The competitive reasons for outsourcing

* How offshore outsourcing affects competition

A few weeks ago, when writing about companies shifting call center work back in-house, I touched on how outsourcing affects competition as well as the broader economic impact of jobs going offshore. Recently, I read this letter to the editor in the Fredricksburg Free Lance-Star titled “Why outsourcing jobs overseas is on my company's agenda, too”.

It was great to see the CEO of a non-IT company discuss the competitive reasons for outsourcing its IT. He writes firsthand about many of the same issues and outcomes I have discussed.

There are two levels of impact at play in the dialogue about the economic affect of offshore outsourcing. Business majors may remember taking freshman micro and macro economics. Microeconomics deals with how individuals, households, and firms make decisions to allocate limited resources. This is sometimes called the “bottom up” view of the economy. In this case, the factors affecting a single company in deciding to keep functions in-house or outsource.

Macroeconomics deals with the behavior of the economy as a whole, once all of the individual economic decisions of companies and industries have been summed. Economy-wide phenomena considered by macroeconomics include Gross Domestic Product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, price levels, and balance of payments between countries. This is the top down view. In the case of outsourcing, the impact of jobs moving offshore, growth of the economy in countries outsourcing work and countries taking on the outsourced work, etc.

So let’s look at this letter to the editor first from a microeconomic view and then from a macroeconomic view. Right from the start the author acknowledges the assumed negative macroeconomic impact of offshore outsourcing to the United States, but has made a microeconomic decision in the best interest of his business based on the facts at hand.

We can’t blame anyone for making the best individual decision. Capitalism is based on the fact that everyone will behave that way. Because this company must compete on cost and productivity to survive, it had to make a decision for the best value contrasting costs and service levels delivered. In this case, that meant outsourcing offshore to India. It has apparently received excellent infrastructure run by smart people for a great price.

Additionally, the expanded global approach has brought this company more business. The author discusses increased business opportunities in Asia and India.

While this 2,500 person company cut 9 IT jobs, it has expanded its core business of water treatment by 30 employees. At the microeconomic level, this decision looks like the right one.

The macroeconomic view of this editorial is even more interesting. I love the way the author admires the energy, drive and work ethic of the Indian people and how he compares it to America 100 years ago. There is a benefit to the U.S. economy as U.S. companies sell into the larger Indian and Asia economies as they grow, in part from offshore outsourcing. This is sometimes lost in the louder dialogue about lost jobs. But the author of this letter to the editor captures the essence of the problem…we have lost our edge and our drive and that has to change if we are to keep jobs here.

A recent study by the Conference Board, the same organization that creates the consumer price index and index of leading economic indicators, reveals one of the keys to domestic competitiveness - productivity. The study shows that lower cost resources in common offshore destinations also have lower productivity. So 80% labor cost savings may only yield 20% total cost savings when productivity is factored in. Use of technology can increase productivity. As wages rise and more infrastructure is applied in the offshore locations, both costs and productivity will increase.

While the American standard of living leaves little room for significant labor cost reductions, working harder and smarter will increase productivity and close the total cost gap.

So instead of complaining about all the jobs going offshore, understand and even be glad that companies are making the right microeconomic decisions for individual businesses. Rising costs in the offshore labor market and productivity gains in the domestic labor market will cause the cost advantages to neutralize over time.

Companies should be sure to consider productivity as well as cost when considering offshore outsourcing. A better deal may exist in your own backyard.


Copyright © 2006 IDG Communications, Inc.

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