Why Companies Outsource Services - Assignment Example

Why Companies Outsource Services Introduction Globalization involves an increased openness in the international business relations, an integration of markets on a worldwide basis, and a movement toward a borderless world. The sources of globalization are varied and include the technological advances, liberalization of trade policies brought into force over the past decades. Of all the sources, the chief source of globalization is the technological advances that have significantly lowered the costs of transportation and communication and dramatically lowered the costs of data processing and information storage and retrieval. Electronic mail, the Internet, and the World Wide Web are some of the manifestations of this new technology. While these are the evident aspect of globalization, the meeting of minds across the constraints of culture and language has also become a reality. Globalization has also spawned outsourcing, which is the new-found paradigm of companies that seek to lower their cost of operations. The biggest factor that any business manager would look for before investing is current and future stability of the business and both short-term and long-term benefits from the business. This is particularly so when a new business is being established in a country. The thrust in globalization and free market strategies has seen many countries opening up their economy to foreign industrial powers. What was once protectionist markets have evolved in many countries, into highly competitive markets that give equal opportunities to both national and international players. As part of the strategy to open up their resources to foreign countries and to attract foreign investments many countries have devised new plans and modified their laws so as to keep up with the times. Such actions have to be followed through by concrete actions which will contribute to building the trust of an investor and making him feel that his investment is safe in that particular land. Outsourcing as a management strategy is not a new concept. Companies have earlier used outsourcing by calling it the name ‘subcontracting’ – OEM (Original Equipment Manufacturers, system integrators and subcontractors have helped management in completing projects on time by providing the necessary skill and resources, particularly in automation and control systems. [Meyers, 2002] The need for outsourcing The communication and information technology (IT) revolution of the late 1990’s revolutionized the business processes from product design and planning to distribution and customer service, fuelling an increased demand for knowledge and IT skills to make the best use of technologies. Traditional manufacturing and service companies seldom had the resources –man and machine power – to meet the new economy demands and began ‘outsourcing’ not only technology and basic business services, but also value addition in each of the business areas. The new service providers, therefore, had to collaborate with the manufacturer in almost all areas and manufacturers often shared their goals strategies, and objectives with suppliers. This led to a new sort of relationship between the user and supplier, which came to be called as ‘outsourcing’. Outsourcing is defined as the ‘strategic use of outside resources to perform activities traditionally handled by internal staff and resources’. It is a management strategy by which an organization outsources major, non-core functions to specialized, efficient service providers [Cited Meyers, 2002]. Although the majority of the growth in outsourcing activity has arisen from areas outside of automation and the plant floor, such as IT and Business Process Outsourcing, popularly known as “BPO”, the fundamental concept of outsourcing also applies to the manufacturing settings and extends to HR, Accounting and other business functions. Based on a study conducted in top 300 global companies on the outsourcing trends, Pricewaterhouse Coopers report that 73% of the companies have outsourced at least one process. [Palle, 2004] Some of the reasons that prompt companies in deciding to outsource services include: Focus on core competencies and key activities Inadequacy of resources and non-availability of trained IT staff Incapability to adapt and adopt new and fast paced technology advancements Global competition - the presence of techno-savvy players with lower operating cost structures pressurizes the company to improve technology base so as to be competitive Down-sizing resulting from merger of business or business restructuring Utilizing the available manpower for other tasks For increasing the profitability and efficiency of business processes Enhancing the infrastructure capabilities so as to be comparable with world standards Increasing the capital fund reserve for business growth and infrastructure development [Palle, 2004; Meyers, 2002] Of all the different factors listed above, the most apparent and common factors that drive companies towards outsourcing in today’s business scenario include increased automation, tapping the global virtual markets, and the decreasingly availability of highly-skilled employees. Organizational advantages of outsourcing We are all aware from the happenings around us that the mechanics of doing business in the modern world has undergone a drastic change. This has been in particular to the approach in which a given task is executed. Managers in most companies are realizing the need to adopt a modular approach to attain their company’s manufacturing objectives. Companies a few decades ago concentrated on the manufacturing process in a more comprehensive manner in the sense that they had their own manufacturing unit that produced accessories to their main product. Companies were divided into divisions that took care of all the products that the main product would require. The political, social and economical influences over the industrial scenario have made many managers to rethink this strategy and have made them to look at processes in their company in a new perspective. They have learnt to identify and differentiate processes and have found the most suitable way of executing that process. Today the managerial objective is to modularize the total manufacturing process of a company and to break it down to manageable, inter-plugable units. Today the decision-makers in a company are more interested to concentrate on or develop, what is called as the company’s core competence. Core competence and outsourcing Modern day managers have utilized the knowledge of the