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Drivers and imperatives influence outsourcing and offshoring
This assignment highlights about the various drivers and imperatives influences outsourcing and also critically analyze the factors that influence offshoring and outsourcing. In addition, the article also analyses the outsourcing and offshoring in the context of international trade theory and also global issues and institutions affecting outsourcing. Further, outsourcing and offshoring problems and sources of competitive advantages are also critically analyzed.
In a world trade, international outsourcing has become a growing phenomenon. According to the evidence from 10 OECD countries data and also from emerging markets, outsourcing alone accounted for 21 percent of countries exports in the vertical chain (Hummels et al., 2001). According to Willcocks et al., 1995 (p.334), IT outsourcing has been defined as “handling over to third party management, for required results, some or all of an organization IT, information systems (IS) and related service.”
Further, Global Outsourcing has been defined as “Any contribution to a client organization by one or more external vendors with a different country of origin in tangible, intangible, human and /or non-human resources related to the IT infrastructure” (Palva and Kumar, 1998, p.1). Several studies have been conducted to evaluate whether the outsourcing met their expectations and one such survey conducted by Laucity & Willocks (1998) revealed fifteen categories of expectations / reasons for sourcing. Table 1 illustrated the drivers of outsourcing among US and UK companies.
Drivers of outsourcing
Although there are a number of drivers has been listed, there are five core areas has been in favor of outsourcing. The five areas include added flexibility to respond to demand changes, market discipline through greater transparency access to state of the art technology, cost control, and business can focus on core technology (Clott, 2004). However, so far listed drivers are available from the companies who are successful in outsourcing as companies are not interested in reporting their failures. This has been reported by Barthelemy (2003) as “the outsourcing seven deadly sins of outsourcing.”
Factors influence outsourcing
- Strategic critically and impact (McFarlan, Porter and Miller, 1985) means firm’s success depends on the control mechanism
- Uncertainty related to technology which means outsourcer avoid into ‘fixed’ contract (Ang, 1993; Richmond et al. 1992)
- Complexity of functional particularly between client and the vendor
- Knowledge related to procedure
- Documentation related to performance
- Specificity related to assets
- Cultural proximity
- Environmental uncertainty
- Infrastructure of the host country IT
Although there are a number of benefits in terms of outsourcing, there is still criticism exists such as globalization of labor force and its effect on organization and individuals and change in employment pattern (Clott, 2004).
Further outsourcing will turn organization from vertical to virtual, and as the business climate dictates, expenses can move up or down where employees do not have fixed employment When labor markets are unionized, there is a consequence for international outsourcing where complaints may arise due to the flow of outsourced work to offshore. In addition, home country workers may become better off owing to increased wage rate due to international outsourcing (Skaksen, 2004). Wage and the level of employment also considered as an important threat or potential due to global outsourcing. Outsourcing has been associated mostly with information technology. India, particularly Bangalore has been considered as an important outsourcing provider due to its advanced processing skills and lower cost (Clott, 2004).
Problems and Issues in Outsourcing
In terms of technological innovation, traditionally the USA became the leader. However, due to outsourcing, the application of renovation developments in information technology has been decreased significantly (Hira 2003). According to Power Bonifazi, Desouza (2004) developing market will observe every labor in ten in the US software industry. This is not only applicable to labor but also wages, which is approximately 3.3 million of the 136 million dollars (Benkovic, Robert, 2004). Moving jobs overseas can be more expensive even though bargain basement labor rates constitute a significant part of outsourcing cost. However, saving from outsourcing cannot be more than 50 percent as per the optimistic opinion, and moreover, it needs a huge upfront investment and take years of effort. For example, the United States saves 20% by outsourcing from their total cost, but from these outsourcing activities lower productivity and the poor process can diminish potential savings according to bargain basement labor law, thus, with long-term payback it would be regarded as a long-term investment.
The cost of outsourcing is affected by various factors, first, in addition to the annual cost of the deal, the expenses of selecting service providers yield the cost from 0.2% to 2%, which mainly consists of negotiating a contract, evaluating the responses and documenting requirements. Secondly, the main burden of outsourcing is the cost of transition, which takes a long time to hand the work over to an offshore partner which is minimum for the period of 3 months to a full year. Third, on temporary visas, offshore employees work in parallel with similarly costly in-house employees during the training period. Fourth, necessary infrastructure has to be built before ahead. Fifth, much more money is demanded by the offshore providers than they are paid. For example, Indian companies are paid around 10US dollars. However, they demand for 20US dollars an hour for employees. Further, there is a significant amount of money lost due to the cost of layoffs were for in-house employees company has to be paid severance and retentions bonuses. Moreover, layoffs result in work slow down and disaffection and with offshore replacements; in-house employees are required to share their experience (Konusu, n.d).
