Zagreb International Review of Economics & Business, Vol. 10, No. 1, pp. 33-66, 2007© 2007 Economics Faculty ZagrebAll rights reserved. Printed in CroatiaISSN 1331-5609; UDC: 33+65Outsourcing to China: Opportunities, Threats, and StrategicFitIlan Alon*Theodore T. Herbert**J. Mark Munoz***Abstract: China is a prominent outsourcing destination in Asia. International labour outsourcing,specially in the IT sector, has grown rapidly in recent years. This article defines outsourcingthrough an extensive review of the literature and discusses the opportunities and challengesfor outsourcing to China. Seeking strategic ‘fit’ among the disparate elements that influencethe firm’s outsourcing decision is recommended. The authors explore the IT and businesslandscapes in China and propose strategies for outsourcing success there.Keywords: labour outsourcing, China, information technology, international business, internationalstrategyJEL Classification: F200IntroductionCorporate participation in outsourcing is evolving and expanding, with notable andincreasing participation of US firms in offshore outsourcing (Guerra 2002). Mostenterprises outsource at least one business function, potentially affecting the courseof thousands of businesses (Logan, 2000). Over 88% of firms in the UK haveoutsourced IT or other business functions, with 82% having outsourced a core IT orbusiness function between 1998 and 2003 (Cap Gemini Ernst & Young 2003). Anincreasing tendency is that multinational companies have begun aligning with smallerfirms in order to heighten specialization (Dana et al 2000). Increasingly, firms have* Ilan Alon is at Rollins College, Rollins-China Center, Winter Park, Florida, USA.** Theodore T. Herbert is at Rollins College, Crummer Graduate School of Business, WinterPark, Florida, USA.*** J. Mark Munoz is at Millikin University, Tabor School of Business, Decatur, Illinois,USA.3334Ilan Alon, Theodore T. Herbert and J. Mark Munozcome to understand that, when undertaken in an enlightened fashion, outsourcingoffers substantial potential for growth, optimizing the use of home-country staff, andincreasing employment opportunities, and other advantages including theopportunities to…turn around dying businesses, speed up their pace of innovation, or funddevelopment projects that otherwise would have been unaffordable. Moreaggressive outsourcers are aiming to create radical business models that cangive them an edge and change the game in their industries. Old-linemultinationals see offshoring as a catalyst for a broader plan to overhauloutdated office operations and prepare for new competitive battles. And whilesome want to downsize, others are keen to liberate expensive analysts,engineers, and salesmen from routine tasks so they can spend more timeinnovating and dealing with customers (Engardio 2006a: 55).While the benefits of outsourcing have been widely publicized, less wellunderstood are the several factors which influence its nature and effectiveness.Through this paper, we provide an overview of the nature of the outsourcing processand some indications of the various approaches used by outsourcers, the complexarray of benefits and pitfalls entailed, and the implications for outsourcing to China,with particular attention to I.T. outsourcing; our end intent is to provide an integrated,strategic perspective useful for practising executives and scholars alike.On the Nature of OutsourcingBefore exploring these factors, definitions are in order, especially since outsourcingoften is misunderstood. Outsourcing is the strategic use of outside resources orsuppliers to perform activities traditionally handled by internal staff and resources(Griffith 2001), also considered as the process used by an enterprise in whichbusiness-related work functions are subcontracted to a supplier external to andunrelated to the outsourcing organization (Drezner 2002). In contrast, internationaloutsourcing (also called ‘offshoring’) is the subcontracting of business functions toorganizations in foreign locations, typically undertaken to improve the efficiencies oreffectiveness of those functions. Examples include half of all telephone calls to UKNational Rail Inquiries being handled by operators in India (Nash 2004), IBMmoving up to 4,700 programming jobs offshore in order to save on costs, andLondon-based bank HSBC’s intended moving of 4,000 customer service jobs to Asia(CNN.com 2003; BBC News 2003).Outsourcing to China: Opportunities, Threats, and Strategic Fit35A further refinement concerns the differences associated with global outsourcing,which is a management strategy in which one organization delegates one or more ofits major, non-core functions to other firms which specialize in efficiently providingservice in specific business functions; these