Pros & Cons of Off-shoring Goods

By Robert J. Martin

Published by Business First in the March 10-16, 2006 issue

As Thomas L. Friedman explains in his current best seller, “The World Is Flat,” recent advances in information technology, world-wide high capacity communications channels, and free trade have opened global business opportunities to all companies. This enables companies to buy and sell products and services from virtually anywhere in the world.

The sourcing of products, parts, or services from foreign countries is known as off-shoring and has caused heated debates at every level in U.S. society. Proponents of off-shoring claim that this natural extension of globalization stimulates employment, provides higher paying jobs, and will result in a stronger U.S. economy based on innovation.

Opponents claim that off-shoring eliminates high-paying jobs in manufacturing and computer services, undercuts the U.S. middle class, and will destroy the U.S. social fabric and democracy. What is especially troubling is that both sides of this volatile issue have data to support their positions. Both sides, however, agree on the following. Off-shoring is increasing dramatically. It is more complex than the current U.S./China competition. And it is profoundly changing our world’s businesses, cultures and environments.

From a U.S. perspective, companies seem to be stampeding to off-shore their manufacturing and business services. This is clearly reflected in China overtaking the U.S. as the world’s premier manufacturer and India’s rapid growth in IT and business services. The stampede will continue until a new global equilibrium is established, but the equilibrium will be a long time coming. As the first wave of developing countries improves their capabilities, they will more closely parallel the technology, innovation, productivity and skills of the U.S. And as the labor rates of these first wave countries increase, other less developed countries will take their places as providers of low-cost labor causing the world to continue to flatten. Throughout this flattening, there is one certainty: U.S. companies will have difficulty surviving if they produce commodity goods or services that compete on price and have a high labor component.

Advantages and Disadvantages

Cost savings is the primary advantage of off-shoring. In addition to lower labor rates and employee benefits, cost savings are often realized through taxes, environmental and safety standards, work rules, and plant and equipment costs. Another advantage for many companies is that off-shoring may provide a physical presence in large, expanding markets that can be leveraged to increase sales and develop international business experience.

Off-shoring has numerous disadvantages. Long supply chains are susceptible to environmental and political disruptions, force companies to produce larger batches, increase inventory and cost flow requirements and provide less flexibility to adjust to changing markets. The direct and opportunity costs of working with distant partners are usually significant, the differences in cultures, values, and legal systems are sometimes problematic, and there are intellectual property risks.

Off-shoring is sometimes a good business decision, and a good analysis will help recognize appropriate opportunities. Since cost is the primary advantage of off-shoring, a thorough cost analysis is critical. Too often, managers compare the costs associated with manufacturing and neglect the direct and opportunity costs associated with off-shoring. They also assume that all the theoretical cost savings can be achieved, ignoring indirect costs such as capital depreciation that often remain after off-shoring. Even with significant cost savings, off-shoring may not be advisable. Reasons include the risk to intellectual property, the need for manufacturing agility required for short product life cycles and customers’ build-to-order requirements.

Key Competencies

A struggling company will often find that off-shoring makes their bad situation even worse. To be successful, companies must possess key competencies including international business and supplier development experience; good IT and financial systems; and experienced professionals to help with international contract and intellectual property law, finance and logistics. Above all, managers involved in off-shoring must have patience and a tolerance for different cultures and languages, because these attributes are often tested in international business.

As the world continues to flatten, most companies will sell and source products and services off-shore in order to survive. Business will become increasingly competitive and U.S. companies will need to be innovative to compete with their lower cost competitors.

This much is certain. If we don’t stay ahead of the competition, we will be run-over from behind.