Outsourcing – Page 3 – The OM Blog by Heizer, Render, & Munson

OM in the News: Japan Ascends From Parts Supplier to Plane Maker

Japan’s golden era of aviation, with its feared Mitsubishi Zero fighter planes, ended in 1946 when American occupiers allowed that nation to manufacture only parts for American military jets. But this year, reports The New York Times (April 10, 2013), Mitsubishi plans the first flight of its Regional Jet, a sleek, 90-seat commercial plane that is Japan’s bid to break into the industry’s big leagues after almost 70 years. Mitsubishi’s comeback was abetted in large part by Boeing’s outsourcing more of its aircraft manufacture to overseas suppliers. As Boeing came to rely on foreign contractors, Japanese manufacturers moved in, designing and supplying some of the jet’s most vital sections.

Over a third of Boeing’s new 787 Dreamliner is supplied by Japanese manufacturers, including Mitsubishi, which makes the jet’s carbon-fiber composite main wings. Japanese suppliers have played an increasingly bigger role in building Boeing aircraft, supplying 15% of the older 767 jet and 21% of the 777. The Japanese government is one of the largest financial backers of these parts projects, handing out billions of yen (about $1.6 billion) in subsidies to help Japanese suppliers develop technology and win lucrative contracts from Boeing. These Boeing contracts have kept tens of thousands of Japanese workers busy for years, and still account for about 40% of jobs in the industry. And in a cozy quid pro quo, Japan’s biggest airlines have for years bought their planes almost exclusively from Boeing — an unusual practice among global carriers.

Mitsubishi has 165 firm orders for the $42 million jet, and it aims to secure as many as 5,000 orders over the next two decades — a goal some experts dismiss as unrealistic. It faces well-established rivals like Bombardier (Canada) and Embraer (Brazil), while the Russians and Chinese are also making jet inroads.

Discussion questions:

1. Did Boeing make a mistake in outsourcing so much of its planes to a future competitor?

2. Why did Boeing outsource over a third of the 787 to Japanese firms?

OM in the News: GE’s Move to Insource Jet Engine Production

Yesterday’s Wall Street Journal (Feb.7, 2013) brings news of yet another firm’s recovery from the U.S. outsourcing addiction: GE is busy bringing work on its jet engines back in-house. This year, GE plans to open a pair of parts factories in Mississippi and Alabama and soon will announce the location of a third. The firm also agreed to buy Italian parts supplier Avio for $4.4 billion, has acquired a 3-D printing company, and is in joint-ventures with a component casting company in Montana and a high-tech ceramic parts firm.

The strategy, writes The Journal, ” is aimed at safeguarding a key source of the industrial conglomerate’s sales.” Aircraft engines account for about half of GE’s $211 billion order backlog, and the company can’t afford missteps (like the ones Boeing faced on its 787) as it gets ready to roll out new designs to power the next generation of commercial jetliners. “We want more under our control,” says the head of supply chain management for GE Aviation. “Rather than pay a supplier to do it, we would like to protect our intellectual property.”

By doing more of the work itself, GE expects to (1) protect its technology, (2) speed up development and (3) secure supplies of needed components. The move is a turnabout for the company that helped pioneer soup-to-nuts U.S. manufacturing and then switched gears to help pioneer industrial outsourcing. Further, GE now plans to replicate its new vertically integrated approach across its businesses from gas turbines to medical imaging devices to subsea oil wells. The trend shifted toward bringing work back in-house in recent years and gained steam after events like flooding in Thailand and the tsunami in Japan made clear that multinational companies’ supply lines had grown too long and fragile.

Discussion questions:

1. Describe GE’s move in the context the outsourcing risks in Table S11.2.

2. What are the causes for this change in operations strategy?

OM in the News: In the Race Between China and Mexico, Mexico Tries to Edge Ahead

The Wall Street Journal (Sept. 17, 2012) reports that China’s rising wages are giving a chance for Mexico to wrest back some of the business that chased cheap labor across the Pacific a decade ago. Mexico may already be a less-expensive place to make products for the U.S. market, as China’s average manufacturing wage topped Mexico’s this year, when accounting for differences in productivity. Mexican workers typically produce more per hour than Chinese workers, and the proximity to the U.S. means companies can ship faster and at a lower cost to American customers. Mexico’s average wage is $3.50 an hour. The average across China has climbed to $2.50 an hour, from 60 cents in 2000.