transactions are encouraged by theenhanced capabilities of contemporary organizations to manage endeavors whichsupport another firm’s business (Elmuti and Kathawala 2000). Executives worldwideare beginning to view the process through the lens of ‘transformational outsourcing’,recognizing that outsourcing is not simply about cheap labour abroad, but pertains tothe potential for huge gains in efficiency, productivity, quality, and revenuesavailable through the full leveraging of offshore talent (Engardio 2006a). Wachovia,the US-based bank, for instance, was one company which carefully studied itsoutsourcing options. Its executives quickly realized that international outsourcing forcost savings yielded but a quick and short-lived ‘fix’, while the substance of thebenefits available lay in the opportunities to transform the ways in which they didbusiness, a much more intensive, multi-year process. Wachovia has proceededcautiously, outsourcing some human resources jobs to a local firm and otherprogramming and analytical work offshore, after having decided to retain as internalfunctions other outsourcing candidate functions like call centres since they werenewly identified as strategic assets (Foust 2006). The experience of Wachovia andothers underscores that the outsourcing process is complex, and entails planning,strategic definition, opportunity investigation, supplier selection, contractformulation, implementation, relationship management, and assessment (Chase1998; Green 1999).In reviewing herein the experiences of Western firms with outsourcing as a basisfor extracting insights useful to other executives and scholars, we cannot identifywith certainty which specific definition of or set of objectives for outsourcing wasemployed by those firms; many imply their intentions to have been that of gainingshort-term cost relief, while others seem to view their outsourcing as a long-termcommitment to fundamental business re-invention, with others having apparentobjectives anywhere between these two end-points. In addition, the specificinformation related to the strategic positioning of the outsourced function typically isunavailable, so we are left to share our insights from a rather broader perspective thanmay be preferred. Thus, when we refer to outsourcing or offshoring, we are using thebroadest appropriate and inclusive term, which for us means the formalizedoff-loading and subcontracting of one or more of a firm’s non-core businessfunctions to one or more organizations, which are typically unrelated to theoutsourcer, which specialize in providing more efficiently and effectively specificbusiness functions and which are sited in foreign locations, for the purpose of gainingcost, financial, staffing, management, or strategic benefits by the outsourcing firm.36Ilan Alon, Theodore T. Herbert and J. Mark MunozWhile such benefits as cost-reduction often are ascribed to outsourcing, inherentchallenges exist even to gain such a benefit. Despite the number of organizations thatconsider themselves to be successful at global outsourcing, the need continues tofurther identify, comprehend, and manage the risk factors that underlie both theoutsourcing process and the realities of doing business in international locations(Elmuti and Kathawala 2000). The potential complexities and risks from offshoringis illustrated in the US case…involving medical transcription, a commonly outsourced process for themedical industry, which the University of California, San Francisco (UCSF)Medical Centre had been outsourcing for the past 20 years. Unknown to them,part of the work was outsourced by the service provider in Florida, whichsubsequently subcontracted the work to Texas, and without knowledge ofanyone, was further subcontracted the work to someone in Pakistan (Bagby2003). This Offshore arrangement went without a hitch for 18 months, untilthe Texas operation refused to pay the Pakistani company, who thenthreatened to post the patient medical histories on the Internet if they were notgiven the back pay, thereby infringing privacy and confidentiality laws (Ho,Atkins, and Eardley 2004: 2).Risks may exist in any outsourcing activities. As the modalities for the creativearbitrage of labour (that is, the major wage gap that exists between developing andindustrialized nations – Engardio 2006a) have expanded within a globalenvironment, an additional priority is added: understanding the business andtechnological intricacies associated with specific locations. There is benefit to begained for the outsourcer’s business practice for putting the factors influencingoutsourcing into perspective.The need to understand the nature of country-based difficulties for foreign firms isparticularly true with reference to outsourcing to China; this is because of theimportance