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Why Money Chases Cheap Labor - The Outsourcing Phenomenon

Why Money Chases Cheap Labor - The Outsourcing Phenomenon

Outsourcing will continue. Think about this fact: The cost per month of health insurance for a U.S. worker in many cases exceeds the total monthly wages of a Chinese worker. It's obvious why companies are so anxious to outsource their products or services to other countries. They absolutely must do this to survive.

By Theodore F. di Stefano
02/03/06 7:00 AM PT

Has it occurred to you that more and more foreign-made products are sold in the U.S.? The fact is, it has become almost impossible to avoid purchasing products that are made in China, Japan, Taiwan or other Far Eastern countries.

Even when it comes to services rendered, many of those emanate from outside the U.S. You may think you are calling an American company asking for information on a product, but you may actually be connected with someone in a foreign country -- perhaps India or even Panama.

Lower Costs

What is going on here, and why do U.S. companies seem to be outsourcing so many jobs? The simple fact is that money chases cheap labor. Put differently, capital, the resource that fuels our industries, has to seek the lowest labor costs in order for companies to survive.

Needless to say, the first challenge for a business is to produce a quality product or render a quality service. The second challenge is to deliver such a product or service at the lowest possible cost.

This need to keep labor costs low is part of a very old capitalistic dynamic whereby a company is compelled to keep its costs down because consumers are demanding good products at cheap prices.

The exception to this is when there is some sort of monopolistic situation whereby the producer/seller of the product or service does not have to worry too much about pricing, because there is little likelihood that another company will come along and offer a similar product or service for less.

However, this type of situation is not very common. There is simply too much competition for customers; this fact alone prevents a company from ignoring its pricing structure.

A Look Back in Time

The cheapest labor for U.S. products and services over the last two hundred or so years has come from the southern United States. In recent decades, however, cheaper labor came from Far Eastern countries like Japan, Taiwan, South Korea and China. Additionally, in the last ten years, a great deal of inexpensive labor has come from India.

Actually, many people aren't yet aware of the extent to which the United States is outsourcing labor to India. A case in point that may be shocking to some is the fact that over 500,000 U.S. Federal Income Tax returns for 2005 will be put together in back offices in India. Yes, it's true that someone in India who doesn't even know your name might have substantially prepared your personal tax return. Why is this?

In the relentless search for cheap labor, U.S. businesses have come to realize that many things can be digitized -- for example, your personal tax return. Your CPA can e-mail all of your tax information to an outsourcing company somewhere in India. The CPA can then leave the office, go to dinner, enjoy the evening, and expect that the information that was e-mailed to India in the afternoon will come back first thing the next morning in the form of a completed tax return.

All the CPA has to do is review the return to be assured that nothing has been omitted or misstated and mail it to you with a bill for services rendered. Not bad!

This is possible because the data in your return, like so many other commercial activities, can be digitized, e-mailed, analyzed, processed and reassembled by a low-paid clerk in India. You get a perfectly acceptable tax return and your bill is quite reasonable. Everybody is happy except the U.S. workers who have been idled by such outsourcing.

Outsourcing will continue. Think about this fact: The cost per month of health insurance for a U.S. worker in many cases exceeds the total monthly wages of a Chinese worker. It's obvious why companies are so anxious to outsource their products or services to other countries. They absolutely must do this to survive.

Labor costs are a large part of the total costs of a company's products or services. Since they are such a major part of what makes up the selling price, these costs must absolutely be kept down in order for a company to survive.

This phenomenon of capital chasing cheap labor will not abate. It will only continue. My feeling is that eventually labor costs will start rising in some of the countries that are presently being used by us for outsourcing purposes, and we will then shift our outsourcing to other, less expensive countries.

In fact, I recently read that some Indian call center supervisors are demanding substantial raises from their U.S. employers or they will quit and go to work for other U.S. companies with operations in India. This recent increase in Indian labor costs is caused by the massive investment of American companies in India. A case in point is Microsoft, which just made a multi-billion dollar commitment to its Indian operations.

Where Are We Headed?

Since the inexorable march of outsourcing will continue, U.S. companies have to take a hard look at how the nation can compete going forward. America obviously cannot compete effectively with the labor costs of developing nations. Where competition is possible, however, is in the technology and science realm.

U.S. firms must continue to innovate and develop great products and services. In many cases, out of necessity, the actual manufacture or assembly of these products or services will be outsourced. But, by and large their creation can and should continue to take place in America.

To assure this flow of new products and services, it is critical to stress education in the sciences from an early age. This will guarantee staying at least a step ahead of the competition. Good luck!


Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which deals in bringing small-cap companies public. He also is a frequent speaker on the subject of financial advice for small businesses as well as the IPO process. He can be contacted at Ted@capitalsourcepartners.com.


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