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Globalization–Transforming the Way America Works

Globalization is transforming the way America does business as firms increasingly rely on an international workforce for goods and services ranging from pharmaceuticals and electronics to telemarketing and financial analysis. What are the key drivers of outsourcing overseas and why is it happening now? What will be the impact on the U.S. economy and American workers? What challenges and opportunities does this create? How will outsourcing affect opportunities for MBAs, and how is the Business School responding to trends in outsourcing? Dividend asked four Michigan Business School faculty to discuss the ramifications of outsourcing/moving a process or function across a firm's boundary and offshoring or outlocating, which involves geographic boundaries. The following is a condensation of their discussion.
Panelists are:

  • Izak Duenyas, the John Psarouthakis Professor of Manufacturing Management and associate dean for faculty development and research
  • Robert Kennedy, clinical professor of corporate strategy and international business and associate director of the William Davidson Institute (WDI)
  • C. K. Prahalad, the Harvey C. Fruehauf Professor of Business Administration and co-chair of the Center for Global Resource Leverage: India
  • Dennis G. Severance, the Accenture Professor of Computer and Information Systems

       

Dividend: What is offshoring and why has it become such an important topic?

Severance: Offshoring is a phenomenon of outsourcing, which has been around since we started thinking about vertical integration -how much a firm should do inside. Work is going to India and China for two reasons: Transportation has become more reliable, and communication costs have dropped. Also, the perceived risk has gone down. Workers in India, China and other countries are doing the same jobs better, less expensively and more reliably than we can in the U.S. We also have developed methods for and feel more comfortable about managing talent overseas.

Kennedy: Is this a continuation of past trends? For example, 40 percent of the people worked on farms and then moved to factories, 40 percent of the people worked in factories and then started moving to services. Is this fundamentally different?

Severance: It is more of the same except it is hitting very close to home, affecting our graduates and other highly trained professionals.

Duenyas: If you look at it from a value chain perspective, you are looking to see whether you can add more value to the service or manufactured good you produce through outsourcing. In the manufacturing sector, companies have long asked what portion of their value chain can be outsourced. For a manufacturing company today, the strategic questions are: What parts are core to the company? What parts can someone else make? In what location do we make it? A company has to consider the value chain and calculate the costs. Services are now going through the same types of analysis and decision making.

Prahalad: It also is important to recognize new characteristics of outsourcing. One is remote delivery of services via telecom network. With IT and other services, your work and response can be real time, changing the character of how you fragment your value chain. By breaking the value chain in new ways, a company can get better service, higher quality and more speed in addition to lower cost.

Dividend: What should businesses do? How do they assess opportunities and adjust to succeed in a truly global marketplace?

Prahalad: The outsourcing movement is challenging the way you run a company, everything from how you create business processes to transaction processing. This presents a challenge for vendors and large global companies. How do we manage internal processes? How do we build a network of sup- pliers so there is no such thing as outsourcing? This forces us to come to terms with what is really the boundary, the basic footprint of the firm.

Kennedy: For example, moving software activity or payments processing offshore offers a much greater cost advantage than moving manufacturing offshore. Typically when you move auto parts offshore, you save 20 percent to 30 percent. When you move software development offshore, you save 60 percent to 80 percent once you have the infrastructure in place. In the past you would get somewhat lower productivity offshore, which was outweighed by the cost savings. Now, some suppliers are seeing productivity actually increase. In the call center business, low-end centers in the United States typically recruit people without high school educations. Turnover is 100 percent to 150 percent per year. In India, they won't interview you unless you speak fluent English and have a college degree, so there are tremendous cost savings and quality improvements. Also, the unit of analysis is much smaller. In manufacturing, we move a whole factory or outsource a large part of the value chain. Now some firms are moving specific jobs, perhaps only three or four, which is blowing apart the value chain. How do we disperse all these activities around the world and then reintegrate them?

Duenyas: I think we can look to manufacturing for valuable lessons about outsourcing. When decisions are made on cost alone, without considering the effect on the whole supply chain, companies typically fare worse. When there are separate purchasing, quality control and logistics departments, all their incentives are different. I worked with a company that changed from a U.S. supplier to a Brazilian firm; the switch was made on price alone. They didn't check on quality, which added enormous costs. Firms that take into account quality, cost and responsiveness in their supply chain and value chain analysis gain a distinct advantage.

Prahalad: The good news about outsourcing services, especially call centers and software transaction services, is that quality standards are set by the vendor, not the customer. Vendors are setting standards that are far ahead of what customers are used to. The first thing Indian software companies do is look at the business practice and say we can bring you to the modern age if you let us. Most firms' business processes are not well documented. Outsourcing forces firms to become more efficient, transparent and better documented.

Severance: I agree that outsourcing requires better documentation but think you need to distinguish between large and small companies. Most large corporations are well run. This kind of discipline is being brought to small organizations.

Prahalad: What the Indians, for example, bring is a methodology on how to document. This underlying methodology is not well understood. For example, it may be a small piece of work involving 50 people. To decide what should be done on site and off site requires a methodology, as does handing over a process from an American company to an off-site location.

Kennedy: In the 1990s, U.S. firms thought a lot about core competence and outsourcing. GE employs 30,000 people overseas, a number that is increasing quickly. I think the benefits you cite–routinizing the task and defining the information flows and processes–also can occur when done within a firm. You must put these structures in place if you are going to operate remotely. Bechtel operates with a huge number of engineers overseas, as do GE, pharmaceutical companies and many software firms. Much of the work is crossing geographic and firm boundaries, to India, the Philippines, Uruguay, Morocco and Costa Rica.

