The Economics of Outsourcing - Strassmann · Interest, Taxes Outsourcing Direct Costs Overhead...
Transcript of The Economics of Outsourcing - Strassmann · Interest, Taxes Outsourcing Direct Costs Overhead...
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The Economics of Outsourcing
Prof. Paul A. StrassmannGeorge Mason University, October 5, 2007
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What is Outsourcing?
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Definitions
Cost ofSales
DepreciationInterest, Taxes
Outsourcing
Direct Costs
Overhead
Profits
Outsourcing = Purchases + Contracts
Value-Added
Outsourcing
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Financial Profile of U.S. Firms
Standard & Poor's Data for U.S. Corporations with 3.8 Million Employees
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Critical Ratios
Outsourcing Ratio = Outsourcing / Value-Added
Overhead Ratio = Overhead / Direct Costs
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Outsourcing and Corporate Economics
• Overhead costs manage not only internal “direct”labor but also outsourcing work done by suppliers.
• Computer applications, optimized for “enterprise”integration have difficulty coping with the suppliers’incompatible systems.
• Unmanaged outsourcing complexity can void laborsaving gains.
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Research Findings
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International Firms Outsource a Large Share of Direct Costs
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Some Banks Outsource Large Share of Value-Added
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Calculating a Firm's Outsourcing Ratio
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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 of anyeconomy.
• Whether outsourcing is economically effectivedepends on the organization of the the value-chain.
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Distribution of Outsourcing Ratios
Median Outsourcing Ratio for 769 U.S. Corporations = 75.6%
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Outsourcing Not Correlated with Profitability
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Distribution of Overhead Ratios
Median Overhead Ratio for 769 U.S. Corporations = 124%
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Overhead Not Correlated with Profitability
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Summary: Outsourcing and Overhead Ratios
• Outsourcing now equals 75.6% of corporate directcosts and is rising.
• Overhead costs now exceed corporate direct costsby 24% and keep rising as direct costs outsourced.
• Neither outsourcing nor overhead correlates withprofitability. Corporate profitability reflectseffectiveness of management.
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Outsourcing in the Value-Chain
Case 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 on theposition in the value-chain.
• The dominant cost in global commerce aretransaction costs, not labor costs;
• Assembly takes place from global sources wheretechnology and logistics dictates sourcing.
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Outsourcing in the Value-Chain
Economic Analysis
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Supply Chain Distribution Chain Consumer
Transaction Costs in the Value Chain
26All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer
0%
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
Manufacturing Supply Chain Costs
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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
28Manufacturers Wholesalers Retailers0%
20%
40%
60%
80%
100%
120%
140%
160%
34%
100% 23.5%
127% 24%
158%
ProfitsTransactions
Other Costs
The Total Value Chain
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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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Summary of Economic Analysis
• The global supply chain has accumulated enormoustransaction costs, far exceeding direct costs;
• There are enormous opportunities for cost reductionand improvement of customer service;
• The challenge is in organization of the value-chain.
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Is OutsourcingDamaging?
A 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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A Comparison With Competitive Indicators
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Summary of GM vs. Caterpillar Comparison
• Despite higher wages Caterpillar increasedemployment;
• Despite high level of outsourcing Knowledge Value ofCaterpillar gains through good management of thevalue-chain.
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A Summary
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A Case of Value-Chain Superiority
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• Collaboration Costs• Coordination Costs• Intermediation Costs• Transaction Costs• Sales, General & Administrative Costs
= Overhead Costs
The Keys to Cost Advantage
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• Economic Value-Added• Information Value-Added• Knowledge Capital
= Enterprise Profit Performance
The Keys to Value Advantage
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A CIO’s Perspective - A Cost Based Point of View
SOURCE: A General Motors case study
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A CIO’s Perspective - A Value Based Point of View
SOURCE: A Bank of America case study
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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.