Monday, May 12, 2008

Off-Shoring and Outsourcing: Problems for Mechanical Model Enterprises

I responded to a wonderful article by David Williamson Shaffer on Epistemic Games. The article was titled, The End of the American Century, and is a good description of America's misunderstanding of the changes that have, and are, taking place in the world economy.

My comments, reprinted here, clarify the difference in perspective between "mechanical" and "organic" business models, and how this difference highlights our cultural dislike for outsourcing and off-shoring.

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David, this is a well written piece. Thanks for your thoughtfulness, and insight.

Yes, the reality is certain, and it is different from that which most Americans assume to be true. There is a larger economic world out there, and most of it is not American.

I was reading Thomas Freedman’s The World is Flat a while back, and, somewhere in the middle, I became frightfully aware of this fact, and of the reality that most of my associates in business believed otherwise. The world’s business models have already changed, and many of us are ignorant of that reality. It became eminently clear that, as Americans, we are erroneously convinced that our long established, mechanical business models, remain the right and true way, and that we should continue to force our businesses to fit those models. This is our form of insanity.

If we are to survive, we must get with the program.

I appreciate your inclusion of the account of the Dallas attorney, Mark Richardson, who said that, out of ethical obligation, he must do what’s best for his clients, and “that includes saving them money.”

His assessment reflects what I believe to be a misapplication of the economic reality he describes. His ethical responsibility is not to “save his clients money,” rather it is to allocate their resources to produce the greatest value for their investment paid to him. His description of off-shoring to a lawyer in India at $60 per hr instead of using his in-house attorneys at a rate of $395 per hr, or his $225 rate for a junior associate, suggests that his rates are, somehow, too high.

I think this perception is common, and a misunderstanding of the real value proposition to be considered. There is a world of difference, and understanding that difference will illustrate the problem many Americans have with concepts such as outsourcing, or off-shoring.

We have a natural distaste for both. It appears that available talent off-shore will take jobs away from Americans. We can’t possibly remain profitable if we are forced to reduce our fees to compete with these off-shore providers, so we think. And, so we fear. However, we miss the basic economics of the opportunity.

America’s infrastructure is considerably well-developed and expensive to maintain. We are also well-entrenched in it. We can’t, and shouldn’t expect to eliminate it, which would be necessary if we are to attempt to compete in this world economy taking the fear-based approach inherent in our “save money” models. Instead, we need to embrace it, to recognize its value, and then use it to our real advantage in the development and delivery of the products and services it can produce. That infrastructure affords us opportunity unavailable and undeliverable by our “competition” in places, which like India, are as of yet under-developed.

The basic tenant of our capitalist economy is the free exchange of resources to gain other, more valuable resources for the betterment of our lives and our companies. At the core of every financial transaction is the idea that all participants gain value in the transaction. A consumer receives greater value from the transaction than what he spends. The seller receives greater value than what he spends to provide the product or service. Done right, both sides profit.

Take the case of the attorney. The law firm's client chooses to buy legal services that provide a greater value than their associated expense. It is the ethical responsibility of the attorney to do just that. Here is where the decision to off-shore aspects of the transaction comes in. The basic research task described in Shaffer's article is an example of a non-strategic offering. Grunt work in simple terms. Such work may provide some value to the client, but the value of that work should not be understood in the framework of the cost to produce it, but in the value of the impact of the work done. The two are really not related. If attorneys in India can provide the entirety of the value to be received for 25% of the cost of attorneys in America, so be it. The value realized is not diminished at all. If attorneys in India are happy and fulfilled only requiring $60 per hr, an efficiency is created, making it possible for the American attorney to deliver the same value to his client at a reduced cost, first to his firm, and secondly, if he should choose to reduce his fee to deliver that value, to his client.

So, off-shoring actually enables the attorney to increase his value to his client, but that value does not lie in his ability to “save his client money.” Such a limited view diminishes his value to his clients, and violates his ethical responsibilities toward his own firm. Both parties have the ethical responsibility to maximize each other’s value, and earnings. Saving money may occur, but cannot be the foundation for value description. Since there is an opportunity to off-shore, the greatest value can now be realized from better utilization of the American attorneys. They can now apply their creativity to strategic activities with the opportunity to add vastly greater value to their clients, tasks well worth the $300+ per hr that they need to maintain the operation and necessity of the firm.

The distinction between the two perspectives lies in the way we tend to view a pricing model. We tend to choose something from our mechanical, manufacturing business models. We consider cost, add some “fair markup,” and assume the rate to be some sort of value. In reality, there is no cost + fair markup anywhere in the value equation. The value exists only in the mind of the customer, and it is not a cost plus proposition. The cost has no significance to him, only that, all things considered, the purchase costs less than the economic value received. Should the law firm be ethically able to charge $300+ per hr for services it provides? Absolutely. However, and this is the critical distinction, it can only support the fee if the value provided is worth multiples of the fee to the customer.

Only when American companies end their love affair with cost plus pricing and adopt value based fees, will we be able to fully embrace every opportunity to send our less-strategic work overseas, and then become what our well-developed infrastructure requires, that is high value/ high margin enterprises.

1 comment:

David Williamson Shaffer said...

CJ--

I do appreciate these thoughtful comments. (Sorry it took a while to reply--it is the end of the semester here.)

I think it is interesting that we are coming at some of the same challenges and transformations of the global economy from different perspectives--you from business, us from education; you trying to change how businesses think about what they do, we trying to change how people think about what kind of education prepares young people to think in these new ways.

In any event, thanks for joining the conversation. I hope you'll keep in touch through the blog.

David