Outsourcing - A Path without Return?

Table of Contents

Contents

Index of Figures

Index of Tables

Abstract

Introduction
Content overview

Chapter 1: Outsourcing as a strategic tool of competitiveness (Ritt, Spatzenegger)
1.1. The advent of outsourcing in strategic functions
1.2. Thinking in competencies
1.3. Sources of competitive advantage
1.4. How to identify core competences
1.5. Core competences and strategic outsourcing
1.6. Suitable outsourcing activities
1.7. Strategic outsourcing and transaction costs
1.8. Other forms of cooperation
1.9.1. Sources of competitive advantage: for example strategic marketing programs
1.9.2. Sources of competitive advantage: for example temporary employment

Chapter 2: Outsourcing versus offshoring (Ritt, Spatzenegger)
2.1. Domestic outsourcing
2.2. Offshore outsourcing
2.3. Offshoring and other forms of international cooperation
2.4. Service outsourcing
2.5. When is outsourcing beneficial for companies?
2.6. When is outsourcing beneficial for the workforce?

Chapter 3: Outsourcing in practice: qualitative interviews (Ritt, Spatzenegger)
3.1. The outsourcing experiences of EMCO Maier GMBH
3.2. Offshoring and outsourcing practised by Palfinger AG
3.3. Major learnings from outsourcing activities
3.4. Ethics and outsourcing

Chapter 4: Impacts of outsourcing on the national economy (Ritt, Spatzenegger)
4.1. The impacts of outsourcing and offshoring to the national economy exemplified with Austria, Germany and other European countries:
4.2. The “bazaar economy” phenomenon:
4.3.1. When German and Austrian companies offshore or outsource to Eastern European countries
4.3.2. Impacts of manufacturing outsourcing for the Republic of Ireland
4.4. Outsourcing and specialisation
4.5. Effects on wages
4.6. Increasing exports
4.7.1. Human capital and outsourcing
4.7.2. Factor price convergence and labour wages
4.8. What betters the position of Germans workforce?
4.9.1. Critics on Sinns “bazaar economy” thesis
4.9.2. The German nation in the future and globalisation

Chapter 5: Consultants on outsourcing (Ritt, Spatzenegger)
5.1. Publications underline the complexity of strategic outsourcing
5.2. Advantages and goals when outsourcing
5.3. Cap Gemini Ernst & Young talks about “transformational outsourcing” as the latest trend
5.4. Roland Berger predicts the situation in Austria 2015
5.5. Conclusion “consultants on outsourcing”

Chapter 6: Strategic frameworks for outsourcing decisions (Ritt, Spatzenegger)
6.1. Outsourcing and strategic change management
6.2. Evaluation of strategic frameworks for outsourcing decisions

Chapter 7: Resumee (Ritt, Spatzenegger)
7.1. The original “stage-gate model” created by Robert Cooper
7.2. The new strategic framework
7.3. Is outsourcing a path without the choice to return?

Sources

Appendix

Index of Figures:

Figure 0: the body of this thesis

Figure 1: recommendations for strategic outsourcing

Figure 2: forms of cooperations

Figure 3: an approach for strategic outsourcing

Figure 4: outsourcing of services

Figure 5: advantages of outsourcing for EMCO Maier GmbH

Figure 6: advantages of outsourcing for Palfinger AG

Figure 7: share of value added in the manufactoring sector in Europe

Figure 8: hourly labour costs in Europe

Figure 9: the “bazaar economy”

Figure 10: relative wages, productivity and unit labour costs

Figure 11: employment in the manufactoring sector

Figure 12: relative wages for skilled workers

Figure 13: drivers of outsourcing

Figure 14: reintegration of business processes

Figure 15: risks related to outsourcing

Figure 16: motivators for outsourcing

Figure 17: vendor transparency

Figure 18: problems faced by participants with negative experiences

Figure 19: Cap Gemini drivers of outsourcing

Figure 20: traditional outsourcing and transformational outsourcing

Figure 21: benefits of transformational outsourcing

Figure 22: the technology adoption curve

Figure 23: characteristics of suitable outsourcing providers

Figure 24: strategic framework for make or buy decisions

Figure 25: operationalisation of the strategic framework

Figure 26: main components of the strategic approach

Figure 27: detailed overview of the approach

Figure 28: types of realtionships

Figure 29: the “stage gate” model

Figure 30: a new strategic framework for successful outsourcing decisions

Index of Tables:

Table 1: top service outsourcers

Table 2: share of foreign intermediate products

Table 3: offshore investments to Eastern Europe

Table 4: intra-firm trade

Table 5: foreign direct investment pattern in Austria and Poland

Table 6: relationsship matrix for investment activities

Abstract

Outsourcing is a complex process. It is a top management issue and a strategic task to maintain competitiveness and sustainable competitive advantage in a corporation. As a main outcome of this thesis the authors developed and created a strategic framework, guided by the aim to increase the quality and efficiency in outsourcing decision processes. It should provide a supportive tool for successful outsourcing decisions in a fast changing environment. Furthermore the authors answer the question whether outsourcing is a path without return or not.