As global location and outsourcing decisions go, there will not be a wholesale rush back to Mexico. The drug war there scares away new business, and the country has built neither the skilled labor pool nor parts-supply chain to mount a serious challenge to China’s manufacturing prowess. But as Chinese wages continue to rise, Mexico looks the best-placed to benefit, as it is the least-expensive country outside the U.S. to manufacture for the U.S. market.

Customers who buy a Dell computer at a big-box retailer get a product made by Foxconn in China. But shoppers on the company’s website can customize their orders –and those computers are assembled and delivered from a massive Foxconn plant near Ciudad Juárez, which churns out 35,000 laptop and desktop computers a day, and can have a truck on the U.S. side in a few hours.

Here are a few World Economic Forum competitiveness rankings (out of 142) on the 2 countries: Overall– China 26, Mexico 58; labor market efficiency-36 vs. 114; available scientists– 33 vs. 86; infrastructure quality– 25 vs. 73. Mexico’s homicide rate is nearly 18 times that of China.

Discussion questions:

1. Why would businesses prefer to locate or outsource to Mexico?

2. Why would they prefer China?

OM in the News: Outsourcing Leads to Delays For The Airbus 350

Just as aggressive outsourcing a decade ago on its 787 Dreamliner caused Boeing to stumble, Airbus now faces exactly the same issues as it prepares its direct competitor, the A350. The Wall Street Journal (July 11, 2012) writes that both companies have lurched through a string of expensive and embarrassing crises while developing their new airplanes. To recover, the competitors are rethinking how they build jetliners. What is emerging is a middle path between outsourcing, which has reshaped the aeronautical industry over recent years, and the highly centralized production systems that preceded it. In a major retreat, Boeing has since bought up suppliers, brought work back in-house and integrated more closely with its remaining contractors. Manufacturing problems on the 787 have left Boeing with more than 40 almost-completed Dreamliners awaiting fixes. Customers are getting their planes 4 years late. For a second, larger version of the Dreamliner, Boeing opted to design many outsourced components itself.

Airbus found internal coordination was equally daunting. The A350 team pressed plants to agree on common standards and buy identical equipment. Some “partners” balked at spending hundreds of thousands of dollars for the digital “tool set” of software to access A350 blueprints. By 2010, A350 blueprints were running late and the project was delayed 6 months. Last spring, bad news again surfaced. Lower-tier contractors were struggling to deliver parts on time. Preparations to manufacture composite parts took longer than the setup for metal parts had. As parts arrived late, delays rippled upstream. Large sections of the first test airplanes weren’t ready for assembly. Airbus could rush the unfinished fuselage parts together and appear on schedule (as Boeing had done), even though it would be harder to complete tasks later, out of sequence. It chose to delay yet another 6 months.

Airbus now monitors 450 suppliers world-wide. “We don’t know everything, but we know all about the risky ones,” says the A350 VP.

Discussion questions:

1. What are the advantages and disadvantages of outsourcing in this industry?

2. What is the impact of a plane delayed by 2-3 years?

OM in the News: Infection Rates and the Outsourcing of Hospital Cleaning

The Vancouver Sun (May 7,2012) has just reported another outbreak of infection rates at Canadian hospitals. The article states that health authorities have been warned for 10 years or more that the outsourcing of hospital cleaners – key personnel in any infection prevention and control program – was a misguided attempt to save money and would put patients at risk. In 2004, incidents at Surrey Memorial Hospital concluded that infection prevention had completely broken down. An auditor-general’s 2007 review found that the ministry of health had failed to implement systems for the prevention and control of infection.

Things heated up in 2009 when Vancouver released reports from its Centre for Disease Control (CDC) on a persistent and lethal infection out-break at Nanaimo Regional General Hospital, the third in four years. The CDC found that: “There were insufficient numbers of cleaning staff to meet the basic daily needs of the facility and they were not adequately trained in appropriate cleaning procedures for a health care facility. They were not able to meet the increased demand for environmental cleaning that is required to control an outbreak.”

