Globalisation and trade

Class 5 Lecture notes

Outsourcing

Jože P. DamijanUniversity of Ljubljana

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Outsourcing at work

ManufacturingExample of Airbus consortium jointly owned by companies from 4 countries: France,

German, Britain, and Spain. wings from Britain, fuselage and tail from Germany,

doors from Spain, cockpit and final assembly in France. 1,500 suppliers in 27 countries More than 35 percent of components for the

consortium's aircraft are supplied from over 500 American companies.

Numerous suppliers also are located in the Asia-Pacific. Singapore Technologies Aerospace produces wing ribs and

passenger doors for the A320, and engine mounts and thrust reverser doors for the A340.

India's Hindustan Aeronautics Limited also builds A320 passenger doors.

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Outsourcing at work

Services Outsourcing of IT services Outsourcing of help lines, Call centers, accountancy

services (to India, e.g.)

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Outline

Definitions of outsourcing Why outsourcing? Who are the major players? Effects of outsourcing How to prepare for not being outsourced?

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Definitions of outsourcing Offshoring : Transferring Activities to another country by hiring local

subcontractors or by building a facility in an area where labor is cheap(er).

Outsourcing: Delegation of non-core operations from internal production to an external entity. Sharing organizational control.

Offshore Outsourcing : When transferring an organizational function to a third party who is located in another

country.

Nearsourcing : Similar to offshore (yet close distance). Example : BMW to Bulgaria

Insourcing : Domestic outsourcing/Increased FDI

Best Sourcing : Associating with the ‘best of the best’ (Tom Peters)

Reverse Outsourcing: Becoming an “ex-pat” by being hired by a country to whom you outsource . Example: US pilots who once

flew for US airlines now being hired by airlines in India.

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Why outsourcing?

Productivity is the key:

Productivity is now a global race between regions and nations.

Those who can make things cheaper, faster, better – win!

US and Europe losing technology advantage Factories & process plants moving

Closer to customers Closer to raw materials

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Knowledge work – anywhere

Transportation and trade cost falling Moving downstream production stages abroad

Internet makes physical location irrelevant Low-cost telephone Help lines, Call centers

Knowledge is power US is losing the big advantage Availability of trained people globally

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Major players

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Major players - China

China – Manufacturing Manufacturing expertise

Good, repetitive quality. Worldwide market-share - 50% of cameras, 30% of

air conditioners and televisions, 25% of washing machines, 20% of refrigerators

One private Chinese company - 40% of all microwave ovens sold in Europe

City of Wenzhou, Eastern China - 70% of the world's metal cigarette lighters

Wal-mart – Buys $ 12 billion from China

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Major players - China

Chinacosm – Hitech looms

700,000 engineers a year, 37% of all college graduates University system - growing in size and quality Engineer pay ranges - $4,000 to $8,000/yr. New CISCO competitor Biotech advances – genome sequencing Space technology advances

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Major players - India

India - Services

World's most populous country (mid-century) Advantage - English-speaking China's pop. growth is under control; India's is not Already the world's largest democracy

US Software – $6-8 billion, 60% growth Infosys - 2003 revenue $750m, profit 25%, growth

38%, Nasdaq market-cap $11.5 billion Wipro - 2003 revenue $ 900m, profit 18%, growth

29%, NY stock exchange market-cap $9 billion

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Emerging players

Global HiTech

Other regions/countries are competing strongly Central & Eastern Europe Ireland Russia Brazil Mexico

US steadily losing advantage in many key technologies

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World competition brews

Third-world - HIC: Hungry Innovative Competitive

Fundamental problem - you cannot simulate hunger

Big offshore tax-holidays to attract shifts

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Do we have to worry?

Job losses Prices Productivity Overall effects

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Effects of outsourcing

Employment Note: Major effects is on job destruction due to relocation

of production / services to cheaper countries

Jobs to be affected by outsourcing (OECD, 2004): EU-15: 19,2% US: 18.1% Korea:13.1%

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Effects of outsourcing

Employment US For comparison: US employment turnover, annual amount of job

destruction alone is estimated to 7 and 8 million jobs In US only around 1-2% of the annual job turnover is attributable to

relocation of jobs outside the US (Mann, 2003; Forrester, 2002). Altogether, by the year 2015, approximately 3.3 million jobs would

be lost due to offshoring (Forrester, 2002) Increase in US employment due to international insourcing from

foreign countries which grew from 2.6 million jobs in 1987 to 5.4 million in 2002.

