Outsourcing - Managerial Accounting

Outsourcing

Erica Inman

BUS630: Managerial Accounting

Professor Oscar Lewis

April 16, 2012

Outsourcing Outsourcing is used very extensively in today’s world. Organizations use all kinds of outsourcing in their ever day activities to improve products and services that they provide to customers. Outsourcing is used to free both capital and brainpower for investment, research, and development. More than 90 percent of companies view outsourcing as an important part of their business strategy. For the past fifteen or so years, decisions regarding outsourcing have been relatively straightforward. It allows companies to cut costs, make better use of their resources, and focus on growth. “During the past 18 months, however, the business landscape has changed, the old realities o longer hold true and the future is no longer about rapid growth; the risks of outsourcing are now more obvious and its financial advantages far less clear.” (Cordon, 2011, pg. 1) Some companies now see big opportunities in in-sourcing and near-shoring. Many businesses have to rethink their business models. To the United States and other Western economies, outsourcing is critical to both growth and success. “Harvard Business Review lists it as one of the most important new management ideas and practices of the 20th century.” (Corbett, 2004, pg. 3.) Many of the worlds most successful companies are also the world’s top providers of outsourcing services. Outsourcing became an important part of business strategy in the early 1990’s. This was a time when the U.S. economy was in a severe recession and businesses were struggling to be competitive. The world that we live in today can be described as hyper-competitive. “Globalization is inextricably linking the world’s major economies.” (Corbett, 2004, pg. 4) The standard of excellence over the years has risen enormously. Today’s standard is not just best in its class but best in the world. In the global world that we live in today, every company must compete against customers coming from all over the world. There are fewer barriers to the market place making new competitors easier to locate, all that is needed is a computer. The most visible result of this hyper-competitive environment is rapid commoditization. The power that producers once had has been shifting quickly to give the consumers the ability to be in control. “A company’s ability to command a higher price for the unique value it offers lasts only for a fleeting moment.” (Corbett, 2004, pg. 5) The pressure on businesses has also risen during this time. Growth and profitability are expected while increased shareholder value is demanded. In response to the hyper-competitive atmosphere, organizations are focusing on being more specialized. They have to evaluate each of their activities to determine whether or not it provides a competitive advantage. When an activity proves itself to be an advantage, it will receive increased internal investments. Outsourcing is generally a market-driven process. There are different factors that work together to shift the balance of the value equation toward the “buy” side, more and more every day. A large factor is the continuous increase in the capabilities of outsourcing service providers. There is outsourcing for every kind of task that a business will need to operate. Another factor is technology. “Technology makes much of the work of the modern organization placeless.” (Corbett, 2004, pg. 7) The last factor is competitive pressure. In order for an organization to continue to perform internally, it has to be better than both its direct competitors and the best outsourcing providers that its competitors can hire. Outsourcing improves the performance of areas of the business that do not provide a unique competitive differentiation. It also reduces both direct and opportunity costs. At an organizational level, outsourcing represents a basic restructuring away from the industrial age and towards the modern business age. The basic reason for outsourcing is to reduce costs. The business can choose to use those savings however they may deem fit. “About 50 percent of executives state that reducing costs is the top reason for outsourcing.” (Corbett, 2004, pg. 12)
The amount saved, in most cases, can be anywhere from 10 to 20 percent. They can also be much higher depending on the size of the gap between the amounts the company’s current cost of operations is and the money it will be paying to the outside provider. One benefit of outsourcing is that the need for new capital is significantly reduced; this is because the provider often brings in the needed resources and current assets can be sold to the provider. This will free up capital dollars that are already invested. They can then reinvest the funds in other parts of the business. “Another often-overlooked, sometimes difficult-to-quantify, but very important aspect of outsourcing’s value is its ability to free an executive’s time to focus on the “what” of the business as opposed to the “how”.” (Corbett, 2004, pg. 15) For the majority of executives, their time would rather be supporting their company externally on customers, shareholders, investors, and suppliers. While outsourcing has had its successes, there have also been failures. “A 2003 report published by IT research and consulting company Gartner reported that one-half of all outsourcing deals are labeled “failures” by decision-making executives because the results do not meet expectations.” (Corbett, 2004, pg. 16-17) another study done by a UK-based PA Consulting Group fount that 66 percent of the benefits anticipated were partially realized. Another 2000 study by Dun & Bradstreet found that 25 percent of the functional areas within the 2,200 companies surveyed had prematurely terminated at least one outsourcing contract during the preceding two years. There are a few barriers when it comes to outsourcing. One is loss of control. It can be argued that when organizations outsource in the correct way that they don’t actually lose but gain control. “A contractual relationship with a top service provider, with proper management reporting, tied to measurable outcomes gives the executives greater control than they had over their previous, typically less formal and less well-defined internal management system.” (Corbett, 2004, pg. 18) Managers feel a loss of control, even in the slightest. Another fear is that the task is too critical to be outsourced. Organizations can and do outsource critical tasks. One example is GM, they have outsourced their payroll and the executive who did so would go out of his way to make sure hat the other executives understood that the outsourcing was not because the task wasn’t critical. “If we don’t make payroll, the union walks. If the union walks, we don’t make cars. If we don’t make cars, we don’t make money, he would say.” (Corbett, 2004, pg. 18) Their payroll was outsourced because it was too critical not to outsource to a professional that could do it better and more efficiently. Another barrier is the loss of flexibility. Instead of reducing flexibility, outsourcing can actually increase it. Outsourcing can benefit the company because it gains access to the provider’s larger resource pool. These new resources can now be used upon demand. Negative customer reactions can also