OUTSOURCING AND OFFSHORING

Outsourcing refers to a firm's practice of paying another firm to perform a function or produce a product that could be done or made in-house by the paying firm. It usually involves more information exchange, coordination, and trust than a mere vendor relationship, since a certain amount of management control is transferred to the supplier. Products and services can be outsourced domestically or to a foreign company. Outsourcing is increasingly associated with firms located overseas, where salaries are markedly lower.

Offshoring refers to business processes—as opposed to product production—being relocated to a lower-cost location, usually overseas. Related practices are near-sourcing and out-tasking. Near-sourcing is the relocation of business processes to lower-cost locations that are in close proximity to the United States, specifically in Mexico or Canada. Out-tasking means turning over a narrowly-defined segment of a business to another firm, on an annual basis or shorter, with continued direct or indirect management and decision making functions retained by the client.

Outsourcing and offshoring began in the 1960s and 70s with the transfer of physical manufacturing processes to lower-cost areas. For example, some U.S. companies shifted production to factories in Mexico that were part of a maquiladora system. Offshoring of physical products then moved to other low-cost locations such as China, India, the Philippines, and Eastern Europe. Despite increased transportation, dock, duty, and broker costs and loss of supply chain speed, firms found that a 30 to 50 percent reduction in labor costs more than compensated for these increases.

The information technology revolution has made location much less important since inputs and outputs can be transmitted digitally. This has facilitated the offshoring of many white-collar functions. For example, the computer manufacturer Dell has outsourced its technical support for residential customers. When customers dial the number for technical support they are connected with technicians in India. With the costs of establishing sufficient bandwidth, compatible software connections, and video hookups decreasing rapidly, more employers may embrace the opportunity to replace employees located in the United States with lower-cost workers overseas.

Some analysts foresee a new global division of labor emerging. They propose that the West will focus on the highest levels of product creation, the part that entails artistry, creativity, and empathy with the customer, and the jobs involving turning these concepts into actual products and services will be sent overseas. However, outsourcing is also used for the process of innovation. Some American firms feel that their current spending on research and development is not yielding a sufficient return, so they are turning to "original design manufacturers" (ODMs). These ODMs completely design products that are then sold to firms such as Dell, Motorola and Philips, who tweak them to their own specifications and label them with their own brand names. Approximately 30 percent of digital cameras, 65 percent of MP3 players, and 70 percent of personal digital assistants (PDAs) are produced by ODMs.

Outsourcing and offshoring have caused considerable controversy in the United States, as the country has lost jobs to foreign nations. Forrester Research predicts that 3.3 million white-collar jobs and $136 billion in wages will shift from the United States to lower-wage countries by the year 2015. Despite possible backlash, some feel that outsourcing and offshoring are beneficial to the United States. Nineteenth-century economist David Ricardo proposed that the nation losing jobs will eventually recover its economic loss by developing worldwide markets for its products and services. Outsourcing can also enable firms to spend more time and resources on their core competencies, leading to more innovative goods and services to be sold globally.