Home / The Outsourcing Rush: Is It In The ‘Manic’ Phase?

The Outsourcing Rush: Is It In The ‘Manic’ Phase?

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Is it just me, or is the heat starting to go to everyone’s head south of the equator?

In his bestseller The Power of Unfair Advantage, John Nesheim illustrates the boom-bust cycle of market phenomena as a “wave” consisting of six stages: displacement, euphoria, overtrading, mania, financial stress and finally, revulsion (during which no one gets funded). It’s a good model, and one that those of us who experienced the tech bubble five years ago (who didn’t?) will identify with. And before that, those that were invested in China in the late nineties will recognise. And if you were active at the time of the market crashes of the late eighties and even 1929, you’ll recognise the stages of Nesheim’s “wave model” too.

Those are just a few examples, so what is it about the nature of waves that keeps them coming back time and time again, only to eventually suck in a zealous camaraderie of supposedly informed market participants? Usually the problem in identifying an overly bullish market is in the fact that it takes on a form we don’t recognise, so it’s harder to see coming. But if there’s a fairly standard pattern, shouldn’t it be obvious?

I’m not sure about everyone else, but almost monthly on the front covers of the Business Monthly and daily in the financial presses at the moment I read more amazing news about the development of outsourcing to all these cheap, far-flung locations and how it is saving Western companies millions/billions of dollars a year on such ‘overpriced’ organizational components as IT and customer service at the same time as providing an entire platform/solution for economic development for these poor economies. In fact, one would be forgiven for thinking that some Western companies are contemplating ‘outsourcing’ the entire organization altogether (actually I think I saw something on that too) and that such reputable enterprises as AT&T and Bell Canada might soon re-brand as IT&T and Bell India.

Has everyone forgotten the days only half a decade ago when every company was going to become ‘virtual’ overnight and the internet was going to totally replace physical reality with such ground-breaking concepts as Pets.com (virtual pets and pet food!), Bamboo.com (virtual real estate agents!) and infamously … Worldcom. (What was it exactly that they were going to do again other than make more millionaires than any other company around?)

Nesheim breaks down his six-stage wave model into the following summaries:

1. Displacement: Something arrives to upset business as usual.

2. Euphoria: The first excited investors being to put money into related new enterprises

3. Overtrading: A rush starts to get in on the ground floor, and money flows into many new companies.

4. Mania: A wild rush to get in before it is too late sends a river of money flowing into anything related.

5. Financial stress: Reality arrives as new enterprises begin to crash and optimism turns to pessimism.

6. Revulsion: Investors depart, many with nothing.

In my experience, stages 4 and 5 are usually accompanied by a distinct set of psychological conditions.

  • First of all, common sense hits the window. Any type of rational analysis is usually put aside at the expense of the hype being circulated in the marketplace.
  • The advocators of the trend being hyped usually admonish “This is happening and you can’t top it!” as pretty much a blueprint reply to any kind of critical attempt at reasoning.
  • At these stages the press is full of articles about how glorious this new revolution is, as the PR machines of organizations that are eager to promote the new trend are working in overdrive.
  • There can be absolutely nothing wrong or potentially perilous about this new trend and anyone who dares to criticise it is “old-fashioned” or “behind the times”.
  • There are usually just a few market participants who are benefiting big time off the new trend, with most zealously “following the crowd” in implementing this exciting new trend of standardisation.

    The parallels between a bull-market rush and the outsourcing phenomenon are so remarkable, I’m very surprised no one has thought to point them out yet.

    In Context
    Common sense suggests to me that if you pay bottom dollar for something, you’re probably getting bottom-dollar delivery. Only for a very short period in time does a trend or solution represent actual value, as microeconomic theory dictates. Someone suggested to me the other day that outsourcing was not only cheap, it was higher in quality than if you did the process yourself. My response to this is: “Please”.

    But it’s not just the cost-saving that is worrying in the outsourcing phenomenon, it’s where the cost-saving is being exercised, and the degree to which it is being done. Areas of organizational operations such as customer service are the fundamental building blocks to any kind of successful operating principle: who would honestly, given the choice, rather have an unknown company 8000 miles away dealing with their customers on a more regular basis than doing that themselves. What is really worrying though is point this perfectly valid criticism out to anyone in the outsourcing industry and you get the standard response: “It’s happening anyway. You’re behind the times.”

