Everest Management Network Inc. : The North American Economy and the Fast Changing Economics of Corporate Globalisation: Offshoring and Outsourcing to Foreign Contractors

Is Labour Arbitrage Vanishing?

There has been extensive debate for some time now around the industrial trend for the past couple of decades of North American companies offshoring work (sending work outside of the country where the company is based), particularly manufacturing. Lately, however, the discussion has taken a hopeful turn that companies will be moving work back to North America, or what has been dubbed reshoring. The initial decision to move labour overseas had to do with Labour Arbitrage – which is taking advantage of lower wages abroad, particularly in poorer countries. Now, however, “as emerging economies boom, wages there are rising” (The Economist). Therefore, one of the determining factors favouring offshoring is quickly becoming inadmissible. According to a recent article in The Economist, the pay for factory workers in China “soared by 69% between 2005 and 2010” and have been increasing at a rapid rate of “10-20% a year,” whereas manufacturing pay in America and Europe “has barely budged” (The Economist). Although this is a step in the right direction for workers in developing countries, this is a sure sign to take a step backward from offshoring, because “the gains from labour arbitrage are starting to shrink, in some cases to the point of irrelevance” (The Economist).

Furthermore, the countries that still do offer low-wages often don’t offer the same production quality. What is more, over the past decades, the risk of business disruptions due to war or natural disaster has become a genuine concern. On top of all of this, there is also the concern with the ability to quickly respond to the demands of key markets, which the lengthy shipping time for products does not allow; something that will be touched on a little later in this post.

Finally, a major realization that many companies are coming to is that offshoring hinders the necessary hand-in-hand relationship that production and R&D hold. In the past it was believed that R&D was purely a part of the intellectual property aspect of things, and was to be done in-house in the home country. More and more, though, companies are finding that “manufacturing somewhere cheap and far away but keeping research and development at home can have a negative effect on innovation” (The Economist). There is actually so much within the production aspect that can shed light on R&D. Not to mention that if say Apple decided to change its screen design at the last minute before production, its Taiwanese production factories wouldn’t have to wake up their employees to come in in the middle of the night to change it (yes this actually happened). One answer to this dilemma would be to move the R&D too, but that can raise a very large threat of losing valuable intellectual property due to theft or imitation (The Economist). If, ultimately, the majority of production is outsourced or off-shored for North American companies, then the selling product they actually possess is their intellectual property, so that comes at too high of a cost to risk. This thought too will be discussed in deeper detail later on.

Companies Moving Back Onshore: Reshoring

The result of these changes in the economic playing-field is that some major North American companies have done the math and are noticing that offshoring isn’t benefiting like it used to, so some of them are taking an exit off of this road and venturing in a different direction or down a different path. The next step in industry prosperity and economic development must be to find a new way to reduce production costs, whether that is reshoring or coming up with another solution to the problem. The Economist lists several companies that have already brought plants and jobs back to America:

“Caterpillar, a maker of vehicles that dig, pull or plough, is shifting some of its excavator production from abroad to Texas. Sauder, an American furniture-maker, is moving production back home from low-wage countries. NCR has returned production of cash machines to Georgia [, and] Wham-O last year restored half of its Frisbee and Hula Hoop production to America from China and Mexico.”

Other businesses that have made the leap to move business back home are Google, General Electric, Ford, and Apple. But does a move back home really mean bringing jobs back home? In a small regard yes, but sadly, many predict that the offshored jobs that have been reshored will merely become automated.

So What is this I Hear about Automation?

Companies that do bring work back to North America are often doing so with the intention to implement automation. So a return to onshore manufacturing isn’t necessarily going to boost manufacturing job availability on the home-front. For offshoring, the cautionary note was ‘don’t get into a career field that can be done by someone else, somewhere else, for cheaper.’ It seems that the new shifting industrial dynamic prompts a new cautionary adage: ‘don’t get into a career field where a machine can do your job for free.’ In his book The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future, Martin Ford predicts that “offshoring is just the precursor to automation.” In an interview about his book with Samson Okalow for Canadian Business, Martin explained his thoughts further, stating that “jobs that are being offshored are eventually going to be automated” (Oakalow). And indeed this makes sense, because offshoring was initially a response to saving in production costs, and what better way to save than to cut out the cost of labour almost completely, and is this not the determining factor rendering offshoring unprofitable anyway? An article in The Economist speaks to this very issue, noting that offshoring is on the decline because of rising labour costs, and notes that with “more automation […] labour’s share of total cost is shrinking anyway.” Martin predicts, however, that this shift to automation won’t affect the developed countries that are already outsourcing and offshoring, because the jobs here are already gone; it will instead hit developing countries hardest, those that have been benefiting significantly from offshore business. Because the rise in offshoring manufacturing created more jobs in the service sector, Martin predicts that it is only within this sector that automation will really have a disruptive impact. Ultimately, the maturation process as Martin sees it begins with jobs going offshore, and then “as technology advances, those jobs will be automated” (Okalow).

