The Real Difference Between Globalization and Outsourcing

29 Jul ’05

I’ve just discovered Christopher Koch’s blog at CIO.com (via a link from Nicholas Carr’s blog), and a post with this title he wrote in April. A few lines in that post gave voice to a concern I’ve had for some time about outsourcing:

There’s no strategy and not much more skill needed to offload work to low-cost destinations. It’s a winning short-term balance sheet move, with potentially disastrous long-term implications if the relationship isn’t more than skin deep. For example, when companies offload manufacturing, and increasingly, R&D, to lower-cost countries, they can cut prices and offer bigger product selections here in the United States. But if all those relationships are arm’s-length, it’s only a matter of time before those offshore suppliers eat their parents alive. They acquire U.S.-funded manufacturing and design capabilities now and add the marketing later (it’s way easier to acquire than most companies let on—yet another myth of U.S. corporate superiority). These companies can build a brand base in their local markets and then come back into the U.S. market under their own name at a lower price point. Worse, in a pure outsourcing strategy, the emphasis is almost invariably upon the U.S. market. There’s little attempt to use the relationship with the supplier to enter growing foreign markets around the world—to develop a global selling network in addition to a global labor network—for when the U.S. market is no longer dominant.

Koch later quotes from a comment left by Peter Koudal, director of Deloitte’s research division (in April Deloitte released a report on outsourcing that calls into question some of the claimed benefits – a report I blogged here), who quotes from a Deloitte article in the Harvard Business Review:

This trend [decreasing foreign direct investment as it is replaced by outsourcing] has troubling implications for the competitiveness of U.S. manufacturing multinationals. Rather than establishing or acquiring their own assets, including plants, equipment, distribution facilities, and office buildings, companies increasingly appear to be using arm’s-length contractual means-such as through outsourcing-to engineer, manufacture, and sell in these markets. However, as the hub of global manufacturing activity moves toward low-wage nations such as China and India, innovation in technology, products, and processes will move as well.

An asset-light investment strategy for low-wage economies may seem attractive to manufacturers seeking to increase their short-term return on assets, minimize fixed costs, and increase flexibility. But holding back on direct investment may extract a high cost over the long term: It could diminish multinationals’ ability to compete against the expanding number of manufacturers rooted in the dynamic low-cost markets where new technologies, consumption patterns, and business models emerge. By failing to take more direct control over a greater share of their sourcing, engineering, manufacturing, and marketing in low-wage, fast-growing economies, multinational manufacturers are, in effect, creating competitors on a massive scale.

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