Outsourcing: effect or cause?
Two people questioned me on something I said the other day about outsourcing … “cost-cutting is a last resort” … one asking for a clarification, the other a justification. Both were getting at the same issue: the fact that the chicken-and-egg problem does not have a self-evident answer.
To recap: I claimed outsourcing is an effect, not a cause … that it happens when your economics go sour, and you struggle to keep your head above water, but it is not the (initial) cause for the decline.
When your income is built on innovation, you inherently grow, provided your innovations are useful and well received. Innovation is like magic: it disobeys conservation laws, and thus blood, sweat, and tears can translate to wealth. The thing about “the American Spirit” that was pervasive throughout the 1700s, 1800s, and much of the 1900s, is that every American considered him/herself an innovator. The inventor was popularized, valued. The net effect was that, on the factory floor, any individual with insight on how to do things better could make a difference.
That is important. Innovation tends to happen where the action is: when you are building something, you think about how to make it better. When you use a tool, you think about how to redesign it so that it might do its job better. When you assemble a product, you think about how to do the same design with fewer parts. The person closest to the action often has the best insight into the problems, and so that person often is the most likely to innovate.
The flip side: if you’re not building anything, it’s really, really hard to innovate.
And so we come to our chicken-and-egg problem: which came first, the flight of manufacturing (outsourcing), or a widespread decline in innovation? Without manufacturing, you cannot innovate well because you are removed from the important problems; without innovation, you cannot manufacture well because you have to compete primarily on cost and not substance.
If we assume that things tend to take the path of least resistance, then the answer is that innovation declined first, leading to lower profits and attempts to cut costs, and ultimately outsourcing.
The easiest way to make money is to innovate, because innovation generates wealth, which is readily transformed into money. It is easier because it is free, like sunshine or rain; anyone is free to innovate and thus generate wealth, and this wealth-generation comes at nobody else’s expense. In fact, most innovations improve the lives of the people who purchase the innovative products, which really is the point.
In contrast, making money by way of cost-cutting is not free: you have to give up something to get it, such as quality or control or simplicity. Also, the amount of money that you can make via cost cutting is limited, whereas the upside of innovation is not. So, fundamentally, on two different axes (convenience and return on effort), making money by way of cost cutting is inferior to making money by innovating, and this specific form of cost cutting (outsourcing) essentially precludes you from ever innovating in that domain ever again by taking manufacturing out of your hands, thus ensuring that you’ll never make as much money as you did back when you were innovating. So I think that most decision makers would resort to cost cutting only if the innovation route was, for whatever reason, taken off the table.
However, the notion behind “the path of least resistance” assumes that all of this stuff was self-evident and that executives were conscious of it. That is not necessarily the case. I think we have two equally compelling arguments:
- Executives blindly chose to outsource their manufacturing, not realizing that the short-term gain would ultimately cut off their ability to innovate in that manufacturing arena, thereby reducing all future potential for growth in that arena.
- A wave of something spread across America and reduced our ability to innovate, or — just as effective — reduced the ability for innovative ideas to make it into a company’s product.
Or, of course, you could have a combination of the two.
And now that I’ve put it that way, I’m more certain than ever that the economic downturn (starting in the 1970s) was caused by education, because this brings back a conversation I had the other day with an economic-policy guy at AEI. Food for the next post.
