Business Breakfast

Reaping the Benefits of Globalization

the Economic Impact of Offshoring
Friday, February 3, 2006

Sponsored by:

Program
09:00

Welcome and Introductions

Ove Hnel, Marketing Manager, International Trade Promotion, Danske Bank
Stephen Brugger, Executive Director, AmCham Denmark

09:10

Perspectives on Globalization
Diana Farrell, Director of the McKinsey Global Institute

09:45

Offshoring in a Danish Perspective Facts, Fiction, and Future Issues

Professor Bent Petersen, Center for Strategic Management & Globalization

10:05

Panel Discussion / Q & A

10:25

Wrap-up and Thanks

Stephen Brugger

10:30

Meeting Adjourned

Upcoming Events

March 15

AmCham Denmark Meet the Leaders Power Lunch:

The Danish Welfare System Challenges and Solutions
Helle Thorning-Schmidt, Danish Social Democratic Party Chair
11:30 to 13:30 (Radisson SAS Scandinavian Hotel)

April 6

Annual General Meeting

Keynote Speaker: Lars Lkke Rasmussen, Danish Minister for
the Interior and Health
14:30 to 17:30 (Deloitte)

May 23

Partner Event w/ Baltic AmChams

U.S. Business Investment and Trade Mission to the Baltic States
10:00 to 17:00 (Riga, Latvia)

Perspectives on Globalization
Diana Farrell
Director, McKinsey Global Institute

McKinsey Global Institute

Perspectives on Globalization
GLOBALISERINGSRDET

Diana Farrell, McKinsey Global Institute

February 2, 2006

Globalization is a hot topic

Fearful Fortress
France French
protectionism
- October 2005

Will global economic

growth come at the
expense of jobs in my
country or yours?
- December 2005

Denmark is ready
for globalization
- April 2005

Outsourcing
strengthens Denmark
- July 2005

Globalization is
ethical and useful
- June 2005

Low income
countries create new
jobs in Denmark
- November 2005

Offshoring is also a bogeyman of the

French anti-globalization movement
- December 2005
Up to 20 percent of jobs in financial
services could be moved to low
income countries by 2010
- November 2005

Thousands of
office jobs are
moving abroad
- May 2005

Globalization
creates more
Danish jobs
than it
destroys
- October 2005

and few topics are more intensely

debated

Industries are restructuring and

operating globally
5
4
3
2
1
Market entry
Enter new
countries to
expand
consumer base;
use production
model similar to
the one used at
home

Product
specialization
Entire
production
process
completed in a
single location
and trading
finished goods

Source: McKinsey Global Institute

Value chain
disaggregation
Different
components
manufactured in
different
locations and
are assembled
into final
product

Value chain
re-engineering
Processes
redesigned
to capture
further
efficiencies/
cost savings

New market
creation
Firms offer new
products at
significantly
lower price
points and
penetrate new
markets

Companies are entering new markets

and specializing production
1 New market entry

2 Product specialization
Auto

Retail

Chevrolet TrailBlazer
(Dayton, OH)
e
ad
r
T

Wal-Mart

Pontiac Aztek
Ramos Arizpe, Mexico

Mexico

Wal-Mart
Brazil

Source: McKinsey Global Institute

3 Value chains are disaggregating

Consumer Electronics: PC Example
Demand market
production
Systems
integration

Specialist
production
MPU design
fabrication

Border zones
production
Desktop final
assembly
Source: McKinsey Global Institute

Specialist
production
Mouses and
key board

Specialist
production
DRAM production

Specialist
production
Semiconductor
design/production

4 Reengineered processes are

improving performance

Services example

4555% saving

3040% savings on offshore cost base

100

6065
510

4555

57
1015

Original
base

Factor cost Additional

savings
telecom
cost

Additional
management cost

Task/process migration

Source: McKinsey Global Institute

Offshore
location
cost

3035

New cost
Process
Task
reenginee- reenginee- base
ring
ring
Task level Process level
improve- improvements
ments

5 New markets are being created

Price

Supply
current

Supply global
opportunity

Demand
Quantity
Source: Interviews; McKinsey analysis; McKinsey Global Institute

Significant
market growth
opportunity if
global cost
opportunities
captured

Offshoring: a growing trend

Offshored services market size 2003, USD billion
Recipients of Danish offshoring
100%= USD 72 million, 2005*, services
South Korea Thailand
China
6 3
Eastern
7
Europe
35
Baltics 10