The basis for the outcome and the method the authors chose to achieve their findings and concluding framework are:

At first: an analysis of the relevant academic publications and a comparison of the main findings with popular scientific literature. Covered topics are outsourcing as a strategic tool for competitiveness, core competence concentration, offshoring versus outsourcing, service outsourcing and ethics in outsourcing.

This was followed by an analysis of long term impacts to national economies caused by outsourcing and offshoring activities. Further qualitative interviews with two Austrian Enterprises and expertise knowledge from the worlds top consulting firms, flow into the development of the strategic framework.

The new framework created by the authors of the thesis is inspired by the “stage-gate-model” of Robert G. Cooper and an advancement of it. This model is originally used in innovation management for the evaluation of new developments and innovations.

Introduction

Outsourcing, that is not a new topic. Outsourcing and offshoring already has already existed for over 30 years, and has gained momentum worldwide over the last years. It is a slow-burner topic, always on discussion and is sparking a lot of interest in both academic literature and economic press. In booming periods companies are aiming to get access to new resources and technologies, and in recession periods outsourcing is used as a measure to cut costs or increase efficiency. Hardly a subject is as controversial as this. And barely a topic has as many socio-political implications as outsourcing.

However, technological progress, the opening of China and Eastern Europe, as well as the enlargement of the European Union in recent years has tremendously changed international trade.

Increased fragmentation and lower costs for service links make production and assembling of different parts of the value added chain at different locations more feasible and profitable. Therefore, the modern industry is characterized by a high number of vertical fragmentation and international outsourcing. Media and political attention seems firmly focused on international outsourcing, even though domestic outsourcing is also common.

Various stakeholders are involved in the outsourcing process. These participants may gain different benefits or have to face different risks. For example, the outsourcing company, the outsourcing partner or the national economy which is influenced by the companies that outsource – each institution will have different aims, experiences and requirements in the entire process.

“This implies and means that the optimal location is chosen for every individual step in the value chain and specialized intermediate producers make use of competitive location advantages all over the world^[1].”

However, measuring international outsourcing in terms of its usability as a strategic tool for competitiveness is a challenge. The authors, Friedrich Spatzenegger and Sylvia Ritt, are aiming to take up this challenge.

Content overview

The authors start this thesis with an overview of the content and the relevant chapters. Titled “outsourcing – a path without return?” this paper is based on three pillars, as shown in Figure 0.

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figure 0: the body of this thesis

Pillar A (chapter 1 – 3): at first, the authors will describe the role of outsourcing as a strategic management tool in corporate decision making processes, and will link it to the topic of core competence concentration in a company, according to the academic literature. The authors will examine what chances and risks occur and distinguish the different forms of outsourcing, for example offshoring, manufacturing or service outsourcing.

It is the aim to examine and establish what the hypes and what the facts about the various types of outsourcing are, discussing and comparing empirical studies and new media literature. Within this pillar the authors also link the characteristics of outsourcing with offshoring and outsourcing experiences of two Austrian based but internationally successful companies, Palfinger AG and EMCO Maier GmbH.

In a second step, within pillar B (chapter 4), the authors prepare a macro-economical analysis and examine the impacts of outsourcing on the national economy exemplifying the German industry and other European Union member countries. Questions like who are the winners and losers of this development, the workforce, the entrepreneurs or the national economy will be answered.

Based on the insights of pillar A – with its viewpoint of an individual corporation and its involvement in outsourcing activities - as well as Pillar B, the macro-economic analysis, the authors are able to deduce in a third step future recommended actions for companies, with the concluding pillar C (chapter 5 – 7): to close the thesis, the writers present the most relevant factors for outsourcing processes and decisions with the creation of a new strategic framework according to the “stage-gate-model” created by Robert G. Cooper^[2]. The outcome is based on the study and evaluation of the academic literature (chapter 2-6), the qualitative interviews (chapter 3) and the outcomes of recently published surveys of leading multi-national consultants, Roland Berger, Ernst & Young Cap Gemini, Deloitte and Accenture (in chapter 5).

The authors refer to chapter 2 (2.3. offshoring and other forms of international cooperation) when talking about various other forms of international cooperation and networks, i.e. strategic alliances or joint ventures.

This paper further compares academic and news media literature. Due to the widely ramified variety in the economy and the literature about the topic, the authors of this thesis do not lodge a claim for completeness and universality of their work. In fact it should show the complexity of strategic management and strategic decisions exemplified with the chosen topic of outsourcing.

Companies practise outsourcing

As repeatedly quoted in academic literature, companies who are undertaking outsourcing activities have very similar expectations from their outsourcing partner and the resulting benefits of this process, although the reasons for the decision to outsource may vary significantly. Companies are not only aiming to cut costs through outsourcing, fact is the tended to do so in the arising decades of outsourcing?