to the individual firm, the increasing centrality of China in globaloutsourcing, and China’s being one of the most attractive and popular outsourcingdestinations in the world (A.T. Kearney 2004; Cohen 2006). China’s appeal hasincreased markedly in the recent past with its WTO-membership-fueledliberalization of laws and government policies, especially those regarding privateownership, intellectual property, and foreign partnerships; heavy investment inacademic technical education; and low labour costs (Furniss 2003).Our intent through this paper is to contribute to improving insights intooutsourcing to China. We begin by considering the nature of global outsourcing.Next, we explore the special but complex situation of China with particular emphasison international labour outsourcing for IT, a valuable business opportunity. In theOutsourcing to China: Opportunities, Threats, and Strategic Fit37section below are detailed considerations of the various challenges and opportunitiesfor outsourcing to China, then we offer a consideration of strategic approaches forenhancing outsourcing success.Outsourcing and the Evolving International LandscapeOutsourcing as a corporate strategy has attracted wide interest and is in the process ofexceptional growth (Bolumole 2001; McCarthy and Anagnostou 2004.). While someconsider outsourcing as a move to simplify or save on costs for business functions,others view outsourcing as part of the evolution of business. Author and formerMIT/Sloan School Professor Michael Treacy’s view is that outsourcing is anadaptation phase in the process leading toward creating more efficient businessmodels, adjustments to inherent organizational weaknesses, and in uncovering betteropportunities (Gibson 2004). This view has helped reshape organizationalmanagement and strategic inter-organizational interactions (Pollalis 2003) and hasspearheaded the trend towards what has been termed ‘worldsourcing’ (Ellis 2004).The Rationales for International OutsourcingAdvocates have pointed out several economic benefits of outsourcing. The positiveend-effects include the firm’s economic improvement in developing locations (Ellis,2004); building foreign-based skills and infrastructure (Harrison 2004); consumerand taxpayer benefits derived from service enhancement and affordability (Griswold2004); trade benefits (Kleinert 2003; Glassman 2004); increased wage rate and tradeunion benefits (Shaksen 2004); impact on the employment level in developedeconomies (Economist 2004); as a gateway to privatization (Prager 1997); and for itsdemonstrated profitability in certain manufacturing sectors (Harrison 2004).Negative economic implications have also been noted. These include job drain(Dolan and Meredith 2004), reduction in employment and aggregate welfare(Shaksen 2004), effect on the pattern of employment (Economist 2004), detrimentaleffects on owners of capital (Shaksen 2004), contribution to insecurity (Ellis 2004),and reduction of skills and infrastructure in the home country (Harrison 2004).Particularly in view of the outsourcing phenomenon’s potential negative effects,closer investigation seems advisable. One useful approach recognizes the increasinginterest in using foreign-based labour through outsourcing business functions,attributable to several factors which should be considered more closely. These factorsmay be considered as offensive or defensive strategic responses to businessdevelopment and the competitive landscape.Offensive approaches refer to the organization’s use of international outsourcingas a strategic move to build its corporate strength or capture new marketopportunities. Influencing factors include market internationalization (Elmuti et al1998; Rao 2004); growing availability and demand for competent yet affordabletalent (Greenemeier 2002); gaining cost and time advantages (Jeffay, Bohannon andLaspisa 1997); reliability of communication technology and enhanced projectmanagement abilities (King 1999; Rao 2004); availability of software tools,platforms, and systems (Webster et al 2000); confluence of the telecommunicationand computing sectors that strengthened web and software applications (Currie2003); standardization of business tasks (Drezner 2004); acceleration of ITinnovation (Mitchell 2004); globalization and trade liberalization in emerginglocations (Rao 2004); improving operational efficiencies and capturing globalizationadvantages (Karklins 2003); productivity improvement (Kulmala et al 2002); betterstaff management and strategic focus (Leung 2003); mutuality of trade benefits toparticipating parties (Glassman 2004); and enhancing competitive advantage andcore competencies (Griswold 2004).An area of offensive opportunity has been expanding recently.

