One of the most controversial (and least understood) issues in business and politics is outsourcing. Politicians condemn it, businessmen defend it, but rarely does anyone step back and take a dispassionate look at why it occurs at all. What are the incentives compelling over half of tech executives (as just one example) to put more of their operations in the hands of overseas workers? Today, we’ll sidestep the rhetoric, scapegoating, and press releases to examine 12 factual reasons companies outsource their operations.
The most compelling financial incentive to outsource operations is lower wages. Simply put, the average United States employee in just about any field earns more per hour (or in yearly salary) than their Third World counterparts. IndustryWeek.com, for instance, reports that “even after doubling between 2002 and 2005″, the average wage for a manufacturing worker in China was still “only 60 U.S. cents an hour.” Earning a slightly higher (but still paltry by American standards) wage is the average Mexican manufacturing worker, at $2.46 an hour. Needless to say, an executive whose primary obligation is delivering maximum return to his shareholders is strongly motivated to outsource such operations as can be outsourced without unacceptable losses in quality.
Lower Regulatory Costs
An under-appreciated incentive to outsource is the high regulatory cost of employing a United States worker versus a foreign worker. Social Security, Medicare, FICA, OSHA regulations, unemployment insurance and a whole host of other government-imposed costs make employing local workers less attractive in light of overseas talent, for whom none of these costs must be paid. In his book Bringing The Jobs Home, economist Todd Buchholz argues convincingly that occupational licensure laws also drive up the cost of American workers in licensed industries – without commensurate social or safety benefits. Everyone knows outsourced workers command lower wages, but it is worth remembering that American workers are generally still more expensive even if the wage discrepancy is ignored.
The desire to minimize corporate income taxes is an undeniable impetus to outsource. Overseas countries are aware of this desire and offer generous tax incentives to companies that outsource their operations there. Whether in the form of regional tax benefits or reduced income taxes, such incentives are difficult for companies to ignore in their hiring decisions. Companies with entire offshore subsidiaries benefit even more from what is known as “unrepatriated earnings”, or revenues that remain in the outsourced country. The TechPolicy Blog quoted a bipartisan Congressional Research Service report claiming that unrepatriated earnings “had increased to $639 billion in 2002 from $403 billion in 1999.”
Ability to Downsize at Will
One of the biggest driving forces behind outsourcing is the desire to avoid damaging lawsuits. As the Dallas-Business Journal noted in 2007, employee lawsuits against employers are and have been rising. One of the factors at work here, according to the Journal, is that “employees are becoming more educated about employment law.” This makes life difficult for executives as regards downsizing, which is virtually never popular but is sometimes necessary from a strictly business perspective. Rather than reacting to market forces as they deem appropriate, some companies avoid downsizing due to fear of employee lawsuits. Therefore, a major financial advantage of outsourcing is the ability to upsize or downsize at will.
A common view of outsourcing holds that the work performed is obviously lower in quality than U.S. workers, but this is justified by lower costs. While this is sometimes true, it is by no means clear that it is always true. In a survey of companies that outsource, InformationWeek found that 20% of those surveyed named improved IT performance as a major reason they outsource. Many of us who have had frustrating phone calls with overseas support staffs might disagree, but the data is clear. It goes without saying that improved performance often lowers costs and/or raises revenues, creating yet another financial incentive to outsource.
Freeing up Resources For Core Activities
An unspoken assumption in many critiques of outsourcing is that the savings are simply gobbled up the CEO or shareholders. However, perhaps just as often, the savings freed up by outsourcing are devoted to the company’s core activities – that is, what they do best and most profitably. From an executive’s point of view, there is no reason for, say, McDonalds to spend priceless capital doing its payroll when the savings from outsourcing can buy more advertising, furnish new equipment or finance a new product launch. Far from simply enriching the company’s owners, savings from outsourcing often goes toward shoring up the company in other areas.
Another financial edge offered by outsourcing is risk management. As HorizonTech.com states, outsourcing ” enables management to turn over to its suppliers certain classes of risks – such as demand variability and capital investments.” Such risk transferrance is made difficult or impossible by working with contracted or salaried U.S. employees. For instance, if a company wants to launch a new product, it can either hire new employees in-house or utilize outsourced talent to get the job done. The in-house employees are now on payroll, and will need to be paid regardless of whether the new product sells. Ditto for their Social Security, FICA and the other government costs discussed earlier. Outsourced talent, on the other hand, can be dropped in a heartbeat if product sales do not justify continuing to pay them. This is just one example of how companies use outsourcing as a risk management tool.
Quicker Turnaround Time
The oldest saying in business is “time is money.” What this means from an outsourcing perspective is that just because a company could do something in-house, it does not follow that they should do it. Nor are immediate monetary savings the only issue. Let’s say a startup wants to expand, but now needs a professional accounting or logistics system to do so. It can take a considerable amount of time to get these systems up and running in-house, between recruiting, interviewing and training the required personnel. In the meantime, the needed functions are not being performed and the company is worse off. Outsourcing sometimes offers a way out of this vexing corporate problem by offering faster turnaround times than establishing new, in-house departments or systems.
Uncertainty Over Political/Business Climate
A 2008 InformationWeek survey found that 25% of CFOs polled listed “uncertainty about the political and business climates” as a reason they outsource. Justified or not, fears about higher taxes, more regulation, unstable currency and political interference in business activity are demonstrably affecting how companies make their hiring decisions. Beyond the immediate cost savings, executives are increasingly looking years (even decades) into the future and outsourcing their operations as a hedge against potentially adverse political changes in the U.S.
Accelerated Time to Market
A timeless business axiom is that the first to market often claims most of the market share. This explains yet another financial incentive to outsource: accelerated time to market. By offering access to workers who are already trained, experienced and ready to perform the exact tasks you need, outsourcing can help companies release new products faster than if it relied exclusively on in-house talent. With so much long and short-term profit riding on time to market, any advantage in this regard looms large in corporate decision making.
General assumptions about outsourcing usually involve huge, household-name companies laying people off to save money. But these cases aside, it should be noted that small businesses are increasingly turning to outsourcing as well. A major reason involves “commodification”, or the ability (made possible largely by low-cost outsourced vendors) of smaller businesses to pay incrementally for services previously available only to larger businesses. In these cases, outsourcing is used not for immediate savings, but to grow at a more rapid pace than prior eras allowed. SmallBizTrends.com discusses this and other items in its article “The Top 10 Outsourcing Trends by Small Businesses in 2009.”
Finally, outsourcing also offers peace of mind when contracts are entered into by the company and the outsourced provider. Rather than being limited to firing or disciplining ineffective employees in-house, outsourced providers can be made to compensate the company for its negligence, poor performance or failure to finish a job. A legally binding contract specifies the precise nature of the work, its timeline for completion and any other loose ends that may exist, but are routinely obscured or unaccounted for when working with in-house employees.