8.6
0.6
3.8
Ireland

3.6

Canada

Eastern
Europe***
0.3

15
CIS**
24

Russia

India

Israel
12.2

0.5

0.3

3.4

Philippines

Mexico

China
0.1
South
Africa

0.4

0.1

Australia

Thailand

India

* The import of services as IT development, call centers, back office to Denmark during the period Jan. 2005 Oct. 2005 used as a proxy for offshored services market size
** CIS (Commonwealth of Independent States) includes Russia, Ukraine, Belarus, Kazakhstan, Kyrgyzstan and Moldova
*** Includes Poland, Romania, Hungary, Ukraine, and Czech Republic
Source: McKinsey Global Institute; The Emerging Global Labor Market; Denmark Statistic; McKinsey analysis

Like other forms of trade, offshoring

creates global wealth

Distribution of value from DKK 1 of spend offshored, service jobs

Perceived loss to Denmark
from DKK 1 of spend
offshored
Value retained in Denmark
from offshoring

Value created in supply

country

Total value created in the

global economy
Source: McKinsey analysis

-1.00

0.93

0.52

0.45

But European countries are not

benefiting fully
Economic impact of offshoring DKK 1, service jobs
Denmark

USA

France

Cost savings for

customers and
investors

0.30

Indirect benefits, e.g.,

Increased exports
Repatriated profits

0.05

0.07

Re-employed workers

0.58*

0.57

Total

0.50

0.93

1.00

Germany

0.36

0.36

0.05

0.03

1.14

1.00

0.44

0.34

0.85

0.73

1.00

Note: Earlier McKinsey studies put Germany at 0.80 cent per Euro (company savings of 0.49 and value of reemployment at 0.29)
* Reemployment rate: T. Eriksson, R. Ibsen, J.Li og N.Westergrd-Nielsen: Globalisering og beskftigelse
Source: How Offshoring of Services Could Benefit France, June 2005, McKinsey Global Institute; McKinsey analysis

1.00

Investment in labor market programs

varies by country and has mixed results
Expenditure
for labor market Not-in-labor
force rates, 2004
policies, 2003
Percent
Percent of GDP
Denmark
Netherlands
Germany
France
Sweden
Austria
Switzerland
Canada
UK
US

Source: OECD (2005)

4.4
3.9
3.5
2.9
2.5
2.0
1.8
1.1
0.9
0.5

19.8
24.4
27.3
30.5
21.3
29.8
19.0
21.8
23.8
24.6

Unemployment
rates, 2004
Percent

GDP growth,
19902004
CAGR, percent

5.4
4.6

2.0
2.3
1.7
2.0
2.0
2.2
1.0
2.8
2.4
3.0

9.5
9.7
6.4
4.5
4.4
7.2
4.6
5.5

Many EU countries have not fulfilled

GDP growth potential
GDP growth, 19902004
CAGR, percent
Germany

GDP per capita, 2004

USD thousand, prices and PPP 2000

1.7

26.2

France

2.0

27.0

Belgium

2.0

27.4

Sweden

2.0

Finland

2.0

Denmark

2.0

Austria
UK

28.8
27.9
29.6

2.2

29.8

2.4

Spain
US
Source: OECD Annual National Accounts; McKinsey analysis

27.7
2.8
3.0

22.5
36.4

Economic growth and wealth are driven

by productivity
Indexed to the US= 100, 2003 figures at PPP in 1990
GDP per capita
110
100
90
80
70
60
Korea
50
40
Russia
30
Poland
20
Brazil
10
India
0
0
20
40

US
Denmark
Japan
France
UK
Germany

60

80

100
120
Labor productivity*

* Defined as GDP per employee

Source: The Conference Board, Performance 2005: Productivity, Employment and Income in the Worlds Economies

The productivity process is fueled

by competition
Innovation (business and IT)

