offshore

4-5b Offshoring versus Not Offshoring

As noted earlier, offshoring—or, more specifically, international (offshore) out- sourcing—has emerged as a leading corporate movement in the 21st century.30 Outsourcing low-end manufacturing to countries such as China and Mexico is now widely practiced. But increased outsourcing of high-end services, particularly IT and other business process outsourcing (BPO) services, to countries such as India is controversial. Because digitization and commoditization of service work are enabled only by the recent rise of the Internet and the reduction of international communication costs, it is debatable whether such offshoring proves to be a long- term benefit or hindrance to Western firms and economies. Proponents argue that offshoring creates enormous value for firms and econo-mies.31 Western firms are able to tap into low-cost yet high-quality labor, translating into significant cost savings. Firms can also focus on their core capabilities, which may add more value than noncore (and often uncompetitive) activities. In turn, off- shoring service providers, such as Infosys and Wipro, develop their core competencies in IT/BPO. A McKinsey study reports that for every dollar spent by US firms’ offshoring in India, the US firms save 58 cents (see Table 4.3). Overall, US$1.46 of new wealth is created, of which the US economy captures US$1.13, through cost savings and increased exports to India, which buys Made-in-USA equipment, software, and services. India captures the other 33 cents through profits, wages, and taxes.32 While acknowledging that some US employees may regrettably lose their jobs, offshoring proponents suggest that, on balance, offshoring is a win-win solution for both US and Indian firms and economies. In other words, offshoring can be conceptualized as the latest incarnation of international trade (in trad- able services), which theoretically will bring mutual gains to all involved countries (see Chapter 5). Critics of offshoring make three points on strategic, economic, and political grounds. Strategically, according to some outsourcing gurus, if “even core functions like engineering, R&D, manufacturing, and marketing can—and often should— be moved outside,”33 what is left of the firm? In manufacturing, US firms have gone down this path before, with disastrous results. In the 1960s, Radio Corporation of America (RCA) invented the color TV and then outsourced its production to Japan, a low-cost country at that time. Fast-forward to 2010: the United States no longer has any US-owned color TV producers left. The nationality of RCA itself, after being bought and sold several times, is now Chinese (France’s Thomson sold RCA to China’s TCL in 2003). Critics argue that offshoring nurtures rivals.34 Why are Indian IT/BPO firms now emerging as strong global rivals to Western firms such as IBM? It is in part because they built up their capabilities doing work for IBM in the 1990s to fix the “millennium bug” (Y2K) problem. In manufacturing, many Asian firms, which used to be original equipment man- ufacturers (OEMs) executing design blueprints provided by Western firms, now want to have a piece of the action in design by becoming original design manufacturers (ODMs) (see Figure 4.5). Having mastered low-cost and high-quality manufacturing, Asian firms such as BenQ, Compal, Flextronics, Hon Hai/Foxconn, and Huawei are indeed capable of capturing some design function from Western firms such as Dell, HP, Kodak, and Nokia. Therefore, increasing outsourcing of design work by Western firms may accelerate their own long-run demise. A number of Asian OEMs (such as Taiwan’s HTC), now quickly becoming ODMs, have openly announced that their real ambition is to become original brand manufacturers (OBMs). Thus, according to critics of offshoring, isn’t the writing already on the wall? Economically, critics contend that they are not sure whether developed econo- mies, on the whole, actually gain more. While shareholders and corporate high- flyers embrace offshoring (see Chapter 1), offshoring increasingly results in job losses in high-end areas such as design, R&D, and IT/BPO. While white-collar individuals who lose jobs will naturally hate it, the net impact (consolidating all economic gains and losses including job losses) on developed economies may still be negative. Finally, critics make the political argument that many large US firms claim that they are global companies and, consequently, that they should neither represent nor be bound by American values any more. According to this view, all that these firms are interested in is the cheapest and most exploitable labor. Not only is work commoditized, people (such as IT programmers) are degraded as tradable com- modities that can be jettisoned. As a result, large firms that outsource work to emerging economies are often accused of being unethical, destroying jobs at home, ignoring corporate social responsibility, violating customer privacy (for example, by sending medical records, tax returns, and credit card numbers to be processed overseas), and in some cases undermining national security. Not surprisingly, the debate often becomes political, emotional, and explosive when such accusations are made. More recently, as the cost of producing in China rises because of rising labor cost and unreliable quality, some Western firms have brought back the work back to their home countries—a process known as reshoring.It is important to note that this debate takes place primarily in developed economies. There is little debate in emerging economies, because they stand to gain from such offshoring to them. Taking a page from the Indian playbook, the Philippines, with numerous English-speaking professionals, is trying to eat some of India’s lunch. Northeast China, where Japanese is widely taught, is positioning itself as an ideal location for call centers for Japan. Central and Eastern Europe gravi- tates towards serving Western Europe. Central and South American firms want to grab call center contracts for the large Hispanic market in the United States.

Business process outsourcing (BPO) Outsourcing business processes to third-party providers.

Source: Based on text in D. Farrell, 2005, Offshoring: Value creation through economic change, Journal of Management Studies, 42: 675–683. Farrell is director of the McKinsey Global Institute, and she refers to a McKinsey study.