Outsourcing in European Emerging Economies

Territorial Embeddedness and Global Business Services

Łukasz Mamica, Łukasz Mamica

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000221169
• Edition: 1
• Topic: Architettura
• Subtopic: Pianificazione urbana e paesaggistica

Drawing on a range of European cases, this edited volume analyses the offshoring and outsourcing of foreign companies, with a focus on territorial embeddedness.

The book opens by developing a theoretical framework and then presents a range of international case studies exploring the experiences of the service hub cities of Brno, Bratislava, Budapest, Krakow, andPrague. Attention is also given to internal and external determinants of embeddedness, with chapters on the employee perspective, the Fintech industry, corporate social responsibility, and the role of universities.

This volume will be of interest to advanced students and researchers in regional economics, economic geography, innovation studies, industrial economics, European economics, and international business.

Part I
Theoretical aspects of the embeddedness of outsourcing and offshoring processes

1
The theory and evolution of outsourcing and offshoring processes

Piotr Kopyciński and Łukasz Mamica

Historical background

The theoretical foundations for the concept of outsourcing were laid by Adam Smith, who, in his Wealth of Nations (1776), discussed improvements in productivity possible owing to the division and specialisation of labour, such as breaking down the job to be done into simple operations, improving workers’ skills, and providing adequate support equipment. In his view, the specialisation of labour favours cooperation amongst groups of employees and improves their individual productivity. In the wake of the 18th-century industrial revolution, Smith’s views on the relocation of production began to be put into practice. David Ricardo’s work Principles of Political Economy and Taxation (1817), in which he explained the main principles of a labour theory of value and theory of comparative advantage, was also important for the development of the theoretical foundations of outsourcing. In his view, free trade between two or more countries can be mutually beneficial, even when one country enjoys an absolute advantage over others in all areas of production. Friedman, when analysing the risks to American jobs as a result of their outsourcing to India due to wage differences, clearly states “Ricardo is still right” (2005, p. 264).

However, the practice of outsourcing by firms did not become widespread until the second half of the 19th century. This was essentially due to two developments: the spread of the railway network since 1830 and the invention of the telegraph in the same decade. Thanks to these innovations, the time of exchange of both information and goods among individual branches of enterprises was reduced. Further improvements in manufacturing technology, which permitted entrepreneurs to take advantage of economies of scale, also enabled them to operate more widely on regional and international markets (Porter, 1992). In the United States, the process of relocating production gained momentum after the Civil War, when the Massachusetts government imposed standards that came to be considered excessive and prompted northern textile factories to move production to southern states (Ouellette, 2013). The growth in outsourcing was fostered by lower tariffs, which fell from an average of 40% in the 1940s to about 5% in the early 21st century (Boudreaux, 2008). In the 20th century, the popularity of outsourcing-based business solutions was associated with the development of information technologies (IT). They permitted a number of in-company processes to be automated; however, the latter eventually became so complicated that they had to be contracted out (Wiencek, 2004). Therefore, the main motive for outsourcing certain processes was not so much to lower the costs of their execution as the desire to focus on the key competences of a given firm, which led to a new division of labour (Factor, 2002). The precondition for any country to accept certain more advanced services from outside was always the availability of a suitably qualified workforce. Since training-up takes a fairly long time and, in most cases, requires the involvement of the public sphere, the capacity to absorb the processes in question depends on decisions taken a number of years previously. An example of such a policy of support for the higher education system, especially in the technical sphere, is India, where the University Grants Commission was established in 1952 and tasked with ensuring adequate teaching standards (I.N.C. for Cooperation with UNESCO, 1998). As a result, India eventually developed sufficient resources to become a key destination for the transfer of IT services.

However, outsourcing became formally seen as a legitimate business strategy only in 1989 (Mullin, 1996). The 1990s brought an increase in the interest of cost-saving measures by outsourcing more and more functions that were classified as not belonging to the core business.

The expansion of outsourcing was also supported by the systemic transformation that took place in Central and Eastern European countries in the early 1990s (Bookman, 1995). The collapse of communism and the centrally planned economy released significant reserves of skilled labour (partly by reducing artificial full-time employment and partly, unfortunately, by the collapse of a number of industries which were unable to survive the shock therapy). Moreover, the low wage levels in the post-socialist countries offered considerable rents to virtually any kind of outsourced production or services. The accession of Central and Eastern European countries to the European Union, the abolition of customs barriers, and the free movement of goods and services provided other impulses in favour of the advancement of outsourcing. The latter was supported on an international scale by the growing globalisation and the upward trend in international trade.

