Entered by Gio Wiederhold, 9 March 2002, updated 20 March 2002, 26Feb2004, 19, 21 May 2005.
Outsourcing means subcontracting work that has been done internally in an enterprise to an outside company. The motivation is often that it is cheaper. It is especially effective if the contractor is specialized and can operates with a better business model. For instance: replacing an aircraft tire management department in an airline with a service company that charges per landings and provides service and quality guarantees.
Off shoring is the tem used specifically for outsourcing to
other countries, for the
For tangible goods offshoring has been facilitated by the drastic reductions in transport costs, largely due to containerization and some, with help of the Internet, through more effective supply-chain management. Maurer, in the "Paranet" book I handed out, considers a distance tax as an alternative, but such a measure is unlikely to be adopted.
There is more to offshoring than
having people in remote locations do the work that
A positive, but long-term benefit is to equalize incomes and
living conditions all over the world. Not having neighbors that are poor, or
disadvantaged should reduce reasons for conflict. Such thinking was the
positive motivation behind NAFTA (North American Free Trade Agreement: {
Outsourcing is part of a business model, i.e., who does what in a business, so we need first to make some definitions.
A company has a number of resources: buildings, machinery, capital, people, and knowledge. Buildings, machinery, and capital are tangible resources, and accounted for in a business annual report (find one on the web of a company you are interested in and extract those numbers). Knowledge resides largely in people. If knowledge is specific to a company – i.e., not obtained by simply hiring people off the street (here or in a remote country), then such knowledge is part of a company's intellectual property (IP). New hires typically acquire IP knowledge by training, by working with colleagues, and through their work enlarge the store of a company's IP.
The value of a company on the open market is (pretty much) the sum of its tangible and intangible value. For a public company, which has outstanding stock that value is estimated by its market value, i.e., what the stockholders are willing to pay for a share of its stock times the number of shares. (Note: a company's annual report rarely gives the market price, but it will always give the numbers of outstanding (out on the open market) shares and the price per share at the last day of the (fiscal) year. (If the price per share is not given, you can find on the web or in news papers).
The market value for a `good' company is always more than its book value. Its knowledge enables it to offer unique and desirable products and profit from it. (More on profit below) If it were less someone could come and buy all its shares, and sell the tangibles and make a profit from such a closing-out sale. For many modern companies the market value is very much higher than the book value by a large multiple (What is the multiple for the company you have chosen). It is that excess that makes the company unique and valuable, since plant and machinery, and even off-the-street employees can be quickly hired by others – who would then draw business away from it.
A company that sells something has revenues. The gross revenue is the sum of earnings from all of its sales.
There is a cost-of-goods-sold, costs associated with sales, and subtracting those leaves a gross profit, formally EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization).
Interest has to be paid on that part of the capital that has been loaned. Other capital has come from the stockholders, when they bought stock from the company.
Taxes will reduce profits
substantially, ~30% in most developed countries, less -- sometimes none
temporarily -- in countries that want to attract businesses.
Depreciation accounts for the loss of tangible resources over time, as production machinery, and amortization is the payback on loans. Those items are of less interest in our outsourcing discussion.
From the net profit, after all obligations are paid a split must be made:
1. Increase
the capital, which for the growing high-IP companies mainly means spending
on research and development. Spending on machinery, buildings, or sales staff
also requires capital.
2. Payments of dividends to stockholders -- important for mature corporations that have fewer opportunities to grow -- and hence little need for more capital.
How to make this split is the most significant management decision for a profitable company.
Outsourcing of jobs is possible because at the same time the companies that outsource jobs instruct the foreign workers on how to perform those jobs. That may be done by training foreign workers here, training leaders here and then having them train more people at the foreign site, or/and sending U.S. staff to the foreign sites for training of workers there.
While some of the training covers routine knowledge, much of what is conveyed is valuable intellectual property (IP) of the companies that do the outsourcing. Such IP is part of the value of the company, as recognized in their market value.
Hence, as part of outsourcing valuable property (IP) is
being moved overseas, property that has been created by prior generations of
workers, and now is now exported without any corresponding generation of income in the
A company giving advice on taxhavens
is Pillsbury Winthrop Shaw Pittman LLP,
The market value of the companies that outsource stays high
of course, because that value includes IP wherever it is globally located. It may well increase, because the profit
margins earned on the exported IP are typically much higher than the margins
that can be achieved in the
Globalization is in issue that we all face, and will be an issue still when you graduate. Just whining about jobs, and gloating about new corporate efficiencies misses ignores the social issues, and the IP transfer that makes it all possible.