Managing creative destruction

Why outsourcing strategies need to be underpinned by human resource planning.

It is said that Henry Ford invented modern capitalist society when he raised his worker's wages to an unprecedented US$5 a day.

Business depended upon his worker’s financial capacity to buy the cars that they made. And this has remained the basis for all capitalist economies for almost a century. It is known as the 'trickle down effect'

Outsourcing presents new opportunities for businesses and customer alike. It also presents new challenges.

The general principle is simple. For any business raw material and energy costs tend be inflexible. In contrast however, labour costs can often be outsourced.

Within a globalised economy this is becoming increasingly easier. In terms of the provision of manufactured goods or the provision of services, labour is also likely to constitute a company's highest cost.

The simplest solution for a company is to tender for most cost-effective supplier of labour. By doing this the company is able to reduce its costs significantly and these savings are, in turn, passed onto the consumer.


The theory is that displaced employees in turn will find new employment in new emerging industries. But there's a problem with this equation. New industries can't necessarily absorb tens of thousands of displaced factory workers.

Also often it simply isn't feasible to retrain older workers. These workers either have to remain unemployed or accept low paid part-time employment.

One of the hidden dangers of outsourcing its that its appeal is partly based on the fact that everyone appears to be doing it.

Yet, if not properly handled, outsourcing is liable to undermine the structural base of the domestic economy. Displaced employees or those that have had to accept part-time low paid employment will lose their purchasing power.

To quote US Federal reserve chairman Ben Bernanke, ' a growing number of the American population have become displaced in terms of their role as domestic consumers'.

Deregulation and outsourcing is partly to blame. Wal-Mart employees in the US for example, have been known to depend upon federal food stamps and use hospital emergency rooms for their basic medical care. No trickle down effect there.

In other words it hollows out the domestic consumer's purchasing power by exporting jobs to overseas companies in developing countries that may eventually become their own competitors. After all today's outsourcing destinations such China and India will, in time, move up the value-chain in terms of their economic activity.

A recent Citibank report suggested that since 2001 the economy is in danger of becoming not one economy but two. One that is in it's growth phase and orientated to new technology and emerging markets and another that is sucumbing to contraction at home as a result of outsourcing and global competition.

This can be further subdivided into three sectors; sector X - knowledge-based or professional services, sector Y- semiskilled employment and sector Z - domestic services or construction.

Outsoucing occurs principally in sectors Y and Z. Also migration of sector Y employees to sector Z will further contibute to a downward spiral of wages down in this bottom sector.

Yet mainstream economists argue that outsourcing will lead to higher economic growth in the long term and even to the creation of more jobs in the outsourcing country.

This contrasts with the opposing view that outsourcing will lead to economic decline and massive job losses in the outsourcing country. The truth lies somewhere between but, in reality, closer to the first scenario. It’s a question of balancing the short-term with the long term.

Afterall outsourcing isn’t new. It’s existed for decades and history has shown that the outsourcing country is nearly always a beneficiary.

However there is a crucial difference between now and before. Namely, it used to be low-grade manufacturing jobs that were outsourced. But today even 'rocket science' in its various guises is being outsourced – infact anything from litigation to design.

Consider also that the pace of change is far more rapid in today’s global economy. Likewise, whereas before outsourcing might affect just a handful of factories, today it can cause a whole sector of economic activity to go into decline.

Yet according to the principles of the economic law of ‘creative destruction’ the gains of outsourcing will more than compensate the losses. In other words it will all be worth while in the end.

Certainly outsourcing is about winners and losers. And women and older workers are disproportionately represented amongst the losers. This is because globally, these categories employees feature prominently amongst the peripheral and lower paid workers. Not surprisingly it’s their jobs that are often the first to be outsourced.

Outsourcing might mean a cheaper option but its doesn’t guarantee a better service. A study conducted in the on behalf of the UK’s Department of Trade and Industry revealed that overall, outsourced Indian call centres provided the service of just one-ninth the cost of a UK provider yet the UK provider was 25% more efficient.

Also there is the added danger that costs might escalate once the outsourcer has been in place for some time. Yet, taken as a whole, the figures are impressive.

According to McKinsley Consultants, for every US$1 that is outsourced, the outsourcing company, on average, saves 58% in net cost reductions. In other words the potential savings are enormous.

Yet not all jobs can be outsourced. These include, for example, those in retail and catering. Also sectors such as these employ vast numbers of people. Not withstanding this however, the numbers of jobs that can be outsourced are substantial and increasing all the time.

Rapid technological change does and will continue to displace jobs. Of that we can be sure. Outsourcing is part of that change process. Afterall the quicker we let go of the old cheese, the quicker we can enjoy the new cheese.

According to Joseph Stiglitz, winner of the Nobel prize in Economics, 'whether a country benefits or loses from globalization depends upon how it positions itself'. As more and more white collar jobs are lost, the US may take measures to protect their own jobs.

As a small country, Singapore cannot afford to do this. Outsourcing like flexibility can only be marginalized at our peril. We can block it for a while but ultimately we will become uncompetitive. At the same time we must develop an economic infrastructure that is sustainable.

This means investing in life-long learning and training and targeting vulnerable groups such as older workers and women.

Also to ask can we continue to move up the value chain? What are our strengths and how can we develop these? All this requires us to make long term contingency plans in terms of our human resource planning before the possibility of outsourcing arrives at the doorstep.

Paul FitzPatrick has published three books and is a journalist with News International. He is a Singaporean PR and runs management training programmes conceptsasia@yahoo.com