Outsourcing

What It Means

Outsourcing occurs when one business firm hires another business firm to perform one or more jobs on its behalf. For instance, a software company, rather than hire its own accountants to work in-house, might hire an accounting firm to keep its financial affairs in order; the software company is outsourcing its accounting work.

Increasingly, the term “outsourcing” has taken on the meaning of the word “offshoring.” Offshoring is outsourcing to a foreign country where labor is cheaper. It has become extremely common for U.S. corporations to move portions of their operations to countries like Mexico, India, China, or the Philippines, where workers typically make only a fraction of the wage that Americans would make doing comparable work. Offshoring has moved millions of American jobs to other countries. For this reason outsourcing has become a very controversial topic and a major issue in the political arena.

When Did It Begin

In the middle and latter part of the twentieth century, corporations wanted to expand and vary their business holdings. A maker of processed foods, for instance, might try to grow by buying a business firm that manufactured lightbulbs, a firm that made movies, and a firm that provided life insurance. Among other benefits, these acquisitions would position the overall corporation to remain profitable in a wide variety of economic circumstances (if the processed-food business was in a slump, another sector could make up for those losses). Beginning in the mid-1980s, however, corporations increasingly found that running such diverse operations resulted in a lack of focus, and many corporations sold off subsidiaries (businesses they controlled), returning to a core group of businesses that took best advantage of their particular strengths. This idea of core competence (the centering of a business around the strengths that could give it an advantage over its competitors) became one of the driving concepts in the corporate world. Part of the streamlining that corporations undertook to establish a core competency led to the outsourcing of basic operations that could be more efficiently handled by an outside company.

The offshore outsourcing trend started in the 1960s, when U.S. companies began to move manufacturing facilities to Mexico and, later, to other global sites offering cheap labor. Even taking into account foreign trade restrictions and the added expense of transporting goods back to the United States, companies typically found that they could reduce costs by 30 to 50 percent by moving the physical production of their goods to less-developed countries. Some items commonly manufactured abroad at the time included clothing, household furnishings, and electronics. Increasingly since this time, U.S. companies that have offshored their production work have focused more on managing the company and on sales and other service components of their businesses: those aspects requiring more human judgment and contact with consumers.

More Detailed Information

Outsourcing offers many advantages. For instance, the software company that outsources its accounting duties might find that the accounting firm can get the work done more efficiently because that is their specialty; the accounting firm would probably also charge less money than the software company would have to pay to maintain its own accounting department. Outsourcing can also make a company more adaptable by allowing for staff reductions and a stable staff size. If the software company’s accounting workload suddenly doubles because new tax laws were passed, it can simply pay its partner accounting firm more money to take care of the extra work rather than undertake the cumbersome work of hiring several new in-house accountants and then firing them if, down the road, the accounting workload eased up.

Outsourcing enables companies to devote their energies to what they do best. This can be particularly important in the early stages of getting a business off the ground. A fledgling business is usually short-staffed, so delegating tedious, noncore tasks to other firms makes sense. Another advantage to outsourcing is that it can increase the level of accountability related to certain tasks. Because the accounting firm is being paid a fee, the software company can clearly demand excellence. If the accounting firm does not deliver an adequate level of service, the software company can terminate the contract and find another firm. The same issues are less clear-cut when working with in-house employees.

But the risks of outsourcing are real. The company that delegates its operations to another firm loses control over the end result. Though the company can fire the firm it hired to do the work, the firm might have done the work so badly as to cause irreparable harm before the problem is even discovered. While this may become less of a risk over time, as a company develops solid working relationships with its partner firms, the risk at the outset of an outsourcing relationship is substantial.

Offshoring is one type of outsourcing that has brought American companies clear gains, but it has raised the opposition of American workers, many of whom have lost jobs because of the practice. When a U.S. shoemaker moves its manufacturing facilities to the Philippines, the motive behind outsourcing is unmistakable: the shoemaker can pay much lower wages in the Philippines than it paid American workers. The outsourcing allows the shoemaker to cut a large chunk out of its operating costs and to make substantially more in profits.

When a company chooses to offshore its production facilities, it can have a domino effect on the industry: once a single shoemaker has made such a business move, competing firms have to do the same if they want to stay in business. With its operating costs dramatically lowered, the first shoemaker can set its prices as far below those of its competitors as it wants. It can easily drive its competitors out of business if they keep their manufacturing facilities in the United States. This model explains the inevitable nature of the most controversial types of outsourcing today. Without government intervention restricting such business practices, the market seems to make it impossible for companies to do otherwise than move American jobs to other countries.

Recent Trends

Although most people currently associate outsourcing with the movement of manufacturing jobs overseas, professional jobs, too, are increasingly being outsourced to countries where salaries are lower. Most notably, large numbers of high-tech jobs, such as computer programming, have been moved to India, which has a very educated but much lower-paid labor force than the United States. Some estimates predict that more than 3 million white-collar jobs will be moved overseas by 2015, representing a loss to American workers of roughly $135 billion. Accordingly, there is a great deal of popular opposition to the concept of outsourcing, and the issue has become increasingly central to national politics since the beginning of the twenty-first century.

Many economists and free-trade advocates argue, however, that opposition to the phenomenon of overseas outsourcing is short-sighted. According to economic theory, the world economy grows more efficient when high quality goods and services can be produced more cheaply. Additionally, some economists assert, the rise in income of workers in impoverished countries ultimately represents new markets for American products. From an economic point of view, to oppose outsourcing is to oppose the inevitable changes that capitalism brings, some of which have substantial benefits.