Adam Smith and outsourcing

Posted: 03/02/2011 - 00:00

What does Adam Smith tell us about outsourcing? The answer is somewhat complicated: Nothing directly, but then again everything.

I’ll explain. Obviously, the term outsourcing did not exist when Smith, the founding father of economics, was alive – but it existed in one form or another as mercantilism, markets and transactions developed and became more sophisticated. For example, when an entrepreneur formed a relationship with a guild of weavers to manufacture and sell garments, the marketing, distribution and manufacture was a mix of mutual outsource relationships, with all of the parties using their unique skills to do what they do best for mutual benefit.

Smith (1723-1790), an eccentric Scottish academician at Glasgow University, observed humans’ propensity for self-interest and formulated the law of supply and demand in 1776 with the publication of An Enquiry into the Nature and Causes of the Wealth of Nations. He said that society benefits as a whole from a variety of trading transactions because humans will naturally seek what is best for them, resulting in fairness and honesty among equals. That was his theory anyway. And as demand for repeat transactions emerged, trading preferences evolved and modern transaction-based business models developed. These transaction-based business models have been a cornerstone of conventional business relationships ever since.

Transactions or exchanges are as old as human history, and markets determine how they work. Smith considered the size of markets and volume of trade as the regulators of the division of labour. In fact, man’s “propensity to truck, barter and exchange one thing for another … [is] the necessary consequence of the faculty for reason and speech,” he observed.

Smith outlined a basic theory of international trade: “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.”

Substitute “company” for “foreign country” in the quote above and you have the idea behind outsourcing. Put another way, what Smith said sounds very similar to what Tom Peters and Peter Drucker famously said more than 200 years later: “Do what you do best and outsource the rest!”

Smith, a pillar of the Scottish Enlightenment, presented the notion that a nation’s prosperity could not be achieved by the rich becoming richer at the expense of the poor; increased wealth had to spread throughout, for “no society can be flourishing and happy, of which the far greater part of its members are poor and miserable.”

His insights were spot on: today, few economic concepts enjoy as much acceptance and consensus among economists as that free and open world trade increases economic growth, while raising living standards.

Smith wrote about the advantages of specialisation and free markets long before it was understood and normal practice to break down work processes into component parts. He wrote that an individual producer who “intends only his own gain … [is] led by an invisible hand to promote an end which was no part of his intention.” This produces a more productive and fairer society than if governments or other authorities recommend what individuals should buy or sell.

Dr. Lionel Frost, an associate professor in the department of economics in the faculty of business and economics at Monash University, says Smith “would have approved” of today’s outsourcing trends in terms of specialisation and division of labour across global markets. “While Smith would acknowledge that some people are affected adversely by outsourcing, he would conclude that on balance, society is better off when people are free to pursue the opportunities that the market presents,” Frost says. “As Smith wrote, while widening the market is usually of general benefit, restricting competition and trade ‘must always be against’ the best interests of society.”

Have modern technology, intense competition, win-at-all costs strategies, the rise of globalisation and giant multinational corporations and market manipulation methods skewed Smith’s premise that people will seek what is best for them through fairness and honesty among equals? Possibly, but these developments have by no means rendered Smith obsolete.

Quite the contrary, I believe that we can and should circle back to that fairness and honesty ideal, especially after witnessing the social and political ferment, and economic and financial turmoil of recent times. This can be done by using technology and modern economic thinking in innovative ways.

There is an emerging and powerful school of thought that unbridled greed and competition is not in everyone’s best long-term interests. What I teach and advocate is to go beyond ordinary one-sided transaction-based outsourcing – the “I-win, you lose” mind-set – to the win-win. This is what University of Tennessee researchers and I describe as the Vested Outsourcing, where both sides commit and collaborate together with flexibility and innovation to achieve mutually beneficial goals, called Desired Outcomes.

The foundation Smith articulated for free markets and specialisation is essential as modern economic and academic thinking on those topics evolves. It’s not free trade and outsourcing that are the culprits in today’s volatile economies and financial markets. It’s about finding ways to make free trade, globalisation and outsourcing more relevant, ethical and user-friendly for all.

Proponents of game theory and the win-win approach to business relationships, such as Nobel Laureate John Nash (about whom I’ll write more in a separate column for this series) actually have taken Smith’s basic precept a vital step further: That individuals and companies will seek what is best for them through fairness and honesty … by working together!

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About The Author

Kate Vitasek's picture

Kate Vitasek is an international authority for her award-winning research and Vested® business model for highly collaborative relationships.   Vitasek, a Faculty member at the University of Tennessee, has been lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce.    Her work has led to 6 books, including: Vested Outsourcing: Five Rules That Will Transform Outsourcing, Vested: How P&G, McDonald’s and Microsoft Are Redefining Winning in Business Relationships and Getting to We: Negotiating Agreements for Highly Collaborative Relationships.

Vitasek is known for her practical and research-based advice for driving transformation and innovation through highly-collaborative and strategic partnerships.   She has been appeared on CNN International, Bloomberg, NPR, and on Fox Business News.  Her work has been featured in over 300 articles in publications like Forbes, Chief Executive Magazine, CIO Magazine, The Wall Street Journal, Journal of Commerce, World Trade Magazine and Future of Sourcing.