Competition
drives
innovation
and diffusion

Company

Improve operations performance

Deliver new high value-added
products and services
Diffusion

Close gap to best practice

Sector
Investments
in IT and R&D
are useful but
not sufficient
to drive
innovation

operations
Shift to higher value added goods
in portfolio

Scaling

Consolidate and standardize to

achieve scale
Sell more goods to increase
capacity utilization

Increased
productivity

In Denmark, sectors competing globally

experience the highest productivity
growth
Labor productivity growth, 19902002
100%= DKK 1,460 billion
Public sector
consumption

1.6%

27%
69%

Other sectors

62%

31%

Export driven sectors*

11%
GDP, 2004

Export sectors
comprise ~10% of
the economy and
contribute with
more than 30% of
the overall
productivity growth
~30% of the
economy is not
exposed to
competition (public
sector)

Productivity gain,
CAGR

* Defined as sectors with ~50%+ export share: agriculture; chemicals, plastic & rubber; food & drink; metal products and textile
Source: Groeningen Productivity Database, Feb 2005; McKinsey analysis

Japans dual economy means domestic

services under-contribute to growth
Japans labor productivity index relative to the US= 100

140
120

120

Export-driven manufacturing
Average
Japanese
productivity= 69

100
80

63

60

Domestic
manufacturing
and services

40
20
0

10

20

30

40

50

60

70

80

90

100%

Share of Japanese employment

Source: OECD; McKinsey analysis

Vibrant dynamics more prevalent in the

US than in Europe
Europe*
Manufacturing sectors in the US and Europe*

Quartile**

Annual growth in employment,

19952000
Percent

0.3

Most productive

6.2
1.0

2nd

4.2
1.2
2.4
2.2

3rd
Least productive

Top US companies grow

faster than top European
companies

-1.6

Least productive
companies in the US are
eliminated; those in
Europe are not

* Weighted average of European countries for which data were available; Finland, France, Netherlands, Sweden, and UK
** Aggregated data for manufacturing sector
Source: Economic and Social Institute (ESI); Vrije Universite it Amsterdam; McKinsey Global Institute

US

Productivity is best understood

at the sector level

France
Germany

French and German sector performance relative to the US

-30
Higher

-20

-10

+10

+20

106

Shooting ahead

Catching up
Automotive

Fixed telecom
Road freight

+6

14

+4

Banking
Productivity
growth
19922000*
relative
to the US

45

Mobile
telecom

Mobile
telecom

12
Banking +2

Fixed telecom

Electricity generation
Electricity distribution
Apparel retail
Food retail
-2
Electricity distribution

Automotive
Apparel retail

Food retail

-4

Electricity generation
-6
Lower

Falling behind

Losing ground

Lower

Higher
Productivity level 2000** relative to the US

* Automotive and utilities 19921999; banking 19942000, retail 19932000

** 1999 for automotive and utilities
Source: MGI analysis

24

Improving public sector productivity

is important for the overall economy
Public sector productivity improvement is
required to close the wealth gap with US

Denmarks public sector is one

of the largest in the world
Country

GDP per capita, 2000 prices and PPP

Required productivity
Thousand, USD

Public consumption
Percent of GDP, 2003

Denmark

growth

27

Netherlands

25

France

45 = US level

24

Finland

22

UK

21

Germany

19

Poland

18

Japan

18

Ireland

16

US

16

27%
30
Public
sector
Private
sector

27%
7.1%

73%

73%

2004

2015

Public sector 31%

share of total
employment

48%

Europe should focus on removing

barriers to competition
Strengthen
competition
enforcement
mechanisms
Finish liberalizing
the service sector

Increase work
incentives & labormarket flexibility
Encourage
economies of scale
where productive

Improve public
sector productivity

3 = applicable
2 = not applicable

Examples of competition impediments

Europe Denmark

Lack of leniency
Mild sentences for breach of competition laws
Lack of personal liability

2
2
3

3
3
3

Legal and administrative barriers to cross-border 3

trade in services
Sector specific regulations
3
(e.g., hours constraints in retail)

3
Restrictive laws on lay-offs
High income taxes reducing work incentives and 3
increasing informal economy

2
3

Simplify/harmonize regulations
Local planning regulations for retailers

Due to the size of European public sectors, improving their productivity

is critical to economic growth

WWW.MCKINSEY.COM/MGI

Productivity performance levers

and examples
Innovation
Development

Diffusion

Scaling

Productivity levers

Examples

1. Find innovative processes

to improve operations

Emergence of on-line banking and brokerage in retail

banking and securities

Warehouse automation in wholesale

2. Create innovative, high

value-added products and
services

Emergence of mobile telephony

New generations of semiconductors
Assembly and sales of higher value components in US PCs

