Regardless of the size of a company’s operations, one of the most pressing issues for management is reduction of costs. With very low economic growth likely to continue for some time and deflation placing pressure on prices in many different industry sectors, management is being called upon to make more efficient use of resources.

So what can Japanese management do to maintain or improve gross margins in such a business environment?

The answer is to lower fixed costs through restructuring value chains by retaining those functions and processes that will contribute to profit in the long term and outsource those that will not.

I am a great believer in the merits of outsourcing. As a nation with next to no natural resources, Japan must make its way in the world by adding value more efficiently than other nations. Therefore, the pursuit of efficiencies in economic activity is an issue that should concern us all, and not just the business community.

In a quest to reduce operating expenses, most Japanese companies have already reviewed discretionary spending such as client entertainment and fringe benefits, many are examining supplier relationships, and some have even started adjusting wage curves. However, relatively few have turned to outsourcing as an aide to strengthen core competencies and improve the bottom line.

Naturally, Japanese managers understand the benefits that can be derived from outsourcing, so what is stopping management from more openly embracing the concept?

In the past decade, the areas where outsourcing has been most successful in penetrating the market have been electronic manufacturing services (EMS), call centers, and Internet data centers.

Outsourcing providers in these fields have succeeded in capturing market share for a variety of reasons. EMS providers were able to reap economies of scale and production efficiencies not available to single manufacturers. Call centers were able to provide the human resources required to cover workload peaks. And Internet data centers gave users access to the technology, environment, and skills required to keep Web servers operational around the clock.

The decision by many companies to outsource electronic parts assembly, call centers, and Web server housing was very straight forward because the cost benefits involved were blatantly obvious. However, the response would be entirely different if you were to ask, for example, a car manufacturer to outsource its entire IT services function. While IT services is probably not one of its core competencies, the car manufacturer would probably reject the notion for such reasons as: it would erode the organization’s skill base; create human resource management (HRM) issues; deprive the company of IT services if the outsourcing provider failed; and compromise the security of confidential internal data. Of course, such concerns are valid and must be addressed in order to successfully outsource critical, but non-core activities. However, none are insurmountable.

There is much anecdotal evidence to suggest that Japanese companies do not yet understand their core competencies, despite the attention this concept has received in the business press over the last few years.

Many large companies still believe they can turn cost centers into profit centers by bidding for business outside the company as well. Experience has shown this has not worked overseas and is not working in Japan, either. However, Japan is just bristling with IT service companies and systems integrators that have been spun off from manufacturers, transport operators, etc.

It is easy to place the blame for such empire building on the management of these companies, but the outsourcing industry must accept some of the responsibility for the current situation as well.

More effort has to be made to understand what management (i.e. the customer) requires and develop offerings accordingly. There are important differences between the business environment in Japan and North America, such as the rights of permanent employees. Therefore, native Japanese outsourcing solutions providing alternative career paths and other options for employees need to be developed by the local outsourcing industry for incorporation into a company’s long-term business and HRM plans.

The competitive environment for Japanese companies is changing rapidly. In the next few years, competitors in Taiwan and China will take more and more lower value-added markets away from Japanese companies. There will be no magical return to the prosperous days of the late ’80s and early ’90s. However, companies whose management and unions have embraced the concept of outsourcing critical, but non-core activities will have the opportunity to enjoy a future far different from those that do not. Companies that do outsource these activities will be able to control their costs, giving them the capacity to pay attractive salaries to employees and larger returns to shareholders. Those that do not will have no choice but to reduce wages and capital investment, causing a contractional spiral in sales and erosion of shareholder funds.

There is no doubt that outsourcing will be an important means of increasing shareholder value in the 21st century. The time has come for Japanese management to consider what role it should play in their companies’ future.

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