Sunday, January 10, 2016

Outsourcing -- Today's profit maker

[I wrote this in 2004 and it has held up pretty well. I'm reprinting it here since I no longer have access to my old blog and because wherever that old blog is living has creaky servers and takes several minutes to fully download.]

We speak in respectful tones about that primordial soup from which profits flow, the marketplace. Great numbers of people worship at that altar...probably more than worship in old-fashioned religious venues. When the numbers are good, the news announcer reading the results often has happy background music playing, something like "We're In the Money". If the numbers are down, the music might be "Stormy Weather". It's as much a part of our culture as sports and popular foods to rejoice when the "Market" is good, and gloomy if the report is "down". At some level everyone, even those who will never see a stock certificate, some of whom will never guess that there is a cap on social security taxes every year for people earning over a certain amount...everyone feels connected.

It's not fashionable to ask where profits come from, however. It's like asking if someone has had cosmetic surgery or was fortunate enough to come into a lot of money following the recent death of a loved one. We want the dealership from which we get our car to be profitable enough to keep up with the warranty service, but we don't want any profit to that dealer from our purchase, and we sure as hell don't want to pay dealer prices for service. Profit is what happens when a company makes a good deal with someone else. When I have to make the same deal, however, they are taking advantage of me.

Not everyone thinks like this, of course. There are lots of people who cheerfully pay a dear price to be the first or latest in their peer group to see a movie or own a certain fashion or travel to some wonderful destination. Big tips, ostentatiously bigger than the norm, are sometimes found by delighted service people who don't care that they say more about the ego needs of patrons than the quality of their service. And I think there are a few people who take a balanced view of profits and don't get disturbed about their contributions to someone else's profit.

In the face of all this resistance on the part of customers, clients and patrons to cut them out of reasonable profits businesses are forced to be imaginative about being able to report ever higher profits. The word "bubble" comes to mind first, because that is the easiest track to profits in the short term. We have seen it many times, from the famous tulip bulbs to the California Gold Rush to the explosion of dotcoms. In the end the bubble bursts (hence the term) but there are what I would call "serial bubbles" (see "serial monogamy") in real estate, fashions, entertainment and advertising. I heard a couple of weeks ago that insurance stock prices go up when a hurricane hits because historically that is when premiums go up, not only to cover "losses" due to weather, but improved profits as well. Why do insurance companies jack up the prices at just the time that their policy holders can least afford to pay more? Because they can.

A few years ago, and to some extent continuing today, the phenomenon of "mergers and acquisitions" yielded breathtaking "profits". When two companies in the same line of work merge it is a win-win situation (except for the people whose jobs are sacrificed for the deal) because the new, stronger company has one less competitor in the marketplace (whew!) as well as a more efficient operation, because the payroll departments, accountants, ad agencies and other support operations can be performed by one department instead of two. All this improved efficiency translates into profits.

Speaking of accounting, now there is the toolbox from which a lot of profits can be made to flow. When they get the cooperation they need from operations there is practically no end to the profits that can result. Just ask the people at Enron how easy it can be.

Have you noticed that so far that nothing has been mentioned about productivity? That is my point. The only real source of profits has to be that something has been produced. Moving the furniture around does not produce anything, unless you are paid to be an interior decorator. Mergers might squeeze a few cents from the economy of scale, but the real improvements, if you can call them that, is that there is more to report for profits because fewer people are being paid.

This brings us to the notion of outsourcing, the ultimate job eraser. Outsourcing has had it's bony finger in nearly every business enterprise in the marketplace. I would like to advance the notion that corporate reliance on outsourcing is tantamount to an admission of failure. It is easiest to see in something like janitorial work, the bottom of the economic ladder by most standards. Very few organizations today directly employ the people who literally clean up behind them. The reasons are easy to grasp. Nobody wants to take out the trash, clean the restrooms and refill the soap dispensers, so it is easier to pay an outside company to do that job than go to the trouble to hire and train someone and hold them accountable. And don't even mention the benefits that the would expect. After a few years they could get to wanting a vacation like everyone else. Next thing you know, they might even want to be getting ahead in life and someone would have to be trained to replace them. Imagine that.