So what do companies expect? Main expectations are improvements in diverse business processes which lead to an increase in efficiency, competitiveness and profit. But outsourcing is not a “silver bullet”. Often an outsourcing opportunity seems attractive at the first impression, but in reality it is a long term process that needs extensive evaluation and efficient usage of the right evaluation criteria. It relies on closely calculated cost management and not primary on degression effects. Moral and political aspects may also influence the decision to outsource activities or leave the process in-house. It is important to consider the small but important things a company’s internal division is executing along the way or the knowledge they build up. Those endeavours should receive extensive attention as well.

When aiming to achieve improvements in effectiveness (in terms of costs or other parameters that help a company to achieve its long-term success), outsourcing seems to be an adequate activity for a great number of corporations. The decision to “make or buy” a product or service often leads to extensive studies and discussions in a company (cp. chapter 1, subtitle strategic outsourcing and transaction costs).

As mentioned above, cost cutting measures are of prime importance, especially in a period of economical recession. Furthermore, an outsourcing partner or a third party company that is a professional in its field may be able to perform a service more economically and efficiently than the company itself.

Moreover, the required infrastructure for business processes may not be available within a company. Often, this is the case concerning IT-infrastructure, which presents a typical outsourcing activity. Professionals provide the IT-infrastructure and additionally skilled labour. So there is no need to invest in infrastructure inside the company.

But outsourcing activities also contain hidden costs, like transaction costs: finding a suitable outsourcing partner takes time for information and evaluation, which is costly. Once the right outsourcing partner is identified, the external company must be adapted and integrated within internal business processes. The outsourcing partner needs to learn how the company works and should understand the core values of the corporation. Furthermore, there is a need to control the performance of the external company regularly, which causes control costs and know-how in the outsourced field.

This quick grasp should emphasize the complexity of the strategic decision whether to outsource or not, and should point out the importance of a detailed evaluation process.

Chapter 1: Outsourcing as a strategic tool of competitiveness

1.1. The advent of outsourcing in strategic functions

Outsourcing once started with simple activities such as security or catering, but has progressed to include more important and strategic functions in areas like Marketing, Controlling, Human Resource Management etc.

Considering the advancement of outsourcing it is also necessary to distinguish in terms of outsourcing activities in different geographic regions. While outsourcing is already at an advanced level in the U.S. (they started practicing strategic outsourcing in the late 80ties) the main activities of European countries (e.g. U.K. or Germany) nowadays are still off-shoring or outsourcing of manufacturing activities. But a tendency to a shift in advanced outsourcing can be observed in these countries too.

Accenture^[3] proclaims that outsourcing activities in the USA are already advanced and therefore stagnating. Outsourcing (especially Business Process Outsourcing) has long been a factor in American business, but the trend is beginning to reach Europe. In the UK and in Germany analysts expect growth rates between 10 and 20 percent in the next few years. They further argue that one main focus of outsourcing, cutting costs in a short period of time, will gain another new strategic dimension (cp. chapter introduction). The new strategic dimension therefore contains new structures of cooperation, networks and new performance control systems. Most economists feel that outsourcing will inevitably remain a part of global trade.

In the field of marketing and public relations, outsourcing has been a popular strategic decision for decades. Multinationals, mid-sized companies or even smaller firms use specialized agencies for their marketing and public relation activities. According to McGovern and Quelch^[4], analytical marketing processes, e.g. in the field of customer relation management, are more and more outsourced nowadays. The main aim is to cut costs, while an increase service quality is possible due to the specialized outsourcing partner. After American express decided to source its Call-Center to India, their service costs decreased about 20-30% per customer, the response time accelerated and customer satisfaction increased about 20 percent. The demand for specialized analytical marketing know-how tends to further increase in future.

1.2. Thinking in competencies

Core competence concentration nowadays is in every mouth and since this trend is widespread it has gained a lot of attention. Furthermore, it is closely linked with outsourcing. Why?

Fact is that outsourcing is strictly a top-management issue and decision. It is a “make-or-buy” arbitration focussing on two dimensions: the external processing of parts of the value chain and an external contribution of affiance. Outsourcing liberates capacities and enables a company to concentrate on what it can do best, to focus on its core competencies in order to improve among others quality, innovativeness, cost structure, or the time-to-market.

Outsourcing fragments the value chain. Upstream (offshored production, outsourcing) or downstream activities (close to customer, specialized in home country, e.g. marketing, sales) may be outsourced, depending on the individual company situation and its core competences as well as its goals and objectives.

In general, the labour-intense upstream activities are outsourced or off-shored, while the capital-intense (human and real capital) downstream activities remain in the domestic region.

The authors will now have a closer look on the terminus “core competencies” and the way core competencies can be identified as well as how an enterprise can benefit by focussing and creating competitive advantage as well as combining it with outsourcing activities.

1.3. Sources of competitive advantage

Strategic outsourcing – as a critical business process – demands that companies first and foremost identify their core competencies (activities, products or services) where the company has or could have pre-eminence and can provide a unique value proposition for the customer.