The productivity for the offshore savings is affected significantly by cultural and language factors. Further, due to lack of developer experience by offshore vendors, the process takes more money and time to complete the task, which rises in 20 percent costs due to a deficiency in productivity. Another important factor in diminishing the productivity is higher turnover. In India, attrition rate increased to 35 percent according to the report from National Association of Software and Service. Further, work turnover is affected due to additional payment to offshore vendors to learn firm’s products, which raise the expense as 1 to 2 percent. There is also increase in the cost of 2 to 5 percent due to language and other cultural differences. Another additional costs such as insuring, auditing, invoicing which are expenses related to managing the actual relationship and offshore contract pose extra burden to outsourcer (Ener, D, and Yelkikalan, N, n.d)
Due to globalization effect, the model of outsourcing is an experienced trend and not has been made and furthers due to high global trade usage and goods exchange and also to maintain balanced resources the outsourcing the impact is worldwide. Every process or model or product has its own life cycle to reach maturity, and on both the ends, outsource and outsourcer there is always loss and gain. Thus, outsourcing would seem more benefits than losses if it is managed the system, relationship, engagement, and communication properly. The quality, timeline and cost advantage can be experienced if driving the offshore engagement with clear coordination and understanding.
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International Trade Theory and outsourcing
The theory of competitive of advantage such as two-factor, two-commodity (and two countries) scenario is emphasized in the international trade theory. Trade theory emphasizes that two countries are made better off by sharing the same technology and engage in wage rates and free trade but subject few pathological exceptions. Although there is a difference in the endowment of capital between two countries, the two countries would absorb an inflow without any effect on the wage rate (Jones, n.d). Further, the theory admits that the individual factors can actually lose and capital and labor share differentially in the gains from trade. Nevertheless, from out of the gains from trade, factors that lose can still in principle be fully compensated for loss (Stolper and Samuelson 1941).
This theory was particularly applied to outsourcing and offshoring. This theory was tested in several empirical studies conducted both in developed and developing countries. According to the study conducted by Sayek and Sener (2001), found that outsourcing increases the demand for unskilled labor in South and for North, it reduces the demand for unskilled labor. Further, the study conducted by Hummels et al. (2001) studied the comparative advantage of China, where both China and the United States benefit equally in ξ. I increase. The benefits for these countries are significant in absolute terms, within each country, the distribution of the benefits amongst the economic agents and finally between the two countries, the benefits are distributed.
Economists say that outsourcing will be effective in the welfare increase in the long term than it causing unemployment. Further other group says that international trade theory will be not applicable to today’s scenario particularly to outsourcing as due to a significant amount of loss labor in the United States. Into the outsourcing agenda, there are different issues raised, and they are as follows
- Prohibition to outsourcing as significant loss of labor and factories also closes
- The labors are transferred to foreign countries
- Due to result of WTO and NAFTA, there is stiff competition for the countries in low-income category resulting tariffs and taxes on the outsourcing labor (Ener, D, and Yelkikalan, N, n.d)
It has been posed that the regulations of WTO and NAFTA and the USA free trade should be canceled and replaced by trade policies in countries, where employees do not belong to any trade union and the environmental condition. However, high technology outsourcing gets prevented due to the cancellation of NAFTA and WTO. The outsourcing today has been adopted by USA administration and observed it as a method of new international trade (Ener, D, and Yelkikalan, N, n.d)
Although there are issues regarding outsourcing, outsourcing has been phenomenal in terms of cost reduction. The loss of labor is temporary which can bring new labor in future, that in turn enhance USA economy’s labor force. Today, countries are moving towards on research, development and infrastructure activities in order to provide long-term growth particularly the countries like European Union (Ener, D, and Yelkikalan, N, n.d)
According to Wright and Boschee (2004), “the success of these offshore providers of outsourced IT derives in large part from two economic trends.” Firstly, due to the recession, US concentrated mainly on their core skills, while outsourced wide services with technology leading the way to developing countries which are not integral to their mission.
Secondly, with an eye on the price of technology, businesses have focused on cutting costs, due to revenues shrinking or flat. This has been a great cost advantage to countries like India which capitalized on these trends with excellent technology. Indian employees are paid lesser than workers in the US but with the advantage of excellent quality is a secret of reduced cost structure. This affected the United States largely as most of US workers, politicians and American Technical workers complained bitterly about the outsourced workflow to offshore due to US employment slump (Wright & Boschee, 2004).