    Most of the hype is centred around India, but on closer analysis, one has to seriously question the validity of the outsourcing model as a long-term strategy. India’s infrastructure is not just second-rate; it’s practically non-existent. One-third of the population is illiterate (half of those women), the transport systems are a nightmare, and the national power grid is one of the worst in the world. To this kind of criticism Indian politicians reply flatly: “We’re a democracy. We can only grow so fast.” That may be all well and true (though it sounds more like a statement to appeal to Western organizations) but with these massive infrastructural faults in place, is there really room for the mass-development of an entire quality industry?

    In the dotcom boom it was the corporate finance departments of major investment banks who were making a killing branding traditional and new businesses with the tech logo and taking them public, which ultimately led to a series of lawsuits and subsequent penalties. In this instance, it seems the Consultants are at fault. Consultants love outsourcing for an obvious reason: it enables them to point to a clear cost-saving solution that looks original and dynamic and implement it with minimal hassle.

    And at first they may have had a point. I’m not denying that outsourcing was not a smart idea and that it has a sustainable future, just that the current rate of quality implementation is unsustainable. The danger is that consultants will become the investment bankers of the turn of the millennium, and end up paying high penalties for poor advice. After all, if a consultant has an existing relationship with an outsourcer in India, for example, and feeds client business that way, where’s the difference in an investment banker giving chunks of what they think is a ‘hot IPO’ to their favourite clients?

    Most people by now have spoken to an ‘outsourced’ department in one capacity or another. Ask yourself: was it always great quality? My experience has been that the quality of these outsourced call centres has declined dramatically in the last few years. Outsourcing is undoubtedly a smart concept, and right for some: it’s just that the current hype in the marketplace is not sustainable given the infrastructure in the outsourcing countries.

    In the stages 4 and 5 above, one of the key signals to an over confident market is when the quality opportunities start running out, and the ‘suppliers’ begin manufacturing clones just to keep the momentum going. Take a look at Chinese private equity in the nineties. There were a number of excellent value opportunities in the market, where a few people were making some above-average returns until London and New York decided that they could develop ‘funds’ to invest in all these exciting opportunities.

    The reason investors lost so much money is that it turned out there just weren’t enough quality private equity opportunities in place to feed the purchasing demand. In the mad rush to get in on the action at any cost, these funds started purchasing anything that could be reasonably construed as private equity, a strategy which was obviously very much in China’s favour as it encouraged more investment directly into its own pockets but which left lots of unsuspecting Westerners seriously out of pocket.

    The same can be said for outsourcing. It is in countries like India’s interest to keep Western companies in the outsourcing cycle; this is what is contributing so massively to the GDP growth, and short-term thinking consultancy companies have the incentive to keep recommending outsourcing as a viable alternative to keep the fees rolling in. The big irony is that outsourcing as a cost-saving phenomenon is going to leave some Western organizations seriously out of pocket just as boom-bust cycles in markets have consistently left the retail investors.

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  • About Daniel M. Harrison

    • Daniel,

      Fascinating piece. (Minor nit: you say at stages 4 & 5, psychological weirdness starts to creep in. Shouldn’t that be 3, 4, and maybe 5?)

      More important, I’m still considering your comparison of the irrational exuberance that periodically distorts fiancial markets with the outsourcing craze going on. No one could disagree that the quality of customer and technical support has gone down, but I’d would like to hear a more detailed explanation of how the two are similar.

      In the case of investors, it’s a relatively simple case of too much money chasing over-valued commodities. The outsourcing case seems much more complex and yet, in the long run, easier for companies to handle and less financially disasterous. There’s something compelling about your comparison, but I may be missing a point.

      FYI, if you haven’t read them, I’d recommend doing a Google search on Daniel Kahneman, psychologist at Princeton and Vernon Smith, an economist at George Mason, the co-winners of the 2002 Nobel Prize in Economis. Their fundamental thesis is standing economics on its head–that the notion of the rational investor is a myth.

      They also address your question about why people tend to forget past disasters. According to them and a number of other scientists, we actually distort memories to fit our current needs. As Kahneman says, our memory is a fickle friend.

      All in all, excellent and thought-provoking piece. Thanks.

      In Jamesons Veritas