I'm trying not to sound cynical, but I'm not trying very hard. I have watched for years as the idea of people skills and management accountability have become less and less a part of business life. Few supervisors are trained to spell out their expectations in language that is clear but not judgemental. Even fewer are trained to be the patient coaches they have to be if they are to develop their subordinates into more than robots. For the past few days I have been thinking that outsourcing is the contemporary successor to mergers as a generator of false profits, because in most cases the end result neither improves the service nor generates any new value to the owner/stockholder.

And the social consequences of jobs being lost....don't get me started.
Shortly after that was written I came across an essay by a venture capitalist who was/is a card-carrying computer programer, Paul Graham, who is still being productive and has his own Wikipedia link. I gather from Mr. Google he is a glittering success, both as programmer and investor -- an ideal subject to be Exhibit A for meritocracy. And as every schoolboy knows, whatever else our economic and social system may be, it is first of all a meritocracy, richly rewarding those who create "value."

His most recent essay indicates he may be somewhat prickly about the Piketty effect (income and wealth inequality and all that) and I'm just an old man blogging in retirement and am not equal to any pissing contest with someone of his accomplishments. Nevertheless, here is a snip from that essay making my point. 
In the real world you can create wealth as well as taking it from others. A woodworker creates wealth. He makes a chair, and you willingly give him money in return for it. A high-frequency trader does not. He makes a dollar only when someone on the other end of a trade loses a dollar. 
If the rich people in a society got that way by taking wealth from the poor, then you have the degenerate case of economic inequality where the cause of poverty is the same as the cause of wealth. But instances of inequality don't have to be instances of the degenerate case. If one woodworker makes 5 chairs and another makes none, the second woodworker will have less money, but not because anyone took anything from him. 
Even people sophisticated enough to know about the pie fallacy are led toward it by the custom of describing economic inequality as a ratio of one quantile's income or wealth to another's. It's so easy to slip from talking about income shifting from one quantile (sic) to another, as a figure of speech, into believing that is literally what's happening.
Did you catch that? The "quantile" reference is a giveaway reference to Piketty. I think he was trying to say quintile, the metric by which most charts about income and wealth inequality are illustrated, with the middle quintile being equivalent to the proverbial middle class. But like most highly successful people Mr. Graham knows better than anyone how he became successful and he has little sympathy or patience with those further down that ladder of success. 

My own focus lately has been exactly on that other end of the economic continuum, those at the bottom, the population commonly called the working poor, who spend their entire working life barely making ends meet, living from one check to the next, with no hope or expectation of life ever getting much better. But that is a subject for another discussion. This morning's reflections are my response to a NY Times article about a group of professionals with demonstrable merit -- high on the meritocracy ladder -- doctors. Seems like an outsourcing trend (as I was railing about in my 2004 link above) has found its tentacles all the way to the top of the ladder in the form of outsourcing doctors, for crying out loud!
Dr. Alexander’s method is at the center of an emotional debate in medicine, in which the imperative to increase efficiency in a high-cost health care system is often at odds with the deference traditionally accorded to doctors. 
It’s a debate that came home to Sacred Heart in the spring of 2014, when the administration announced it would seek bids to outsource its 36 hospitalists, the hospital doctors who supervise patients’ care, to a management company that would become their employer. 
The outsourcing of hospitalists became relatively common in the last decade, driven by a combination of factors. There is the obvious hunger for efficiency gains. But there is also growing pressure on hospitals to measure quality and keep people healthy after they are discharged. This can be a complicated data collection and management challenge that many hospitals, especially smaller ones, are not set up for and that some outsourcing companies excel in.
To be fair to Mr. Graham, his essay also refers to the rentier class (although he doesn't use that exact term, but that's the reference).
As a manufacturer of economic inequality, the underlying causes are something I know about. Yes, there are a lot of people who get rich through rent-seeking of various forms, and a lot who get rich by playing games that though not crooked are zero-sum. But there are also a significant number who get rich by creating wealth. 
And that group presents two problems for the hunter of economic inequality. One is that variation in productivity is accelerating. The rate at which individuals can create wealth depends on the technology available to them, and that grows exponentially. The other problem with creating wealth, as a source of inequality, is that it can expand to accommodate a lot of people. 
I'm all for shutting down the crooked ways to get rich. But that won't eliminate great variations in wealth, because as long as you leave open the option of getting rich by creating wealth, people who want to get rich will do that instead.
But as in nearly every case, that creation of wealth theme trumps all other arguments, leaving the rest of the discussion in the dust.  But as in the case of the working poor, that is a subject for that other discussion I mentioned above. This one is about doctors.

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