What is Home Anyway?: Multiple Home-Based Companies to Compete for Market Demand

I said that companies needed to think of reshoring, or to consider another solution to the unprofitable offshoring problem. And indeed they have put thought into another strategy that seems to be so common-sense that they should have thought of doing this a long time ago, and indeed some companies have. It is not reshoring and automation, although that will probably occur anyway in some degree, but is rather foreign home-bases. This is not offshoring in the traditional sense, but is creating a company base within another country purposed to generate businesses within that country, targeting a specific market: it is “being ‘onshore’ in new places” (The Economist). In other words, this is a company operating within other countries for the sake of that country and the market is presents, not merely to exploit that market for cheap labour.

According to The Economist, “firms are rapidly moving away from the model of manufacturing everything in one low-cost place to supply the rest of the world.” This is because emerging countries such as China are no longer seen as “a cheap manufacturing base” but are now seen as “a huge new market” (The Economist). Increasingly, the main reason for multinational companies to move production is to be close to customers in big new markets. Working from a local-base position, they can make customized products and be able to respond more quickly to local demand.

Indeed, this is the key to being a truly international company, wading in the water of many lucrative international markets. Siemens, the German engineering firm, has been practicing this sort of internationalism all along. Their chief executive Peter Löscher noted that “the ‘home shore’ for Siemens is now as much China and India as it is Germany or America” (The Economist). He further states that “the notion of offshoring is in any case an odd one, for a truly international company” (The Economist); in other words being an international company shouldn’t be about exploiting workers in other countries for cheaper labour, but expanding the marketability of the company and its brand by accessing international markets.

Similar to Löscher, Pierre Beaudoin the chief executive of Bombardier claims that “the firm used to focus on cost savings made by sending jobs abroad; now Bombardier is in China for the sake of China” (The Economist). To be fair, this isn’t really a new concept, it is colonization revisited. What I mean by that is that just as empires started colonies in far-off distant places to grow their empire and thus their control over larger portions of the world and foreign affairs, so too is this shift a sort of industrial colonization: the purpose of a foreign home-bases is to increase market exposure and have one’s hand in a bigger piece of the pie. Being close to emerging markets allows companies to respond to that market’s demands and cater to that market’s needs, which can only mean an increase in revenue. It is an inflow of cash from multiple markets without extensive shipping driving up costs and slowing down product delivery. So, it would seem, that foreign home-bases are a win-win.

But is it Too Late?: The North American Inability to Compete and Dependence on Foreign Contractors

The real question though, is whether it may be too late for some American companies to be able to compete against their emerging counterparts. Gary Pisano of Harvard Business School notes that

even if wages in China explode, some multinationals will find it hard to bring many jobs back to America […] In some areas, such as consumer electronics, America no longer has the necessary supplier base or infrastructure. Firms did not realise when they shifted operations to low-wage countries that some moves ‘would be almost irreversible.’ (The Economist)

As can be seen by the state of American personal computing companies, there isn’t a strong enough presence and market anymore for American companies to compete with their foreign competitors. For example, “Dell shut two big American factories in 2008 and 2010 in a big shift to China, and HP now makes only a small number of business desktops at home” (The Economist). Although there was recently some excitement over a new manufacturing facility being built in Whitsett, North Carolina that will be producing personal computers at ‘home’ in America instead of overseas, this new manufacturing facility is not being built by an American company, but by the Chinese technology group, Lenovo (The Economist). The reason that Lenovo is moving some production to America is the same as what I was just speaking about above, the shift to foreign home-bases because of the desire to be close to profitable markets. Being in the U.S., Lenovo “will be able to customise its computers for American customers and respond quickly to them. If it made them in China they would spend six weeks on a ship” (The Economist).