Best practices in infection prevention programs highlight the vital role of hospital cleaning: adequate staffing and training, proper equipment and supplies, and real communication and cooperation among hospital personnel at all levels. None of these factors are included in the government-ordered cleaning audits (which were confined to visual inspections only) that report hospitals passing with flying colors even while infection outbreaks were raging.

Scotland banned the outsourcing of hospital housekeeping in 2008 and brought cleaning back in house. The result? Infection cases have dropped dramatically. Reviews of Ontario’s devastating 2003 SARS outbreak named hospital cleanliness as a critical component in preventing and containing infections, and hospital cleaners’ involvement essential.

Discussion questions:

1. Why are janitorial services successfully outsourced in most organizations, but not here?

2. What OM tools are available to address this quality issue?

OM in the News: Outsourcing’s Passage Out of India

“For years there was pretty much one choice for US firms seeking to move jobs offshore: India,” writes Businessweek (March 19-26, 2012). Outsourcing grew to a $69 billion business there that transformed backwaters such as Chennai and Hyderabad into teeming cities. But this wave has crested. Last year, companies in Latin America and Eastern Europe opened 54 new outsourcing facilities vs. 49 for India.

This change comes as American corporations increasingly ship higher-level jobs (such as skilled positions in research, accounting, procurement, and financial analysis) offshore. Because these jobs are not the mass-processing functions that are India’s forte, there are greater opportunities for countries such as Argentina, Poland, Brazil, and Guatemala. An Argentinian accountant costs 13% less than one in the US (while an Indian is 51% less), but there are other considerations. “If you’re working with a hedge fund manager where you interact 10-15 times a day, the same time zone is important,” says one CEO.

Brazil now has the most Java programmers in the world and the second most COBOL programmers. Poland’s Gen Y population is highly educated (50% of its 20-24 year olds are in college)–and prolifically multilingual. There are 26 languages spoken at H-P’s Polish center that serves its European, African, and Middle Eastern operations. They perform high-level services including finance, accounting, marketing, and supply chain analysis. Coca-Cola moved its finance and accounting centers in Paris, Brussels, and London to Poland as well. Other centers have been opened there by IBM, Microsoft, and Ernst & Young.

Even Tata Consultancy Services –India’s outsourcing leader (with 2011 sales of $9.8 billion)–has 8,500 employees in South America in an effort to “nearshore” to clients.

Discussion questions:

1. What are some advantages in moving higher-level functions to Eastern Europe and South America?

2. What are India’s outsourcing strengths and weaknesses?

OM in the News: How “Total Cost of Ownership” Brings Manufacturers Back to the US

Businessweek‘s (Feb.8,2012) headline reads: “For Some US Manufacturers, Time to Head Home”. It appears that when the total cost of ownership is computed (which includes intellectual property risk, the cost/time to travel to visit distant suppliers, the negative impact of separating manufacturing from engineering back at HQ, and 28 more factors), the true costs of outsourcing can be assessed.

When measured on price alone, says the Reshoring Initiative, the cost of products and components made in the US vs. China are 108% higher. But when total cost of ownership is included, the US averages only 12% higher. “The US is a lot more competitive than people realize,” says the group’s founder. “Over the last several years, firms got caught up in the outsourcing trend without thinking through the costs.”

Two of the factors that drove firms overseas, cheap fuel and labor, no longer favor far-flung ventures. A barrel of oil has jumped from $23 to $88 in the past decade, so the price of shipping goods has gone up. And wages in China have increased 15% a year in that same time frame. Further, the dollar has declined 23% since 2002, with the result that factory labor here is 11% cheaper in dollar terms over that period.

As companies have also gotten better at reducing inventory and adopting JIT delivery, supply chains that stretch around the world have started to look like liabilities. Researchers at Gartner predict that by 2014, 20% of the goods made in Asia that are destined for the US will shift to the Americas. And a recent survey by Accenture, called “Manufacturing’s Secret Shift,” reports that 61% of 287 manufacturers are thinking of moving operations closer to customers.

Don’t expect a hiring frenzy if some factories return, though. “It’s a marginal improvement, not a tidal wave,” says Businessweek.

