Have We Started to Consider the End of Outsourcing?

Outsourcing Page_16229722

Published in the Telegraph-Journal 7th December 2012

In recent interviews with business media, Apple revealed that it will begin to manufacture computers in the United States for the first time in years. “Next year we’re going to bring some production to the U.S.,” said Apple CEO Timothy Cook. This announcement comes on the heels of decisions made by companies such as General Electric which are moving some of their manufacturing operations back the U.S. after years of outsourcing their production offshore to countries such as China and India.

Reversing the offshoring trend —insourcing— to bring manufacturing back to the U.S. addresses a number of challenges: transportation is simplified and less expensive, intellectual property is more easily protected and costs can be managed with greater transparency closer to home. Companies are better able to manage innovation and productivity because they are more involved in the key elements of production. But these developments don’t mean that the era of outsourcing to offshore locations is over. Nor does it mean that jobs that have been offshored are coming back to North America in large numbers.

Many offshore outsourcing decisions were based on the single determinant of dramatically less expensive labour. In many cases, offshore labour was so cheap—fifty cents an hour against as much as $20 an hour in North America—that it compensated for higher costs and risks in other areas. Labour arbitrage may have been a determining factor for many firms seeking to reduce costs, but there are other advantages to countries such as India and China. Offshore labour generally lacked troublesome unions, and safety and environmental conditions tended to be less onerous than in the West.

There is another reason that many U.S. companies are reconsidering their commitments to offshore production. Any one of four critical risks can torpedo an outsourcing relationship: economic fundamentals, behaviour, execution and relationship management. Reviews of outsourcing relationships increasingly reveal that many were not well managed. Relationships frequently lacked common, shared metrics which then led to disagreements about quality. Overlapping operational and contract management roles contributed to interpretations of metrics that were overly dependent on management of the day. With no agreed objective measurement of performance, misunderstandings about success were often difficult to avoid. Maintaining an effective outsourcing relationship requires conscious ongoing investment of management expertise as well as financial. Since the rationale for offshoring was cost cutting, some firms were unwilling to contribute to that investment. Poor economic fundamentals often were unresolved.

Changes in the global economy have caused many firms that had been committed to offshoring to reconsider their options. The cost of fuel is one of those key changes. Shipping cargo is much more expensive than even ten years ago as oil prices have tripled. The cost of wages in China has increased exponentially and is forecast to rise at more than 15 per cent per year in the medium term. In the U.S., labour unions have become more compliant if not more acquiescent in the wake of the 2007-2008 financial crisis. Unions are more agreeable to making deals that reduce the costs of wages and benefits to corporations. Productivity has increased substantially in the U.S. largely as a consequence of robotics, computerized inventory control, voice recognition and online commerce. This trend has accelerated during the current recession with the result that productivity increases have compensated for higher labour costs. Labour has become a smaller proportion of the total cost of finished goods.

There is a dawning realization in many U.S. firms that management failures have been chiefly responsible for the reversal of commitment to offshoring and outsourcing of all kinds as the economics have changed in favour of bringing jobs back. Although much of American manufacturing many never return, the rebirth of even a portion of manufacturing will require a rethinking of the critical role of management to the survival of the firm.

Advertisements

Leave a comment

Filed under Economics, Foreign Direct Investment, Innovation strategy, Job creation, Labor force management, Offshoring

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s