Zagreb International Review of Economics & Business, Vol. 10, No. 1, pp. 33-66, 2007© 2007 Economics Faculty ZagrebAll rights reserved. Printed in CroatiaISSN 1331-5609; UDC: 33+65Outsourcing to China: Opportunities, Threats, and StrategicFitIlan Alon*Theodore T. Herbert**J. Mark Munoz***Abstract: China is a prominent outsourcing destination in Asia. International labour outsourcing,specially in the IT sector, has grown rapidly in recent years. This article defines outsourcingthrough an extensive review of the literature and discusses the opportunities and challengesfor outsourcing to China. Seeking strategic ‘fit’ among the disparate elements that influencethe firm’s outsourcing decision is recommended. The authors explore the IT and businesslandscapes in China and propose strategies for outsourcing success there.Keywords: labour outsourcing, China, information technology, international business, internationalstrategyJEL Classification: F200IntroductionCorporate participation in outsourcing is evolving and expanding, with notable andincreasing participation of US firms in offshore outsourcing (Guerra 2002). Mostenterprises outsource at least one business function, potentially affecting the courseof thousands of businesses (Logan, 2000). Over 88% of firms in the UK haveoutsourced IT or other business functions, with 82% having outsourced a core IT orbusiness function between 1998 and 2003 (Cap Gemini Ernst & Young 2003). Anincreasing tendency is that multinational companies have begun aligning with smallerfirms in order to heighten specialization (Dana et al 2000). Increasingly, firms have* Ilan Alon is at Rollins College, Rollins-China Center, Winter Park, Florida, USA.** Theodore T. Herbert is at Rollins College, Crummer Graduate School of Business, WinterPark, Florida, USA.*** J. Mark Munoz is at Millikin University, Tabor School of Business, Decatur, Illinois,USA.3334Ilan Alon, Theodore T. Herbert and J. Mark Munozcome to understand that, when undertaken in an enlightened fashion, outsourcingoffers substantial potential for growth, optimizing the use of home-country staff, andincreasing employment opportunities, and other advantages including theopportunities to…turn around dying businesses, speed up their pace of innovation, or funddevelopment projects that otherwise would have been unaffordable. Moreaggressive outsourcers are aiming to create radical business models that cangive them an edge and change the game in their industries. Old-linemultinationals see offshoring as a catalyst for a broader plan to overhauloutdated office operations and prepare for new competitive battles. And whilesome want to downsize, others are keen to liberate expensive analysts,engineers, and salesmen from routine tasks so they can spend more timeinnovating and dealing with customers (Engardio 2006a: 55).While the benefits of outsourcing have been widely publicized, less wellunderstood are the several factors which influence its nature and effectiveness.Through this paper, we provide an overview of the nature of the outsourcing processand some indications of the various approaches used by outsourcers, the complexarray of benefits and pitfalls entailed, and the implications for outsourcing to China,with particular attention to I.T. outsourcing; our end intent is to provide an integrated,strategic perspective useful for practising executives and scholars alike.On the Nature of OutsourcingBefore exploring these factors, definitions are in order, especially since outsourcingoften is misunderstood. Outsourcing is the strategic use of outside resources orsuppliers to perform activities traditionally handled by internal staff and resources(Griffith 2001), also considered as the process used by an enterprise in whichbusiness-related work functions are subcontracted to a supplier external to andunrelated to the outsourcing organization (Drezner 2002). In contrast, internationaloutsourcing (also called ‘offshoring’) is the subcontracting of business functions toorganizations in foreign locations, typically undertaken to improve the efficiencies oreffectiveness of those functions. Examples include half of all telephone calls to UKNational Rail Inquiries being handled by operators in India (Nash 2004), IBMmoving up to 4,700 programming jobs offshore in order to save on costs, andLondon-based bank HSBC’s intended moving of 4,000 customer service jobs to Asia(CNN.com 2003; BBC News 2003).Outsourcing to China: Opportunities, Threats, and Strategic Fit35A further refinement concerns the differences associated with global outsourcing,which is a management strategy in which one organization delegates one or more ofits major, non-core functions to other firms which specialize in efficiently providingservice in specific business functions; these transactions are encouraged by theenhanced capabilities