CIO — IT service providers are touting the benefits of outsourcing's increasingly higher-value and more complex IT work to lower-cost locales. And IT customers still hyper-focused on cost cutting in today's economic doldrums are more than willing to consider the pitch. But Harvard Business School professors David Pisano and Willy Shih argue that "moving up the value chain" with offshoring can irreversibly damage a company's—and a country's—competitiveness and ability to innovate.

The two researchers made headlines with their 2009 article, "Restoring American Competitiveness," asserting that the America's relentless outsourcing of manufacturing operations had not only hurt the United States' trade balance and job prospects for its citizens, but also hindered its ability to innovate. CIO.com talked to Pisano and Shih about how their research applies to IT offshoring and what CIOs can do to retain their competitive advantage while cutting costs offshore.

CIO.com: You assert that as U.S. companies were steadily outsourcing development and manufacturing work abroad and cutting spending on basic research, American competitiveness and innovation eroded. What's the most conclusive evidence of that?

Willy Shih, Professor of Management Practice, Harvard Business School: The troubling thing that our research turned up is that offshoring can lead to damage to what we call the industrial commons—a set of capabilities embodied in your supplier network, your workforce, the educational infrastructure associated with a technology area. For example, in the 1960s Kodak (EK) gave up making sophisticated film cameras, and the U.S. consumer electronics companies offshored their product manufacturing and development. So the industrial commons for consumer electronic and optoelectronic devices in the U.S. withered away. So when the digital camera revolution came along—even though Kodak invented the first digital camera in the 1970s—there was no longer any capability base in the U.S. to develop or manufacture such products.

Gary Pisano, Harry E. Figgie, Jr. Professor Of Business Administration, Harvard Business School: Just look at what has happened in the mobile communications industry today. A lot of PC companies first gave up manufacturing, and then design. They became reliant on third party suppliers. Now we see what Apple has done with the iPad, and it seems to me there are an awful lot of PC manufacturers scrambling to find an "off- the-shelf" design to compete in the tablet computing space. The problem is, from my perspective, there is nothing unique about any of those designs. They have not competed well against the iPad.

CIO.com: Proponents of offshore outsourcing say it not only cuts costs, but also can enable companies to focus on their core value. But you found that many companies developed a taste for offshore labor arbitrage and outsourced more high-value tasks. Why didn't they funnel offshore savings into innovation?

Shih: If outsourcing improves your numbers over the short term, sometimes it is difficult to take those savings and reinvest them. That was one of the drivers behind improving the numbers in the first place—bringing more to the bottom line. This is driven by the pursuit of profit, which is a good thing. I'm not being critical of that. But it highlights the importance of being thoughtful about outsourcing capabilities or damaging the commons.

Pisano: This is partly about having too short of a time perspective, but there is also something deeper. It's rooted in how many management teams have come to view their source of advantage. For many, it seems, the name of the game is arbitrage. The key is to be a good "trader." You find good opportunities to buy stuff less than you can do it your self, and you capture the value on your brand. They do not see having unique capabilities as the true source of competitive advantage.

Continue Reading