Is Outsourcing Profitable? - Strassmann · Summary of Case Study •The definition of...

Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY

1

Is Outsourcing Profitable?

Prof. Paul A. StrassmannGeorge Mason University, March 6, 2006


2

Outsourcing: Rising or Losing?


3

What is Outsourcing?What is Outsourcing?


4

Definitions

Cost ofSales

Operations

DepreciationInterest, Taxes

Outsourcing

Direct

Overhead

Profits


5

Financial Profile of U.S. Firms (2004)

Standard & Poor's Data for U.S. Corporations with 3.8 Million Employees


6

Outsourcing and Corporate Economics

• Overhead costs now manage not only internal“direct” labor but also outsourcing work doneby suppliers.

• Computer applications, optimized for“enterprise” integration have difficulty copingwith the suppliers’ incompatible systems.

• Unmanaged outsourcing complexity can voidlabor saving gains.


7

Critical Ratios

Outsourcing Ratio = Outsourcing / Direct Costs

Overhead Ratio = Overhead / Direct Costs


8

Distribution of 2004 Outsourcing Ratios

Median Outsourcing Ratio for 769 U.S. Corporations = 75.6%


9

Outsourcing Not Correlated with Profitability


10

Distribution of 2004 Overhead Ratios

Median Overhead Ratio for 769 U.S. Corporations = 124%


11

Overhead Not Correlated with Profitability


12

Summary: Outsourcing and Overhead Ratios

• Outsourcing now equals 75.6% of corporatedirect costs and is rising.

• Overhead costs now exceed corporate directcosts by 24% and keep rising as direct costsoutsourced.

• Neither outsourcing nor overhead correlateswith profitability. Corporate profitabilityreflects effectiveness of management.


13

Was Outsourcing Was Outsourcing Profitable for GM?Profitable for GM?

A Case StudyA Case Study


14

GM Employment and Outsourcing


15

GM Outsourcing Increased Overhead Costs


16

The Keys to Competitive Advantage

• Collaboration Costs• Coordination Costs• Intermediation Costs• Transaction Costs• Structural Costs• Sales, General & Administrative Costs

= Overhead Costs= Overhead Costs


17

Do Cuts in I.T. Indicate Success?


18

A Comparison of I.T. With Business Indicators


19

A Shareholder View


20

A Comparison With Competitive Indicators


21

While Outsourcing, Market Share Declines


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Summary of GM Case

• Outsourcing to lower costs did not stop marketshare erosion.

• Value-chain did not improve while outsourcing;

• Despite a decline in employment and outsourcingoverhead costs are up;

• I.T. can not be successful if business is indicators reveal information-related malfunctions.


23

Is OutsourcingIs OutsourcingDamaging?Damaging?

A Case Study: GM vs. CaterpillarA Case Study: GM vs. Caterpillar


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Employment: GM vs. Caterpillar


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Outsourcing: GM vs. Caterpillar


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Knowledge Value: GM vs. Caterpillar


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Compensation: GM vs. Caterpillar


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Summary of GM vs. Caterpillar Comparison

• Despite higher wages Caterpillar increasedemployment.

• Despite high level of outsourcing KnowledgeValue of Caterpillar gains.


29

Research FindingsResearch Findings


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Highly Profitable Firms Outsource Less


31

There Will Always be Outsourcing (2002)


32

Outsourcing Ratios Differ by Industry


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Higher Pay Need not Result in Outsourcing


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Summary of Research Findings

• “Outsourcing” is essential for the growth ofany economy.

• Whether outsourcing is economically effectivedepends on the organization of the the value-chain.


35

Outsourcing Outsourcing in the Value-Chainin the Value-Chain

Case StudyCase Study


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Estimated Cost of a Logitech Mouse


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Different Perspectives on Outsourcing


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Distribution of Costs of a Logitech Mouse


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Summary of Case Study

• The definition of “outsourcing” depends onthe position in the value-chain.

• The dominant cost in global commerce aretransaction costs, not labor costs;

• Assembly takes place from global sourceswhere technology and logistics dictatessourcing.

• The greatest damage to the U.S. economycan come from vertical integration thatreduces transaction costs.


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Transaction Costs in the Value Chain

Supply Chain Distribution Chain Consumer


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Manufacturing Supply Chain Costs

All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

4.7%

15% 5.8%

33%8.1%

56%

15.9%

100%

ProfitTransaction Costs

All Other Costs

Purchases


42

Costs in a Manufacturing Supply Chain

All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

4.7%

15% 5.8%

33%8.1%

56%

15.9%

100%

ProfitTransaction Costs

All Other Costs


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The Total Value Chain

Manufacturers Wholesalers Retailers0%

20%

40%

60%

80%

100%

120%

140%

160%

34%

100% 23.5%

127% 24%

158%

ProfitsTransactions

Other Costs


44

Potential Gains in the Automobile Industry

Old Value Chain New Value Chain0%

20%

40%

60%

80%

100%

120%

140%

160%

64%

81%

13%

60%

55%

15%

All Other InformationProfits

130%

158%

Gain


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A Value Chain View of Information Costs


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A Perspective of the CIO’s Job


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Impacts of Information Technologies

• Information drives an economic “arms race”.• Obsolete assets will be discarded.• Collaboration favors global consolidation.• I.T. becomes an economic weapon.


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A Case of Value-Chain Superiority


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Outsourcing andOutsourcing andthe U.S. Economythe U.S. Economy


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Is the US Economy Off-Shoring Itself?


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Summary

• Outsourcing is not subcontracting I.T. costs.• Outsourcing is not “off-shoring.”• Outsourcing is the distribution of labor and

knowledge through specialization.• Gains from increases in Value-Added.• Losses from divestment of Knowledge.


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Issue: Cut Costs or Lose Knowledge Assets?


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Next GMU Lecture

When: April 17,2006Topic:What is the Worth of Employee Knowledge?What is the Worth of Employee Knowledge?

Prior lectures available on:

http://video.google.com/videosearch?q=strassmann

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