be a barrier. “Although outsourcing may be a sensitive issue for some customers, improved service quickly puts these concerns to rest.” (Corbett, 2004, pg. 19) Companies do not need to make the fact that they use outsourcing known if it is not detrimental to their business. Other companies such as shipping companies may prefer to make this information known to their customers because it gives them a larger playing field. Another company to profit from outsourcing is IBM. “International Business Machines Corp. agreed to take over most of the computer operations of auto-parts maker Visteon Corp. in an outsourcing deal that the companies say is likely to be valued at more than $2 billion over 10 years.” (Hechinger, 2003, pg. B.3) Employee resistance is another known barrier. Employees may be concerned with the impact the outsourcing will have because of their job role. This can be particularly true when the company involves offshoring. Outsourcing can also open up career opportunities for employees. “After all, does a custodial or food services employee have a better long-term career opportunity working for a pharmaceutical company filled with Ph. D.s, clinical researchers, and sales professional, or at a major outsourcing provider of those services, such as ARAMARK, Compass, or Sodexho?” (Corbett, 2004, pg. 19) An employee may find a career with an outsourcing agent who specializes in a certain field rather than a job somewhere where their role is not the primary concern. Offshoring is not a new idea; it has in fact been around fro decades. Think of the Made in China labels that are frequently seen. For years, Western companies have taken their processing overseas. The cost effectiveness of manufacturing products overseas and having them shipped back to America has been essential to a lot of major companies. The only thing new about offshoring is the global digital infrastructure that was built in the 1990’s. This now makes it possible to perform information-based activities anywhere in the world and have the results delivered instantaneously. “This development has essentially made much more of the work of the modern organization “placeless”.” (Corbett, 2004, pg. 39) Companies of all sizes are finding that offshoring can dramatically reduce costs while increasing quality, speed, flexibility, and overall capabilities. In recent years, offshoring has allowed businesses to cut costs by 40-80%; moving manufacturing or other processes to cheaper countries has done this. It has also allowed firms to develop factories in the best possible economic location. The advantages of offshoring and global specialization need to be compared to those of near shoring, which includes market responsiveness, development of the local economy, risk reduction and being more environmentally friendly. “Rapid increases in the costs associated with major offshoring destinations mean there is no longer a clear financial argument to be made in its favor.” (Cordon, 2011, pg. 2) The climate of the current economy may make it more reasonable for a company in Brazil to offshore some its activities to Mexico and vise versa. “Geoff Harries at Fiserv believes an organization’s capacity to develop additional operational capabilities for fund accounting, performance measurement, risk management and corporate actions processing “will determine whether they develop in-house or outsource. Many hedge fund administrators have developed some of the post-trade capabilities that hedge funds will increasingly need and so, if hedge funds need to respond quickly to pressure for middle and back-office operational maturity, then a cost-efficient way to achieve this may be to outsource.” (Hedge Fund Reviews, 2009, pg. s5) This is the majority for small to medium sized funds. Outsourcing technology and certain operational tasks are trends within the industry. In contrast to the previous, author Jim Benes believes that offshore production, quality and supply issues along with shifting economic dynamics are brining more manufacturing back to the U.S. “Although low offshore production costs once appeared attractive, other long-distance factors have reduced the perceived cost advantages to a fraction of the expected savings.” (Benes, 2009, pg. 16) Another problem with offshoring is that manufacturers rely on distant suppliers and lose control over factors that hamper their response to customer needs, and the ability to pursue product and service customization strategies. Many manufacturers looked to offshoring production and supply functions as a way to stay competitive. “However, the same factors that made offshoring an attractive strategy for reducing costs have shifted dramatically, and now are eroding many of those savings.” (Benes, 2009, pg. 16) The result of this is that on-shore and near-shore production is slowly becoming more viable and competitive for a large number of producers. “In a June 19, 2008 article, Business Week’s Pete Engardio pointed out how the economic of global trade are starting to tilt back in favor of the U.S.” (Benes, 2009, pg. 16) Is outsourcing inevitable? Offshore outsourcing is not a natural result of market forces. There are factors that help promote it such as U.S. immigration and tax laws; foreign governments explicitly target U.S. jobs; and U.S. companies and management consultants who have actively promoted outsourcing. Outsourcing is not a phenomenon; it reflects longer-term changes in the global economy. The U.S. government has largely ignored these changes. Instead the policies towards outsourcing have been characterized by short-term reactions rather than long-term planning. Outsourcing is not just about jobs. The potential impact is not only on our quality of life but also on our national competiveness and national security. “Our competitive edge—the reason, until now, America has been the beacon for immigrants to come and achieve the American Dream—has been our ability to create new high-wage jobs.” (Hira, 2008, pg. 8) Outsourcing is taking away the workforce that has been a key part in the success of the United States. The return of offshore production to the U.S. is good news not only for the machine tool industry, but also for the U.S. economy. “A recent survey of a nationally representative sample of Americans, commissioned by Deloitte LLP, shoed that the majority of respondents (71 percent) view manufacturing as a national priority.” (Benes, 2009, Pg. 17) A Vice chairman and U.S. Consumer and Industrial Products Industry Leader Craig Giffi, of Deloitte LLP said, “Americans clearly still believe that manufacturing remains the backbone of the economy.” Outsourcing is a touchy subject for some, there are many that believe that outsourcing should be banished while others think that it is a great business tool. I believe that each company must use their resources and determine which source would be the best for each to use. Outsourcing is used very extensively in today’s world. Companies must use do their own research and make educated their decisions. The global market is expanding and companies are outsourcing more and more. With more than 90 percent of companies using outsourcing as an important part of their business strategy it seems as though outsourcing is here to stay. This opinion can be disputed therefore both can be correct for two different companies.

