Hard Data on Offshore Sourcing Benefits and Risks

Companies have greatly increased their outsourcing activities in many industries. Manufacturing has seen major activity in this area for sometime. IT functions are shifting abroad in droves at this time.

As places like China, India, Singapore and Hungary become more advanced, more US companies are looking at sourcing products and services from these countries. In many cases, these outsourcing decisions are hurting economic development in US cities and regions. My earlier article on foreign direct investment (FDI) pointed to the increased competition by these countries in attracting FDI. They are expected to be even stronger FDI competitors as the economy continues to heal.

So, what about the economics and risks of outsourcing? Can they be quantified and what arguments should US communities and states make as they fight to keep business from sliding off to latest and greatest developing country. A recent analysis by the WEFA/Global Insight group offers some perspective.

According to Global Insight, the main way to quantify thel ower cost advantage of outsourcing is by comparing wage costs. However, these lower wage costs can differ among industries, and they may not reflect all the input cost factors for a particular industry—a barrel of oil is a global good and sells at roughly the same price no matter where one's factory is located. Furthermore, shifting production from, say, the United States to China may yield a cost reduction in the year that the transition takes place, but future years will not bring the same dramatic cost savings. Finally, sourcing inputs globally entails different risks. Therefore, any cost savings decisions should incorporate some analysis of risk factors.

The recent SARS epidemic illustrates this trade-off. Some global manufacturers shifted production from newly built Chinese factories to existing facilities in Mexico and Europe. Supply-chain dependability became as important a factor as cost.

How much do costs drop for US companies outsourcing to Asia? Global Insights estimates at least a 50-60% drop and in some cases it is even higher.

But all is not rosy in these new markets. Risks are greater, which the Global Insight analysis considers. Along with the lower costs, however, is an increased exposure to different country-specific risks. Using the current and proposed sourcing patterns, these risks can be estimated. We do so by creating weighted averages of the individual country risks prepared by our International Risk Service. Not surprisingly, the movement of production facilities and supply chains to China, Hungary, and India entails larger business risks as well as larger total risks, including political instability. There is also a greater risk of significant inflation in consumer prices with the new proposed production plans.

The argument for US economic developers to make, at least for now, is that US locations are more stable and do not pose as many or as great of risks to business operations.

Read more here.