3. Close gap to best-practice

operations

Adoption of lean production methods by French auto OEMs

Operational improvements in French/German fixed telecom
Increased load factors in European road freight
Operational improvements in German utility industry

4. Shift to higher-value goods

within existing product
portfolio

Substitution to higher value goods in US apparel retail

Increased sales of high-value SUVs in US auto sector
Shift to more convenient service formats in retail banking
ISDN in German fixed telecom

5. Consolidate to better
leverage scale

Consolidation of clerical/administrative functions in

6. Sell more goods to increase

capacity utilization

retail banking
Consolidation of road freight industry
Consolidation of US wholesale pharmaceutical industry

Increased transaction processing in retail banking

Reduced stockouts in retail

A number of levers can be applied to

improve public sector productivity
Cost areas

Typical cost share

Typical improvement levers

Overhead

1520%

Procurement

Service
operations

3040%

Source: Danish Statitstics; McKinsey

Consolidation of buying power

Value engineering/redesign to reduce costs
Demand management
Assessment of total cost of ownership

Application of lean principles to reduce lead

times, raise quality and lower costs
Optimization of processes

4055%

100%

Elimination of duplicated and/or unnecessary

processes
Prioritization of end products by estimating costs
per end product

Data does not support idea of investment in R&D and IT being a silver bullet
for growth and productivity
OECD Countries

US industry sectors

GAGR in GDP, 1991-2003, PPP adjusted

Percent

Jump in productivity growth rate

CAGR, 19952000, percent

8.0

0.20

7.0

0.15

6.0

0.10

"New Economy"

Non IT story

5.0

0.05

4.0
0.00

3.0
-0.05

2.0

-0.10

1.0

"No story"

0.0
0.0

0.2
0.4
0.6
0.8
Average government spend in R&D
in percent of GDP, 19912003

Source: OECD; McKinsey analyses

-0.15
-0.20 -0.10

"Paradox"
0.00

0.10

0.20

0.30

0.40

Jump in IT capital intensity growth

CAGR, 19952000

Overview of Danish productivity growth

per sector
Contribution to aggregated productivity growth 19902002, percent
Auto-related retail
Automotive
Fuels
Wood
Other transport
Pulp & Paper
Other manufacturing
Mineral products
Textiles
Mechanical engineering
Metal products

140

120

Other non-business
services
Private households

Construction
Hotels &
Restaurants
Printing & Publishing
Utilities
Other
Renting & Leasing
business
IT Services
Food & Drink
services
Legal, technical &
Finance & Insurance
Electrical machinery excl. High Tech advertising services

100

80

Real estate

High Tech & Components

Chemicals, Plastics & Rubber

Mining
60

Telecom
Transport services
40

Agriculture

20

Wholesale & retail

0
0

10

20

30

40

50

60

70

80

90

100

Source: Groeningen Productivity Database 2005; McKinsey analysisAverage size of sector 19902002, percent of total value added

Questions

Offshoring in a Danish Perspective

Facts, Fiction, and Future Issues
Bent Petersen
Professor, Center for Strategic Management and
Globalization, CBS

February 3rd, 2006:

Reaping the Benefits of Globalization
- The Economic Impact of Offshoring

Offshoring in a Danish Perspective Facts, Fiction, and Future Issues

Bent Petersen bp.smg@cbs.dk
Center of Strategic Management and Globalization
at INT

Initial words of wisdom :

- also applicable to companies offshoring

A pessimist sees the difficulty in

every opportunity; an optimist
sees the opportunity in every
difficulty.
- Sir Winston Churchill

Agenda
1. What is the evidence of offshoring effects
on the Danish economy?
2. What are the new business models of
offshoring?
3. Future issues: Will Danish MNCs - and the
Danish economy in general - benefit from
offshoring in the long run?

What is the evidence of

offshoring effects on the
Danish economy?

Offshoring terms
.