Core competencies can be defined as sources of competitive advantage within a company. Hinterhuber^[5] argues that real sources of competitive advantages can be identified in a company if management is able to bundle skills across business areas and business processes companywide. Business areas and processes include technologies, know-how, processes, resources and attitudes. Furthermore, it is essential that companies are able to combine and coordinate resources in order to create additional customer value. This can be achieved if companies are able to combine and coordinate resources with organizational learning processes. In the long term, companies must create strategic core competencies to remain successful. Already existing and achieved core competencies need to be revised and reengineered to understand and control changes in the environment of the company as well as to guarantee ongoing competitiveness.

Core competencies mainly arise from organisational learning processes. In detail, this means that they arise in the process of consolidating skills and resources. All business processes contribute to the daily business work, but core competencies are crucial for company success. Hinterhuber^[6] constitutes that the package of processes and resources determines core competencies and the core competencies determine customer value as well as a value increase in the company. Therefore, core competencies are developed within business processes as a result of various process chains. Core competencies might be understood as strategic business processes if they offer important value to the stakeholders^[7].

Hinterhuber^[8] furthermore mentions that process orientation in developing and designing core competencies influences outsourcing, that is it brings outsourcing into a new light.

Besides the trend towards outsourcing, companies also decide to insource - mainly due to strategic reasons. These companies want to make sure that they can define the outcome of important key processes themselves, and not by an external supplier. This way, companies can assure that competitive skills and potentials, which can lead to core competencies within a business process, remain in-house. Their core competence concentration could be combined with outsourcing of other, e.g. functional activities like IT or staff administration. It is essential to understand that also in functional activities, distinctive capabilities can be found and used for competitive advantage. “Thinking in competences” are the key words managers should understand here. Thinking in competences doesn’t substitute “strategic thinking in business units”, it completes it, and provides a basis for future competitiveness of business units. Because it is not substituting the “strategic thinking in Business Units” it is completing it, as it is the base for future competitiveness of Business Units.

Concentration on core competencies also can lead to growth-processes within the company if new markets are available, on the other hand to shrinking processes if the company decides to outsource parts of its value chain that are not connected with the company´s core competencies and therefore can be more efficiently executed by third party companies.

This can be exemplified within the automobile industry: Due to innovation and cost pressure, and an increasing variety of products and rapid technological change, a complete in-house production seems increasingly inefficient. Vertically integrated multinationals are often too inflexible to meet the swiftly changing market requirements. With outsourcing, they are able to focus on the core competences and increase the ability to react to market changes.

1.4. How to identify core competences

To identify core competences, the success factors from the resource and the market based view are combined. Inside the company it is necessary to determine the relative strengths of the company’s competencies without including the environment of the company.

Hinterhuber^[9] suggests the classical analysis of value chains, and to supplement the analysis of the corporate company performance and to structure the current product range. In a first step, the competencies a customer does not notice must be identified. An analysis of a company must necessarily contain both, the product oriented technologies, and additionally overall product characteristics, features, services and processes. The environmental situation must be analyzed as well: The effective strengths of a company can be determined through a comparison of the company’s competencies with the competition and its suppliers. Benchmarking is an adequate technique to identify and take advantage of success factors within the company. The precise value a customer attributes to a certain competence can be seen as an own dimension in the portfolio of competencies.

In the portfolio of competencies (cp. figure 1) all single analysis of the company can be consolidated and the main outcomes can be defined and visualized. As a result the competencies can be positioned in four quadrants.

illustration not visible in this excerpt

figure 1: recommendations for strategic outsourcing^[10]

1.5. Core competences and strategic outsourcing

The first quadrant is characterised by competences with low customer value and low relative strength in competences, whereas competitors have the same level of competences. It does not imply a competitive advantage for the company, because e.g. only facility management activities are included, which hold a relatively low customer value. The second quadrant is strategically very important and is defined through competence gaps. Customers attribute high customer value to these competencies. In contrast, the company offers comparatively low competence strength relative to the competitors. Competence gaps arise in the difference between customer wishes and expectations and what the company can offer them in exchange. It is crucial for the company’s success to verify the determined success factors at the market and at the success factors in order to satisfy the customers, due to the strategic importance of this quadrant.

The third quadrant describes competence capabilities. Competence capabilities occur when a company holds a leading position in the market but customer value is comparably low. If so, companies do e.g. release products that do not come up to the customer expectations or companies simply do not understand the customer needs. It is of immediate importance to establish a connection between existing capabilities and market trends. The fourth quadrant describes core competencies. In this case a company has high competence strength and customers additionally appreciate those competencies. Companies who offer products with imperfectly imitable features thereby enable themselves to build up a relative competitive advantage.

1.6. Suitable outsourcing activities

The critical question is: which activities can be outsourced most easily or most effectively?

According to Hinterhuber^[11], the core competences, represented by areas with a high degree of customer value and a high degree of competence strength compared to competitors, need to remain strictly in-house. In these areas, a company holds the key capabilities, for example the “success factors”, which are responsible for prosperous growth. By keeping the core competencies in-house, the company has the opportunity to constantly improve and further develop them.