core competence of a company to leverage its prospects in national and international markets. Managers adopt the strategy of encouraging their company’s core competence, and outsourcing services which they think can be done in a better manner by another firm. By adopting this strategy the company maximizes its resource utilization in four demonstrable ways. It maximizes returns by focusing on what the company does best It prevents the entry of competitors, because the sheer expertise of the company gives the competition a hard time. It fully utilizes external support which would take considerable time and money if the company was to duplicate the same service And finally, it reduces production cycles, costs and risks and increases customer responsiveness Since a successful company is usually involved in many diverse fields of operation, its core competence may be classified according to the role that it plays. The types of competencies can broadly be classified according to the results obtained from the studies mentioned before. Core competence may be classified as per the following criterion. 1. Superior technological know-how 2. Reliable processes. This can be manufacturing processes or process like in a service industry and 3. Close relationship with external parties Superior Technological know-how means the technological expertise that a company has. It is usually seen that technological know how arises from a continuous exposure of the company to a particular technology or domain. For example the best automobile manufacturers today are those which have been in existence for decades. Superiority in technology is due to the company’s work culture that stresses at continuous research and development. There are also many companies in our world that has perished because it took technology for granted and did not pay attention to research and development. Technological superiority is the catalyst to growth because this enables the company to penetrate more markets and discourage its competitors. It manifests as company profits and the trust of customers worldwide. A Reliable processes enables the company to deliver its wares in the most efficient manner quickly and consistently with least inconvenience to its customers. Reliability is particularly important in international transactions because, international business is always associated with inconsistency and mistrust partly due to geographical locations and partly due to the inherent business practices and bureaucracy. When customers require a customized product, the company must be able to maintain its reliability in providing a solution even to the extent of breaking up its current design and incorporating the necessary changes. Such requirements will depend on the modularity of the processes that the company pursues as its development policy or strategy. The services of Citicorp are an example, which shows how reliability can increase the reputation of a company globally. A close relationship between external vendors, suppliers and other business associates will help the company to bolster its growth by mutual associations and partnerships. This action also would compel potential competitors to reciprocate such behavior. A favorable consideration by vendors will surely boost business. Many companies encourage vendors to be a part of their research and development team. This has a psychological effect on the vendor, who sees the company as a real partner. The company also benefits from the relationship, because the vendor may be able to suggest critical modifications to the final product. Suppliers may be able to inform the company about better parts and how it would increase the overall performance of the final product. This also helps to keep the company abreast to new technology and challenges by way of gossip or market trends The need for finding new markets for the product In the modern world, where the business environments are in a constant state of flux, companies can no longer remain content by restricting their business in the home country. They need to expand their business into other countries and have to find out new markets and customers, who would buy their products. Of course many foreign government policies are not always open to allowing foreign investors in a country and hence, have their own systems, which frustrate the foreign country's designs to dominate the local market. However, such protectionist markets are becoming very rare due to the changed economic situations in the world, where internal as well as external pressures are forcing protected markets to open up to foreign investors. The performance of the company can be assessed in terms of three models of business analysis that can predict the direction in which a particular industry as a whole is moving. These models predict the ground realities that exist in a business environment, and also help companies to take adequate and firm decisions based on informed decisions gained from environmental inputs. Porter’s five forces model In Porters five forces model, the industry is seen as being influenced by five complimentary forces that essentially decides the feasibility of a business venture. These five forces are supplier power, barriers to entry, buyer power, and threat of substitutes and rivalry Porter’s generic strategy model The generic strategy model speaks of applying strategies in terms of cost leadership, product differentiation, and market focus. The company operations may be explained in terms of these variables in different ways. Cost leadership efforts were certainly taken by the firm because it had various products that catered to the different sections of the society. It had premium brands as well as brands that were meant for the cost conscious customers. However, the company adhered to the principle of creating all its products on one platform that would offer peripheral variations according to the need of the local customers. This perhaps added to the total costs of the company because it meant that the products, whose quality being uniform throughout, could not be sold at a lower rate in markets where the cost benefit was much less Resource based view The resource based view advocates that the company must use its resources in the best possible manner in order to actualize better profits Economics of outsourcing According a 2003 research by Forrester Research the percentage of offshore outsourcing for U.S. IT budgets increased more than double -- from 12 percent in 2000 to 28 percent in 2003. The META Group predicts that offshore outsourcing would increase at more