cfo.com

Print this article | Return to Article | Return to CFO.com

Men and Machines

Technology and economics have already revolutionized manufacturing. White-collar work will be next.
Ben Edwards, The Economist
November 19, 2004

The industrial complex that Henry Ford built on the banks of the Rouge River in Dearborn, Michigan, was a wonder of the new age of mass production. Into one end of the plant went iron ore, coal, sand and rubber, brought in by railway and on Great Lakes steamships. Out of the other end rolled Model T Fords. By 1927, there had been 15 million of them. At that stage, Dearborn was handling every step of the car's production, from rolling steel to making springs, axles and car bodies, and casting engine blocks and cylinder heads. The plant even had its own glass factory.

Ford built the Dearborn plant around the labor-saving properties of machines. Automation lowers production costs, which bolsters profits. Companies spend these profits on improving what they sell, and on building more labor-saving machines. As technology advances, these improvements make products more complex. To the basic design, modern car makers add heated seats, air conditioning, guidance and entertainment systems, computer chips that regulate engine performance, and many other gadgets to please their customers. It took 700 parts to make the Model T. Modern cars pack many more into their radios alone.

As industries advance, manufacturers manage the growing complexity of their products by outsourcing: they share the work of making them with others. This enables each company in the production chain to specialize in part of the complicated task. The car industry, for instance, relies on parts companies that make nothing but electrical systems, brakes or transmissions. These parts companies, in turn, depend on the work of other suppliers to make individual components. At each level of production, outsourcing divides up growing complexity into more manageable pieces.

In the office, the tool used to mechanize work is the computer. Computers automate paperwork and hence the flow of information. Companies that sell information products, such as banks and insurance firms, employ computers to automate production. And all companies use computers to automate the administrative work needed to maintain their organizations: keeping their books in good order, complying with rules and regulations, recruiting, training and looking after their employees, managing offices, dealing with company travel and so on.

Bells and Whistles
Like assembly-line machinery, computers save labor, bring down costs and raise profits. Banks and insurance companies have used some of these profits to add bells and whistles to their products, making them more complex. Banks that used to provide basic mortgages now sell fixed loans and floaters, caps, collars, locks and other financial exotica to befuddled home-buyers. Credit-card companies offer loyalty programs, membership rewards and cash-back deals. Insurance firms tailor car and life insurance to fit their customers' appetite for risk.

Corporate administrative work has also become more complicated. The demands of securities regulators and investors for financial information have expanded with the capacity of firms to supply it. IBM's annual report for 1964 contains a scant half-dozen pages of financial information; its most recent one includes 40 pages of financial statements and accounting notes. The more services that corporate HR departments provide to employees, the more employees expect. Ever-more prescriptive accounting and audit rules proliferate as fast as accounting departments can automate the work of complying with them.

The spread of computers through companies has added a third layer of complexity: the task of managing the information systems themselves. The work of company IT departments is particularly complicated at older and larger firms that have bought different sorts of computer systems at different times. The core processing systems of insurance companies, airlines and banks, for instance, are built on a mainframe-computer technology that celebrated its 40th anniversary this year. Companies have added extra systems as they have sold new products, grown abroad or acquired competitors. Most IT departments at most large companies spend most of their time simply fighting to keep this tangle of systems going.

In all three areas of white-collar work, companies are struggling to manage growing complexity. The chief reason for the recent recession in corporate IT spending is that the IT industry's customers are no longer able to absorb new technologies, thinks IBM's Mr. Harreld. Entangled in new products and the computer systems that support them, banks cannot even do something as basic as ensuring that customers who asked one department not to send junk mail do not receive it from another. "If a bank was making cars, every tenth car would come out without a steering wheel," says Myles Wright of Booz Allen Hamilton, a consultancy.

Just as in manufacturing, the solution to the growing complexity of white-collar work is to do less of it in-house. Some companies have outsourced the work of their IT departments, from managing the physical hardware to maintaining and developing business software and managing corporate computer networks. Up to half the world's biggest companies have outsourced some IT work, reckons IBM.


As well as outsourcing their business systems, some companies are doing the same with the workers who operate them. This is called business-process outsourcing (BPO). First Data Corporation (FDC), for instance, will handle some or all of the administrative work involved in running a credit-card business, from dealing with applications to authorizing credit limits, processing transactions, issuing cards and providing customer service. Few bank customers will have heard of the company, yet FDC employs nearly 30,000 people, who administer 417 million credit-card accounts for 1,400 card issuers.

Likewise, companies are outsourcing chunks of administrative work and their supporting systems. Accounting departments are farming out tasks such as processing invoices and collecting payments from debtors. HR departments have shed payroll work. ADP, a payroll-outsourcing company, pays one in six private-sector workers in America. Increasingly, big companies are handing over entire HR departments and the systems that support them to outside specialists such as Hewitt, Accenture and Convergys, says Duncan Harwood of PricewaterhouseCoopers.

One way for manufacturers to manage growing complexity is to adopt common standards. Carmakers, for instance, have reworked their manufacturing processes so they can assemble different car models from the same production "platform", with several cars sharing a number of parts. This allows parts companies to specialize more and produce fewer parts in larger numbers.

Eventually the organization of car manufacturing may begin to resemble production in the consumer-electronics industry, where the adoption of industry-wide standards (along with de facto standards, such as the Intel microprocessor) has enabled suppliers to become highly specialized. Companies such as Flextronics and Selectron now offer outsourced manufacturing platforms for whole categories of consumer electronics. All the branded makers have to do is handle the logistics, badge the goods and send them off to the shops.