Competence gaps which occur in the second quadrant can be compensated internally or through mergers and acquisitions or even with outsourcing. Strategic outsourcing plays insofar a major role, because in this case companies tend to outsource not only functional areas but key processes to an external company. This option may be viable for a company if competitors are able to produce these key processes at lower costs and more efficiently. Hinterhuber^[12] demonstrates that when doing so, it is necessary to control all important key elements in the value chain. A company then has more resources available for customer oriented processes. On the one hand, outsourcing can become a critical success factor concerning marketable competences, due to the fact that competitors have access to the same capabilities. On the other hand, new and innovative capabilities must remain in-house in order to establish imperfectly imitable core competencies with a high customer value.

The competence capabilities in the third quadrant are important to determine a potential future competitive advantage. A company can decide whether to invest and therefore enlarge core competencies to remain competitive, or outsource activities to a third party company. The second alternative requires a know-how transfer to the external supplier to remain competitive. Current core competences may become less valuable due to the ability of competitors to imitate products. Therefore, outsourcing seems to be an adequate method because it frees up labour which can be used to an advantage in more lucrative areas.

Finally, standard competences in the first quadrant, which are characterised by low competence strength and low customer value, should be outsourced.

1.7. Strategic outsourcing and transaction costs

The identification of core competences and what to outsource is only half of the decision - of equal importance is the consideration “who to source it to”?

Strategic outsourcing decisions therefore should also consider the incidental transaction costs when e.g. optimizing the organisational structure as well as inter-company relationships. Often transaction costs like transfer of information and evaluation of potential partners are underestimated. Hinterhuber^[13] emphasises that all business activities need to be strategically organised, with the aim to optimise coordination processes and therefore create cost savings. As a rule, the higher the transaction costs, the more an external supplier must be integrated and coordinated.

1.8. Other forms of cooperation

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figure 2: forms of cooperations^[14]

As shown in Figure 2, several options regarding a make-or-buy decision can be identified. These options are called hybrid forms and are based on vertical partnerships. According to J. Welch and R. Nayak

“…the sourcing dilemma to buy or not to buy – is of central importance. While cost is always important in any business decision, managers should consider strategic and technological issues in conjunction with the decision. Companies that continue to make sourcing decisions based solely on cost will eventually wither and die, as many already have. Conversely, thoughtful use of the

strategic sourcing model, in conjunction with a rigorous cost analysis, can help companies make the sourcing decisions that will move them towards world-class stature^[15] .”

When does strategic outsourcing make sense? Transactions costs don’t only concentrate on product based transfers. In fact, long term structures among the partners are preferable^[16]. This is because long term structures allow the value chains of the transaction partners to become linked, and a long term connection of single competences can be guaranteed. This building of strategic networks strengthens the competitiveness of all participating companies. In summary, the main aim or idea of strategic outsourcing is not the individual progression of single processes, but the continuing connection of competences and the amelioration of the competitiveness of every participating company. In forming such networks, companies can benefit as well as protect and further develop their core competences, and reduce transaction costs by an amalgamation of their value chains. Figure 3 concentrates all opportunities as described on the last pages and once more shows how companies can benefit from strategic outsourcing.

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figure 3: an approach for strategic outsourcing^[17]

1.9.1. Sources of competitive advantage: for example strategic marketing programs

Outsourcing marketing programs like industry marketing, financial communication, consumer- and turnaround marketing, may lead to an improved performance for companies and therefore improves the result of a company overall. By outsourcing marketing programs, a company gets access to new and promising knowledge in the field of marketing. This procedure is called performance marketing and is a combination of strategy, classical advertisement, sales optimisation and measurement of results^[18]. Performance marketing is a component of the marketing-mix and can be established for the acquisition of new customers as well as to prolong customer loyalty. The different performance marketing tools follow the goal of gaining measurable customer response and are an integrated approach^[19]. The performance marketing tools are linked together to influence customer and potential customer behaviour. Performance marketing tools include search-engine marketing, classical online marketing, e-mail marketing, affiliate marketing and mobile- (SMS) marketing. With this mix of tools, it is possible to control and optimise the performance of a campaign significantly. Furthermore, access to real time information is possible. Companies receive more accurate data for their marketing strategies and activities, and are able to perform better than their competitors. For this reason performance marketing is a source of competitive advantage, providing that marketing goals are clearly defined, the right tools are chosen, campaigns are accurately defined, and target groups are analysed.

If a company has limited resources of people and/or marketing expertise, the company should consider outsourcing these important business processes to an external provider. But there is not always the need to outsource a corporate business process. Sometimes it is satisfactory when an external provider offers support for an existing marketing department, or gives support for the implementation of marketing actions. Marketing leaders are being increasingly confronted with complex tasks that need to be organised, performed and adapted within a shorter period of time. Companies cooperate with several suppliers and agencies, and there is hardly time to control all these business processes. An external provider can help to control and coordinate these business processes. Oftentimes a company needs to realise important marketing projects, but there are no resources and sufficient time available within the company. Marketing is always an important success factor, and if marketing does not belong to the core competencies of a company, the employees are not able to work as efficiently as specialists from an external provider. Marketing agencies have additionally contacts to suppliers, designers, etc. that are useful to the outsourcing company.