of contemporary organizations to manage endeavors whichsupport another firm’s business (Elmuti and Kathawala 2000). Executives worldwideare beginning to view the process through the lens of ‘transformational outsourcing’,recognizing that outsourcing is not simply about cheap labour abroad, but pertains tothe potential for huge gains in efficiency, productivity, quality, and revenuesavailable through the full leveraging of offshore talent (Engardio 2006a). Wachovia,the US-based bank, for instance, was one company which carefully studied itsoutsourcing options. Its executives quickly realized that international outsourcing forcost savings yielded but a quick and short-lived ‘fix’, while the substance of thebenefits available lay in the opportunities to transform the ways in which they didbusiness, a much more intensive, multi-year process. Wachovia has proceededcautiously, outsourcing some human resources jobs to a local firm and otherprogramming and analytical work offshore, after having decided to retain as internalfunctions other outsourcing candidate functions like call centres since they werenewly identified as strategic assets (Foust 2006). The experience of Wachovia andothers underscores that the outsourcing process is complex, and entails planning,strategic definition, opportunity investigation, supplier selection, contractformulation, implementation, relationship management, and assessment (Chase1998; Green 1999).In reviewing herein the experiences of Western firms with outsourcing as a basisfor extracting insights useful to other executives and scholars, we cannot identifywith certainty which specific definition of or set of objectives for outsourcing wasemployed by those firms; many imply their intentions to have been that of gainingshort-term cost relief, while others seem to view their outsourcing as a long-termcommitment to fundamental business re-invention, with others having apparentobjectives anywhere between these two end-points. In addition, the specificinformation related to the strategic positioning of the outsourced function typically isunavailable, so we are left to share our insights from a rather broader perspective thanmay be preferred. Thus, when we refer to outsourcing or offshoring, we are using thebroadest appropriate and inclusive term, which for us means the formalizedoff-loading and subcontracting of one or more of a firm’s non-core businessfunctions to one or more organizations, which are typically unrelated to theoutsourcer, which specialize in providing more efficiently and effectively specificbusiness functions and which are sited in foreign locations, for the purpose of gainingcost, financial, staffing, management, or strategic benefits by the outsourcing firm.36Ilan Alon, Theodore T. Herbert and J. Mark MunozWhile such benefits as cost-reduction often are ascribed to outsourcing, inherentchallenges exist even to gain such a benefit. Despite the number of organizations thatconsider themselves to be successful at global outsourcing, the need continues tofurther identify, comprehend, and manage the risk factors that underlie both theoutsourcing process and the realities of doing business in international locations(Elmuti and Kathawala 2000). The potential complexities and risks from offshoringis illustrated in the US case…involving medical transcription, a commonly outsourced process for themedical industry, which the University of California, San Francisco (UCSF)Medical Centre had been outsourcing for the past 20 years. Unknown to them,part of the work was outsourced by the service provider in Florida, whichsubsequently subcontracted the work to Texas, and without knowledge ofanyone, was further subcontracted the work to someone in Pakistan (Bagby2003). This Offshore arrangement went without a hitch for 18 months, untilthe Texas operation refused to pay the Pakistani company, who thenthreatened to post the patient medical histories on the Internet if they were notgiven the back pay, thereby infringing privacy and confidentiality laws (Ho,Atkins, and Eardley 2004: 2).Risks may exist in any outsourcing activities. As the modalities for the creativearbitrage of labour (that is, the major wage gap that exists between developing andindustrialized nations – Engardio 2006a) have expanded within a globalenvironment, an additional priority is added: understanding the business andtechnological intricacies associated with specific locations. There is benefit to begained for the outsourcer’s business practice for putting the factors influencingoutsourcing into perspective.The need to understand the nature of country-based difficulties for foreign firms isparticularly true with reference to outsourcing to China; this is because of theimportance to the individual firm, the increasing centrality