The Hindu Business Line : Winners and losers in the outsourcing game

Far from being a blot, outsourcing and offshoring are powerful tools to help solve the competitiveness problem and, provided the right structural reforms are implemented, may also assist in solving Europe's low employment problem.

Smart companies that want to `wet their toes' start in terms of offshoring functions, not factories.

Napoleon learnt from his mistake of fighting two wars at the same time that no two wars are ever the same any more than you can step on the same banana peel twice.

The phantom that is haunting Europe these days is not in the shape that Napoleon saw it but in the form of outsourcing and offshoring, which allegedly will rob Europe of the highly-skilled high-paying jobs. Far from being a blot, outsourcing and offshoring, are powerful tools to help solve the competitiveness problem and, provided the right structural reforms are implemented, may also assist in solving Europe's low employment problem.

Offshore outsourcing

European governments are slowly realising that offsho ring and outsourcing are not simply "trade issues" but require policy responses on far broader fronts, such as labour markets, education, and regional policies. On the other hand, the European corporate sector is simply unable to opt out. Let's take a look.

Offshoring is occurring as purchases of intermediate inputs at arm's length from foreign suppliers, in which case one may describe it as offshore outsourcing. BMW switched to buying car parts from a Czech supplier for use in Bavaria, and AXA uses an Indian company for IT application maintenance. Tasks such as technical drawings in architecture, radiologist readings of X-rays, certain legal services are being sent overseas. Estimates predict that 1.16 million IT and other services sector jobs will be sent outside Europe by 2015.

Britain will account for the largest share (two-thirds) of the services jobs at risk. Language and cultural barriers to a degree insulate most European countries against much competition from India. But other major European languages, such as German, French, and Spanish, are seeing increased low-wage language-based competition from Latin America (Spain), Eastern Europe (Germany), and North Africa (France), respectively.

A steep learning curve

That so many West European companies see offshoring and offshore outsourcing as important for future profits, despite their initially disappointing savings, indicates that European companies foresee a steep learning curve and expect to eventually realise the potential savings. Savings will vary from industry to industry and country to country, but most industry expert estimates range between 30 and 60 per cent.

Obviously, whether European countries emerge as winners or losers from offshoring and offshore outsourcing depends on whether they can create more winners than losers and whether they can turn losers into winners. We need to wait and see.

Europeans are slowly realising that offshoring and offshore outsourcing is not a choice for Europe — it is a fact. That it is an opportunity, rather than a threat. Europe thus already has much of the right medication to gain from offshoring and offshore outsourcing. It simply needs to swallow hard.

Continental's experience

Not long ago the survival of Continental AG, the large tyre and automotive components manufacturer based in Hanover, Germany, seemed very much in doubt. Struggling under a heavy debt load and facing relentless pressure to reduce prices, the company was widely seen as a likely takeover target. Today, however, Continental remains proudly independent.

In fact, despite the general sluggishness of the car industry, the company has been thriving. Its profits are up dramatically, and its stock price has risen almost fourfold over the past three years.

Much of Continental's success can be traced to the aggressiveness and sophistication of its global supply-chain strategy. The company has shifted many of its production functions to an array of low labour-cost countries, from Slovakia to China to Brazil.

At the same time, it has kept other critical functions within Germany as well as in other relatively high-cost countries such as Japan.

Focus on individual products

Continental's highly modular approach is shared by other supply-chain leaders such as General Electric, Honeywell, Siemens International, and Emerson Electric. Rather than think in terms of entire factories, when they make offshoring decisions, these companies focus on individual functions and products.

Transplanting entire factories is also seen as the best route, as there are significant improvements in cost competitiveness that are critical to survival. The cost of closing down a manufacturing facility in a high-cost country can be considerable — as much as 200,000 Euros per labourer in a country like Germany. Even if you have to add in the cost of constructing a new plant in an LCC plus various hidden "legacy" costs such as those related to disrupting relations with local suppliers, the price of shifting an entire production facility is often so low that it does make economic sense.

The wider debate

Smart companies that want to `wet their toes', start in terms of offshoring functions, not factories. They realise that just by shifting certain carefully selected processes or activities, they can often approximate the savings of moving facilities without having to bear the shut-down and start-up costs. In particular, they focus on moving the most labour-intensive functions — whether simple assembly or complex engineering-while keeping highly automated functions within their traditional locations.

In today's climate, such decisions to keep manufacturing in Europe are not always easy for companies to sell to the wider investment community.

In the wider debate, however, there's no mistaking the fact that manufacturing employment across Europe, and in other developed economies, has been falling for many years. Production is relocating to low-cost emerging markets.

A lot of volume is disappearing from Europe. While many European firms have large and growing manufacturing base in East Europe, they don't want to put all of their eggs in one basket. That throws enormous opportunities for India.

There is a growing recognition at many companies that high flexibility and low cost don't have to be mutually exclusive. What these companies are striving for, is to have a supply chain that is lean in some areas and more agile in others, usually downstream, closer to customers.

Today Europe, through offshoring and outsourcing, is feeling the "gaiatsu" of an outside world that has raised its game in terms of competitiveness and human talent to new heights.

This rapid development of the world around them is making European decision makers realise that status quo is now even less sustainable. In fact, if Europe stands still now, it will be run over.

(The author, a former Director of CII, is a business consultant living in Cologne, Germany.)

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