Outsourcing and offshoring are chosen by more and more firms as means to access resources which are otherwise unavailable to them, with the purpose of reducing operating costs, increasing efficiency and managing risk. This paper seeks to find reasons as to why British firms are experiencing this increasing trend and how the UK economy is affected by this growth.
Outsourcing consists in strategically using resources from other firms to perform activities traditionally carried out within the firm. This is typically done by contracting out this part of the firm’s activity to a third party (Webb, 2018). A simple example of this would be a telecommunications firm contracting their customer service activity to a specialist call centre elsewhere in the country. Outsourcing allows growth at a rate that would have been unattainable simply with the firm’s own staff and is especially productive if the third party’s workforce is trained or has previous experience in carrying out the required task.
Cost reduction constitutes the most common rationale for outsourcing. Over the years, firms have greatly changed the way in which efficiency savings are made, moving away from reducing employee numbers and instead maximising the use of their core competencies (Pine, 2018). The aim of firms to maximise production through the use of their most productive resources is shown to be more and more relevant and correct management of the outsourced activities is crucial in ensuring maximum benefit is gained from this practice. Managerial discipline includes addressing issues both at senior level and at the operational level, to ensure that procedures adopted by the host company are in line with the parent firm’s objectives. The increasing responsibility bestowed upon managers over the course of the years (Farrell, 2018) and the increased risks associated with their performance are to be attributed to the continuous pursuit of efficiency gains and the rise of outsourcing in the UK.
The benefits of outsourcing have spurred the growth of many multinational businesses. In the UK, this has mostly been the case in business services, an industry in which employment grew by 92% between 1984 and 2001 (Abramovsky et al., 2004). In this time frame, the industry grew significantly faster than others, driven by “increased demand from UK companies for UK-produced business services”. This phenomenon is known as domestic outsourcing, which triggered the contracting-out of economic activity to other British firms and had significant spillover on markets directly related to business services, such as computing, renting of machinery and the legal, technical and advertising sector.
This practice is also adopted by firms with the aim of gaining access to resources which fulfil their operational needs. Plimmer (2013) observed the increase in outsourcing by the UK public sector following the adoption of Margaret Thatcher’s free-market principles and associated this with the home country’s adoption of austerity measures. Businesses are shown to focus their resources on activities which they are specialised in and benefit from economies of scale from this practice. This however, may not always be in the best interest of the stakeholders: the British Government recently outsourced military recruitment to a private firm following large budget cuts faced by the Army (Lusher, 2017), drawing media attention to what is considered to be “a crisis in recruitment and retention”. This move may be of benefit to the Government as it streamlines the recruitment process and reduces the costs previously incurred in enlisting individuals, while the Armed Forces can focus on training and deploying their personnel. However, the number of trained troops is falling, and the public considers the move as a political strategy rather than an improvement on national defence (Bond, 2018). This is evidence of large potential risks related to this practice, in selecting the wrong partner in the department’s operations and overlooking personnel issues. Both are considered to be “deadly sins’ of outsourcing by Barthélemy (2003).
Offshoring refers to the procedure of relocating economic activity to a different country, where this is undertaken by either the same multinational corporation or a third party. Compared to outsourcing, this is a mostly geographic change with the aim of benefitting from cost differentials and from streamlining the supply chain, reflecting the increasingly international division of labour.
Many companies engaged in offshoring do so primarily in response to a shortage of skilled domestic employees rather than cost cutting. Most adopt a hybrid of onshore/offshore labour which allows them to innovate and adapt quickly to compete in markets such as manufacturing of cars and mobile phones in which China and Korea, among others, enjoy competitive advantage (Shay, 2013). It is observed that MNEs tend to choose FDI offshoring for skill-intensive production but opt for arm’s length transactions for low-skill tasks (Sheng & Yang, 2014). This means that the parties involved act independently (in their self-interest) and there is no collusion with the offshoring of low-skill activity. As trade costs fall, more skill-intensive tasks are contracted offshore as it becomes more profitable and firms are able to gain greater surpluses from this process.
Gagliardi et al. (2015) explored the impact of offshoring on domestic jobs in the United Kingdom and observed job losses in “routine occupations in areas that have been more exposed to the relocation of production abroad’, regardless of the level of economic development of the host country. Positive effect was shown on generating non-routine jobs when these are relocated to emerging economies. Offshoring impacts are mediated by the behaviour of the MNEs who adopt this type of practice, as they are able to benefit from efficiency gains and the opportunity to concentrate more productive tasks in the UK. As such, the generation of non-routine jobs and greater demand for domestic skill intensity eliminate the costs incurred in the home economy.
This conclusion is supported by Driffield, Pereira and Temouri (2017), who in addition observed that the post-crisis period lessened the impact of offshoring service FDI on employment at home and highlighted differences between service offshoring and other types. In particular, outward FDI has been shown to be carried out with purposes, among others, of “market seeking, asset seeking, resource seeking, and efficiency seeking”. These are core motivations in firms gaining competitive advantage and flexibility in the way they carry out their economic activity. Distributing operations around the world and optimising the resources of those different locations has become a natural process through globalisation and the resulting reduction in transport and communications costs, giving rise to the Global Factory (Enderwick & Buckley, 2015). This practice allows smaller firms to become more competitive: these companies are enabled to secure cheaper supply sources and assets, while benefitting from fewer managerial obstacles compared to a MNE due to the simpler nature of the flow of resources involved in the offshoring process, a feature which makes them less susceptible to the volatility of global markets.
Offshoring also has considerable potential effects on the home country’s balance of payments. Total UK services exports rose from £123.2 billion in 2015 to £142.7 billion in 2016, while imports increased by £10.2 billion to a total of £68.7 billion. (ONS, 2018). Outsourcing by UK firms is one of the largest components of UK service imports, and considering that imports of business services grew at a slower rate than domestic production (Abramovsky et al., 2004) we can conclude that the impact of outsourcing has a positive overall effect on the balance of payments.