How Much Savings through Outsourcing? Article from October-December 2004 issue of Business Strategies Newsletter By Bill Birnbaum, CMC There’s certainly a lot of confusion regarding the potential savings from outsourcing. In one article, we learn that India’s wage rate for computer programmers is 15% that of a programmer in the United States. But in that same article, we hear from an industry expert that “Realistically, a company might expect to save about 20% through outsourcing.” Can both figures be correct? Yes, they can. Let’s take a look.    First, we need to recognize that there’s a fixed cost associated with establishing and maintaining a relationship with any supplier. And if that supplier is located overseas, that fixed cost is generally higher. The figure above shows both the higher fixed cost, and also the lower variable cost (the slope of the total cost curve), associated with outsourcing work to another nation. Note that the variable cost for outsourced work is much less (about15%) that of keeping the work in-house. This is a reflection of the fact that “India’s wage rate for computer programmers is 15% that of a programmer in the United States. At point A, the two total cost curves (“in-house” and “outsource”) intersect. Beyond this point – that is, at a transaction volume greater than volume level A – the company would save money by outsourcing. At a transaction level below this number, the company would save money keeping the work in-house. Regarding the industry expert’s comment that, “Realistically, a company might expect to save about 20% through outsourcing,” note volume level B on the curve. At this transaction volume level, it’s about 20% less expensive to send the work overseas than it is to perform the work in-house. Clearly, at yet higher volumes, the percentage saved is greater. At lower volumes, the savings is less. Logically, outsourcing should be of less interest to smaller companies. For they generally don’t have the necessary transaction volume to overcome the fixed cost associated with establishing and maintaining the necessary overseas relationship. Yes, this is certainly true. But guess what? Outsource companies are opening offices in the US and other industrialized nations to accommodate smaller companies’ lower transaction levels. Thus, the offshore companies are driving down the fixed cost associated with their services – making it easier for smaller companies to do business with them. In fact, outsourcing is becoming especially important to smaller firms. For they’re being pressured into sending work overseas. An article in The Wall Street Journal (“Small firm’s Outsource Abroad by Tapping Offshore Producers” January 7, 2004), tells of large, industrial customers giving their smaller suppliers an ultimatum. They’ve said, “If they [the smaller company suppliers] don’t have an offshore operation within six to 12 months, they will lose business to competing producers who do.” Originally published in Bill Birnbaum's Business Strategies Newsletter