Discussion questions:

1. Why won’t a shift in manufacturing result in millions of new jobs?

2. Why should the total cost of ownership be included in outsourcing decisions?

OM in the News: Why Indian Firms Outsource Even More Than American Ones

The front page headline in the New York Times (Dec.2,2011) reads “Outsourcing Giant Finds It Must Be Client, Too”, describing how most employers in India rely on contract hiring agencies to avoid India’s restrictive labor laws. India, of course, is known the world over as a prime innovator of outsourcing for foreign firms which take advantage of its cheap, English-speaking labor force. Less well-known is the extent to which Indian companies outsource their own jobs within their own country.

To skirt laws that prevent companies from laying off workers, Indian firms hesitate to hire permanent employees, instead turning to firms like TeamLease to field “temporary employees”. Factories employing more than 100 workers, for example, are not allowed to lay off employees without government approval. Economists assert that firms will continue the outsourcing trend, although they are reluctant to admit to it because of political and societal pressures. Already, 1/4 of India’s industrial laborers and perhaps 1/2 of service sector workers are on outsource contracts.

Walk into any of India’s shiny new shopping malls and many of the store clerks, janitors, and security guards will be on the payroll of outsourcing companies. Firms like TeamLease supply workers who are paid half of what a “permanent employee” can earn, with few benefits to boot. Today, one of TeamLease’s biggest clients in India is Whirlpool. It has hired 1,850 salesmen for the American giant and sent them to stores to sell appliances. This avoids the myriad of employment laws and taxes that differ by region and simplifies Whirlpool’s entry into a new market.

Discussion questions:

1. How does outsourcing impact Indian companies and employees?

2. What are the disadvantages of outsourcing in general?

OM in the News: Why Amazon Can’t Make a Kindle in the US

This interesting article in Forbes (Aug.17,2011) proposes that “decades of outsourcing have left US industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy”. Even if Amazon wanted to, says Forbes, the Kindle could not be made here because of the migration to Asia of: (1) the circuit connectors (to China); (2) the display (to Taiwan) ; (3) the case (to China), because the supplier base for toys, electronics, and computers went there; (4) the wireless card (to Korea), the center for mobile phone components; (5) the controller board (to China), when the US transferred printed boards to Asia; and (6) the battery (to China), when it migrated with the manufacture of notebook computers.

The main point, however is that the decline of manufacturing in a region sets off a chain reaction. Once manufacturing is outsourced, process-engineering expertise can’t be maintained, since it depends on daily interactions with manufacturing. In the long run, say two Harvard profs, “an economy that lacks an infrastructure for advanced process engineering and manufacturing will lose its ability to innovate”. Already lost are 2 dozen industries ranging from flat-panel LCDs to rechargeable batteries to desktop/notebook/netbook PCs to hard drives. The list of industries “at risk” is even longer and more worrisome.

Take the story of Dell Computer and its Taiwanese electronics manufacturer as an example of an industry lost. The supplier started by making the simple circuit boards inside the PC. It then proposed: “Why don’t you let us make the motherboard for you? Circuit manufacturing isn’t your core competence anyways and we could do it for 20% less”. On successive occasions, the supplier took over: (1) the PC assembly, (2) the supply chain, and finally (3) the design. Dell’s revenues were unaffected and its profits increased. But the next visit from the supplier wasn’t to Dell, rather to Best Buy, offering its own brand PC at 20% less than the Dell!

Discussion questions:

1. What are some other industries lost to Asia?

2. What can the US do to reverse this decline?

OM in the News: Rethinking Outsourcing

“Outsourcing has transformed global business”, writes The Economist (July 30-Aug 5,2011), with $100 billion in new contracts signed every year. In Britain alone, 10% of all workers are in “outsourced jobs”, to the tune of $200 billion/year. Even war is being outsourced: the US now has more “contract employees” in Afghanistan than soldiers. This is not a new phenomenon, of course. When I was toiling away 40 years ago as a college student scrubbing floors as a janitor at Sears, I never really worked for the retailer. I was on the staff of the company that Sears hired to do all its cleaning. As we note in Supp.11, Outsourcing as a Supply Chain Strategy, tasks like cleaning, and many other back-office jobs, are peripheral to a company’s core business and can be done better/cheaper by specialists.

But The Economist goes on to point out that outsourcing may have reached maturity in economies such as the US and Britain. It suspects that much of what can be outsourced already has been. A recent quarterly index of outsourcing shows an 18% drop globally.

