An Emerging Meme on American Business Gone Awry

Scott Francis
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I was struck by a series of articles I’ve read recently regarding Outsourcing and how it is really hurting American businesses.  Robert Hayes raises the specter of the US possibly killing its Innovation Machine, and compares outsourcing of High Tech to the Subprime-Mortgage fiasco. He makes a few powerful points, for which it isn’t hard to look for data points to support.
The same forces can lead a number of manufacturing companies — each independently making apparently rational decisions to outsource certain segments of their operations — to ravage their industrial commons: the valuable infrastructure of suppliers and skills that underpins them. The supposed savings they expect to generate from such activities are based on costs that often do not properly reflect the damage they are causing.
As I read this, I think of Dell, once the pinnacle of the PC industry’s drive toward efficiency… But under the hood of Dell’s efficiency engine we discovered that a lot of their benefits had to do with financial engineering – taking ownership of inventory as late in the process as possible, owning the warehouses (and charging rent) that their vendors used to store their equipment prior to final assembly, and paying creditors as late as possible.  Reading on in Mr. Hayes report:
A company’s competitive advantage is rooted in things it can do (e.g. design, make, distribute, or market) that its competitors cannot do as well, if at all. As the number of these core capabilities decreases, the company’s competitive vulnerability to those that are able to master the same capabilities goes up.
This sounds like what Dell did – outsourcing the manufacture of increasing parts of the value chain, until you reach the logical conclusion, where Dell no longer does even final assembly of much of its inventory, it is simply the design, marketing, and distribution vehicle for other companies’ computers.  They reduced the number of areas in which they could differentiate from the competition.  And the competition (HP, Lenovo, Acer) have adopted very similar business models, and now enjoy similar (and in some cases, better) margins.  As Mr. Hayes writes: “[…] teaching an armada of hungry potential competitors first how to master, then how to surpass their capabilities.” Meanwhile, it is difficult to unwind this change in the food chain because the necessary infrastructure and skills to support manufacturing and assembly in the US has now been outsourced overseas (largely to Taiwan and China). Restarting that infrastructure in the US is a daunting task in dollars, time, and leadership. Mr. Hayes makes a persuasive argument that these companies have not, in fact, been improving profitability – that they have instead been cashing out their intellectual property and assets in exchange for a temporary improvement in margins… Which is now evaporating. Now that the field has been reduced to competing largely on: Design, Marketing, Distribution… Branding becomes more important.  And this probably explains in large part why Apple has been so successful of late -they can outsource the production efficiencies that Dell (and others) have produced in overseas outsourcing shops, and they can exceed these other manufacturers with differentiated software and hardware design and branding (The aluminum unibody Macbooks with Mac OS X are the envy of the industry), better marketing (Apple ads), and distribution innovation (Apple Stores). What Mr. Hayes is arguing isn’t entirely new, but our titans of industry have been unwilling to listen.  In an issue of CIO magazine in 2005, the then-CIO of Aflac, Jim Lester, said that he wouldn’t consider outsourcing his IT because he couldn’t replace the organizational learning, the knowledge of the business, and the alignment with the business that he had in his current IT organization (some people call this caring about your company).  But he was a minority voice at the time.  The fact that his organization out-performed the insurance industry as a whole for the next few years might be unrelated, but I wouldn’t bet on it.  Of course if particular IT services trail the industry averages then it may make sense to switch to commodotized service offerings as a way to play “catch-up” with the industry – a firm will sacrifice its ability to excel in that area, but will eliminate the possibility of self-inflicted wounds in that area, while it can then focus on the areas it knows best.  One could argue that this is what Apple did with its back-end fulfillment – which trailed the industry in efficiencies – so that it could focus on its strengths in design without the drag of inefficient manufacturing operations. I worry that over the last 10 years, the US been on a similar course with regard to software development. Increasingly attempting to jam down the costs of software developers, and going anywhere in the world in order to achieve it, without regard to the specific qualities of the firms they are outsourcing to.  If this goes too far, we’ll lose the critical ecosystem here in the US that supports software developers (and many software-related professions and the businesses that are based on them).  I see signs of this in startups who don’t do any software development in the United States and assume that this financial engineering will give an edge to their “ideas”.  But what software has often proven is that ideas are cheap.  Execution is differentiating.   These startups are betting the farm on unproven execution resources, which then puts them in competition with hordes of competitors with fewer ways to differentiate.  Counter to this trend, I also see a number of firms now with hybrid software development models that include doing development on- and off-shore to gain some cost advantage but without losing the ability to try to differentiate on execution. In a very cogent piece on the subject of Indian outsourcing in particular,  Jaisundar argues that IT can sharpen competitive advantages, rather than diminish them.  That India based service providers need to migrate from being order takers to a deeper relationship that can address business process problems proactively and cooperatively.  This is likely true, but it runs counter to much of the order-taking culture at these firms – it will take time to push the mindset in the right direction and to find and train the right people to lead them in that direction. Meanwhile, there’s quite a bit of abuse of foreign workers going on in the US.  An expose in Business Week on this practice goes into excruciating detail of some of the worst cases.  However, BusinessWeek makes the claim that most employers are unaware that these abuses are being perpetrated by the staffing firms that they employ.  I don’t buy that argument.  I think companies bear a responsibility to know that the people they staff are legitimately employed, and brought to the US under appropriate Visas (for all the attention on H1-B visas, no one is talking about the vast abuses of L1 visas going on right now). Companies bear a responsibility to work with reputable firms – if they don’t, then it is with the intent of getting workers at below-market conditions, which normally can only happen when you have a captive or disadvantaged workforce.  This is a bit like buying a Cartier watch for $10 and pretending that you don’t know it either (a) isn’t a Cartier, or (b) wasn’t acquired in a legitimate fashion. The buyer has a responsibility to buy legitimate goods and services. In another article, Charles Green blames the money-first-above-all-else culture of Wall Street (and, increasingly, the executive suites of large firms) on Harvard Business School.  Charles Green, himself an alumna of Harvard Business School, argues that HBS has failed to imbue our “Best and Brightest” with a well rounded perspective of business:
Harvard Business School led the charge away from an approach to business centered in relationships and commerce, and toward one rooted in markets and competition. They promised us competitive advantage and efficiency. They delivered.
Unfortunately, the cost of this change is that American business is not prepared for a world that is increasingly interconnected, and increasingly relationship-driven.  Its a great, thought-provoking read.  As a long-time professional services guy, hearing someone say that business is relationship-driven is a bit like hearing that the sky is blue.  Of course it is relationship-driven, trust driven, commitment-driven.  And when organizations ignore this or trample on these aspects of their business, the chickens will come home to roost.  But apparently this was hasn’t been part of the culture of Wall Street for some time. These articles only scratch the surface of what I’ve seen lately in the press and in blogs, but I think each one captures a specific issue perfectly.  If you can’t differentiate part of your business, it may make sense to outsource it, but be careful.  There are serious landmines in outsourcing, and it isn’t clear that American businesses have correctly assessed those trade-offs for the long run.

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