.14 while the receiving country captures, on average, just 33 cents (Exhibit 6).
Offshoring value in the global economy
Aftermaths of offshore outsourcing
Concerns about the quality of products
Many American jobs are now being sent to the overseas market. Jobs from many aspects such as blue jean manufactures, shoe manufacturers, software companies, and telemarketing jobs have moved overseas, Outsourcing (2007).This is because, many companies are now unsure of offshoring due to numerous customer complaints regarding the quality of service and communication problems. Those companies moved software development to foreign countries with the idea that they would get better quality. Many times, this is not the case. Also Vogel & Connelly (2005) develops that many of the quality ratings were based upon only a portion of their development process and not the final product. Some companies have begun to break contracts with their offshore partners prematurely due to lack of delivery. The provider (offshore contractor) had financial difficulties or failed to deliver on commitments because many of the companies had poor turn around time on their commitments. Also, some of the lack of quality in products is a direct result from the language barrier. In India, (telephone) customer service is usually pretty good --the reps are very nice to callers. The problem is, that the calls are escalated to the supervisors and people are in (telephone) queue longer, and at the end, a lot of times, there is no resolution.Complex organisations
Outsourcing jobs causes a very complex infrastructure for both employees and employers. "It causes loss of control over primary organisational assets such as company data and innovative technology and techniques," Dulebohn, (2005). Also as Bednarz, (2006) explains, many outsourced companies are consolidating with other companies without informing their American companies. With this loss of control, many of the outsourced companies are taking on too much and not able to make commitments on time. "Another problem with the complex infrastructure is the organisational resistance", Borg (2005). Outsourced companies, due to differences in religion, culture, and language are resistant to change, US employers don't understand how to manage the offshore team and the offshore team isn't comfortable taking instructions from an American . The language barrier is the biggest obstacle to overcome when it comes to infrastructures. For example, the word yes in American can have numerous meanings from sure, ok, maybe, etc. The word yes in India means "I'll think about it and get back to you". Besides the cultural differences and language barriers, other factors contribute to outsourcing being a disadvantage to America.
Many businesses assumed they would profit from offshoring. "Most of the economic comparisons were relating the pay scale of an American employee to their foreign counterpart" Bednarz, (2006). Indeed Businesses that expected to save up to 70% have only seen up to 20% .No one considered the hidden costs: The costs of bringing in teams of foreign counterparts to train them in the states." Many of the outsourced businesses made false promises; they are unable to deliver the product and their companies are financially unstable" Bednarz, (2006). Also, as Russel (2006) affirms offshoring causes taxes to increase on the remaining jobs held in the United States because now there are fewer taxpayers due to loss jobs.Consumer safety
Also, Consumer safety has become a hot topic in the last several months as children's toys have been the target of multiple recalls due to dangerous levels of lead in the paint. In a September 5, 2007 article by Kelly Marshall and Rob Kelley entitled, Mattel Announces Third Toy Recall, the authors report that "The Consumer Product Safety Commission, in cooperation with Mattel, announced a recall of 844,000 toys that contain excessive levels of lead paint Tuesday night - the third such recall of Chinese-manufactured toys by Mattel this summer." Julie Vallese, Consumer Product Safety Commission's Director of Information told CNN that she was expecting more toy recalls because the lead paint on toys wasn't just isolated to Mattel, but that the smaller competitors would probably be making similar announcements of violations to lead standards.In a related safety concern, more Chinese made toys were recalled because they contained a different dangerous chemical. In a November 8, 2007 article entitled, Toy Contaminated with 'Date Rape' Drug Pulled, 4.2 million Aqua-Dot bead toys were recalled because scientists discovered that they were coated with a chemical that when metabolized by the body, turns into the drug GHB, which is often referred to as the 'date rape drug'. Some of the children who swallowed the toy suffered from vomiting, while others became comatose. Offshoring does increase the risk that products are less safe. Cheaper doesn't mean betterLoss of jobs
But one fierce criticism is that unemployment rate increases with offshoring .Indeed Offshoring has caused many American business to close or layoff employees. "Many of Silicon Valley's giants and dozens of companies elsewhere have imposed layoffs at home and hired cheaper talent in India", states Dolan & Meredith, (2004)." "It's easy to say, go back to school and get another job. But of those that were laid off, 31% were not fully re-employed, 36% soon found jobs that matched or increase their pay, but 55% were, at best, working with an 85% pay cut" argued Sheats III (2005). Offshoring has also caused a decrease in job morale in the Information Technology (IT) profession. IT leaders need to admit how big a cloud outsourcing is casting over IT. Outsourcing is causing the number of American college students to decrease in majors of engineering and computers Dulebohn, (2005). The students are afraid to graduate and not be able to find a job. America will not be able to compete with upcoming technological jobs due to outsourcing. So, over time, the US may lose the technological and innovative advantage it has historically held because of its (India and China) highly skilled workforce. Many Americans are turning to jobs that can not be sent over a telephone or over the internet. Many will have to turn to service related jobs; jobs that require face-to-face interaction. Even with the jobs that require face-to-face interactions, some may be sent over a wire.
