A Broader View of Offshoring

Many Western execs see only cost savings when they can learn so much more from Chinese and Indian companies Offshoring has been a hot topic in recent months, as Western companies have cut tech labor costs drastically by shipping such jobs to countries like China and India. But the trend means more than just job loss at home or short-term wage arbitrage for the West. In their book The Only Sustainable Edge ($25, Harvard Business School Press), John Hagel III and John Seely Brown argue that the rise of the tech industry in China and India will lead to the creation of formidable overseas competitors. The advantage has less to do with sheer population figures, they say, and more with the differences in how these new powers do business.


Brown is the former director of Xerox's Palo Alto Research Center. Hagel, a former McKinsey & Co. consultant, is the author of several books on the Internet and competitiveness. Recently a group of editors and reporters from BusinessWeek sat down with Hagel to discuss how the East is changing technology in business, and what Western companies can do to keep up. Following are edited excerpts from that conversation:

Q: What was the idea behind the book?
A: I think executives are viewing offshoring much too narrowly. John Seely Brown and I had been collaborating on some broader, strategic questions. The book is primarily targeted to business executives. The fundamental theme is that companies should be shifting how they see strategic advantages. If I have a particular skill, fine. But the real source of advantage going forward comes from figuring out how to build on that capability and refresh it more rapidly than anyone else.

Q: So what's an example of a company that has this dynamic?
A: There's one we focus on in the book, called Li & Fung, in China. Li & Fung works with clothing designers. Calvin Klein, for instance, will tell them what its new line of fashion is, how many units it needs at what price points, and where the distribution points are. It takes care of everything else. Their initial advantage was being able to access a lot of different suppliers and orchestrate their activities. But over time, they've recognized that the value they can provide is to help their partners become better at what they do. It's not just figuring out what a particular customer needs and organizing the right set of resources. For example, cutters will start to have conversations orchestrated by Li & Fung with weavers, and say, you know, if you wove the yarn in a particular way, it would make our cutting operations a lot more efficient. And so they'll have these kinds of interactions [and] deepen their skills at what they do -- to coordinate their activities better -- that's one example.

Q: Couldn't you make the counterargument that their true competitive advantage is sitting within a nation of 1.2 billion people who do this kind of work in textiles at the lowest cost? It's really a geographic advantage?
A: You could certainly make that case, and there's an element of that. Their partners are located in 35 different countries around the world. So a lot of it has to do with geographic proximity. If you're dealing with an apparel designer in Europe, you want to have operations that are closer to the end customer than China would be. But it's also about creating the flexibility of organizing these resources.
One of the interesting stories around Li & Fung was: Immediately after 9/11, they had a fair amount of their operations in countries like Pakistan that were at high risk in terms of political instability. Within three weeks they had moved all the operations that were time-sensitive out of the Pakistani partners and into countries that were more politically secure. That degree of flexibility [in reaction to] unanticipated events is a skill set that most Western companies don't have.

Q: Which Western companies have been good examples of that ability to be flexible?
A: There are relatively few. Cisco Systems on their customer-relations side has thousands of very specialized channel partners. They'll work with the customer to configure systems, qualify the needs of the customer, and then they'll decide which of their thousands of partners are appropriate to serve that particular customer. Nike has also done a good job of orchestrating a similar global process network. It's focused on identifying very specialized providers of the various materials and on how they're assembled into shoes.

Q: You say giants like India and China take over innovation and come back to compete on Western soil. But isn't the vast majority of science research and technical innovation still performed in the U.S., Europe, and Japan?
A: A large amount of technical innovation is still occurring in the West. I think what's driving the innovation in countries like China and India is much more of a boot-strapping mentality of, again, rapid incremental innovations. That tends to argue against basic research and long-term research investments and [focuses] much more on: What can I do quickly to build my capability and add more value? And increasingly, what we're seeing are large companies in the U.S. and Europe setting up research facilities in China and India to do advanced research. What happens is the pattern that we saw, for example, in software development in Bangalore. Initially, U.S. companies came into Bangalore to do software development, but over time the people that were trained in those facilities set up their own ventures. Entrepreneurship took root. Now those companies are competing against the U.S.

Q: So what are some of the things Western companies should be learning from offshoring?
A: Rather than doing it purely as wage arbitrage, where you're just looking for contract low-wage labor, think about it as a way to access distinctive skills, in a much more distributed fashion -- and focus on partners who can build their skills much more rapidly. If you talk to most Western executives about emerging markets like China and India, they'll say they're strategically important. "They're real growth engines," and so forth. We think that's accurate. These markets are providing a catalyst for product innovation and process innovation. Either you're the attacker, or you're going to be attacked by companies with more innovative products.