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*** Journal of Business Strategy ***
The ethics of outsourcing: when companies fail at responsibility
Journal of Business Strategy, Vol. 39 Issue: 5, pp.7-13,
https://doi.org/10.1108/JBS-03-2018-0037
Nelson Oly Ndubisi
King Fahd University of Petroleum and Minerals
College of Industrial Management
Dhahran, Eastern Province, Saudi Arabia
&
Arne Nygaard
Professor of Marketing,
Kristiania University College
Postboks 1155 Sentrum
Kirkegaten 24-26, 0107 Oslo, Norway
Phone 952 43 656
E-mail arne.nygaard@kristiania.no
&
Norwegian University of Science and Technology (NTNU)
Teknologivegen 22, 2815 Gjøvik, Norway
December 2016
ACKNOWLEDGEMENTS: The authors contributed equally to the article.
Introduction
Management literature suggests that outsourcing is an effective device to create
incentive collusion, which reduces opportunism, externalizes monitoring costs and
facilitates the competitive organization of supply chains. However, we argue that the
eagerness to outsource operations may cause an avoidable problem, and that ethical
behaviour may be reduced when the aim is to get rid of transaction or production
costs. Outsourcing through offshoring relates to the relocation of business to another
country. According to the Economic Policy Institute (Kimball and Scott, 2014), 3.2
million US jobs were outsourced to China between 2001 and 2013. New business
models and supply chain networks promote the outsourcing of domestic jobs in both
manufacturing and service industries. Some of the emerging market economies have
developed refined and effective systems for acting as offshoring destinations. Lower
international labour rates are financial incentives for outsourcing through offshoring.
An analysis presented by the Wall Street Journal concluded that thirty-five large
multinational US companies created new jobs faster than other US-based companies.
However, although the companies that outsourced jobs globally grew faster, three-
quarters of the jobs were created overseas (Thurm, 2012). In the US, the number of
workers in manufacturing dropped by 8 million over 30 years because many jobs
were outsourced to third world countries. Some large companies have outsourced all
of their manufacturing operations outside the US. For instance, Apple and Nike have
sub-contracted their manufacturing to independent companies and have been
innovators of outsourcing as a business model based on the foreign operation of
manufacturing processes (Roberts, 2016).
The reason behind outsourcing
The increased globalization of outsourcing operations in recent years has been the
modus operandi of textbook models of competitive strategies. The received theory and
empirical evidence have pointed to core business, taxation regimes, regulations, the
costs of production, labour, resources and energy, and transaction costs as
motivations for offshore outsourcing. During the past decade, private equity
investors have put pressure on costs. Consequently, the cost focus is driving
outsourcing strategies. Although the production costs of outsourcing are pretty clear,
the true cost of the environmental and social impact of outsourcing is hidden behind
a complex network of contractual relationships, and arises through cultural,
geographical and system differences.
In the new world of globalism, sustainability should be an integrated platform
for future competitive business models (Porter and Linde, 1995). Steve Jobs and Elon
Musk provide benchmarks for this new wave of open, global and sustainable
strategies. The simplistic approach that only has an eye on production costs does not
only ignore the true costs of unsustainable global operations. It also prohibits firms
from making disruptive technological changes in the new world of zero emissions,
electrification and social evolution. The intertwined effect of these elements is
ultimately a precondition for long-term economic growth.
Fast fashion and the Rana Plaza collapse
In the 1960s about 95% of the clothes made for the American market were made in
the US. Today, about two per cent of the clothes bought in the US are made there –
98% of the production has been outsourced to the third world. Outsourcing as a
business model in the garment industry really took off in the 1980s, when chains like
Gap Inc. and J.C. Penney pioneered the strategy (Cline, 2012). The leading company
in the fast fashion industry, Inditex, now has 6,298 factories located in over 50
countries. The development means that production is outsourced from countries
with strong traditions of controlling social aspects through labour unions, media and
institutions to countries where this control system is not so strong. Outsourcing
production might therefore lead to operations with unintended high social and
environmental costs. In other words, cutting social and environmental costs through
outsourcing operations to the third world might have become an integrated part of
the business model branded as “fast fashion”. The reality is that the reduction of
these social and environmental costs might have led to deflation in product prices in
the market for fashion. This unfortunate development has pushed the costs of cheap
production to the weakest link in the supply chain – the female garment workers in
underdeveloped countries. No case describes the social costs of outsourcing better
than the Rana Plaza accident.
Rana Plaza was a location where clothes and other products for reputable
companies in the west were manufactured. Companies like Benetton, Wal-Mart,
Mango and El Corte Inglés had clothing factories in the building. Benetton proudly
announce that their sustainability label, Dress Safely, reflects:
“the ethical approach of Benetton Group, whose social commitment, concern for the
environment and transparency towards the consumer have for years been the key
values of a responsibility that goes beyond its commercial objectives.”
