David Ricardo's comparative advantage theory and outsourcing trends

Outsourcing Trends

About outsourcing

The concept and practice of outsourcing are based on economist David Ricardo's theory of comparative advantages. This theory states that if a country or company, registers lower costs of producing a certain good you need, it is more effective for you to use that other company to produce those goods, instead of producing them yourself.

A direct result of such thinking led to the intense implementation of outsourcing practices. The process of outsourcing has been defined in several ways, a relevant definition being given by Tech Encyclopedia, which states that outsourcing implies "contracting with organizations outside your country for work that could otherwise be done by employees within your company."

The procedure of outsourcing can be extremely useful to the cost saving process, but if incorrectly implemented, it can do more damage than good. As such, a company that desires to outsource, has to follow the next five steps: "bid process, due diligence, contract negotiation, transition and ongoing operation."

The outsourcing process has raised numerous debates amongst supporters and disclaimers, each placing more emphasis on the advantages or disadvantages of outsourcing. Among the advantages that make supporters promote outsourcing are: reduction of costs, "improvement of company's focus, access to world class capacity, non-critical business functions, shared risks, improvement of production and abstraction of delays, minimalist human risk and additional profits."

2. Outsourcing trends

Regardless of the opinions forwarded by economists, the outsourcing process continues to expand and develop in accordance with international business features. For instance, fierce competition led to the growth of the outsourcing marketplace and its maturation. A wide array of outsourcing possibilities has generated a more severe selection process, and higher expectations from the clients. For example, if in the recent past outsourcers were interested in reducing costs, today, they desire to increase productivity and also the quality of the purchased services. Other outsourcing trends include consolidation, globalization, person-to-person offshoring, green sourcing, virtual worlds and Outsourcing 2.0.

2.1 Increase of outsourcing procedures

The general and most obvious trend in outsourcing is that of its increase, proof of this trend standing the large number of companies that are currently engaging in outsourcing procedures, and also the great number of companies that desire to engage in such actions. "Recent market surveys indicate that almost 80% of companies expect to increase their investment in outsourcing."

2.3 Increase cost reduction, productivity and quality

Even if achieving cost reduction is no longer the sole advantage for outsourcing, most companies still consider it to be a highly motivating factor. In addition, when searching for an efficient outsourcing contract, the international client is looking to maximize the productivity and the quality of the services purchased abroad.

Here is how 240 companies in a Cutter Consortium survey viewed the future of outsourcing businesses regarding the three major factors:

Cost reduction: not successful - 3.8%; minimally successful (less than 10%): 16.2%; moderately successful (10 up to 30%) - 51.7%; significantly successful (31 up to 50%) - 20%; very significantly successful (more that 51%) - 5.8%. 2.5% answered they didn't know.

Increased productivity: not successful - 7.9%; minimally successful (less than 10%): 24.2%; moderately successful (10 up to 30%) - 44.6%; significantly successful (31 up to 50%) - 15%; very significantly successful (more that 51%) - 5.8%. 2.5% answered they didn't know.

Increased quality: not successful - 12.9%; minimally successful (less than 10%): 32.9%; moderately successful (10 up to 30%) - 30.8%; significantly successful (31 up to 50%) - 15%; very significantly successful (more that 51%) - 5.8%. 2.5% answered they didn't know.

In a nutshell, most outsourcing companies expect the next decade of outsourcing to bring them moderate cost reductions, moderate increase in productivity and minimal increase in the quality of the services.

2.4 Consolidation, globalization, person-to-person offshoring, green sourcing and virtual worlds

The consolidation of businesses, brought about by outsourcing, is generated by the fierce competition on the marketplace, and it is prone to materialize in numerous mergers between companies activating in similar areas.

The globalization trend of outsourcing means that in the near future, companies will outsource contracts to most countries of the globe, unlike nowadays when most contract are being sent to India. "According to a study by analyst IDC, cities in China will overtake their Indian counterparts as top destinations for offshore global delivery by 2011."

Person-to-person outsourcing implies that the contracts signed will no longer solely refer to large scale outsourcing, but they will also include smaller size companies and operations that require less personnel.

Green sourcing means that in the near future, outsourcers will take into consideration the environmental factor within a country, before deciding whether or not to sign contracts with companies in that country.

And finally, the virtual worlds trend implies that in couple of years time, companies will be able to organize their employees, based both nationwide as well as around the globe, into virtual groups that will be able to meet in virtual offices.

2.5 Outsourcing 2.0

As compared to Outsourcing 1.0, where the emphasis was placed on cost savings, "Outsourcing 2.0 is about core competencies." It aims to increase efficiency, level of customer satisfaction, level of employees' training, experience and capabilities. Furthermore, Outsourcing 2.0 shifts contracts from large companies to small and medium-size organizations. If Outsourcing 1.0 implied that only large companies were encouraged to outsource, Outsourcing 2.0 points out how "more middle-market and small companies are in fact turning to outsourcing."

In addition, Outsourcing 2.0 reveals the top three activities that are no longer performed within the original company, but are being outsourced to second parties: accounting, information technology consulting and marketing and sales.

3. Outsourcing issues and solutions

There are numerous shortcomings to the outsourcing process and specialized economists criticize the next trends. For instance, the increase of outsourcing procedures could lead to massive job losses in the outsourcer's country. For example, if United States companies continue to outsource it jobs to India and China, American developers will be faced with imminent unemployment. Two solutions could be proposed to solve the problem of unemployment: 1) a moderate and controlled increase in the number of outsourcing contracts or 2) the possibility that companies in the outsourcer country do outsource work for a third nation.

However, both alternatives present the parties with potential loss. In the first case, the company would have to limit its outsourcing contracts and work with more expensive internal workforce, a situation that generates increase of costs. The second situation presents potential loss for the workers, as they would probably have to accept lower wages from the foreign outsourcer.

The market maturation trend poses the issue of monopoly. Given the fierce competition on the international outsourcing marketplace, smaller companies would be eliminated by larger corporations or, in order to survive, would be forced to merge. Currently, there is no viable solution to the growing competition on the outsourcing marketplace.

Furthermore, also a consequence of the market maturation is the intensified selection process. As clients now look for more than reduced costs, they select vendors based on numerous criteria. This makes the selection process a time consuming and costly activity.

One of the most disturbing elements of outsourcing, common in both 1.0 as well as 2.0, is the loss of managerial control over the performed operations. Managers find it more difficult to control virtual teams than the employees that work in the direct sub-hierarchy. In order to regain some of the lost control, managers could delegate internal workers to the vendor and charge them with the supervision of the foreign team. However, this solution increases the costs, as the delegated managers have to be paid extra for having been sent away from home; also, the company has to insure accommodations for them. Nevertheless, the economies made through outsourcing should more than cover the expenses registered with the delegated managers.

Other issues brought about by outsourcing are business confidentiality, diminished and slow communications or hidden costs. In order to solve these problems, the outsourcer has to implement highly selective criteria, he has to know his partner extremely well and he has to hire judiciary consultants to go over the contracts, all time consuming and cost increasing activities.