The major challenge in outsourcing is work organization where knowledge can be shared across borders and only between traditional separate lines. The line of separation should be between private and government, research & development and operational units, and between managers and employees. Further, there is a significant effect on service production and knowledge based product in future due to global outsourcing. Agarwal et al. (2003) stated three ways where companies can boost their capital productivity without comprising the wage.
- Hiring cheap labor with compromising quality rather than purchasing expensive products. For example, American Express hired software person to reconcile their accounts
- Automation reduction. For example, instead of using expensive imaging software, employees can check the input manually.
In order to gain full potential benefits by reaping offshoring companies have found a variety of cost structure to increase their revenue. Webster (2004) lists the tips for arranging offshore operations via vendor in order to avoid pitfalls of offshoring
- Exit strategy should be designed so that if the goals are not met properly, this helps the company to get back their contract. For example month to month contract terms
- Employees should be told about cost savings and domestic job reduction
- Companies should not outsource their core competencies to offshore operations
- Before relocating their offshore may be sophisticated or simple, companies have to measure worker performance, quality, and results.
- Outsourced companies need to employ own managers on-site in order to monitor the work being done for security performances and lapses.
- If companies are setting up an offshore subsidiary, the international law needs to be consulted about the laws related to tax and labor.
- Accounting regulations should be reviewed with regards to operations of offshore
Although there are issues regarding outsourcing, outsourcing has been phenomenal in terms of cost reduction, the loss of labor is temporary which can bring new labor in future, that in turn enhance USA economy’s labor force. Today, countries are moving towards on research, development and infrastructure activities in order to provide long-term growth particularly the countries of the European Union.
Agrawal, V., Farrell, D., & Remes, J.K. (2003). Offshoring and beyond. McKinsey Quarterly, 4. Retrieved from web11.epnet.com
Benkovc R.S. (2004). Comparative Analysis of Prohibiting vs. Tolerating Outsourcing, English 2003, April 8.
Barthélemy, J. (2003). The seven deadly sins of outsourcing. Academy of Management Executive, 17(2), 87-100.
Clott, C. B. (2004). Perspectives on global outsourcing and the changing nature of work. Business and Society Review, 109(2), 153-170.
Ener, D & Yelkikalan, N (n.d) Outsourcing as a business strategy and its role in International trade, 127-135 Retrieved online
From http://girisim.comu.edu.tr/dergiall/eskisyilr/2in1/yelkikalan.pdf Gottschalk (2006), P E-business Strategy, sourcing and governance. Idea Group of publishing Retrieved from web http://bib.tiera.ru/dvd57/Gottschalk%20P.%20-%20E-Business%20Strategy,%20Sourcing,%20and%20Governance(2005)(351).pdf
Hummels, D., J. Ishii and K.-M. Yi (2001), “The nature and growth of vertical specialization in World Trade”, Journal of International Economics, vol. 54, pp. 75-96.
Hira R, (2003). Recent Trends and Possible Implications, Testimony of P.E. Chair, Research and Development Policy Committee The Institute of America to the Committee on Small Business United States House of Representatives on Global Outsourcing of Engineering Jobs, 18 June.
Jones, R.W. (n.d) Immigration vs outsourcing: effects on labor markets Retrieved online From http://www.sas.rochester.edu/eco/Faculty/jones/Immigration_vs.pdf
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Power Mark, B.C., & Desouza, C.K. (2004). The Ten Outsourcing Traps to Avoid, Journal of Business Strategy, 25, (2), 37-42.
Samuelson, P. A. (1971). Ohlin was Right, Swedish Journal of Economics, 73, 365—84.
Sayek, S., & Sener, F. (2001, October). Dynamic Effects of outsourcing on Wage inequality and skill formation. Presented at the International Conference METU, Ankara, Turkey, September 2000; Eastern Economic Association Meetings, New York, March 2001; and at the Union College Economics Seminar. Retrieved from http://idol.union.edu/senerm/Research/Outsourcing_wages_10_01.pdf
Skaksen, J. R. (2004). International outsourcing when labor markets are unionized. Canadian Journal of Economics, 37(1), 78-94.
Willcocks, L., Hindle, J., Feeny, D., & Lacity, M. (2004). IT and business process outsourcing: The knowledge potential. Information Systems Management, 21(3), 7-15.
Webster, S. (2004, June). Offshore. CFO, 45-76.
Wright, S., & Boschee, K. (2004). The offshore IT provider is under fire — Will the US company be next? Employee Relations Law Journal, 30(1), 60-64.
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