This is evidence that foreign companies are performing the same industrial shift to employ business branches as a home-base within a host country, allowing them to have a unique access to the market that they are trying to target. But, what if, let’s say, the U.S. no longer has a market-base for personal computers (having lost the majority of the market business to conglomerates like Lenovo) then will American companies really be able to compete?

Ultimately, if the majority of what is actually produced in America is intellectual property, brand power, and an impeccable sales and marketing force, how do we ensure the physical product? Do North American companies really have the power that they think they do, and what happens if this intellectual capital dissolves? According to Dr. Paul Craig Roberts, outsourcing is

rapidly eroding America’s superpower status. Beginning in 2002 the US began running trade deficits in advanced technology products with Asia, Mexico and Ireland. As these countries are not leaders in advanced technology, the deficits obviously stem from US offshore manufacturing. In effect, the US is giving away its technology, which is rapidly being captured, while US firms reduce themselves to a brand name with a sales force. (Roberts)

We already know that foreign competitors are imposing on the market through imitation of American designs, for example the all mighty iPhone. If the core value of a company, like Apple, is its superior product, which is in incredibly high demand (mostly motivated through a superior marketing force), what happens to that company when there are 100 more designs just like it for a fraction of the price? Obviously sales suffer, and product value decreases. As the Hira brothers (Ron and Anil) point out in their book Outsourcing America, there is “no evidence that [American companies] will be able to outcompete local Chinese and Indian companies, who are very rapidly assimilating the technology and know-how from the local US plants.” In fact, the Hira brothers point out “Indian IT companies have been consistently outcompeting their US counterparts, even in US markets” (Hira’s), so there is nothing saying that the same can’t be true of the technological market, and we are even seeing evidence of this now.

According to The Economist, American and European companies have made a mistake in outsourcing as much manufacturing as they have, because this allowed other firms “a great deal of insight into their processes” (The Economist). After all, many outsourcing contacts and former suppliers quite frequently turn into competitors. Samsung, for example, is a good reminder; Samsung was once an outsourcing partner, but is now an "electronic giant" that "dwarfs its competition" (The Economist).

Another risk is just become too dependent on foreign partners, for example, the relationship between Apple and Foxconn. A billion dollar partnership can’t be taken lightly, and there is no argument that the two companies are inextricably linked, and it has been so far a very successful partnership. However, since reports of poor working conditions for Foxconn employees surfaced, this tether may begin to closer resemble a noose. From mistreatment of employees, to workplace violence, and even under-aged labour, this controversial partnership runs the risk of creating a public distrust in the brand or a mistrust of the company. The troubles being reported with Foxconn put Apple’s reputation directly in the line of fire. When the major contribution that American companies have to offer is a brand name and intellectual property, then an advantageous relationship that suddenly becomes disadvantageous could mean a significant blow to its sales, and if it is a company less stable than Apple, it could mean a downward spiral towards the company’s dissolution.

Amanda Labelle

Sources:

“Here, There, and Everywhere” The Economist, 19^th of Jan, 2013. Web.

http://www.economist.com/news/special-report/21569572-after-decades-sending-work-across-world-companies-are-rethinking-their-offshoring., accessed 14^th March, 2014.

Hira, Ron and Anil Hira. Outsourcing America, American Management Association. May 13^th, 2005.

“Home or Abroad?: Herd Instinct,” The Economist, 19^th of Jan, 2013. Web.

http://www.economist.com/news/special-report/21569575-companies-need-to-think-more- carefully-about-how-they-offshore-and-outsource-herd-instinct. , accessed 14^th March, 2014.

“Moving Back to America,” The Economist, 12^th of May, 2011. Web.

http://www.economist.com/node/18682182., accessed 14^th of March 2014.

Okalow, Samson. “Technology Makes Life More Efficient, But Could It Soon Take Your Job?: Too Much of

a Good Thing,” Canadian Business, 11^th April, 2013. Web.

http://www.canadianbusiness.com/companies-and-industries/automation-makes-life-more-efficient-and-eventually-it-will-take-away-your-job/, accessed 14^th of March 2014.