By Dr. Fereidoon Shahrokh
Faculty Member, Marketing and Economics at American Public University
The current state of the U.S. economy rests in part on the Federal Reserve’s monetary policy of keeping its funds rate at near zero, which assures short-term interest rates remain low. Such an economic environment reduces the debt service burden of businesses significantly, which is the reason for especially robust business lending. Regardless of the state of the economy, outsourcing has become a strategic component of business and is expected to continue to grow.
In economics, outsourcing is when a firm contracts with a company, inside or outside of the same country, to provide a product or service. Based on David Ricardo’s “comparative advantage,” outsourcing increases a firm’s production efficiency and economic productivity. The sole purpose of outsourcing is to maximize profit—reduce the cost of production and increase revenue.
One of the major reasons for outsourcing is to reduce the cost of operation and production including labor costs, energy costs, transportation costs, government regulations, and taxes. Outsourcing can allow firms to take advantage of economies of scale, reduce prices, and expand market share.
An article by David Wessel published in April 2011, in the Wall Street Journal states that U.S. multinational corporations–the big brand-name companies that employ a fifth of all American workers–cut their work forces in the U.S. by 2.9 million during the 2000s while increasing employment overseas by 2.4 million. Aside from cutting costs, the overseas fast growing markets (such as China, Brazil, India and Russia) offer the potential demand for products and hence the opportunity to increase capacity. In addition, by establishing strict quality control, these firms have been able to maintain or even increase the quality of their products.
Outsourcing helps firms to focus on their core business, resulting in increased productivity, quality, and reduced prices. Through business process outsourcing, firms gain access to a larger talent pool and increase innovations.
There are several approaches to outsourcing. Firms may outsource their operations along vertical and horizontal lines inside and/or outside geographical boundaries. In backward diversification, a firm outsources to foreign firms to produce intermediate goods or inputs for its finished products (e.g., automobile components or computer components). As such, the key input to this type of outsourcing is the availability of cheaper of production. Firms may outsource to businesses located closer to the raw material sources or talent and expertise.
In forward outsourcing, a business contracts with foreign firms to market the finished products. The key issue in this type of outsourcing is demand for products by foreign consumers, market size, transportation costs, import restrictions, and taxes.
About the Author
Dr. Fereidoon Shahrokh has been teaching graduate and undergraduate level courses in economics and quantities analysis for APU since 2007.His professional expertise is in the field of economic modeling and forecasting which involve the development of economic-based complex and inter-related mathematical models for statistical analysis, simulations and forecasting. He started his professional career as an Econometrician in charge of developing and maintaining the first large-scale micro-macro forecasting model of West Virginia economy and its coal industry. Later on he joined Virginia Power in charge of design and development of a large-scale forecasting model of Virginia economy to determine the future energy capacity needs. For the next six years he worked as the Associate Director at University of Baltimore managing a team of 16 professional economists and financial analysts, constructing housing, demographic, economic, and welfare forecasting econometric models. Fereidoon has a doctorate degree in economics, and he has published in several refereed journals including Journal of Regional Science, Energy Economic, Review of Regional Studies and several others.
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