Dividend: Suddenly India and China are big players in the global marketplace. Why and how important will this be?

Prahalad: India and China have one often-overlooked competitive advantage–the magic of large numbers. When you have a billion people, it changes the game. Imagine an India with 200 million college graduates (only 16 percent of India's population) and 500 million technically trained people (carpenters, electricians and software-maintenance types), which represents only 40 percent of India's population. Imagine a labor pool of 200 million people. It is beyond our comprehension. In the United States, 35 percent of people go to college so at most we can have 70 million college-educated people. For the first time we are starting to say population may not be a disadvantage if you know what to do with it.

Duenyas: India has two important advantages: the early-mover advantage and English is widely spoken there. A Finnish company recently moved its call center to India because it had the infrastructure, an example of the early-mover advantage. Because Indians don't speak Finnish, the firm relocated Finnish college students to India to answer the phones.

Severance: Speaking English is important currently because the largest markets at this time are English-speaking countries. India's advantage is certainly difficult to match: a society that values diligent work and is well educated.

Dividend: What should other countries do if they seek to emulate India?

Severance: There are alternative models for outsourcing work. You talk of GE hiring 30,000 people overseas. You see firms like Dow experimenting with corporations that are headquartered in Singapore, India, Ireland or Israel. In the dominant model, third-party providers–IBM, Accenture and EDS-type firms–go to India to find qualified staff. As a manager, I write my contract with Accenture and the work winds up being outsourced. Some people say if it is important, I won't do it overseas, citing 9-11 fears, fears of privacy, poaching and unforeseen delays once into the relationship. Even if there are functions I would not offshore, I may do so inadvertently because a third-party provider moves the records.

Kennedy: India for some historical reasons had a big head start on software and developed an infrastructure, a head start that has translated into back office processing as well. India is going to stay fairly far ahead, but I think there will be many smaller providers nipping at its heels. No one is going to have millions of jobs, but in Costa Rica or Uruguay, 100,000 new jobs make a huge difference.

Dividend: How should business people think about offshoring?

Duenyas: The first thing is to understand and document your value chain. The next step is to understand what is strategic, what tasks to keep inside and what can be outsourced, and then decide if you will do it yourself or hire another firm. You should develop the expertise to understand your value chain for yourself. That is a key competitive issue.

Severance: Offshoring creates opportunities for technology organizations. For decades we have had an undersupply of qualified IT professionals. Now, you find people overseas who are quite capable of doing this at a higher quality than you can do it here. Traditional barriers–it's not been done before, concerns about telecommunication costs, unfamiliarity with different work practices and ethics–have been broken down.

Duenyas: We tend to ask: "Is this good for the U.S, for U.S. labor and U.S. firms?" These are three separate questions. I believe the businessperson must perform the analysis at the company level and think about companies that will be good business partners. Many good companies are in India now, but in the future good companies will be elsewhere. The businessperson should take into account the risks, including where the company is located and the rewards of offshoring, but that has always been part of the analysis that companies make. From the point of view of the person looking for work or the state trying to increase employment, the only important question is where the jobs are. Offshoring is bad if it is taking jobs from where you live, good if it brings jobs from other countries to where you live. If you are looking for work in Kentucky, Toyota is the greatest U.S. company. We are now in the situation where GE, traditionally considered a U.S. firm, is taking some of its jobs to India, and Toyota is opening more factories in the U.S. At the company level, both firms are offshoring from their traditional locations because this is benefiting them. For the person looking for work, the benefit/cost calculation is entirely different.

Prahalad: We have promoted globalization, and it is working. Unfortunately, globalization is hurting segments of our people. America's biggest advantage is its continuous capacity to innovate and create new businesses. The biggest mistake we have made is under-investing in R & D. We must invest massively in research, biotechnology and bioinformatics, which will support new businesses. You cannot protect jobs that can be done better somewhere else, but you can create fundamentally new jobs that no one else knows how to do.

Dividend: How will these changes affect how we educate MBAs and others?

Prahalad: The question we must ask is, "In what new skills do we have to train our MBAs?" For example, how do they manage projects in multiple locations? How do we train people to understand basic IT infrastructure in the company? In human resource management, we should look at it as an opportunity to get more diversity into our companies. How will we prepare managers for the next 15 years?

Severance: When you get a $1 job done for 33 cents, you have created 66 cents excess, and the country that gets the job is better off for it. But someone has been dislocated from a job. If this person has a comparative advantage, he or she ought to move on to a job that makes use of that comparative advantage and creates additional excess. The issue for the individual who has been displaced, however, is does the job exist and am I capable of doing it? We must invest at the macro-level–stimulation of R & D–and at the individual level–retraining–to lubricate the transition to the next thing we are going to do.
Prahalad: Traditionally in the United States, we have assumed the individual bears the total burden of making the transition. How can we make it less painful? Tariffs and visa restrictions are self-defeating because we lose credibility as a nation. My attitude is that every time other countries become successful, we sell more jet engines, so it is not bad for China and India to be successful. They donít make jet engines or CAT scanners. We do. And if 33 percent of our students are from overseas, it's one of our nice exports, exports that keep us employed.

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847
Email: bernied@umich.edu

(Back to the Outsourcing Special Report)