Furthermore, jobs that Americans once considered stable long-term employment are now being outsourced at a rising rate. According to the Bureau of Labour Statistics, the unemployment rate in 1944 was only 1.4 percent. Business was growing strong and so was the economy. In the 1970's and early 1980's, with operating costs rising, business began looking to outsourcing to save millions of dollars. Hundreds of thousands of jobs in the manufacturing sector were outsourced to third world countries. The unemployment rate, according to the Bureau of Labour Statistics, went from 3.5 percent in 1969 to as high as 9.7 percent by 1982 (2006, p. 1). Over the years, the blue-collar workers that had lost their jobs were retrained into white collar jobs in the service industry. The service industry, like the manufacturing industry of the past, was growing at an increasing rate as was the U.S. economy. As history repeated itself, this industry finds with increased growth came the increased cost of operation. Businesses once more are using outsourcing to balance their corporate budgets at the expense of the worker. Ellen Heffes (2007) finds that 2 million financial sector jobs will be outsourced by 2009. Alan Garner's economic review (2004,) stated that outsourcing in the service industry has increased to about 200,000 to 300,000 jobs annually and the loss of jobs is projected to reach 4.4 million by 2015. Alan Garner also states that "about 14 million service jobs were at risk of Offshoring in 2010, while about 96 million service jobs had a low risk of Offshoring." The former blue collar workers of the 70's and 80's, who retrained for the service industry, are at risk of losing their jobs all over again. With competition from younger better trained new graduates, the chance of finding employment is slim. They are at risk of losing their homes, possessions, and entire way of life.
It is obvious that in one hand the goal of any business is to create a profit and growth. If US can no longer support the needs of US based businesses, they must go elsewhere to find what they need to create success. Just as we citizens are given the right to pursue our aspirations, we must afford that same right to American businesses. However this practice is detrimental not only for the worker who loses his job but also for the country as a whole. How can they solve this problem?
The starting point is convincing people of the probability of re-employment. The U.S today employs over 130 million non farm workers. According to the OECD report (2006), despite the lowest employment protection legislation, it has the highest rate of re-employment of any OECD country by a factor of nearly two times. Over the past 10 years, the U.S. economy has created a total of 3.5 million new jobs per year. At this rate of job creation, the vast majority of displaced workers are re -employed within 6 months. What has made that possible is the flexibility in the job market and the mobility of workers across the country .The fact that offshoring offers a great opportunity for global wealth creation on the whole, and that the U.S economy will benefit disproportionately will not make the worries and anxiety go away.
A look at the facts reveals that the wealth created by offshoring does not completely offset the hardships it creates for some of those affected .Over the period studied (1986-2006) the bureau of labour statistics found that 31 percent of those jobs were displaced by trade and were not fully reemployed .The statistics reveal that 36 percent of displaced workers soon found jobs that matched or increase their former wages.
As a result, according to the bureau of statistics (2006), Offshoring is likely to increase in volume by 30 to 40 percent over the next 5 years. This will mean a loss of some 200,000 jobs a year in services over the next decade. So U.S policy and businesses need to reinforce the flexibility of the economy and soften the impact to those workers likely to be affected by offshoring.
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