Nevertheless, the Rana Plaza tragedy in 2013, when 1,129 people were killed,
is the worst accident in modern industrial history. No doubt Benetton is now one of
the serious companies in the garment industry that have sustainability as an
everyday aspect of their operations. However, in the shockwave of the disaster they
denied that their factory supply came from Rana Plaza, and refused to support the
Rana Plaza Donors Trust Fund. Heavy protests in the aftermath of the tragedy
contributed to the closure of the Oxford Street shop in the UK (Butler, 2015). The
background is Benetton’s outsourcing strategy for benefiting from manufacturing in
Asia. Their production in India could reduce their production costs by 20%
(Procurement Leaders, 2007). From its cultural roots and production origins in north
east Italy, the company suddenly faced a complex network of manufacturing systems
that it handled with lower monitoring costs. The Rana Plaza disaster shows how
applying the textbook approach that we teach to our business school students can go
catastrophically wrong. The global supply chain network is seen as a physical
logistical chain, and the people operating it as cheap input factors. Conventional
textbook wisdom applauds the outsourcing of standardized technology and products
whenever zero-specific investments and zero switching costs characterize the
relationship. The market competition itself secures the interests of the principal – the
general and straightforward roadmap for business relationships that has been known
since Berle and Means’ work in 1932. The market as an institution is a disciplinary
device that controls opportunism, but will it fuel the success of globalism through
outsourcing? In the general literature on the strategic choice between markets,
contracts and hierarchy, the theoretical model of the perfect market may or may not
be an open and transparent marketplace. The monitoring of outsourced production is
complex, and observation is costly. Problems of safety, social security or
environmental hazards are typically difficult to discern. Benetton may therefore have
ignored the fact that aspects like geographical distance, cultural differences,
complexity and uncertainty raise the monitoring costs of choosing overseas
outsourcing.
We have long known that ownership and control do, in fact, affect our
options, because of monitoring costs (Jensen and Meckling, 1976). This approach,
though, focuses on the potential observability of the concept of “performance”, so
that the principal company can write outcome-based contracts with the agent who
signs the outsourcing agreement. Today, this is seen as a far-fetched “old school”
strategy because “performance” is no longer only the “bottom line figure” but is
rather a construct of indicators of “sustainability”. As we know, the concept of
sustainability includes financial, social and environmental performance. In the Rana
Plaza case, it is obvious that the brands produced there were measured according to
only one of these dimensions – financial performance – and were motivated by cost
benefits. The companies survived the strategic shock after the disaster by following
the “walk the talk” procedure. They understood that sustainability was not just a few
nice lines on their webpage but was also a real, true, transparent and documentable
process. Their reputation depended on their ability to create credible sustainable
actions. Sustainable outsourcing is a multidimensional strategy that creates
performance ambiguity within the organization. Thus, in relation to monitoring
costs, outsourcing should be a much more integrated business than the markets can
normally offer. A company needs to develop strict control and reporting procedures
to allow continuous monitoring of their businesses and their contract manufacturers
abroad. Eco-brands, Eco certification systems and activists may provide valuable
control information. The Rana Plaza tragedy did not have to happen. The absence of
monitoring, combined with opportunism among the clothing manufacturers, forced
the garment workers into a building that was a death trap. Structural cracks in the
building had even been filmed and documented. The principal companies behind the
luxury brands probably did not know this, or did not wish to monitor the social and
environmental impact of their own production. The market itself did not provide the
information. This is an ethical market failure that could have been avoided through
old school monitoring. Outsourcing, therefore, may in general facilitate unethical
practice if the principal companies do not include their home-grown moral codes in
their foreign strategy. Ethics should not be outsourced to irresponsible
manufacturing in order to lower manufacturing costs. Ethics along the entire product
life cycle, from raw materials to recycling, is a signal part of the brands. Fast fashion
cannot eliminate its responsibilities through outsourcing production.
Food safety and horse meat
Another industry that has recently been studied through the lens of business ethics is
the food industry. Like the fashion industry, the ability of the food industry to access
global sourcing has become a major opportunity for reducing costs, enhancing
quality, innovating and differentiating products. Food safety, however, has been a
concern for a long time. Mad cow disease broke out in the UK in 1986 and caused
Creutzfeldt–Jakob illness, which probably killed 177 people in the United Kingdom
and 52 in other European countries. This disease made it clear how serious this
matter was. The control of all aspects of the entire food chain became critical. On the
other hand, the EU development of a common European market motivated
outsourcing and international supplies through access to fast-growing international
markets. In a new European order of food regulations and free trade, could we trust
the institutions that promoted outsourcing and market transactions in the food
markets? Prior business research has pointed out the essential nature of institutional
trust for emerging European markets if costly business-to-business relations are to be
supported and replaced (Dahlstrom and Nygaard, 1995). Institutional trust manifests
itself in a trustworthy legal system and policing that can safeguard contracts in the
market (Zucker, 1986). Consequently, the food market is essentially vulnerable to
institutional trust. Nestlé, the world’s largest food company, should therefore be
rational and sensitive about regulations affecting the outsourcing of the food supply
in its relationships with 165,000 direct suppliers and 695,000 individual farmers
worldwide. Its sustainability strategy states that: “Working alongside NGO partners,
we map our supply chains, and conduct supplier audits and farm assessments to
ensure the procurement…” (nestle.com). However, even in the largest and probably
the most professional food company in the world, the complexity of monitoring the
supply chain has created the potential for opportunism when taken alongside the
company’s intention to use supplier relationships to build a competitive global
advantage.
