Discuss why multinational companies outsource production to cheap labor countries
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Today, outsourcing to cheap labor countries has become a common practice among large corporations. Although an old phenomenon, outsourcing has gained a new dynamic boosted by cheaper transportation, communication costs, and advancements in technology. Boosted by globalization, outsourcing enables companies to cut costs while maximizing profit. The inclusion of developing countries in global production systems enables firms to profit from the generally lower labor costs in developing countries. There are many advantages of outsourcing to low-cost countries; outsourcing benefits businesses by lowering transportation, raw material, and labor costs which results in affordable low-cost country sourcing. Besides, lower salary expectations and differences in currency rates between low-cost countries and developed countries also act as an incentive. The production processes in developed countries like the United States, and the United Kingdom, are also costly due to expensive infrastructure, machinery, and high wages, among others. Besides, low-cost countries have regulations and provisions like economic incentives, tax cuts, etc., aimed at encouraging multinational corporations to outsource mass-scale production into their countries. All in all, outsourcing to low-cost countries will enable companies to improve their bottom line cost-effectively. Despite all the advantages of outsourcing to developing countries, the research also revealed major disadvantages of outsourcing production; language barriers, challenges in quality control maintenance, hidden costs, and security concerns were some of the negative effects of outsourcing to low-cost countries. The report critically analyzed why multinational companies outsource production to cheap labor countries. It assessed the advantages and disadvantages associated with outsourcing production to cheap labor countries.
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Outsourcing Production to cheap labor countries Case Study
Key Learning Outcomes
By the end of the case, students should be able to:
- Understand what outsourcing is and why major companies outsource production to cheap labor countries
- Understand the pros and cons associated with outsourcing production to cheap labor countries
- Understand and discuss the benefits of outsourcing production to developing countries
1.0 INTRODUCTION
Today, outsourcing production to cheap labor countries has become a major phenomenon among large organizations. According to the Internationalization Theory of Dunning (1993), offshoring companies are often seeking efficiency since they mainly relocate their production abroad to take advantage of less costly resources and assets. Moreover, low-cost countries tend to offer incentives in the form of special regulations and tax cuts as a way of encouraging multinational corporations to outsource mass-scale production in their countries.
A study on why Austria’s companies offshored to Eastern Europe revealed low wages and reduced tariff barriers as the main reason (Egger and Egger 2003). Considering that capital is generally more mobile than labor, price differences are usually greatest for labor. According to Kohler (2004), offshoring an organization’s labor-intensive production stages to a low-wage country can be seen as a “vehicle for arbitraging” these differences. The opening of countries such as China and India has given multinational companies access to a large labor pool and boosted the profitability of material and service offshoring.
The entrance of these two countries into world trade has resulted in a wage differential between the industrialized economies whereby the lowest available wage rate has further decreased. Although cost cutting is the main reason, companies also seek quality, increased productivity levels, and good infrastructure. Companies outsource production to get access to more competencies, expand capabilities and exploit new business opportunities. Developing countries have a growing consumer market which sourcing companies can serve effectively.
Despite all the advantages associated with outsourcing production, it also comes with challenges including language barriers, challenges in quality control maintenance, hidden costs, and security concerns among others. Moreover, it is vital to note that labor costs across major outsourcing countries in Asia have been on the rise partly because most Asians are now willing to pay a premium for products, causing an increase in production costs. Since the late 2000s, many Asian countries have seen a hike in wages mainly due to the shift of labor from agricultural work into more productive jobs in industry.
As Asian economies continue to grow, living costs will gradually increase and workers will demand higher wages. Labor costs in China and India have been increasing over the years. China was initially one of the lowest labor cost countries known. However, due to the rising demands of people and the increase in the cost of goods, China is no longer regarded as the ‘cheapest’ country to manufacture goods anymore. Outsourcing may introduce challenges in maintaining quality control.
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