The Hidden Costs of Outsourcing

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THE HIDDEN COSTS OF GLOBAL OUTSOURCING

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TABLE OF CONTENTS

Introduction………………………………………………………………………………….Page 2

The Cost of an Outdated Outsourcing Strategy………………………………………….….Page 3

The Cost of Management and Coordination of Contractors………………………………...Page 4

The Cost of Subpar Inventory Performance…………………………………………………Page 5

The Cost of Unplanned Logistics Activities and Premium Freight…………………………Page 5

The Cost of Inappropriate Sales and Operations Planning…………………………….……Page 6

The Cost of Poor or Substandard Quality…………………………………………………...Page 6

The Cost of Warranty, Returns, and Allowances……………………………………………Page 7

The Cost of Supplier Management………………………………………………………….Page 7

The Cost of Cash Flow………………………………………………………………………Page 8

The Cost of Unplanned and Unforeseen Risks……………………………………………...Page 8

The Cost of Outsourcing on the U.S. Economy……………………………………………..Page 9

The Cultural Costs………………………………………………………………………….Page 11

The Bottom Line……………………………………………………………………….......Page 11

Discussion………………………………………………………………………………….Page 12    

Works Cited………………………………………………………………………………..Page 14

The Hidden Costs of Global Outsourcing

        What is the real cost of outsourcing? Reports from respected sources have conflicting views on outsourcing that can cause any company to have anxiety over the decision on outsourcing. Outsourcing offshore can potentially mean that a company can reduce their cost while increasing the firm’s ability to compete globally. However, there is still social and political pressure on companies to stay within the United States border. To be effective in outsourcing, a firm should be selective in what processes they are sending offshore otherwise they are just playing a game of labor rate arbitrage which in the long run, can potentially backfire on the company.

        When a firm decides to move any of their processes offshores, there are several hidden costs they could face that might not be thought of upfront. In many cases, the decisions to outsource were based on foundations that are not solid and are driven by a spreadsheet analysis that focused on labor. There are also other visible profit/loss elements to cost that influence a company’s decision to outsource. Companies that do not take into consideration other costs associated with outsourcing, have unfortunately followed this type of decision. The process of using the same decision making process as other similar companies is hurting the company. This process does not include all the costs associated with global outsourcing, it covers more of saving money on the labor wage rate.

Over the last century, outsourcing production has gain a lot of popularity among firms as they are a way to cut some costs and increase their profits. Most companies have looked towards China, Brazil, India, and other dynamic countries which have a potential to generate the huge demand for goods and services. However, the problem that companies are facing today is coming up with a strategy that covers all the cost factors associated with outsourcing. Since the early 2000s, oil prices have tripled making cargo-ship fuel much more expensive, and wages in China are now five times more than what they used to be and continuing to rise at an annualized rate of twenty percent. However, that isn’t all that is affecting the outsourcing strategy, American labor unions have also learned a thing or two about today’s economic reality and even they are obliged to become globally competitive. Also, with the natural-gas boom that the United States has recently witnessed, it lowered operating and facility costs in the United States, but in Asia the cost is still four times the amount the United States is currently dealing with. These overlooked factors add up to 14-60 percent of the purchase price of the good and services that are created overseas. Luckily, for most firms the increased profits they are making are covering the costs for now. 

Cost of an Outdated Outsourcing Strategy

The reduction in costs that outsourcing provides involves rationalization and the need for a reassessment of the current outsourcing strategy in terms of revenue versus decisions that can drive costs. Since the market is dynamic and shifts over time, firms may see an increase in logistics, transportation, in-transit handling damage, and other hidden management costs. A complete analysis of all costs that could arise should be taken into consideration and in few instances, the results may conclude that the firm stay or return to their original countries.

Cost of Management and Coordination of Contractors

When you look at all the transactions that take place in any given day for a firm, one can only imagine the amount of work it takes to make sure that everything is running smoothly. Managing the center of production from another country requires a significant amount of work that would involve invoicing, auditing, ensuring cost centers are charged correctly, and making sure that employee time is recorded properly. For some companies, assigning someone to handle the offshore facility is a must to make sure projects move forward and the work needed gets done. The bottom line of it all, firms should expect to pay an additional 6-10 percent on just managing the offshore facility. This cost would include the cost of travel for the person overseeing the production for the offshore facility.