A similar platform-production system is emerging in white-collar work. A few popular business-software packages sold by companies such as SAP, a German software firm, and PeopleSoft, an American one, are now offering standard ways of organizing and delivering administrative office work. When companies outsource HR departments, specialists such as Hewitt and Accenture add them to their HR-services production platform. Convergys, for instance, claims to be the world's largest operator of SAP's HR software. FDC, for its part, has built a production platform that offers credit-card services.

Thanks to the internet's open standards, extreme specialization is now emerging in outsourced business services, just as it did earlier in consumer electronics. Next door to a Safeway supermarket on the Edgware Road in London, a group of British accountants and tax experts has built a business service called GlobalExpense that handles employees' expenses over the internet. Employees of its customer companies log on to the GlobalExpense website, record their expenses on standard forms and put their receipts in the mail. GlobalExpense checks the receipts, pays the expenses and throws in a few extras such as related tax work and information on whom the company's employees are wining and dining.

This year GlobalExpense will pay out £60 million-worth of employee expenses, which probably makes it the biggest expense-payer in Britain. With a large, flexible pool of foreign students in London to draw on, the company says it can handle expense claims and receipts from anywhere in the world.

And So to Bangalore
In the late 1980s and early 1990s, as transport and communications costs fell and logistics technology improved, rich-country manufacturers began moving production to cheaper nearby countries. American carmakers and consumer-electronics firms started manufacturing in Mexico; European makers went to the Czech Republic, Slovakia and Poland; and Japanese, Taiwanese and Korean firms moved to China. By the late 1990s, European manufacturers such as Philips, Siemens and Nokia, and American ones such as GE and Motorola, were moving further afield, to China. American imports from China rose from $66 billion in 1997 to $163 billion last year. By one estimate, foreign companies opened 60,000 factories in China between 2000 and 2003. The country's exports rocketed.

In the same way, with the cost of telecommunications bandwidth falling, some firms in rich countries, mostly in America and Britain, began moving some of their business services abroad, so far mostly to India. IT-service companies such as IBM, EDS and Accenture have hired thousands of Indian software engineers to carry out work previously done near their customers in rich countries. An Indian GE subsidiary called GECIS handles administrative processing work for the firm's financial businesses. NASSCOM, the Indian IT-industry lobby, has high hopes for these young export industries. By 2008, it thinks, they will employ over 4m Indians, generating up to $80 billion-worth of sales.


Firms may choose to outsource work when they move it abroad, and they may not. But actually moving particular operations abroad is more akin to introducing labor-saving machinery than to outsourcing in the sense of improving the management of complexity. It brings down the cost of production, mostly by making use of cheaper employees.

Sometimes companies even change their technology when they move abroad, making their production less automated so they capture more benefits from lower labor costs. For example, some big carmakers are reconfiguring their production to use more manual work in their Chinese factories than they do elsewhere, says Hal Sirkin of the Boston Consulting Group. Wipro Spectramind, an Indian firm, recently moved work for an American company to India. This work involved 100 people, each of whom cost the firm $6,000 in software-license fees. The American company had been trying to write software to automate some of this work and reduce its license-fee payments. Wipro scrapped the software project, hired 110 Indians and still did the work more cheaply.

Once work has moved abroad, however, it joins the same cycle of automation and innovation that pushes technology forward everywhere. Optical-character-recognition software is automating the work of Indian data-entry workers. Electronic airline tickets are eliminating some of the ticket-reconciliation work airlines carry out in India. Eventually, natural-language speech recognition is likely to automate some of the call-centre work that is currently going to India, says Steve Rolls, the heir apparent at Convergys, the world's largest call-centre operator.

All this helps to promote outsourcing and the building of production platforms in India. GE is selling GECIS, its Indian financial-services administrator, and Citibank, Deutsche Bank and others have disposed of some of their Indian IT operations. Thanks to the growth of these newly independent firms, along with the rapid development of domestic Indian competitors, such as Wipro and Infosys, companies will increasingly be able to outsource work when they move it.

Dashing White Collars
Manufacturing has already gone a long way down the road of outsourcing and globalization, but there are now fears that white-collar work will be reorganized much more quickly and disruptively, thanks to the spread of the internet, plummeting telecommunications costs and the realization that the machines used by millions of expensive white-collar workers in the West could be plugged in anywhere.

Manufacturers' shipping costs have declined more slowly than the telecommunications costs of providers of remote services. The logistics of shipping goods over long distances remain complicated and inexact. For example, the V6 car engines that Toyota sends from Nagoya in Japan to Chicago take anywhere between 25 and 37 days to arrive, forcing the car company to hold costly stocks. The movement of white-collar work, on the other hand, is subject to no physical constraints. Communications are instant and their cost is declining rapidly towards becoming free.

Yet powerful barriers to moving white-collar work remain. When work moves out of a company, the firm negotiates a commercial agreement to buy it from a supplier. For manufacturers, this is straightforward: they take delivery, inspect the goods and pay their suppliers. Supplying a service, by contrast, is a continuous process. The outsourcing industry has evolved legal contracts in which suppliers bind themselves to deliver promised levels of service. There has been much legal innovation around these contracts, not all of which has been satisfactory. The upshot is that it still takes trust and cross-cultural understanding to achieve a good working relationship. Moving a company's IT department to India is likely to put such understanding to the test.

The other big barrier is that, despite the spread of business machines, white-collar work still tends to be much less structured and rule-bound than work done on the shop floor. Unstructured work is hard to perform over long distances: without guidance, workers are apt to lose their way. The most likely outcome is that would-be outsourcers will proceed in two steps. First they will hand IT services, administrative tasks and other white-collar work to trusted specialist suppliers close to home. But once those suppliers have added structure, rules and standards, the outsourcers will move the work abroad.




CFO Publishing Corporation 2009. All rights reserved.