of China in globaloutsourcing, and China’s being one of the most attractive and popular outsourcingdestinations in the world (A.T. Kearney 2004; Cohen 2006). China’s appeal hasincreased markedly in the recent past with its WTO-membership-fueledliberalization of laws and government policies, especially those regarding privateownership, intellectual property, and foreign partnerships; heavy investment inacademic technical education; and low labour costs (Furniss 2003).Our intent through this paper is to contribute to improving insights intooutsourcing to China. We begin by considering the nature of global outsourcing.Next, we explore the special but complex situation of China with particular emphasison international labour outsourcing for IT, a valuable business opportunity. In theOutsourcing to China: Opportunities, Threats, and Strategic Fit37section below are detailed considerations of the various challenges and opportunitiesfor outsourcing to China, then we offer a consideration of strategic approaches forenhancing outsourcing success.Outsourcing and the Evolving International LandscapeOutsourcing as a corporate strategy has attracted wide interest and is in the process ofexceptional growth (Bolumole 2001; McCarthy and Anagnostou 2004.). While someconsider outsourcing as a move to simplify or save on costs for business functions,others view outsourcing as part of the evolution of business. Author and formerMIT/Sloan School Professor Michael Treacy’s view is that outsourcing is anadaptation phase in the process leading toward creating more efficient businessmodels, adjustments to inherent organizational weaknesses, and in uncovering betteropportunities (Gibson 2004). This view has helped reshape organizationalmanagement and strategic inter-organizational interactions (Pollalis 2003) and hasspearheaded the trend towards what has been termed ‘worldsourcing’ (Ellis 2004).The Rationales for International OutsourcingAdvocates have pointed out several economic benefits of outsourcing. The positiveend-effects include the firm’s economic improvement in developing locations (Ellis,2004); building foreign-based skills and infrastructure (Harrison 2004); consumerand taxpayer benefits derived from service enhancement and affordability (Griswold2004); trade benefits (Kleinert 2003; Glassman 2004); increased wage rate and tradeunion benefits (Shaksen 2004); impact on the employment level in developedeconomies (Economist 2004); as a gateway to privatization (Prager 1997); and for itsdemonstrated profitability in certain manufacturing sectors (Harrison 2004).Negative economic implications have also been noted. These include job drain(Dolan and Meredith 2004), reduction in employment and aggregate welfare(Shaksen 2004), effect on the pattern of employment (Economist 2004), detrimentaleffects on owners of capital (Shaksen 2004), contribution to insecurity (Ellis 2004),and reduction of skills and infrastructure in the home country (Harrison 2004).Particularly in view of the outsourcing phenomenon’s potential negative effects,closer investigation seems advisable. One useful approach recognizes the increasinginterest in using foreign-based labour through outsourcing business functions,attributable to several factors which should be considered more closely. These factorsmay be considered as offensive or defensive strategic responses to businessdevelopment and the competitive landscape.Offensive approaches refer to the organization’s use of international outsourcingas a strategic move to build its corporate strength or capture new marketopportunities. Influencing factors include market internationalization (Elmuti et al1998; Rao 2004); growing availability and demand for competent yet affordabletalent (Greenemeier 2002); gaining cost and time advantages (Jeffay, Bohannon andLaspisa 1997); reliability of communication technology and enhanced projectmanagement abilities (King 1999; Rao 2004); availability of software tools,platforms, and systems (Webster et al 2000); confluence of the telecommunicationand computing sectors that strengthened web and software applications (Currie2003); standardization of business tasks (Drezner 2004); acceleration of ITinnovation (Mitchell 2004); globalization and trade liberalization in emerginglocations (Rao 2004); improving operational efficiencies and capturing globalizationadvantages (Karklins 2003); productivity improvement (Kulmala et al 2002); betterstaff management and strategic focus (Leung 2003); mutuality of trade benefits toparticipating parties (Glassman 2004); and enhancing competitive advantage andcore competencies (Griswold 2004).An area of offensive opportunity has been expanding recently. Beyond shiftinglabour offshore for cost savings, another emerging function to be outsourced is that of