Business Strategy drives Strategic Sourcing

I’ve read a number of blog posts recently that suggest outsourcing and offshoring may have run its course as a sourcing strategy. The opinion seems to be that President Obama’s comments about outsourcing in the State-of-the-Union speech are going to lead to a significant change.

Outsourcing has been with us since the beginning of time, and offshoring although a new term has been with us since sailing ships began to move commerce. I don’t think either solution is going away anytime soon nor should it. Offshoring is a basic commercial transaction, and while the impact of offshoring on domestic unemployment may not be positive, you can’t blame offshoring for delivering more cost effective labor rates than domestic labor.

However, offshoring without a clear strategy can lead organizations to mixed results and potentially great harm. Labor arbitrage is always a fleeting value proposition, because it is completely based on the temporary imbalance of two labor-markets. It is the nature of labor arbitrage that the act of investing in a depressed labor-market causes those labor-related costs to rise as the oversupply of labor is exhausted. As oversupply is exhausted, attrition increases as new jobs reap higher pay than older jobs. The combination of increasing salaries, increased labor-related costs, rising currency exchange rates, and increased attrition quickly exhausts what Adam Smith called the, “Absolute Advantage” in 1776.

In my experience offshoring is a strategy often relied upon when the business strategy for the category is overly simplistic and focused only on cost reduction. A GOOD business strategy is rarely so monochromatic, and requires a more comprehensive set of goals and objectives including sales, revenue, net income as well as cost. When the strategy is broader, a more holistic sourcing strategy can be created delivering a result that is built upon consensus from more than one part of the organization. When a business process is outsourced, the profit of the outsourcer is based almost entirely on the ability to standardize the service and carefully control and optimize the use of labor to operate within a shared operation. Taking a business process offshore is even more complex where the added complexities of naturalization and accent neutralization are required for every new recruit.

Offshoring under these conditions can render business processes very fragile, and difficult to adapt and transform over time. The biggest challenge that offshore category sourcing faces over the long-term is the impact of this fragility on customer satisfaction, quality, and eventually customer-loyalty which translates into an impact on sales, revenues and net income. When a more comprehensive business strategy for the category includes a transformation program, the results are more consistent with the objectives of the overall business and most importantly can be sustained regardless of the changes in labor markets.

By reducing the labor requirements in general, the strategic importance of a lower labor rate in an offshore market can be reduced. When the labor requirements are reduced to the most important process steps, labor can be sourced more directly based on value, and where domestic labor produces a more valuable outcome it can be justified.

The bottom-line is that we need transformation to drive strategic sourcing especially in categories considering offshoring.

Ed Fullman Partner, Adam Smith Consulting
ed.fullman@adamsmithconsulting.com
www.adamsmithconsulting.com