The outsourcing of products and services to external suppliers continues to expand, as firms search for ways to lower costs while improving their products to remain competitive. By the end of 1998, it is estimated that U.S. companies had spent more than $100 billion on outsourcing. Outsourcing is commonly used by firms in the areas of communications, computers, and semiconductors. Firms that outsource often realize cost savings and an increase in capacity and quality. In spite of its fast growth, outsourcing is frequently perceived to be poorly controlled, high in cost, and a drain on quality and service performance (for advantages and disadvantages, see International Perspective 17.5). A firm can undertake outsourcing under various arrangements.
1. Wholly Owned Subsidiary
A firm may move production of parts or components to an affiliate established in a low-cost location abroad. The firm will then import the output as it is needed. For example, Sony outsources production of parts to its manufacturing plants located in China and other low- cost locations around the world.
2. Overseas Joint Ventures
A firm can import supplies made under a joint-venture arrangement. For example, Fujitsu imports parts for its DRAMs production from its joint-venture partner in Taiwan. Mitsubishi Electric and Toshiba have also contracted DRAM manufacturing to Taiwanese partners.
3. In-Bond Plant Contractor
A firm sends raw materials and components to be processed or assembled in a low-cost location by an independent contractor. No customs duty is imposed by the country where the goods are assembled (temporarily imported under bond), and when the products are re-exported to the home country, import duties are imposed only on the value added abroad. The most popular is the maquiladora (manufacturing operations in a free trade zone (FTZ), where factories import material and equipment on a duty-free basis for assembly, processing, or manufacturing and then export the assembled, processed and/or manufactured products, sometimes back to the raw materials’ country of origin), which allows U.S. or other foreign companies to combine their technology with low-cost labor in Mexico. The raw materials or components imported in bond and duty free are processed or assembled for eventual re-export. The maquiladora can also be established as a wholly owned operation of the foreign firm.
4. Contract Manufacturing
A company enters into a contract with a foreign supplier to import a given quantity of products according to specifications. The supplier manages the day-to-day operation of the production process and allows the importer to focus on other core activities. The contract will provide for assurance of quality and quality control. Nortel, a Canadian-based manufacturer of communications equipment, outsources nearly $1 billion worth of components to contract manufacturers abroad. Cisco uses contract manufacturers to reduce production cost and to focus on research and development. Its products are mostly made by global manufacturers such as Flextronics and Jabil.
Source: Seyoum Belay (2014), Export-import theory, practices, and procedures, Routledge; 3rd edition.