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

1

Is Outsourcing Profitable?

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

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

2

Outsourcing: Rising or Losing?

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

3

What is Outsourcing?What is Outsourcing?

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

4

Definitions

Cost ofSales

Operations

DepreciationInterest, Taxes

Outsourcing

Direct

Overhead

Profits

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

5

Financial Profile of U.S. Firms (2004)

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

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

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.

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

7

Critical Ratios

Outsourcing Ratio = Outsourcing / Direct Costs

Overhead Ratio = Overhead / Direct Costs

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

8

Distribution of 2004 Outsourcing Ratios

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

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

9

Outsourcing Not Correlated with Profitability

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

10

Distribution of 2004 Overhead Ratios

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

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

11

Overhead Not Correlated with Profitability

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

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.

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

13

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

A Case StudyA Case Study

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

14

GM Employment and Outsourcing

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

15

GM Outsourcing Increased Overhead Costs

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

16

The Keys to Competitive Advantage

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

= Overhead Costs= Overhead Costs

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

17

Do Cuts in I.T. Indicate Success?

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

18

A Comparison of I.T. With Business Indicators

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

19

A Shareholder View

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

20

A Comparison With Competitive Indicators

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

21

While Outsourcing, Market Share Declines

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

22

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.

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

23

Is OutsourcingIs OutsourcingDamaging?Damaging?

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

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

24

Employment: GM vs. Caterpillar

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

25

Outsourcing: GM vs. Caterpillar

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

26

Knowledge Value: GM vs. Caterpillar

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

27

Compensation: GM vs. Caterpillar

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

28

Summary of GM vs. Caterpillar Comparison

• Despite higher wages Caterpillar increasedemployment.

• Despite high level of outsourcing KnowledgeValue of Caterpillar gains.

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

29

Research FindingsResearch Findings

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

30

Highly Profitable Firms Outsource Less

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

31

There Will Always be Outsourcing (2002)

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

32

Outsourcing Ratios Differ by Industry

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

33

Higher Pay Need not Result in Outsourcing

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

34

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.

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

35

Outsourcing Outsourcing in the Value-Chainin the Value-Chain

Case StudyCase Study

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

36

Estimated Cost of a Logitech Mouse

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

37

Different Perspectives on Outsourcing

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

38

Distribution of Costs of a Logitech Mouse

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

39

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.

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

40

Transaction Costs in the Value Chain

Supply Chain Distribution Chain Consumer

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

41

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

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

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

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

43

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

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

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

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

45

A Value Chain View of Information Costs

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

46

A Perspective of the CIO’s Job

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

47

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.

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

48

A Case of Value-Chain Superiority

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

49

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

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

50

Is the US Economy Off-Shoring Itself?

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

51

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.

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

52

Issue: Cut Costs or Lose Knowledge Assets?

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

53

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