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Rising to the offshoring challenge--part 2: in the nonstop drive to outsource more and more activities overseas, there's a golden opportunity for supply chain managers.

Last month's Insights column examined the dynamics that are driving a rapid increase in the scale and scope of "offshoring"--the practice of outsourcing business activities to providers overseas. This month we take a closer look at what it all means for today's supply chain professional.

The past several months have produced a flurry of stump speeches, editorials, op-ed pieces, and semi-investigative journalistic endeavors on the departure of manufacturing and service jobs to offshore locations. When While House economist Gregory Mankiw suggested that outsourcing jobs to foreign countries was a form of trade and good for the U.S. economy, the roof fell in on him. His comments reflected good economics but poor politics in an election year.

One presidential candidate even used the term "Benedict Arnold CEOs" to describe executives who outsource jobs out of the United States. Congress has already passed legislation that prevents companies bidding on certain work done by government employees to move that work overseas. Waiting in the wings is the Defending American Jobs Act, United States Workers Protection Act, USA Jobs Protection Act, Jobs for America Act as well as a host of state legislation to limit offshoring. This is the political dimension of outsourcing that will probably rise to a steady drumbeat as election day nears.

As Dr. Mankiw discovered, the political perils of outsourcing trump several hundred years of business experience and economic theory. It is not our purpose to try to reconcile the economics camp with the political camp. This would be an overly ambitious (and probably even quixotic) goal given the positions of the two camps. So we will wait until after the election in hopes that some economic rationality might suddenly appear in the political discourse over the outsourcing issue.

If the reader accepts the premise that outsourcing overseas will continue to expand, the issue at hand becomes the successful integration of the global supply chain network. A recent article in the Wall Street Journal described a successful example of integration with the development and launch of a new Hewlett-Packard server product. The product idea was hatched in Singapore and approved in Houston. Initial concept design was done in Singapore with the engineering design completed in Taiwan. Final assembly took place in Singapore, Australia, China, and India. An HP spokesman noted that the decisions on where and how to make and market the product were driven by a combination of logistics, tariffs, and labor cost.

The point of this brief example from HP is to highlight a few key facts:

* The offshoring decision is not driven exclusively by lowest labor cost.

* Tariffs play an important role in the location of manufacturing facilities.

* Logistics costs and performance can be a key factor in regional and national flow of parts, services, and finished goods around the globe.

* The interplay of factors that determine the least cost, highest performance supply chain differ from month to month depending on the corporate planning cycle.

Recognizing the Pitfalls

Before discussing some of these points, it probably makes sense to identify the pitfalls of offshoring. The first major pitfall is appropriation--specifically, the danger of choosing an outsourcing partner that appropriates technology, code, or manufacturing techniques without your permission. The danger is further heightened by the lack of intellectual property protection in many developing economies. The risk of technology or manufacturing appropriation could also include a corresponding risk to the outsourcing firm's core competencies. (In one interesting wrinkle, China agreed to purchase GE engines but required GE to provide proprietary technology as 'part of the purchase contract.)

A second major pitfall relates to the ratcheting up of cost saving expectations. The literature suggests that the services of a computer programmer, call center manager, or even a radiologist can be acquired offshore for just a fraction of the cost of a domestic employee. The reality is that when total costs are factored into the outsourced operation, actual savings reported, though still significant, are more modest--typically in the range of 30 to 50 percent.

A third pitfall is that offshoring simply does not work for some companies. The nuances presented by complex programming, applications development, tech support, or customer-service response can more that offset the cost savings of offshoring. To date, we've not seen any formal large-scale study of failed offshore relationships. But there seems to be a growing base of anecdotal evidence that describes failed or significantly modified offshore business relationships.

A fourth pitfall centers on the potential for serious backlash against offshore initiatives. As noted earlier, job retention is a popular cause for election-minded politicians. So, too, for some of the more militant unions concerned with job security. Finally, consumers may target specific domestic products or service offerings of firms that replace domestic workers with offshore labor.

Perhaps the greatest potential pitfall is the challenge of integrating globally dispersed partners into a high-performance supply chain. The addition of software, information applications, and services to the supply chain mix only complicates the integration task. Until the outsourcing/off shoring surge, most companies managed their own information resources in house. Or in some cases, they outsourced their hardware and software to a domestic company such as IBM or EDS. Yet even then, the service provider typically assigned their people to the customer's facilities to manage the activity. In the new business model, however, the employees of the outsourcing company can be thousands of miles and multiple time zones away. Today, an offshore supply chain partner providing specific manufactured products could be replaced much easier than a supply chain partner that develops and maintains your information infrastructure.

How Will You Respond?

Regardless of how many politicians choose to hurl themselves into the breach, outsourcing and offshoring will continue to grow as they have since the Industrial Revolution. It's important to remember that outsourcing grows in both directions. In the last decade alone, consider the tens of thousands of jobs created in the United States by Honda, Toyota, BMW, and Mercedes. Think about the value of U.S. exports of legal work, computer programming, telecommunications, banking, engineering, management consulting, and other professional services. The figure reported in 2003 by the U.S. Commerce Department was $131 billion--an increase of $8.43 billion over 2002.

Of course, all of this is small consolation if you're one of the 2.2 million people who lost their jobs to offshoring over the last three years. The politicians ranting about the evils of offshoring might spend their time and energy more productively by creating effective job training programs and boosting innovation and entrepreneurship in the U.S. economy.

The bottom line is that the new wave of offshoring makes supply chains more complex, creating both a product and information dimension to the supply chain manager's challenge. Longer supply chains crossing countries, cultures, and time zones increase the risk but also increase the payoff to the business enterprise. But there's also some very good news here for supply chain managers: Those that can rise to the challenge will find an enhanced role in bringing value to their organizations.

Bernard J. "Bud" La Londe is professor emeritus of logistics at The Ohio State University.
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Title Annotation:Insights
Author:La Londe, Bud
Publication:Supply Chain Management Review
Geographic Code:1USA
Date:Apr 1, 2004
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