Unemployment caused by increased productivity much bigger Automation has reduced headcount Computers & Internet

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Effects of outsourcing

Employment EU Small to negligible effects, altogether 1.2% jobs lost in

manufacturing over 1979-1991 Clothing and textiles, leather and footwear, shipbuilding and basic

metals have lost the largest number of jobs over the past two decades

Hence, despite not being cause for concern at the macro level the costs of delocalisation, resulting from job losses, may be strongly felt (at least in the short-term) in certain sectors and in the regions where these sectors are concentrated.

In the long term, if delocalisation allows firms to improve their competitiveness the impact on the aggregate level of employment can be positive.

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Evolution of employment in manufacturing sectors in the EU due to outsourcing from 1979 to 2001

(Source : M.O’Mahony, B. Van Ark (2003))

Clothing -3.39%Leather and footwear -3.28%Shipbuilding -3.26%Textiles -3.15%Basic metals -3.06%Radio and TV receivers -2.33%Railroad equipment and transport equipment -2.08%Mineral oil refining, coke and nuclear fuel -1.99%Other instruments -1.83%Non-metallic mineral products -1.29%Chemicals -0.13%Telecommunication equipment -1.25%Mechanical engineering -1.06%Insulated wire -1.01%Wood & products of wood and cork -1.00%Pulp, paper and paper products -0.98%Fabricated metal products -0.77%Motor vehicles -0.74%Other electrical machinery and apparatus -0.69%Furniture, miscellaneous manufacturing, recycling -0.69%Aircraft and spacecraft -0.62%Office machinery -0.60%Food, drink and tobacco -0.57%Scientific instruments -0.23%Printing and publishing -0.08%Electronic valves and tubes -0.07%Rubber and plastic 0.57%Manufacturing sector -1.18%

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Effects of outsourcing

Employment Kirkegaard (2003) notes that between 1999 and 2002 the majority of

job losses in the category “occupations at risk of offshoring” did not happen in services but in the manufacturing industries.

Moreover, these were generally low-wage jobs, with services employment in the same occupational category increasing.

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Effects of outsourcing

Productivity and prices over 1995 to 2002, the international fragmentation of IT hardware

manufacturing led to a price decrease between 10% and 30% of IT hardware.

this translated into a higher productivity growth of 0.3 percentage points per year corresponding to an accumulated USD 230 billion in additional GDP (Mann, 2003)

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Effects of outsourcing

Overall effects MGI (McKinsey Global Institute) estimates: US: $1.14 per corporate dollar spent on offshoring, of

which a base saving of $0.58 per corporate dollar invested in

offshoring, a directly related benefit to the US economy of $0.09 per dollar

due to additional exports to India and profits transfers by India-based US providers

additional benefits of $0.47 stemming from re-employment of workers who lost their job in the process

Germany: $0.80 per dollar due the fact that the major German offshore location is Eastern

Europe, and not India where wages are much lower India: $0.33 per dollar Global benefits: $1.47 per dollar invested in offshoring

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Effects of outsourcing

Re-employment effects questioned by the BLS study: in the period 1979-1999 31% of those who lost a job due to trade

were not fully re-employed. only 36% of the displaced workers were able to find a new job

with matching or higher wages, 55% were at best working for 85% of their former wages, and 25% were working for 70% or less of their former wage.

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Empirical evidence on outsourcing and productivity

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How to prepare for not being outsourced?

Companies

Proprietary products Customer productivity important Continuous upgrade to maintain leadership Outsourcing is irrelevant – productivity is the key

High-value-added Proprietary knowledge Tailored to specific customer needs

Go global – think local Special needs, custom requirements must be handled locally Partnership and proximity

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How to prepare for not being outsourced?

IndividualsBe:

“Special” (ex-Bill Gates) Have a global market for your services

“Specialized” Your work cannot be easily digitized (ex-Surgeon’s technique)

“Anchored” Location specific requiring face-to-face contact. BUT even Parts here can be ‘fungible’.

“Really Adaptable” Grow your skills—you may have to move horizontally but growth

creates new specialties

Friedman, The World Is Flat

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Sources

DG EcFin (2005). Delocalisation: Which challenges for the EU economy?

OECD (2006). Productivity Impacts of Offshoring and Outsourcing: A Review. STI Working Paper 2006/1

Michael Pitts (2006). Outsourcing, Lecture Slides Jim Pinto (2004). Automation – A global shift.