A pet issue is that the claim that outsourcing and offshoring lower costs is greatly exaggerated. Offshoring and outsourcing (we’ll just say “outsourcing” for the purposes of this post) do lower direct factor and lower-level worker costs. But they do so at the increase of greater coordination costs of much more highly-paid managers. And they also increase shipping and financings costs, and downside risk. Having people work at a distance, whether managerially or by virtue of being in an outside organization where the relationship is governed by contract, increases rigidity (harder to respond to changes in market demand) and the odds of screw-ups due to communication lapses. And outsourcing also reduces an organization’s skills. Those lower-level people have a lot of product know-how that you lose when you transfer activities to an outside operation. It’s nice to think that you can hollow out your organization and just do all the sexy design and marketing stuff and dump the grunt work on other players. But over time you are breeding future competitors.

Thus offshoring is best understood as a device for transferring income from the rank and file to middle level and senior executives.

Yesterday in commments, reader Clive explained how outsouring over time starts to create its own bureaucracy bloat. It’s the modern corporate version of one of the observations of C. Northcote Parkinson: “Officials make work for each other.” As Clive describes, the first response to the problems resulting from outsourcing is to try to bury them, since outsourcing is a corporate religion and thus cannot be reversed even when the evidence comes in against it. And then when those costs start becoming more visible, the response is to try to manage them, which means more work (more managerial cost!) and/or hiring more outside specialists (another transfer to highly-paid individuals).

From Clive: