Benefits and Problems of Outsourcing/Offshoring November 24, 2004 Outsourcing occurs when a company hires another company to do some needed work for it, instead of hiring workers itself and doing the work within the company. For example, a company needs to pay its workers, so it hires a payroll company to keep track of earnings, withholding, social security, and other benefits or deductions and to send the checks to the workers or deposit the money in their bank accounts. As another example, a company might hire another company to answer its telephone calls for customer service. In today's world, outsourcing often occurs across international borders. Moving business to another country is called offshoring. Because of the Internet, high-quality phone and data lines, cheap communications, and the availability of communications equipment in all countries, companies can hire another company in another country. The hired company and country typically have low wages, few regulations, little unionization, and large numbers of workers with good English, and they encourage overseas investment and partnerships. Outsourcing is only done to benefit a company by saving money and avoiding problems. The hired company is expert at doing that job, has knowledge of all laws and regulations, and can do the job cheaper and better. If a company can do the tasks itself more cheaply, then no outsourcing occurs. International outsourcing was not a big factor before 1990. In the early 1990s, American Express and other companies set up back-office operations in India, where many workers have good English and wages are low and the government encourages foreign investment as well as local high-tech enterprises. In the 1990's, the U.S. economy was doing very well, so such outsourcing was not noticed. The number of jobs leaving the United States was far lower than the number of jobs created in the United States economy. Loopholes in tax laws allow tax exemptions for companies operating overseas if funds are kept overseas. This promotes outsourcing and offshoring. In the 2000's, the American economy started to lose jobs, so the flow of jobs overseas became an issue. Now the economy is growing again but at a slow rate. It is predicted that the number of outsourced jobs will increase for many years. The total effect on the U.S. economy is not known. The Forrestor predicts the loss of jobs in America will only be about 0.2 percent of the labor force, which would be a small part of the unemployment rate. Perhaps 22 million new jobs are expected to be added between now and the year of 2010, and the number of those jobs going overseas would be a small percentage of that number. Outsourcing can have benefits for a country and its people, as well as for a company. More typically, outsourcing can cause problems for workers in a company and people in a country. Therefore, outsourcing has two sides, pro and con. The rest of this report lists the pros and cons. Pros * The main pro is that many American businesses using businesses and workers in other countries have better profits and lower costs. U.S. firms save money and become more profitable, benefiting shareholders and increasing returns on investment. McKinsey Global Institute has estimated that for every dollar spent on outsourcing to India, the United States reaps between $1.12 and $1.14 in benefits. For example, Delta Airlines outsourced 1,000 call-center jobs to India in 2003 and had $25 million in savings, which allowed the firm to add 1, 200 reservation and sales positions in the United States. Large software companies such as IBM, Microsoft, and Oracle have simultaneously increased outsourcing and domestic payrolls. If companies are in better financial health, they can hire more people. Current indicators show there has been a net increase in payroll jobs and in small business employment since 2003. * Companies in better financial health can also increase entrepreneurial activity, innovation, research, and development, and so build new jobs for the future. Sometimes technological innovation can result in a short-term loss of jobs, but typically it results in more jobs in the long term. The Federal Reserve Bank of New York suggests that the economy is undergoing structural transformation. Jobs are disappearing from old sectors (such as manufacturing) and being created in new ones (such as mortgage brokering). Such structural transformation from products to services allows more outsourcing activities, but also can lead to new and higher-paying jobs. * The standard case for free trade says that countries are best off when they focus on sectors in which they have a comparative advantage - sectors that have the lowest opportunity costs of production. Free trade allows all countries to increase their productivity, resulting in cheaper goods for everybody, with greater variety. The same idea holds for labor and people. Companies and countries find the most efficient distribution of labor, with the highest productivity per worker. High productivity can lead to economic growth. Catherine Mann of the Institute for International Economics estimates that the globalization of IT production has boosted U.S. GDP by $230 billion over the past seven years. Reducing barriers to labor movements, trade, and investment can benefit all countries through lower costs. Protectionism in trade and labor reduces global productivity. * When U.S. companies outsource, they can sell computers and telecommunications equipment, necessary for the outsourced function, to the hired overseas company. When foreign countries and workers make more money, it boosts overseas demand for U.S. products. * Typically, lower-skilled jobs are sent over seas, leaving higher valued jobs for the U.S. The average wage can increase in the U.S. U.S. workers often get more competitive, better paying jobs. For example, although 70,000 computer programmers lost their jobs between 1999 and 2003, more than 115,000 computer software engineers found higher-paying jobs during that same period. * The U.S. has long enjoyed the benefits of "insourcing" from overseas companies to American companies. Just as U.S. firms outsource positions to developing countries, firms in other countries outsource positions to the United States. For example; outsourced jobs increased from 6.5 million in 1983 to 10 million in 2000, but the number of insourced jobs increased even more in the same period, from 2.5 million to 6.5 million. Outsourcing works both ways, often to the benefit of both countries. Cons * The main con is that a country can lose jobs and wealth. Jobs previously done in the U.S. go outside the United States. IBM outsourced 3,000 IT jobs. * Another problem of offshore outsourcing is that people feel that their jobs are being threatened and lose morale and incentive. They think the situation is uncertain and unjust. This can cause unrest in a country. * Especially, lower-skill worker lose jobs. If they cannot be retrained or learn new skills, they may be out of work a long time. * More and more, high-skilled jobs are being sent overseas, such as R&D jobs. * Firms with excellent financial results are sending jobs overseas, though their own workers are doing efficient work. Such companies are jumping on the outsourcing bandwagon. * Unfair outsourcing can increase friction between people of different ethnic groups and result in political actions and attacks, not based on efficiency and productivity. * Free trade is a good slogan, but all markets must be regulated to be fair and work correctly. * In the case of telephone service, customers might complain about poor English, accented English, or delays. Communication gaps are also caused by cultural differences. * Often, the benefits and working conditions overseas are substandard. * Pollution controls overseas are lax. Pollution from overseas factories affects people's health, resulting in asthma and skin cancer. Also, workers have few health protections. * Temporary employees or employees far from the customer might have lower levels of expertise and give poorer service. * Outsourcing can hide the results of neglect, lack of vision, and poor processes. * Some multinational companies that outsource financial functions do not find it to be cost effective. Dan DiFilippo, performance improvement analyst at PwC, said "companies that turn to outsourcing for cost savings should conduct comprehensive feasibility studies to better understand their potential return on investment. Many companies enter outsourcing arrangements without conducting a proper cost-benefit analysis." Companies cannot calculate return on investment as well. * Perhaps in a short time, the wage differences will become small and the experiment in outsourcing will no longer be cost effective. The company will have to bring the jobs back to the U.S. Pay scales are rising fast in India and China for college educated, English-speaking professionals. To make offshoring work, it is estimated that a company needs at least a 300% to 400% wage spread for writers, engineers, accountants, and call-center employees. Conclusions Outsourcing and offshoring will expand over the next decade. Many have seen the negative effects toward the future of the U.S. economy. However, others think that outsourcing is beneficial in the long run, for the U.S. and all countries. Companies are taking advantages of outsourcing because it can save the companies the opportunity cost of production, increase productivity, and give them an international presence. Companies can focus on their core business, reduce risks, improve processes, gain an international presence, manage costs, and avoid capital investment. Consumers are happy because they can purchase products at a lower cost. However, the negative downside would be a crisis of unemployment in the United States, with reduced salaries. It is possible that the U.S. could benefit from the changes to the U.S. economy in the long run. Other countries can see a rise in employment, wages and working conditions. They can partner with more experienced international companies. And they can gain technical skills.