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Is Outsourcing Profitable?
Prof. Paul A. StrassmannGeorge Mason University, March 6, 2006
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Outsourcing: Rising or Losing?
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What is Outsourcing?What is Outsourcing?
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Definitions
Cost ofSales
Operations
DepreciationInterest, Taxes
Outsourcing
Direct
Overhead
Profits
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Financial Profile of U.S. Firms (2004)
Standard & Poor's Data for U.S. Corporations with 3.8 Million Employees
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Outsourcing and Corporate Economics
• Overhead costs now manage not only internal“direct” labor but also outsourcing work doneby suppliers.
• Computer applications, optimized for“enterprise” integration have difficulty copingwith the suppliers’ incompatible systems.
• Unmanaged outsourcing complexity can voidlabor saving gains.
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Critical Ratios
Outsourcing Ratio = Outsourcing / Direct Costs
Overhead Ratio = Overhead / Direct Costs
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Distribution of 2004 Outsourcing Ratios
Median Outsourcing Ratio for 769 U.S. Corporations = 75.6%
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Outsourcing Not Correlated with Profitability
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Distribution of 2004 Overhead Ratios
Median Overhead Ratio for 769 U.S. Corporations = 124%
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Overhead Not Correlated with Profitability
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Summary: Outsourcing and Overhead Ratios
• Outsourcing now equals 75.6% of corporatedirect costs and is rising.
• Overhead costs now exceed corporate directcosts by 24% and keep rising as direct costsoutsourced.
• Neither outsourcing nor overhead correlateswith profitability. Corporate profitabilityreflects effectiveness of management.
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Was Outsourcing Was Outsourcing Profitable for GM?Profitable for GM?
A Case StudyA Case Study
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GM Employment and Outsourcing
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GM Outsourcing Increased Overhead Costs
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The Keys to Competitive Advantage
• Collaboration Costs• Coordination Costs• Intermediation Costs• Transaction Costs• Structural Costs• Sales, General & Administrative Costs
= Overhead Costs= Overhead Costs
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Do Cuts in I.T. Indicate Success?
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A Comparison of I.T. With Business Indicators
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A Shareholder View
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A Comparison With Competitive Indicators
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While Outsourcing, Market Share Declines
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Summary of GM Case
• Outsourcing to lower costs did not stop marketshare erosion.
• Value-chain did not improve while outsourcing;
• Despite a decline in employment and outsourcingoverhead costs are up;
• I.T. can not be successful if business is indicators reveal information-related malfunctions.
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Is OutsourcingIs OutsourcingDamaging?Damaging?
A Case Study: GM vs. CaterpillarA Case Study: GM vs. Caterpillar
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Employment: GM vs. Caterpillar
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Outsourcing: GM vs. Caterpillar
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Knowledge Value: GM vs. Caterpillar
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Compensation: GM vs. Caterpillar
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Summary of GM vs. Caterpillar Comparison
• Despite higher wages Caterpillar increasedemployment.
• Despite high level of outsourcing KnowledgeValue of Caterpillar gains.
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Research FindingsResearch Findings
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Highly Profitable Firms Outsource Less
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There Will Always be Outsourcing (2002)
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Outsourcing Ratios Differ by Industry
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Higher Pay Need not Result in Outsourcing
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Summary of Research Findings
• “Outsourcing” is essential for the growth ofany economy.
• Whether outsourcing is economically effectivedepends on the organization of the the value-chain.
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Outsourcing Outsourcing in the Value-Chainin the Value-Chain
Case StudyCase Study
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Estimated Cost of a Logitech Mouse
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Different Perspectives on Outsourcing
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Distribution of Costs of a Logitech Mouse
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Summary of Case Study
• The definition of “outsourcing” depends onthe position in the value-chain.
• The dominant cost in global commerce aretransaction costs, not labor costs;
• Assembly takes place from global sourceswhere technology and logistics dictatessourcing.
• The greatest damage to the U.S. economycan come from vertical integration thatreduces transaction costs.
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Transaction Costs in the Value Chain
Supply Chain Distribution Chain Consumer
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Manufacturing Supply Chain Costs
All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
4.7%
15% 5.8%
33%8.1%
56%
15.9%
100%
ProfitTransaction Costs
All Other Costs
Purchases
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Costs in a Manufacturing Supply Chain
All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
4.7%
15% 5.8%
33%8.1%
56%
15.9%
100%
ProfitTransaction Costs
All Other Costs
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The Total Value Chain
Manufacturers Wholesalers Retailers0%
20%
40%
60%
80%
100%
120%
140%
160%
34%
100% 23.5%
127% 24%
158%
ProfitsTransactions
Other Costs
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Potential Gains in the Automobile Industry
Old Value Chain New Value Chain0%
20%
40%
60%
80%
100%
120%
140%
160%
64%
81%
13%
60%
55%
15%
All Other InformationProfits
130%
158%
Gain
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A Value Chain View of Information Costs
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A Perspective of the CIO’s Job
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Impacts of Information Technologies
• Information drives an economic “arms race”.• Obsolete assets will be discarded.• Collaboration favors global consolidation.• I.T. becomes an economic weapon.
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A Case of Value-Chain Superiority
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Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
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Outsourcing andOutsourcing andthe U.S. Economythe U.S. Economy
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Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
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Is the US Economy Off-Shoring Itself?
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Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
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Summary
• Outsourcing is not subcontracting I.T. costs.• Outsourcing is not “off-shoring.”• Outsourcing is the distribution of labor and
knowledge through specialization.• Gains from increases in Value-Added.• Losses from divestment of Knowledge.
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Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
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Issue: Cut Costs or Lose Knowledge Assets?
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Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
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Next GMU Lecture
When: April 17,2006Topic:What is the Worth of Employee Knowledge?What is the Worth of Employee Knowledge?
Prior lectures available on:
http://video.google.com/videosearch?q=strassmann