The Outsourcing Dilemma: Is Your Company Sending Out the Wrong Work?

A Discussion with Gary Kusin and Prabhudev Konana

The issue of offshore outsourcing by U.S. firms is a hot-button topic of discussion for politicians and media pundits. In business circles, the dialogue centers more on investigating the real-world successes and failures of outsourcing and the implications those results have for American firms competing in today’s global economy. Recently, Gary Kusin, BA ’72 and former CEO of FedEx Kinko’s, and Prabhudev Konana, associate professor in the Department of Information, Risk, and Operations Management at McCombs, discussed Konana’s research on the subject.

Prabhudev Konana: Offshore outsourcing is an economic reality driven by market forces and, to some extent, herd mentality. Pundits often exaggerate failures or successes of sourcing decisions to prove their biases, and emotions become deeply intertwined with economic decisions that may not be rational. We need to step back and evaluate choices realistically. This motivated me to dig deeper beneath all the headlines to evaluate sourcing choices and to develop strategies for meaningful decisions.

Gary Kusin: There are two distinct camps in this world: There’s a very vocal group against outsourcing of any kind, and then there’s another group of people who are very vocal about outsourcing as a positive force in reducing cost in the business world. However, the latest news in the area of sourcing is that more and more companies are outsourcing—yet they’re not getting the outcomes they wanted or expected. A report from Deloitte found that 75 percent of the outsourcing contracts did not yield desired results. I think Professor Konana’s research has helped us understand why.

Konana: As Mr. Kusin points out, many companies have not been reaping the benefits they were expecting from their sourcing initiatives. Why? In our study, we looked at 93 companies that were either looking into sourcing options or had already outsourced some processes, and we found several possible explanations. First and foremost, we discovered that firms may be sourcing the wrong processes.

Conventional wisdom says that if a process within a company is highly modular, self contained and already deemed a success, it’s very likely you can offshore that process with positive results. However, we found that companies are doing the opposite. In our discussions with executives and managers, problematic processes that are difficult to address internally—rather than the successful ones—are being sent offshore.

Perhaps it is because managers face fewer organizational challenges to change problematic processes. Or maybe managers are less reluctant to change processes that work very well and have fewer issues. Some managers suggested that it is organizationally difficult to justify changing processes that work very well, even noting that changes could lead to lower organizational morale. This raises numerous issues. Are firms just transferring problems and risks to outside vendors?

Kusin: A lot of this is just human nature. Corporations tend to want to give the parts of their business they have not succeeded with to some other party and hope they can do a better job. And that’s exactly the wrong part of the business to outsource. I think the 25 percent that are meeting with success are companies that have outsourced the parts of their business that are most effectively managed today.

Konana: Another area I think has caused problems for companies looking to benefit from a new sourcing choice is that they have tended to underestimate the costs. It is generally assumed that low-wage offshore locations have lower production costs—even with lower productivity and quality—because the wage differential between the U.S. and low-wage countries is significant. Offshore vendors may also provide lower production costs due to higher economies of scale and specialization, and they may have better efficiency due to market forces. And companies do a good job forecasting these production costs—the direct labor and material involved in creating or delivering a product or service.

But that is not the whole picture. There are what we call transaction costs that need to be taken into account: the costs in identifying the right vendors, coordinating activities overseas, and writing and enforcing contracts. There are also many costs that are even less tangible which have to do with managing the risks associated with safeguarding intellectual property, potential opportunistic behavior by vendors and disruption of activities due to terrorism, war, power failures, hurricanes and social upheaval. So, there are a lot of hidden costs, and firms that have been unsuccessful have only a short-term understanding of the costs involved, but may not fully grasp the long-term costs.