While sailing troubled waters companies are excused for being tempted by the siren’s call of outsourcing. “Cost reductions and staffing flexibility,” sing the treacherous creatures, “increased business agility.” After luring in their prey with the sweet promises of financial rewards, outsourcing can drag the company to the depths of the blue. But not all perish at the hands of outsourcing, and some find every reward they set out for – but they must know how to swim.
There has been an upsurge of outsourcing operations in the UK after a couple of years in decline, according to Duncan Aitchison, North European president of ISG, an outsourcing analyst. In the US the issue has become a political hot potato, with both incumbent and nominee wrestling for who is doing the most to prevent the dreaded loss of jobs. But the mechanics of outsourcing are often much more complicated than simply moving jobs or production lines from one place to the other and many companies fail when attempting it.
Whatever the reason to outsource any type of operation, there are as many potential pitfalls as bountiful rewards on the long road to success. Recent research suggests that all but the best-laid schemes will often go awry. Lyda Bigelow, from the University of Utah’s David Eccles School of Business, has led a team that found out that companies are more likely to fail when they outsource components critical to their competitive abilities. “This is a critical strategic choice that firms make,” Bigelow said. “Companies need to retain adequate control over specialised components that differentiate their products or have unique interdependencies, or they are more likely to fail to survive.”
It has been suggested that outsourcing can reduce labour costs between 25 and 50 percent. That enables companies that usually have slim profit margins to significantly increase the bottom line and keep shareholders happy. But it is easy to forget the underlying costs of the process. Bigelow’s research shows that the failure rate for companies that choose to outsource production is raised by up to 70 percent, depending on the level of risk the company is willing to undertake with technological changes, type of product being outsourced and its original market share.
According to Bigelow, in the current environment, extreme competition is forcing firms to shift their focus to the reduction of costs without compromising value to customers. But not everyone is successful. She cites as an example the recent case of Toyota, which in its haste to overtake GM as the biggest auto-manufacturer in the world outsourced a number of components in their vehicle’s electrical systems and accelerators. Toyota’s motivation was rapid expansion, and in order to achieve that they had to cut cost, but the cut corners were just unplanned side effects.
The wheels fall off
Toyota parts today come from as far afield as Japan, Thailand and the US, amongst others. The firm had developed a sterling reputation based on their strong and reliable links to their suppliers, but in their expansion bid, old partners were traded for cheaper manufacturers. Since October 2009, the company has recalled around 8.5 million vehicles because of factory defects, namely floor mat interference with the pedals, and a sticky accelerator. The recalled accelerator pedals were all produced by a factory based in Elkhart, Indiana, in the US; none of the pedals manufactured by the original supplier Denso Corp in Japan have shown any problems. It has also been speculated that a design shift in favour of an electronic throttle has been problematic. Most recently the company has announced it will be recalling as many as 412,000 additional cars for issues with the steering.
Toyota’s former president and current vice-chairman Katsuaki Watanabe has claimed that “the fact that Toyota is growing suddenly shouldn’t be used as an excuse.” But the company’s own research suggests that outsourcing at a time in which it sought to grow fast might have led to the company’s later issues because they had to rely on suppliers who often did not have sufficient incentives to maintain and improve quality.
“In this situation, it’s no surprise when things break down,” Bigelow said. “In 2004 and 2005, Toyota’s premier goal was to overtake GM. This desire for rapid expansion, combined with an increased level of complexity in its auto designs, left Toyota with few supply options, as generating an in-house infrastructure to accommodate the increased production would’ve taken years.”
Toyota’s outsourcing strategy broke one of Bigelow’s key rules; outsourcing parts of the operation that were integral for its overall success. In the long run the company might have achieved its goal of surpassing GM as the world’s largest car manufacturer, but the cost of the recalls are estimated at over $2bn – Not to mention the dent to its once unblemished reputation for great quality automobiles.
Outsourcing has become a political nightmare in the US right now, where the Obama camp has latched on to Mitt Romney’s past role as chief executive at Bain Capital, a company charged with outsourcing US manufacturing jobs to China. Romney in turn accuses the incumbent of depleting American jobs himself. Because it is election year, every American company who partakes in outsourcing has been pushed under the microscope, and Apple has been no exception; it has been on the receiving end on some extremely negative press. Criticism mostly revolves around American jobs having been lost when faced with the low wages paid to the staff at the Foxconn factory in Southern China where the iPhone is assembled.
In making the iPhone, Apple has outsourced its parts to countries that have the cutting-edge technology and highly skilled labour they require for the most intricate and sophisticated pieces of its product. About 30 percent of the iPhone is produced in Japan, and 17 percent of it is made in Germany, where the precision manufacturers are paid considerably more than in the US. A further 13 percent is made in South Korea, where wages are on par with those paid in America. Apple still employs 43,000 people domestically; most are designers, lawyers and financial managers who can earn considerably more than the median wage. However, 700,000 people are employed overseas.