The Food Safety Authority of Ireland (FSAI) revealed in 2012 that horse meat
was mixed into the beef food chain. In January 2013 it became known that retailers
like Tesco, Dunnes Stores, Aldi and Lidl were selling beef products mixed with horse
meat. As a result of the scandal, Nestlé withdrew the pasta products Buitoni beef
ravioli and beef tortellini from the Italian and Spanish markets, as well as lasagne
produced in France. The complexity of international sourcing created a vacuum for
international opportunism that turned out to be difficult to control. The horse meat
scandal involved more than 7,000 firms. The police found that the complexity
included “post office” firms and dummy companies that further complicated the
investigation. The question raised in Zucker’s classic article is whether we should
trust the regulatory system offered by the EU and the national food control regimes
to produce food safety. Nestlé as a brand signals food quality of a particular standard
to consumers all around the world, but the horse meat case demonstrates that brands
cannot live without a regulatory system to support them. We see, in the
underdeveloped market economies, that “lemons” eliminate trust and in that way
undermine the entire market. Through the lens of Akerlof’s (1970) article, brands
may serve as a signal of quality and thus develop market growth. In the context of
outsourcing in the food market, it is also crucial to understand the institutional trust
that supports the brand signals that are sent to consumers. The nutrition and food
businesses have a strong impact on sustainable development. Nestlé’s marketing of
breast milk substitutes in underdeveloped countries led to boycott actions back in
1977. Today, stakeholder groups and NGOs are integrated into the strategic planning
process to “create shared value”. Sourcing therefore is a defined strategic goal,
manifested in the Nestlé Responsible Sourcing Guideline, where a commitment related
to responsible sourcing is specified in every area (nestle.com):
• Nestlé Supplier Code
• Nestlé Policy on Environmental Sustainability
• Nestlé Commitment on Climate Change
• Nestlé Commitment on Deforestation and Forest Stewardship
• Nestlé Commitment on Child Labour in Agricultural Supply Chains
• Nestlé Commitment on Rural Development
• Nestlé Commitment on Farm Animal Welfare
• Nestlé Commitment on Water Stewardship
• The International Bill of Human Rights
• The 8 ILO Core Conventions
• United Nations Global Compact Principles
However, sustainability is a multidimensional performance construct based on
social, environmental and financial aspects. Sustainability therefore affects the
measurement ambiguity inherent in business-to-business relationships. Although
Nestlé shows professionalism and has experience in the governance of global
relationships, the horse meat scandal illustrates the immense complexity of
multinational sourcing in international markets.
Conclusion
Our review has looked at sourcing in two leading multinational companies:
Benetton, in the fast fashion industry, and Nestlé, in the food industry. Benetton
experienced the biggest catastrophe in the garment industry, the Rana Plaza collapse.
Nestle went through the horse meat scandal, perhaps one of the most complex food
crime cases in history. Both cases illustrated the strategic vulnerability that arises
from the international outsourcing of production. What strategic lessons can we learn
from these cases?
Sustainability contributes to performance ambiguity. Production costs are no
longer a complete indication of performance. Management control systems should be
especially vigilant when outsourcing transfers social and environmental
responsibility from one contract to another in a global business context.
Monitoring costs cannot be outsourced when it comes to sustainable social
responsibility and environmental aspects. Management information systems and
reporting processes might curb opportunism. The problem, though, is that there are
no contracts that can address every aspect of a future uncertain and global world.
That is why stakeholder groups, activists and NGOs might help companies to
monitor their international operations. Business research has for a long time argued
that if there are many managerial tiers, long distances and many cultural contexts,
this might complicate the monitoring of sustainable operations. Transparency might
therefore produce a satisfactory background from which host country stakeholder
groups can follow and control social responsibility and environmental performance.
Contracts in general, and outsourcing in particular, thrive in countries with
institutional trust. A new global business world can only grow when business-to-
business contracts are safeguarded through the legal system and international trade
agreements. The protected development of brands, trademarks and company names
is the best shield against “lemons” contractors (Akerlof, 1970). Without being able to
navigate through institution-based trust to protect brands, it is difficult to make
rational outsourcing decisions.
Global sourcing adds uncertainty to business-to-business relationships.
Management can only confront these complex problems by increased integration and
control. Social, cultural, legal and technological change directly affects potential
inter-organizational uncertainty and opportunism (Achrol et al., 1983). However, we
can sometimes see that norms might affect behaviour. For instance, leading by
example probably also facilitates a culture in which sustainability can be developed.
When top management does not take social responsibility and the environment
seriously, a laissez faire culture that creates opportunism develops easily.
Reversed globalism encourages 3D-printing and the automization and
robotization of production. Thus, technological development might curb these ethical
concerns in the long term. Furthermore, information technology and social media
provide additional transparency in the system. As a conclusion, however, global
outsourcing in any industry should transfer not only industrial operations but also
credible and responsible social and environmental benchmarks.
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