The Ohio State University

onCampus

• Help
• Buckeye Link
• Map
• Find People
• Webmail
• Search

  Search Ohio State Go

John Gray, Fisher College of Business

Posted on | September 23, 2009 | 2,732 views |

What are outsourcing and offshoring?
Good question; the terms are often misused. Outsourcing refers to the act of turning over an activity (e.g., manufacturing, IT, call center) to a separate company, regardless of the location in which the activity is performed. Offshoring refers to the act of locating an activity in a separate (usually low-wage) country. Offshore outsourcing refers to doing both.

What are the trends in outsourcing, offshoring and offshore outsourcing?
Outsourcing and offshoring have been around for a long time and they are here to stay. Outsourcing has increased in the last two decades for various reasons, including companies being encouraged to focus on their “core competence,” the increasing technological complexity of products and service offerings (making it difficult for one firm to be the best at everything) and technological advances that have made the management across organizational boundaries easier. Offshoring has also been increasing for many years, due to liberalization of trade policies, ease and costlessness of information transmission due to the Internet as well as the improvement of capabilities and infrastructure in many low-cost countries. High shipping costs due to oil prices in 2008, a spate of quality recalls since 2007, issues with intellectual property, rising costs in China and other destinations as well as a feared loss of innovation capability have all caused some rethinking of offshoring. Even GE’s CEO has recently called for a reindustrialization of America. Overall, it seems that the growth in offshoring is slowing to some degree.

What are some of the downsides?
The benefits are fairly clear, at least with offshoring, which usually benefits firms through lower costs and/or learning about a potential new market. Outsourcing often is about cost, but is also about getting specialists to perform work better than can be performed in-house. The potential risks of both outsourcing and offshoring are numerous but often are harder to quantify and articulate than the benefits. For example, my research has shown that both offshoring and outsourcing can pose a quality risk, which is difficult to quantify. Both outsourcing and offshoring create distinct coordination challenges. Outsourcing involves dealing with a separate company with its own objectives. Providers have been known to sell their services below cost to win the business, especially in situations where the buyers will be locked in to a relationship due to the necessity of relationship-specific investments and/or the lack of a competitive provider market. Offshoring also poses numerous risks. With manufactured goods, there is increased risk of supply disruption due to the sheer length of the supply chain as well as possible port shutdowns, etc. And shipping costs are a larger percentage of costs and are subject to change due to fluctuations in oil prices.

Further, exchange rate fluctuations and local tax policy can have a significant impact on profitability. For example, the Chinese government (as of 2008) was phasing out the tax refunds it gave to many traditional manufacturing industries. These refunds were on the order of 10 percent of sales — a big change. And the rapidly evolving local labor market can cause problems. Wages have increased steadily in China in the last few years. Numerous firms who have offshored IT work to India have faced extensive employee turnover — quite detrimental in knowledge-intensive work. All in all, the risks and downsides are real but often underappreciated. Much of my research has been to rigorously identify and quantify these risks, as well as approaches to mitigate them. However, the presence of these risks does not mean that offshoring and outsourcing are not often the right thing to do — the savings and other benefits often far outweigh these risks.

Comments