The Trouble with Outsourcing

In my class on Management strategy and policy, one of the subjects we cover at some length is Outsourcing, and specifically the positive and negative effects it can have when employed at various levels of business. The concept has gotten a lot of bad press in recent years, given that the term is usually used to refer to outsourcing production to other countries, which means a loss of jobs in whatever country, state or city the speaker is from. And, in fairness, it is sometimes possible to shift production or other activities to some place where labor is cheaper, required resources are more readily available, or various regulatory laws are less problematic, all of which remains wildly popular with the people responsible for containing costs. But unfortunately, the loss of job opportunity in the home country is really only the beginning…

Consider the case put forward by Nobel Economics Laureate Robert Mundell in a Forbes interview from earlier this month. One of President Regan’s economic advisors, and one of the key people behind “Reaganomics,” Mundell is now warning that the deterioration of the American manufacturing sector that has resulted from excessive outsourcing has left the U.S. without the technical or intellectual base needed to remain competitive – or even to maintain economic or military assets without foreign assistance. The article also cites Dominic Gates of the Seattle Times, and his description of the issues with the new Boeing 787 Dreamliner: apparently, Boeing outsourced the plane’s electronics to a French company, which then sub-contracted most of the work to a series of Japanese companies. This undoubtedly saved Boeing a great deal of money over having the work done in Washington State, but when the Dreamliner’s batteries began to over-heat and catch fire Boeing’s own engineers did not have the technical expertise to address the problem…

Now, as any MSU undergraduate (or, at least, any of the ones who have been subjected to Management 409 with me) can tell you, this issue happens all of the time and is considered to be one of the most common drawbacks of outsourcing production. In fact, even in cases where production activities are outsourced to other domestic companies and never leave the home country there remains an excellent chance that the original designer will lose the ability to create or service their own products. At best this is annoying; at worst it could negatively impact both the economy and the security of the home country. The real question is what to do about it…

Most Protectionist/Isolationist pundits would just tell you not to outsource anything – keep all of your production domestic, and if this results in higher final prices reaching the consumer, too bad! All true patriots will understand the need to keep your industry at home, and willingly make up the difference in cost! And, in fairness, “American Made” is a powerful selling point in the U.S., and might work for companies from other nations in their home countries as well. But if nationalism always won over price it would probably still be possible to purchase a television set manufactured entirely in U.S. territory (which it hasn’t been for over 20 years at this juncture). And with any commodity product there’s really no point in even asking…

Some companies will attempt to counter this problem by retaining part of the manufacturing process under their direct control, either by moving the final assembly of the product to a domestic facility, or by purchasing the offshore facilities where production takes place instead of outsourcing production to another company. But purchasing foreign companies – or even just their major production assets – can be risky, especially in uncooperative countries, whereas Boeing does perform final assembly of the Dreamliner at their facility in Seattle, and that does not appear to have helped them. Up until now the risk of losing control (or even understanding) of your own technology was just something companies had to accept in order to gain lower prices and higher margins, but if this trend continues that risk is going to become less and less attractive…