References
Bennes, J. (2009) Made in the U.S.A.: Returning Home, American Machinist Magazine, July 2009, pg. 16 Retrieved from Ashford Library. Cobbett, F. (2004) The Outsourcing Revolution: why it makes sense and how to do it right. Chicago, IL: Dearborn Trade Publishing. Cordon, C. (2011) Inshore, Offshore, Which Shore? SCE Magazine pg. 12, Retrieved from Ashford Library. Hechinger, J. (2003) The Wall Street Journal: IBM Gets $2 Billion Outsourcing Job --- Most Computer Operations OF Visteon to Be Taken Over As It Diversifies from Ford. New York, NY. Feb 12, 2003. Pg. B3
Hira, R. (2008) Outsourcing America. New York, NY: AMACOM

References: Bennes, J. (2009) Made in the U.S.A.: Returning Home, American Machinist Magazine, July 2009, pg. 16 Retrieved from Ashford Library. Cobbett, F. (2004) The Outsourcing Revolution: why it makes sense and how to do it right. Chicago, IL: Dearborn Trade Publishing. Cordon, C. (2011) Inshore, Offshore, Which Shore? SCE Magazine pg. 12, Retrieved from Ashford Library. Hechinger, J. (2003) The Wall Street Journal: IBM Gets $2 Billion Outsourcing Job --- Most Computer Operations OF Visteon to Be Taken Over As It Diversifies from Ford. New York, NY. Feb 12, 2003. Pg. B3 Hira, R. (2008) Outsourcing America. New York, NY: AMACOM