than 20 percent annually [Hyman, 2003] Many people believe that outsourcing is not a big drain on the economic reserves of a country. The most important reasons that compel a company to outsource its facilities are cost savings as well as localization. For example big multinationals can outsource localization programs and strategies to local companies who can do the work at much lower rates. The economic parity and the huge difference in the dollar conversion rates is a very important fact that makes outsourcing such a compelling option for many companies [Prewitt, 1994]. For example an average worker may be hired in India for less than 200 dollars a month, which is a tremendous cost-saving option. Seamless integration of services is another factor that appears attractive for firms thinking about outsourcing their jobs to local companies. For example companies can spend a fraction of their establishment cost and setup factories in countries like India where manpower is cheap. The cost involved in setting up an overseas shop will soon be retrieved because the company can save a lot of money in terms of lower salaries. Similarly many of the Asian workers need not be paid benefits that would have been a must for employees in the US. Another very important reason why companies in the US are turning to Asian countries is the fact that many of these nations are already international hubs as far as specific business are concerned. For example, India is considered to have software and BPO potential. Similarly, Hong Kong and Taiwan has a well experienced and thriving electronics industry that can transfer much of their experience to firms that are planning to set up shop in these countries. Firms need only to invest and maintain a supervisory role while the local governments in these countries arte ready to offer industrial sops and concessions for these companies to set up shop here. In terms of operational efficiency, one advantage that India has is that the standard of written and spoken English in this country is pretty high and people are eager to learn the American accent to help them perform their work. This is a very big advantage that most other Asian countries cannot provide. Many companies in the US have become more open to outsourcing because of the fact that they can use the services and time of their staff to concentrate on more creative and strategically important works while mundane and routine works can be given to the local workers. Based on a study conducted in top 300 global companies on the outsourcing trends, Pricewaterhouse Coopers report that 73% of the companies have outsourced at least one process. Some of the reasons that prompt companies in deciding to outsource services include: - Focus on core competencies and key activities - Inadequacy of resources and non-availability of trained IT staff - Incapability to adapt and adopt new and fast paced technology advancements - Global competition - the presence of techno-savvy players with lower operating cost structures pressurizes the company to improve technology base so as to be competitive - Down-sizing resulting from merger of business or business restructuring - Utilizing the available manpower for other tasks - For increasing the profitability and efficiency of business processes - Enhancing the infrastructure capabilities so as to be comparable with world standards - Increasing the capital fund reserve for business growth and infrastructure development [Palle, 2004] Of all the different factors listed above, the most apparent and common factors that drive Companies towards outsourcing in today's business scenario include increased automation, tapping the global virtual markets, and the decreasingly availability of highly-skilled employees Experts claim with statistical proof that the productivity gains and savings have resulted in value creation to businesses as well as new job generation, thereby benefiting the US economy. A summary of the finding is listed below to gain insight on the economic impact of US outsourcing from India, on the US economy. Offshore outsourcing to India has resulted in quality and productivity gains of the order of 15-20 percent to the US companies. US banks, financial services and insurance (BFSI ) companies have saved US$6-8 billion in the between 1999 and 2003 as an IT outsourcing to India. These savings have helped companies to prevented layoffs and further add 125,000 more jobs. Added to this is the benefit of enhanced customer satisfaction of almost 85% due to off shoring to India in comparison with their European competitors, enabling The IT Enabled Services (ITES /BPO) market is expected to reduce to US Dollar 142 billion in 2009, against the 2003 estimate of US$532 billion for the services. Thus US Economy is expected to gain a net savings of US Dollar 390 billion from off shore outsourcing. The savings would benefit the common man in the US as new jobs will be created Nearly 170 Indian IT companies have physical establishments in the US. Indian IT companies in the US, providing IT Services have contributed to the US economy by employing nearly 60,000 people in the US in 2001. These 60,000 people paid nearly $810 million in taxes, federal and local, in 2001. The employees in the Indian IT companies bought goods and services worth $1.2 billion in the US in 2001. The companies have also paid nearly $300 million for social security in 2001. [Kurien, 2003] Of the total contribution of US Dollar 16.8 billion from Indian IT sector, IT outsourcing contributes USD 10-11 billion. Adverse impacts of outsourcing Economists and market experts have contradictory views regarding the impact of outsourcing on the national economies, particularly the US economy, which outsource the skill and assets from India or other countries – some consider it beneficial, whereas many consider it adversarial. This has led to legislative reactions at the state level in New Jersey, Connecticut, Hawaii, Maryland, Michigan, Missouri, North Carolina, and Washington to prohibit offshore outsourcing of government work. The main argument raised against outsourcing from the economic perspective is the loss of jobs to Indian counterparts [Strassmann, 1995], which leads to unemployment and loss of revenue to the US economy. In fact, the global debate on outsourcing is becoming shriller considering the fact that job opportunities are coming down in many developed countries. While people in those countries which receive the projects feel that outsourcing is a boon, others in the developed nations feel that outsourcing can be a major cause for