Is Outsourcing Profitable?: Prof. Paul A. Strassmann George Mason University, March 6, 2006

Is Outsourcing Profitable?
Prof. Paul A. Strassmann

George Mason University, March 6, 2006
1
Prof. Strassmann, GMU March 6, 2006 Lecture, REPRODUCED BY PERMISSION ONLY
Outsourcing: Rising or Losing?
2
What is Outsourcing?
3
Definitions
Profits
Depreciation
Interest, Taxes
Cost of Outsourcing
Sales
Overhead
Operations
Direct
4
Financial Profile of U.S. Firms (2004)
Standard & Poor's Data for U.S. Corporations with 3.8 Million Employees
5
Outsourcing and Corporate Economics
• Overhead costs now manage not only internal

“direct” labor but also outsourcing work done
by suppliers.
• Computer applications, optimized for
“enterprise” integration have difficulty coping
with the suppliers’ incompatible systems.
• Unmanaged outsourcing complexity can void
labor saving gains.
6
Critical Ratios
Outsourcing Ratio = Outsourcing / Direct Costs
Overhead Ratio = Overhead / Direct Costs
7
Distribution of 2004 Outsourcing Ratios
Median Outsourcing Ratio for 769 U.S. Corporations = 75.6%

8
Outsourcing Not Correlated with Profitability
9
Distribution of 2004 Overhead Ratios
Median Overhead Ratio for 769 U.S. Corporations = 124%

10
Overhead Not Correlated with Profitability
11
Summary: Outsourcing and Overhead Ratios
• Outsourcing now equals 75.6% of corporate

direct costs and is rising.
• Overhead costs now exceed corporate direct
costs by 24% and keep rising as direct costs
outsourced.
• Neither outsourcing nor overhead correlates
with profitability. Corporate profitability
reflects effectiveness of management.
12
Was Outsourcing
Profitable for GM?
A Case Study
13
GM Employment and Outsourcing
14
GM Outsourcing Increased Overhead Costs
15
The Keys to Competitive Advantage
• Collaboration Costs
• Coordination Costs
• Intermediation Costs
• Transaction Costs
• Structural Costs
• Sales, General & Administrative Costs
= Overhead Costs
16
Do Cuts in I.T. Indicate Success?
17
A Comparison of I.T. With Business Indicators
18
A Shareholder View
19
A Comparison With Competitive Indicators
20
While Outsourcing, Market Share Declines
21
Summary of GM Case
• Outsourcing to lower costs did not stop market

share erosion.
• Value-chain did not improve while outsourcing;
• Despite a decline in employment and outsourcing

overhead costs are up;
• I.T. can not be successful if business is indicators

reveal information-related malfunctions.
22
Is Outsourcing
Damaging?
A Case Study: GM vs. Caterpillar
23
Employment: GM vs. Caterpillar
24
Outsourcing: GM vs. Caterpillar
25
Knowledge Value: GM vs. Caterpillar
26
Compensation: GM vs. Caterpillar
27
Summary of GM vs. Caterpillar Comparison
• Despite higher wages Caterpillar increased

employment.
• Despite high level of outsourcing Knowledge
Value of Caterpillar gains.
28
Research Findings
29
Highly Profitable Firms Outsource Less
30
There Will Always be Outsourcing (2002)
31
Outsourcing Ratios Differ by Industry
32
Higher Pay Need not Result in Outsourcing
33
Summary of Research Findings
• “Outsourcing” is essential for the growth of

any economy.
• Whether outsourcing is economically effective
depends on the organization of the the value-
chain.
34
Outsourcing
in the Value-Chain
Case Study
35
Estimated Cost of a Logitech Mouse
36
Different Perspectives on Outsourcing
37
Distribution of Costs of a Logitech Mouse
38
Summary of Case Study
• The definition of “outsourcing” depends on

the position in the value-chain.
• The dominant cost in global commerce are
transaction costs, not labor costs;
• Assembly takes place from global sources
where technology and logistics dictates
sourcing.
• The greatest damage to the U.S. economy
can come from vertical integration that
reduces transaction costs.
39
Transaction Costs in the Value Chain
Supply Chain Distribution Chain Consumer
40
Manufacturing Supply Chain Costs
100%
100%
90%
All Other Costs
80%
Transaction Costs
70% 15.9%
Profit
60% 56%
50%
40% 8.1%
33%
30% Purchases
20% 5.8%
15%
10%
4.7%
0%
All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer
41
Costs in a Manufacturing Supply Chain
100%
100%
90%
All Other Costs
80%
Transaction Costs
70% 15.9%
Profit
60% 56%
50%
40% 8.1%
33%
30%
20% 5.8%
15%
10%
4.7%
0%
All Other Suppliers Secondary Suppliers Prime Suppliers Manufacturer
42
The Total Value Chain
158%
160%
140% 24%
127%
120%
23.5%
100%
100%
80%
Other Costs
60%
Transactions
40%
34% Profits
20%
0%
Manufacturers Wholesalers Retailers
43
Potential Gains in the Automobile Industry
160%
158%
13%
140%
130%
Gain
120% 15%
81%
100% Profits
55% Information
80%
All Other
60%
40%
64% 60%
20%
0%
Old Value Chain New Value Chain 44
A Value Chain View of Information Costs
45
A Perspective of the CIO’s Job
46
Impacts of Information Technologies
• Information drives an economic “arms race”.

• Obsolete assets will be discarded.
• Collaboration favors global consolidation.
• I.T. becomes an economic weapon.
47
A Case of Value-Chain Superiority
48
Outsourcing and
the U.S. Economy
49
Is the US Economy Off-Shoring Itself?
50
Summary
• Outsourcing is not subcontracting I.T. costs.

• Outsourcing is not “off-shoring.”
• Outsourcing is the distribution of labor and
knowledge through specialization.
• Gains from increases in Value-Added.
• Losses from divestment of Knowledge.
51
Issue: Cut Costs or Lose Knowledge Assets?
52
Next GMU Lecture
When: April 17,2006

Topic:
What is the Worth of Employee Knowledge?
Prior lectures available on:
http://video.google.com/videosearch?q=strassmann
53

Is Outsourcing Profitable?: Prof. Paul A. Strassmann George Mason University, March 6, 2006

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Is Outsourcing Profitable?

Prof. Paul A. Strassmann

• Overhead costs now manage not only internal

Outsourcing Ratio = Outsourcing / Direct Costs

Overhead Ratio = Overhead / Direct Costs

Median Outsourcing Ratio for 769 U.S. Corporations = 75.6%

Median Overhead Ratio for 769 U.S. Corporations = 124%

• Outsourcing now equals 75.6% of corporate

• Outsourcing to lower costs did not stop market

• Value-chain did not improve while outsourcing;

• Despite a decline in employment and outsourcing

• I.T. can not be successful if business is indicators

A Case Study: GM vs. Caterpillar

• Despite higher wages Caterpillar increased

• “Outsourcing” is essential for the growth of

• The definition of “outsourcing” depends on

Supply Chain Distribution Chain Consumer

• Information drives an economic “arms race”.

• Outsourcing is not subcontracting I.T. costs.

When: April 17,2006

Prior lectures available on:

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