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Outsourcing beyond taxation

President Obama’s most recent outburst against offshore outsourcing appears to be nothing more than his response to the threat posed to American jobs being shipped to offshore destinations, including India. Given the state of the American economy, Obama’s desire to create more jobs in the US, and retain existing ones, is perhaps justified. And while his plan to overhaul the US tax code is criticised as being protectionist, his intention to ensure that US corporations avail of tax deductions or deferments, for foreign expenses, only when they pay tax in the US on their foreign profits, may not be entirely without merit.

However, one must understand that outsourcing to third party offshore vendors does not generate profits. Profit is in fact generated only by captive units of US corporations, for example, when Dell establishes operations outside the US which it owns and manages. Outsourcing to third party vendors, especially those in Bangalore, is actually an expense. Companies began to undertake such expense due to the lack of skilled professionals in Buffalo. Additionally, overseas destinations offered better cost structures.

Hence, while the end of tax incentives to US companies, generating jobs overseas, will impact outsourcing, it is important to analyse the reasons why companies began to outsource, since such discussion will demonstrate that the offshoring model, even after paying taxes, may continue to remain attractive.

1.Reduction in operational and labour costs: The savings derived from having the same work done, at comparable service levels, at a much lower price is one of the primary reasons why corporations outsource. In today’s economic climate, it is important for companies to stay competitive and any reduction in operating costs with marginal to little reduction in quality is welcome.

2.Access to specialists and experts: One of the greatest strengths of any service provider is its human capital. These providers, therefore, deploy large amounts of capital in developing their human resources. Given the shortage of skilled workers in Western countries, including America, outsourcing allows companies to engage such specialists, which eventually allows these companies to enhance their productivity.

3.Redeployment of workforce: Back-end operations, like data warehousing, application and development maintenance, technical support and system integration, forms a bulk of what is outsourced to IT vendors. The allocation of resources from these non-core activities to focus on the core competencies, allows companies to better service their customer base.

4.Risk mitigation: In today’s rapidly changing technical environment, companies cannot always keep pace with the changes or commit the financial investments required to stay ahead. Outsourcing vendors support their clients by almost always sharing the investments costs, thus helping reduce the ancillary risks associated with such large investments. The vendor can spread its own risk over multiple clients and this allows companies to take advantage of the service provider’s economies of scale.

5.Lack of internal resources: When companies enter new markets or are experiencing rapid growth, the internal resources may not be commensurate with their expansion. Additionally, companies may not immediately want to spend on supporting such expansion. In such circumstances, outsourcing allows companies access to resources required for supporting such developments.

The above brings to fore the obvious cost efficiencies in outsourcing, which, till date, have benefited US corporations. American enterprise cannot afford to lose its edge to their European and Japanese competitors merely because such competitors are able to get work done cheaply. Thus, while much hue and cry has been raised over Obama’s proposed policy, the doomsday predictions for offshore outsourcing may be premature. Industry is hopeful that the US Congress, before approving any change, will evaluate, in detail, all consequences of the amendments to the US tax code. Given that the fundamentals of offshore outsourcing remain strong, if the US Congress were to approve President Obama’s proposed measures, they will, in the long run, affect the competitiveness of American corporations, which was never the avowed objective.

 

First Published in Business Today on June 14, 2009

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