Outsourcing to China

Weighing the Effects of Doing Business Offshore

November 3, 2009

By Joseph Greco

Over the past decades, many U.S. companies have been lured to outsource much of their manufacturing to China by the prospect of higher profits due to the low Chinese cost of production. Funded by a U.S. Department of Education grant, the research staff at the Center for the Study of Emerging Markets in Mihaylo College of Business and Economics has spent the last three years studying the impact of offshore outsourcing on Southern California businesses.

The economic growth record of the Chinese economy has grown to legendary proportions and justifiably so. Following the introduction of the new economic policies of Deng Xiaoping in the late 1980s, the China’s economy began to grow at a robust 12 to 15 percent annually. Although recent years have seen a slowing in the rate, even 2008 GDP at a “slowed” rate of 9 percent will turn out to be a banner year compared to the rest of the world.

The number of cases of successful outsourcing to China also has grown to significant proportions as one competitor after another reaps the benefits of offshore outsourcing, or so it would appear to the casual observer. Although the success stories abound, it is too easy to overlook a darker side that may mislead the potential outsourcer to imagine the “China Solution” is an easy fix for whatever ails the company, starting with high operation costs. Not every company that chose to outsource to China succeeded.

The findings of the center indicate a few words of caution are warranted:

• First, outsourcing offshore should never be a spur of the moment, a few weeks or a few months decision, nor should outsourcing be the brainchild of one key employee with Chinese ethnicity or family ties in China. Obviously, if the key connection leaves the company, serious and negative side effects result. The decision to outsource a select manufacturing function or a business process should be weighed carefully, and it may take some time before the best choice is identified. A key guideline is to outsource whatever process is not your core competency. Once the outsourced process is identified, the selection process of an outsourcing provider should be guided by an expert, preferably an experienced consultant, and the relationship with the service provider should be a long-term arrangement.

• Second, the Chinese legal system presents challenges for outsourcing companies who want to protect their intellectual property. Although China has come a long way over the past decade to align its legal system with those of developed countries, it still has some significant ground to make up. Intellectual property right protection is still uncertain and a strategy should be in place to protect a company’s IP before it outsources.

• A third area of caution when outsourcing to China is to insure the ability of the Chinese service provider to produce the level of output specified while maintaining an acceptable level of quality control. To ensure these two criteria, some outsourcing firm have found success using an in-country representative to visit the foreign installation on a monthly basis.

Although the current economic global slowdown has affected its robust growth rate, there continue to be many positive reasons to turn to China to outsource. Given the high number of Chinese firms seeking to attract foreign clients, the competition for business will benefit the outsourcing firm as long as it does not lose sight of these cautions.

Joseph Greco is the director of the Center for the Study of Emerging Financial Markets. He has taught finance on campus since 1996.

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