Why? Perhaps : (1) an uptick in legal disputes over outsourcing marking a well of discontent over badly written/handled contracts; (2) vendors who overpromise to get contracts, then fail to deliver; (3) companies undermining their overall customer service by contracting to foreign call centers, then wondering why their customers hate them; (4) a move towards shorter-term , smaller, and less-rigid deals (indeed “mega” outsourcing contracts, over $100 million, dropped by 62% this year).

The nightmare story of Boeing’s decision to outsource the bulk of the 787 some 8 years ago may also be a reason why companies are rethinking the strategy. If the Dreamliner rolls off the assembly line later this year, it will have been billions over budget and 3 years behind schedule. This is largely because of sub-contractors who failed to deliver on time or who made parts that did not fit together.

Discussion questions:

1.Will outsourcing continue to be a good strategy for most firms? Why?

2. Where, globally, does outsourcing continue to grow?

OM in the News: Universities Turning to Outsourced Profs–Can it Be?

When I used to teach the topic of outsourcing (Ch.2) in my OM class, I would always joke with the students, saying ” the one job that can never be outsourced is mine”! Oh, oh. USA Today’s headline (June 29,2011), “Universities Turn to Outsourced Instructors” turns the joke around. It turns out the Missouri State University, Florida Atlantic U., Lamar U., and others are having classes taught by teachers not on the university payroll.

The article opens with this line: “This fall, when students of Missouri State take an introductory journalism class, they’ll have some of the most qualified teachers in the field”. The instructors, however, work for Poynter Institute, which supplies the university with teachers for the class via the internet. Virtually unheard of a decade ago, instructional outsourcing is sprouting on campuses nationwide. Lamar U., for example, has outsourced some online graduate programs since 2007. Enrolments in two masters degree programs in education reached 4,100 students, higher than the total of all students at the Beaumont, Texas, school. It moved Lamar’s Graduate College of Education from 211th in the US to 7th in just 18 months. “Financially , it’s been very good for Lamar”, according to a spokesman.

Here are the 2 views: Proponents see outsourcing as another innovative way to cut costs, access bigger markets , and add expertise to classrooms.The department chair at Missouri State says the outsourcing brings educators who “are likely to have superior credentials than would a per-course instructor hired from the local pool”.

Opponents say outsourcing threatens faculty jobs, diminishes interaction between students and profs, and can turn colleges into diploma mills. They are skeptical of the content and quality of such classes and of turning instruction over to an out-of-town company.

Discussion questions:

1. Do your students think this “innovative” way of looking beyond traditional boundaries is a good idea? Why or why not?

2. Compare the concept in the article to the outsourcing of legal, IT, or engineering work.

OM in the News: “Comparative Advantage” and American Jobs

This is the first time I recall The Wall Street Journal (Jan.26,2011) treating the subject of the Theory of Comparative Advantage. We cover this topic in Supplement 11 as a means of justifying outsourcing. The theory basically states that each country should concentrate its energy and skills on the goods and services that it is more productive at than the rest of the world.

Matt Slaughter, a dean at the Tuck School at Dartmouth, points out that the last time the US had 11.7 million manufacturing jobs (the number we have today) was in 1941. Should we have more? He writes: “A competitive America does not mean competitive success for every American industry. Many voices argue that manufacturing is somehow special….But a key insight into the principle of comparative advantage…is that hard-working Americans are not going to excel at everything….It’s okay that Phil Mickelson is better off on the golf course and not painting his own house”.

“Imports do not represent failure”, Slaughter adds. ” They raise the standards of living”. Questions of whether we have a comparative advantage in emerging clean technologies “are best left to the markets”.

He suggests that for the US to be globally competitive, we must invest abroad as well as export there. Manufacturers of aircraft engines, elevators, and earth movers, for example, require after-sales maintenance and support that requires foreign investments on our part. More maintenance and repair of tractors in China and India mean more R&D jobs here. And more Wal-Marts and Red Lobsters in those countries mean more logistics jobs in the US.

He concludes that “excessive government backing of particular companies and industries typically squanders taxpayer resources and stifles sustainable growth”.