1.9.2. Sources of competitive advantage: for example temporary employment

There is obviously a trend that companies are looking more and more for flexible forms of employment like temporary employment.

How can temporary employees help me as an entrepreneur to build up competitive advantage? It enables a quicker response to technological changes, or simply covers fluctuating demand. Temporary work is a triangular relationship, involving the temporary helping firm, the hiring firm and the temporary working employee.^[20] The temporary helping firm is the employer. However, an employee must follow the instructions of the hiring firm when working at its location. Furthermore, companies avoid cost intensive investment in human resources, and are able to get access to competences in times of high demand. Therefore, companies transfer their responsibility as an employee to an external service provider, such as Adecco or Manpower. They can be seen as a human resources and business services organization and lend employees for a certain charge to their customers. This special form of B2B cooperation is a source of competitive advantage for companies, because it enables them to concentrate on core competencies and additionally to save costs. Employment in temporary help firms is not just limited on production activities, but also in the field of high professionals. The temporary help firms are more and more integrated in the human resources strategies of their customers.

As a result, services like job interviews or quality control can be transferred to the external provider^[21]. This form of outsourcing leads to advantages for both employees and companies. Employees are no more confronted with the problem of unemployment or extensive search for employment. Furthermore, employees have the chance to get in contact with various employers and gain insights in various companies.

Chapter 2: Outsourcing versus offshoring

Adam Smith, in the law of absolute advantage^[22], created the concept that products and services will be produced by those who can do so at the lowest cost. David Ricardo expanded the concept, in the law of comparative advantage^[23], by demonstrating that work will be done in the lowest-cost manner relative to other alternatives. The roots of outsourcing may lie in these theories, explaining not only the nature of past, but also of modern strategic management decisions.

In the following chapter, the authors will examine various forms of outsourcing, starting with the differentiation of domestic and international outsourcing, followed by the examination of service outsourcing. The writers determine what the hypes and what the facts about the various types of outsourcing are, and discuss and compare empirical studies with new media literature.

2.1. Domestic outsourcing

When talking about outsourcing, it is crucial to distinguish between three relevant terms: domestic outsourcing, international outsourcing and off-shoring. What is the difference?

Onshore outsourcing (also called domestic outsourcing) is the obtaining of services from someone outside a company, yet within the same country. In contrast, international outsourcing is the obtaining of services from third party companies outside the country. Off-shoring is the “outsourcing” of activities e.g. production within the company, but outside the country, e.g. the Swedish based textile Multinational H&M with production plants in China.

Reasons for onshore outsourcing may be cost savings, but more commonly include expertise knowledge from the outsourcing partner. Nowadays, domestic outsourcing is a popular alternative. In Austria for instance, the successful Red Bull Incorporated is outsourcing two important business areas, the entire production process (outsourcing partner is Rauch) as well as logistics and transport (partner is Spedition Quehenberger). Both partners where chosen for their expert knowledge in the field. Red Bull Incorportated, with the charismatic owner and leader Dietrich Mateschitz, is therefore successfully focusing on its core competence Marketing and Sports-Sponsoring.

When aiming to save costs by opting for domestic outsourcing, it is crucial to focus on domestic areas which offer a skilled workforce, but to below the countries average wages (e.g. in Austria regions like the “Burgenland”, the “Waldviertel” or some parts of Styria) to provide maximum value and benefit.

Nowadays, micro-economic units, like companies, are not the only “small” unit which practices outsourcing. Even smaller units, like families, follow the trend: The very traditional field of childcare is beginning to be domestically outsourced as a recent survey showed^[24]. Why? The increase in the use of day-care for children can be explained by the increasing number of dual earners and single households as well as a general behavioural change, indicative of a shift in societal values concerning childcare. Parents are more inclined to hire childcare, irrespective of their personal characteristics. Other household activities, like gardening or cleaning, have partly been “outsourced” for decades, but the writers do not understand this as true outsourcing. It may be seen more as the use of an “external supplier” (the cleaning lady, the baby-sitter, the cook, etc).

2.2. Offshore outsourcing

Off-shoring is similar to outsourcing. When off-shoring, huge companies, mostly multinationals, transfer entire business divisions or business locations to other geographic areas where they can reduce costs. Usually, these areas are emerging markets with a lower wage level compared to industrialized countries. In contrast to third-party-outsourcing, the off-shored parts of the value-chain remain in-house. It can therefore be seen as a dislocation of parts in the production or value chain. Within multinational companies, parts of the value chain are transferred or relocated to new locations, driven by the search for new market access, regional know-how, qualified white- and blue-collar workforce or cost savings. Off-shoring often occurs as the dislocation of entire business processes and is called “BPO” (Business Process Outsourcing). It is closely related to technological progress: both are driven by competitive pressures to reduce costs, and both result in displacement of existing jobs and productivity gain.

