(Written in February 2004 - This was done as part of my M.S. course work. The following is a purely economic analysis from management standpoint. Employee issues in the developing countries are not addressed in the present article. Do not think Nike. Think of a software company outsourcing to their partners in India.)
The recent trend in outsourcing has been towards the countries that have undergone economic liberalization in the past decade. This list of countries includes China, India and Russia. This article focuses on those companies with management controlled by the locals, rather than those that are subsidiaries of US companies.
There are great short-term and long-term benefits to management of such foreign companies. However, they have some challenges in front of them too. In the immediate future, these companies stand to gain huge profits, because they can charge US rates and continue to pay local rates for labor and material.
For example, according to the World Bank, in 2002, China and India had per capita incomes of $940 and $480, respectively. In comparison, the United States had a per capita income of $35,060. Let us assume that a US worker works 75% of the year at minimum wage for forty hours a week. This is approximately 1500 hours at $5.15, which is equivalent to $7,725. Even assuming a Chinese or Indian worker is paid twice the per capita income; the labor cost is three to six times less in those countries. Material costs (especially those from labor-intensive industries) are also low. With such low costs, the outsourcing companies can become competitive in the global market.
An interesting aspect of the factors (lower salaries and costs) that contribute to outsourcing is that they become the standard for those outsourcing destinations in the short term. For example, salaries for a Chinese worker will never rise above a US worker in the same industry because the market dynamics requires them to be kept low to obtain projects. Thus, the foreign management can rely on salaries and costs being low to obtain outsourcing contracts.
Russia, China and India are part of the low-cost, high-skill market as opposed to "high-skill, high-cost" countries such as Israel and Ireland and "low-skill, low-cost" countries such as Philippines and Bulgaria. All these economies have invested heavily in higher education producing a huge pool of highly skilled professionals. Until recently, most of them remained in low-paying jobs under-utilizing their skills or they migrated to other countries in what was termed "brain drain." Because of the huge population, unemployment and semi-employment remains high. Foreign management can depend on a steady supply of skilled and non-skilled labor.
However, foreign outsourcing companies do face several challenges. In the case of China and Russia, there is a language and cultural barrier that they must overcome to get outsourcing projects from the US. While the local education system adapts, the management gets around the problem by using project managers with the required English skills and shielding other employees from contact with clients.
Rampant corruption is another problem faced by the management. China and India place at 59 and 73 on a list of 102 world countries in 2002 in terms of corruption. Although corruption affects local non-outsourcing companies, it becomes even more of a problem for outsourcing companies because of issues involving trade, foreign exchange, customs, travel and international standards. Corrupt government officials force companies to pay "protection money" to avoid huge government fines. International labor and environment standards can be flouted easily by bribes or political connections and that affects companies that play by the rules. However, the wealth creation resulting from the influx of outsourcing capital will create a stronger middle class and reduce corruption.
Infrastructure is a huge barrier for foreign outsourcing companies. In India, electricity brownouts happen in many cities and companies have to rely on expensive generators. Much improvement is still required in terms of telephone networks, roads and airports. With more interest in foreign outsourcing, infrastructure development has been increasing both by foreign capital and budget allocation of the respective governments.
Foreign companies face intense competition with other companies from the same or different country. Many establish local sales and marketing offices in the US. Telemarketing and requests for proposals seem to be the preferred method to obtain business. Each company tries to put forward its unique selling proposition - costs, skills, international awards, location, etc. The influence of competition helps foreign managements improve their areas of weakness.
Outsourcing is less a hard sell than it used to be, because of the intense media exposure to the benefits and the urgency due to the economic recession. However, many US companies and managers are still reluctant to outsource, because they are uncertain of the credibility, skills and capabilities of outsourcing companies. Most foreign companies have hit a stonewall trying to obtain lucrative projects involving intellectual property rights and sensitive information (such as related to government or military), because of the lack of sufficient and trustworthy legal and security guarantees. In the long-term as customers start working with foreign vendors, they gain trust and credibility, which helps them convince new prospects.
The most important challenge faced by foreign outsourcing companies is the realization by US companies that they could further improve their bottom line by eliminating the middlemen and directly opening their own branches in the foreign countries. Many companies such as American Express, Ford and GE Capital have opened centers in India and China. Although this mode of operation poses many difficulties and is not feasible for mid-size and small-size American firms, they may be more comfortable partnering with an American subsidiary in China instead of a local Chinese firm. Local restrictions against one hundred percent foreign-owned companies might be removed upon further globalization of those nations.
In the long-term scenario, foreign managements stand to benefit a lot. They gain global markets, trust and credibility. Wealth creation is facilitated by influx of capital. This enables them to harness their knowledge and resources to be innovative and inventive. As the market economy develops, there are more entrepreneurs in the society, which contributes to increase in the standard of living. Finally the influence of US subsidiaries and foreign conglomerates increases the standards of the foreign companies, enabling them to compete better in the global market.
Copyright © 1999-2008 Krishna Kumar, All Rights Reserved.