The concepts of outsourcing and offshoring

The starting point for the discussion of these concepts is Porter’s value chain (Porter, 1985). In his approach, any firm’s activities can be divided into: 1. primary ones, which are directly concerned with the manufacturing/creation and delivery of a product/service; and 2. back-office/support activities intended to ensure that the primary activities are as efficient and effective as possible. It should be emphasised that company core activities are generally not subject to transfer. The concepts of outsourcing and offshoring apply to the transfer of support services (back-office services), such as finance, HR, IT, supply chain management, help desk, information security, technology tools, and cloud platforms. This allows the firm to commit more of its resources to primary activities. Relocation occurs by consolidating and providing one or several support services from one central location rather than duplicating the roles in organisation within an in-house department or a local/overseas external third-party provider. The main aims of outsourcing and offshoring carried out in this manner are to reduce costs and to increase efficiency and effectiveness of company operations.

In the initial period of outsourcing, the prevailing motivation for moving production abroad to mainly southeastern Asian countries was to reduce manufacturing costs. A client that ordered products or services was considered as an owner of accumulated knowledge and experience, whereas the vendor as an entity whose main advantage was a lower-cost workforce; the latter being the crucial factor in deciding where to locate production. Over time, the concept of outsourcing evolved into strategic outsourcing based on the client’s partnership with numerous vendors. The essence of such a change is well illustrated by the example of Dell (Power et al., 2006), which started cooperating with a number of parts suppliers, and decided to focus on IT systems. Its development model assumes that hardware suppliers have their own capacity to deliver progressively more technically advanced solutions and do not expect to be providing strictly defined parameters or specifying methods of manufacturing parts and components as long as they meet the required standards. The network of suppliers as well as the knowledge accumulated and developed by them become part of Dell’s business strategy, which does not have sufficient resources to control and research new hardware solutions. The vendor that offers the lowest manufacturing cost becomes an equal business partner, whose development and research success also impacts on the competitive position of the customer. IBM also offers a good example of business strategy that involves creating new products or services through alliances and outsourcing arrangements (Ghemawat, 2007). The main mechanism regulating the relations between the suppliers and the recipients of outsourcing services are interfirm contracts, which provide the formal arrangements for this process and stabilise the entire sector (Anderson & Dekker, 2014).

The concept of outsourcing assumes greater budget flexibility due to the fact that services are purchased as and when the need arises. This flexibility of outsourcing reduces the costs resulting from the need to adapt one’s own organisational structure to changing demand. Organisational inertia associated with both the recruitment and training processes, as well as the costs incurred due to the reduction of employment when the demand for a given service drops, makes outsourcing of selected aspects of a company’s operations a more attractive option. Furthermore, large companies are the object of interest of the media and the public opinion; hence layoffs invariably attract negative publicity. Outsourcing therefore allows for a relatively straightforward employment reduction during an economic downturn or in the face of problems due to other reasons without unduly raising negative public emotions.

However, this kind of managerial approach to outsourcing has come under heavy criticism due to the unwillingness of companies with more capital to act as labour market stabilisers during a downturn, and thereby to take responsibility for the social dimension of their business decisions. The supporters of offshoring, i.e. business entities which order goods or services from more distant locations, are also accused of attempting to evade their domestic social security regulations or occupational safety standards. This approach was epitomised by the Dhaka garment factory collapse in Bangladesh in April 2013. As a result, more than 1100 people were killed and about 2500 were injured. The collapsed eight-story structure, originally erected as a commercial rather than industrial building, itself built in blatant violation of construction regulations, housed garment factories that manufactured clothes for many famous clothing brands worldwide. However, the criticism of outsourcing typically targets the loss of jobs caused by their relocation abroad (Dobbs, 2004). Such a perception of outsourcing is also fairly common in the eyes of public opinion in countries from which jobs are transferred. A survey conducted in the USA by the New York Times showed clearly that this process is responsible for the loss of jobs; moreover, two thirds of respondents expect firms to take greater responsibility for preserving manufacturing jobs (Conelly, 2012). The American experience shows that the process of outsourcing indeed involves job losses: a 10% increase in services and materials offshoring leads to a 2.6% reduction in the share of value added transferred to workers (Milberg & Winkler, 2013). Consequently, the sole beneficiaries of outsourcing are capital owners, a factor that increases the already high inequality levels in America. Even...