Critics fail to mention that important components of the iPhone are made in advanced technological facilities in developed countries where salaries are at least comparable, if not higher, than those paid in the US, because the technology and level of skill required for the production of precision parts in its smartphone are not readily available in their homeland. But the iPhone’s assembly line is indeed in Shezhen, China, where it costs Apple under $7 per phone. So cheap labour is part of the equation but not the only part.
A tough call
There are countless reasons why a company can choose to outsource some of its services or parts of its production line. A recent survey by The Outsourcing Institute listed the top reason as “to reduce and control operation costs”; the third most cited reason for outsourcing was “to gain access to world-class capabilities”. This seems to reinforce the notion that companies have evolved past being anchored to one town or country and instead have evolved into “global networks that design, make, buy and sell things wherever around the world it’s most profitable for them to do so,” according to Robert B Reich, of the University of California, Berkeley, in his popular economics blog.
According to Reich, companies seldom feel bound to any particular place; Keith Bradsher and Charles Duhigg of the New York Times cite an unnamed Apple executive as saying: “We don’t have an obligation to solve America’s problems. Our only obligation is making the best product possible.” Unfortunately, it seems that at least for Apple, the best possible product cannot be made in the US any more. “America isn’t educating enough of our people well enough to get American-based companies to do more of their high-value-added work here,” explains Reich. For him, until countries can make their labour force competitive and highly skilled again, they will continue to experience job migrations to greener pastures.
However, that is certainly not the case when it comes to call centres, often the trend-setting sector when it comes to outsourcing activities. Over the past two decades it would have seemed impossible to call any form of customer service helpline, be it for a bank or an electric goods manufacturer, and not be greeted with the friendly tones of the East. India was the destination of choice for business process outsourcing (BPOs) facilities like call centres because of its cheap and adequately skilled labour. In 2010, the last year for which figures are available, BPOs generated $5.5bn for the Indian economy and over 330,000 people were employed in the industry.
But as India has continued its growth spurt, so too have the costs of outsourcing business process facilities there. Many countries are moving their operations elsewhere. The Philippines have emerged as the clear winner from India’s losses: from 2006 the average annual growth of the business process outsourcing in the Philippines has been 46 percent.
In 2001, the industry generated $350m in revenues; this figure shot up to over $10bn in 2011, according to a survey by IBM. The Philippines have also surpassed India in the number of people employed in business processes, with an estimated 600,000 people being hired in 2010 alone, according to the Business Processing Association of the Philippines, a local trade group. The same research suggests that the number of call centres in India has fallen by as much as 50 percent over the past three years. Call centres make up 70 percent of the BPOs in the islands. Businesses are attracted to the low operations cost of IT outfits in the islands and the high-level language skills. American businesses are also interested in the huge pool of proficient English speakers in the Philippines, who are reported to have more Americanised accents than call centre workers in India.
At your service
But a new trend has been emerging in the customer service industry that may well threaten the survival of call centres everywhere. The process, known as ‘unsourcing’, involves companies taking advantage of their own customers to provide the same services as the laborious call centres, for a fraction of the cost. By harnessing their consumers’ knowledge and experience through internet forums and communities, on their own website or even Facebook or Twitter, customers are being put in touch with others who have bought and used the same products. The peer-to-peer helping mechanism can provide significant advantages, like huge time-savings for the customers who won’t need to phone up and wait in a call queue, and perhaps more significantly labour costs are sharply cut as advice and guidance is provided by unpaid customers themselves. There are, of course, limits to the scope of services that can be provided by unsourcing, for example, an internet forum will never be able to resolve billing issues, but the potential for savings is still vast.
Vodafone, Logitech and GiffGaff have all reported tremendous success in the unsourcing experiences, but TomTom has reported the greatest gains yet. The satellite navigation system is said to have reduced their customer services costs by nearly $150,000 by turning to social media in the handling of 20,000 cases in their first two weeks of unsourcing.
Though it might not be as simple as it sounds, in order to create a successful avenue for customer service online, the company needs to foster an approachable online image, as well as invest in building a community around its brand. Like Bigelow’s research suggests, companies that do not look beyond labour saving costs will not be successful in this strategy. “Across the board, we find statistically significant increases in the failure rate for firms that don’t consider transaction costs in their outsourcing decisions,” said Bigelow. “Firms need to look beyond production costs to other costs such as poor quality, delivery delays and risk of price increases by suppliers.” But the benefits are there to be reaped; research by Gartner suggests that savings can run up to 50 percent by using online communities to solve support issues.
Whatever the type of business a company engages in, be it auto-manufacturing or electric goods, it is likely that at least a portion of its operations will be outsourced, from parts to customer service. And while debate about the practice will always be healthy in improving it, it must be remembered that there is more to outsourcing than mere job losses and savings in labour costs. It can help companies with small profit margins increase their bottom line, and thus reward shareholders back home.
Proponents of outsourcing also point to the fact that as a company grows, any jobs lost in manufacturing are likely to be adequately made up for by jobs gained in design and administration. But only a well-thought-out strategy, properly prepared and executed will prevent a company from succumbing to the hidden costs of outsourcing.