Thus, offshoring is one potential chance for significant economic growth and prosperity in developing countries like Asia, Latin America or Eastern Europe, at least for some parts of society because it lowers costs and prices. For example the consultant McKinsey estimates net cost savings up to 50% when off-shoring^[25]. In the IT-setor it is a very popular strategic decision. To state an example, the British Telecom is offshoring and migrating its customer relationship center and its data processing center to India. Within that process, 300 employees were affected. 50 employees from the British Telecom have been sent to India onsite and 250 jobs have been created at the outsourcing partner on location.

“Off-shoring means that domestic firms set up new factories abroad to produce the intermediary products themselves^[26] .”

Oftentimes the empirical literature mentions IT-offshoring to India or Asia, i.e. to the People’s Republic of China, representing countries with a significantly lower wage level than the USA or Germany. Compared to the USA and Great Britain, off-shoring in Germany is quite minor so far.

This is due to language and cultural barriers. As English is one of the official languages in India, advantages for the acquisition of orders from Anglo-American countries occur. A special form of off-shore outsourcing is called “near-shoring.” From a Central European point of view, this means offshoring to Eastern European countries.

What kind of chances and risks occur when off-shoring or internationally outsourcing?

Within offshoring activities, a variety of chances occur (cp. Chapter 3: Outsourcing experiences within two Austrian based companies: Palfinger AG & Emco GmbH). It enables to focus on core competences, but can lead to a higher level of flexibility and efficiency as well, due to the possibility of reducing manpower in the outsourced business functions. This enables the company to adopt and transfer the employee’s activities inside the company. Due to the partially high connection to the outsourcing partner and the long-term nature of this partnership, the selection of the outsourcing provider is a critical task. A comprehensive inspection and evaluation of potential partners is essential to avoid unwelcome developments after a contract conclusion. Communication between the outsourcing company and its partner is a must have to make sure that the outsourcing process leads to the expected results. One of the most fatal errors in outsourcing processes is the failure of participants to regularly practice intense communication (and live a strict detachment). Other important factors like political risks (country stability, laws), language, time zone differences, credit risks (fulfilment of contract) and technology translation need to be considered.

In terms of financial service, offshoring security is the main aspect to focus on. The use of offshore contractors has grown rapidly in the past few years, due to the flexibility offered by new information technology and the prospect of lower cost. Often, such partners became more than partners over the years, e.g. EMCO Maier GmbH (based in Taxham, Salzburg) purchased a Czech supplier a few years ago and established a Czech subsidiary.

But the advancement of information technology is also causing difficulties when dealing with customers. They have become more concerned about privacy (e.g. international e-banking), and the abuse of personal data has increased.

Nevertheless, if all partners involved in the outsourcing process focus on some basic parameters, outsourcing can become a success factor for every company.

2.3. Offshoring and other forms of international cooperation

It is not only the opening of the Eastern European countries, the Republic of China or the sinking transportation- and telecommunication costs that lead to broader opportunities for global collaboration and networks. It is also the rising potential of information and telecommunication technologies that facilitate the development of various forms of international cooperation: for example strategic alliances, joint ventures, licensing and franchising contracts etc. Furthermore, such cross border activities play a part in shaping the global economy.

“The advantages of cooperation are an immediate access to broad know-how, the bundling of resources and the share of risk. Strategic alliances unite the flexibility of small companies and the muscles of global players^[27].”

Despite the fragmentation of the value chain and continuing dislocation, internal growth, fusions and acquisitions are a very popular form of capacity extension. One significant example of this concentration process and development is the automotive industry. Big subcontractors are strengthening their market positions through acquisitions and are mutating into big conglomerates. Specialisation and non-specialisation, integration and disintegration in different parts of the value chain, are all dynamic developments that occur parallel to each other. For example multinationals do in-source with take-overs or cooperate with a variety of subcontractors and partners. They are vertical integrated and dispose over external networks. The central location of services and goods rendered is more or less not one single company, but an inter-organisational-network.

2.4. Service outsourcing

In one of McKinsey Global Institutes (MGI) survey the following statement is published^[28]:

“History shows that as economies grow, some job categories shrink or vanish and new ones appear: auto assemblers replace carriage makers, and factory workers replace farmers. The same thing is now happening in Call Centers, back-office operations, and some IT functions go offshore. Opportunities for redeploying labour and investing capital to generate opportunities in higher value-added occupations will continue to emerge, even if it isn´t always possible to say exactly where. Twenty years ago, for instance, no one could have predicted that the global mobile-phone industry would now employ hundreds of thousands of people.”

Technological innovation enabled companies to offshore services without loosing market closeness (for example the outsourcing activity of a Call-Center of Germany’s national airline Lufthansa to Ireland. Clients do not even know that they are calling a phone number in a different country). This example shows the usage of service outsourcing in the field of customer relationship management.