concern. Ethical issues Outsourcing often gives rise to ethical issues that can create problems that are beyond management of economics. Nike, which outsources most of its manufacturing tasks to other companies, had to face stiff public censure for possibly encouraging labor practices that provided very little compensation to the workers. Most of Nike’s shoe and apparel manufacturing units are situated in the Asian region where the labor costs are far less when compared to rates in the US. Additionally, the workers in the Asian region are less organized, are constrained to work at lower wages in order to overcome poverty and familial pressures, and so were easily available even if the conditions in the factories were pathetic according to US labor standards. The main issue that often came in for public criticism was that Nike used the services of ladies who could be paid much less in the Asian job markets. Similarly, the peculiar societal culture in the Asian region ensured that large numbers of ladies were available to take up the jobs offered by Nike's business associates in these countries. Another serious allegation which rocked the business prospects of the company was that Nike's business counterparts in Pakistan used child laborers to make footballs. The fact that child labor is banned and considered unethical in the developed nations was a major factor that turned public opinion against the company. The factories that partnered with Nike also paid much less attention to safety standards of its workers. While their American counterparts attended to research and development activities in the relative safety of their offices in the US, the contract workers were exposed to chemicals and strong scents in very hot and humid conditions. The chemicals with which they dealt were quite harmful to the body and could pose serious diseases that affected the skin, lungs and even the reproductive organs. That the workers paid scant respect to the insufficient safety procedures in the factories pointed to the fact that they were either not informed of the harmful effects of the chemicals, or they were much less concerned for safety when faced with the question of their livelihood. Either way it was plain exploitation of cheap labor and abundant manpower. The ill treatment of workers who often had to work under great mental pressure in the factories was also a great concern that attracted media attention. Workers, especially women, were often rebuked and even assaulted by their supervisors and they had to work for long hours in order to keep their jobs. Often women had to commit to extra hours of unpaid duty in order to confirm to the strict productivity requirements within the company. The pay parity in the companies was also a very big issue when compared with the American standards. The stakeholders of the company and the general public of the United States were particularly peeved at the fact that women had to put in long hours of work in exchange for a pittance for their efforts. In short, Nike’s manufacturing units witnessed human exploitation and economic opportunism that provided rich dividends to the company. Similarly, Setting up operations in different parts of the world has its associated issues and problems. Different cultures, many languages, legal issues, different attitudes and work ethics have to be considered while managing operations globally. Human Resource Management is a vital issue in Global Operation Management as it is not always possible to deploy manpower from the host country. Local personnel have to be employed. This requires training of the personnel. Moreover, the local culture, language and attitudes have to be understood by the corporate management. The legal and ethical issues of the country in which the operations are set up should be taken into account. Company laws, labor laws, tax laws and environmental regulations vary from one country to another. The management should be well conversant with these laws Materials management and Supply chain management is another important aspect in any operations. When operations are moved, material availability, logistics, warehousing and distribution should be taken care of. [Dornier, Phillipe-Pierre, March 1998] Conclusion Outsourcing is a management strategy that is aimed at controlling costs and increasing value to the company. Companies resort to outsourcing once they identify their core competence. Core competence of a firm has a tremendous impact on its policies and business strategies. It may be asserted with certainty that the cut throat competition and one-upmanship between companies has an underlying need to prove its core competence to its competitors and its customers. Since the objective of any business is to develop a loyal customer base, this competition seems justified. Companies are working day and night to develop competence either in response to a demanding situation or in expectation of an emerging opportunity. Core competence is the driving force behind any business. It is therefore no surprise that companies are spending huge amounts of money to maintain its competency in a particular field. Outsourcing effectively supplements this strategy by isolating the firm from repetitive work that can be performed by other firms. This allows the firm to concentrate its efforts and resources on the task that it performs best. Outsourcing, while providing many benefits to the firms, also throws up economic and ethical issues. This is because outsourcing can also lead to exploitation and lowering the work standards of a region. References 1. Meyers, Jeffrey T. Why Companies Outsource Services: Opportunities and Challenges, 2002 Available at: http://oeiwcsnts1.omron.com/pdfcatal.nsf/0/6B03B04F72D268E186256B7D007AC07C/$File/OutsourcingArticle.pdf?OpenElement 2. Palle , Nagi Offshore Outsourcing: Competing in a Global Economy Current Trends and Practices in Offshore Outsourcing, 2004. Available at http://www.globalchicago.org/reports/ccfr/Offshore%20Outsourcing.asp 3. Prewitt Milford, (1994), Real-estate out-sourcing a boon for small companies, Nation's Restaurant News, August 29 4. Hyman, Gretchen (2003) Overseas Outsourcing Hurts U.S. Economy, Says Firm: March retrieved from http://www.internetnews.com/ent-news/article.php/2118191 on November 19, 2004 5. Strassmann, P.A. (1995) Outsourcing: A Game for Losers, Computerworld. August 21. 6. Kurian Vinson (2003 ) US firms save billions by off-shoring to India': The Hindu Business Line July 2003 7. Donier, Phillipe-Pierre, Global Operations Management and Logistics, Wiley John & Sons March 1998 Read More