Discussion questions:

1. Compare Slaughter’s comments to the ideas of Liveres in yesterday’s blog.

2. What is our comparative advantage in this country?

3. Where do services fit into this mix?

OM in the News: Philippine Call Centers Overtake India

For the past decade, when you called an 800 number for customer service or a plane reservation, the chances are you would be speaking with a young person in Bangalore or Gurgaon, India. But Businessweek (Dec.6-12, 2010) reports that you are now more likely to be phoning up the Philippines. With $5.7 billion in call center work this year,vs. $5.5 billion for India, the Philippines have overcome a slow start in outsourcing. OM managers in the US may wish to take a note.

Why the move from India? (1) English is taught in all schools; (2) Filipinos have a cultural affinity for the US (with teens weaned on radio stations that play US Top 40 and hip-hop); (3) Special economic zones offer tax breaks and exemptions from import taxes on telecom gear; and (4) power is more reliable than in India, where companies often rely on diesel generators. The call center jobs are popular, as nocturnal workers can earn $6,850 a year in a country where per capita income is 1/4 of that.

This is not to say that India is giving up its dominance in outsourced work that requires a higher level of skill. Its overall outsourcing revenues are still $70 billion (vs. $9 billion in the Philippines). Indian outsourcing firms are migrating from answering phones to account management,high-tech support (it graduates 400,000 engineers annually),and financial and supply chain consulting. “In IT and software, India really doesn’t have any competition”‘, says a Wipro exec.

As a sidebar/update, on Jan.10,2011, USA Today devoted a cover story article to the Philippines call centers.

Discussion questions:

1. Why are the Philippines a popular call center alternative for US, European, and Australian firms?

2. How has the call center industry matured in the past decade and what has been its impact on India?

3. Identify other outsourcing industries that have migrated from one country to another in the past 20 years.

OM in the News: Hospitals Fear Outsourcing Records to India

Whenever I blog on the subject of outsourcing (see Chapter 2), I find myself using the word “controversial” (as on 10/12/10). And, indeed, this week’s Wall Street Journal article (Nov.2,2010) describes the contentious issue of outsourcing digitizing of hospital medical records to India. Overseas providers, it is commonly feared, do not have the security and privacy controls that US hospitals require. “As soon as it leaves the confines of the US, its not subject to the same rigorous laws as we are”, says the CIO of a Texas chain of 40 hospitals.

Every company in IT wants to cash in on the lucrative $50 billion US health care market fueled by a federal mandate for hospitals to convert to electronic records by 2017. Amazingly, only 20% of US hospitals currently have electronic health records. Its a carrot and stick approach, with $6 million grants to an average sized hospital (I wonder where all this money comes from!) and penalties for missing the deadline. Its “like another Y2K opportunity” for software firms, says the head of New Delhi’s HCL Technologies.

So the real question is, who should get the contracts? Its not so simple. HCL has about 2,400 American employees in N.C. Then again, Cognizant Technology Solutions is a US firm in N.J., but has most of its staff in India. Indian tech giants Infosys, Wipro, and Tata are all lined up with bids. But so are IBM, Xerox, and Dell in the US.

Discussion questions:

1. How do students feel about sending medical records abroad for automation?

2. Can this impact relations with India, which sees this as protectionist? (President Obama visits India in 2 days).

3. Why was Y2K such a boon to the IT industry? (Some of your students may not remember the drama that year).

OM in the News: The Outsourcing Controversy

Outsourcing has been a controversial topic and a political football for well over a decade now. We have tried to maintain a balanced view of the pros and cons. But with the elections nearing in a month, many Congressional candidates and the AFL-CIO have been unveiling an anti-outsourcing campaign. And the Senate fell just 7 votes shy of passing the “Creating American Jobs and Ending Offshoring Act”.

If you teach this topic and plan to cover Chapter 2, today’s Wall Street Journal (Oct.12, 2010)carries an interesting editorial piece by William Cohen, former Defense Secretary. He states, “Most people treat outsourcing as a zero-sum game–one foreign worker replaces one American worker. But this is not how the dynamic global economy works…The fact is that that for every job outsourced to Bangalore, nearly two jobs are created in …American cities”.

Discussion questions:

1. If anyone in your class has seen the new NBC comedy “Outsourced”, ask them to comment on this issue.

2. Should the government raise taxes on companies that move operations abroad (the Senate voted 53-45 last month to do so)?

3. Should we discourage skilled workers from India and other countries from coming to the U.S. to work?