Another survey^[29] shows furthermore that 40 percent of Western Europe’s 500 largest companies have already begun moving service operations abroad. Service outsourcing is undertaken – in contrast to manufacturing outsourcing - not only due to cost-reduction reasons, but also for balancing out missing knowledge or lack of access to critical skills in companies. “Service outsourcing” does not necessarily occur internationally, also domestic service outsourcing is popular, for example outsourcing of human resources tasks e.g. recruiting, financial services, marketing or R&D and IT. Sectors which are most affected by outsourcing in the next years should be: the Telecommunication and the Public Sector as well as HR and IT^[30].

illustration not visible in this excerpt

figure 4: outsourcing of services^[31]

Figure 4, a graph of a recently published survey of manpower UK, shows which fields of service outsourcing are currently the most popular in the UK. Unsurprisingly, core activities like Marketing, sales or R&D are listed below supporting activities like IT or design activities.

What do companies need to have a look at when involved in service outsourcing activities? How is it different (to manufacturing outsourcing) in terms of execution and control? Deloitte^[32] argues that it is tricky to measure the quality of services outsourcing, due to the intangibility of the service and the interdependency of most services. When outsourcing, it is difficult to maintain the interdependency and the required closer relationships with every vendor and among vendors. In fact, it requires far more management resources than product outsourcing. Due to the interdependency of processes in services outsourcing, it could lead to an increase of complexity in all stages of the value chain. Companies should be aware of this when planning to source services out and evaluate this decision carefully.

Another way in which service outsourcing is qualitatively different from material outsourcing, is in terms of the “stress effect”:

“Accountants did not fear that someone abroad would take their high-paying jobs, but they certainly benefited from the cheaper imported manufactured goods that open trade allowed^[33].”

Among white-collar workers in developed countries, a tremendous amount of anxiety arises. This is the workforce which was once protected from global competition. The anxiety arises in terms of the deterioration of side effects of international service outsourcing. The anxiety is mainly derived from reports in news media, stating that global service trade is exploding. In the 1990ties, when outsourcing was booming, news media reported enthusiastically about the benefits of outsourcing. But recently, academic literature and news is calling a change in the outsourcing market, and started reporting negative medium or long term side effects for both companies and the national economy.

Enabled by the digital revolution, the news media argues that outsourcing activities are dominantly one-way; from developed countries to developing countries, therefore leading to massive job losses. The lack of control and the worry that service outsourcing could spread contributes to the fears of white collar workers. Is this fear justified? For a detailed analysis of job losses and effects on wages please refer to chapter 4.7.1.

[...]

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^[1] Egger, H. and Falkinger, J.,2003, p. 2

^[2] Cooper, R., 1994, p. 3-14

^[3] Accenture is a worldwide operating service provider, with Outsourcing knowledge as one of their core competencies, see : http://www.accenture.de/static_pdf/st_outsourcing_0802.pdf

^[4] McGovern, G. and Quelch, J, 2005, p. 12

^[5] -8 Hinterhuber, 2004, p.120-122

^[9] Hinterhuber, 2004, p. 123

^[10] Hinterhuber, 2004, p. 123

^[11] Hinterhuber, 2004, p. 129

^[12] Hinterhuber, 2004, p. 130

^[13] Hinterhuber, 2004, p. 132

^[14] Hinterhuber, 2004, p.133

^[15] Welch, J.A. and Nayak, R., 2000, p. 19

^[16] Hinterhuber, 2004, p. 133

^[17] Hinterhuber, 2004, p. 134

^[18] http://www.montfortwerbung.com/common/docs/ccg_brochure.pdf, visited at 21.9.2005

^[19] http://www.cpc-consulting.net/cpc2/consulting/knowhow/57/Performance-Marketing-2.html, visited at 21.9.2005

^[20] https://webcopas.t-online.de/s0002/cocomore13536009/Inhalt/zeitarbeit/VK28-Zeitarbeit-Leseprobe.pdf-karrierewissen, visited at 20.9.2005

^[21] Hirschfeld, 2004, p. 8

^[22] A person has an absolute advantage in the production of two goods if by using the same quantities of inputs, that person can produce more of both goods than another person. A country has an absolute advantage if its output per unit of inputs of all goods is larger than that of another country

^[23] The ability to produce a good at lower cost, relative to other goods, compared to another country. In a Ricardian model, comparison is of unit labour requirements; more generally it is of relative autarky prices. With perfect competition and undistorted markets, countries tend to export goods in which they have comparative advantage.

^[24] http://asj.sagepub.com/cgi/content/abstract/47/3/219, visited at 30.09.2005

^[25] http://www.brookings.edu/comm/policybriefs/pb132.pdf, 2004, p. 3

^[26] Feenstra and Hanson, 2001, p. 2

^[27] Powell, 1990, p. 298

^[28] Farrell, D. 2003, p. 9

^[29] Agrawal, V. and Farrell, D. ,2003, p. 9

^[30] http://www.manpower.co.uk/news/outsourcingsurvey.pdf, p. 2

^[31] http://www.manpower.co.uk/news/outsourcingsurvey.pdf, p. 2

^[32] Deloitte, 2005, p. 23

^[33] Amiti, M. and Shang-Jin, W., 2004, p. 4