Re-location to

Home country

Foreign country

Ourselves

Onshore
sourcing

Captive
offshoring

Strategic supplier
(Insourcer)

Onshore
outsourcing

Offshore
outsourcing

Operator

Positive effects on the Danish economy

Effects of offshoring are presumably very similar to those for the US
economy - and dissimilar to e.g. the German economy (characterized
by a rigid labor market with high unemployment rates)
Example of service offshoring effects per DKK 1 offshored to India:

Cost savings for Danish investors or consumers

Increased export to Indian suppliers
Repatriated earnings by Danish investors/owners
Direct benefits to Danes of offshoring to India

DKK 0.58 (0.30)

DDK 0.02
DDK 0.03
DKK 0.63

Value of workers re-employed (indirect benefit)

Total recapturing of offshoring to India

DKK 0.48 (0.58)

DKK 1.11 (0.93)

Sources: McKinsey (2003), Tnketanken Fremtidens Vkst (2005), Own calculations

although modest so far

Over the last years the overall job destruction

(and job creation) in Denmark has been in
the range of 270,000 jobs annually.
Of these jobs, only 2% - approx. 5,000 jobs
- are lost due to offshoring (Goldman-Sachs

2003, Confederation of Danish Industries/DI 2003).

The bulk of job destruction is due to

technological change, including increased
automation (Goldman-Sachs 2003).

More on offshoring job effects

The number of jobs offshored to Denmark

(2002-2005) seems to exceed jobs offshored
from Denmark almost by a factor of 2:1
(Rambll Management 2005)

though, a net loss of blue collar jobs and net

gain in terms of high-skill, specialized jobs
(i.e. crowding-out effect).
Mixed results concerning job creation by
offshoring firms vis--vis Danish firms in
general (Rambll Mgt 2005, Muusmann Consulting
/IDA 2005, DI/CBS 2003).

What are the new business

models of offshoring?

A value chain approach

With I&CT advances MNC managers

consider offshoring in relation to individual
value added activities.

Michael Porters value chain includes distinct

business activities that may differ
significantly in terms of scale and scope
economies, transaction costs/risks, resource
requirements, and strategic importance.

A value chain (Porter, 1985):

N
RGI

PRIMARY ACTIVITIES

MA

SUPPORT ACTIVITIES
(Back-office activities)

Re-configuring the Value Chain

I&CT is likely to lead to a
globally distributed value chain
within firms, with higher
specialization in specific locations
and higher coordination across
locations as well.
- Saheer and Manrakhan (2000)

Re-Configuring the Value Chain

MNCs are in the process of a dual
transformation of their value chains:
1. A surge from dispersed to concentrated
configuration strategies in which offshoring
plays a vital role.
2. A surge in the direction of a more
disaggregated and modularized value
chain in which offshoring also plays a
prominent role.

Dispersed value chain configuration

Denmark (HQ)

Sales

US Subsidiary

Sales

Germany

Norway

HQ, sales units, and mini-replica

Requires modest coordination

Concentrated value chain configuration

Denmark

USA
M&S

Norway
HRM

R&D
Manufacturing
IT
India

Integrated network of specialized activities

Requires a lot of coordination and a global
mindset among managers

China

Some Danish company examples

of dispersed value chain configuration
Carlsberg
Rockwool
Maersk Sealand (upstream activities)
of concentrated configuration
GN Resound
Ecco Shoes (upstream activities)
Maersk Sealand (downstream/marketing
activities)

Typical Re-configuration Pattern

0. Point Zero: Dispersed, un-coordinated MNC
units.
1. Establishment of (regional) Captive Shared
Services Centers Consolidation in terms of
scale economies and transparent cost
structures.
2. Fragmentation and modularization of value
chain activities.
3. Decision about location (on/near/off-shore?)
and ownership (captive/JV/outsourced?).

Will the Danish MNCs and

the Danish economy as a
whole benefit from
offshoring in the long run?

Employment of Danish MNCs

Source: Confederation of Danish Industries and CBS
300
Index 1986 = 100
250
200

Ansatte i Danmark
Ansatte i udlandet

150
100
50
1986

1990

1996

2002

Ecco Shoes: Composition of

employees by geography
(Source: Various annual reports of Ecco)
Composition of employees in ECCO by geography
.

10000
8000
6000
4000
2000
0
1980

1982

1984

1986

1988

Employees in Denmark

1990

1992

1994

1996

1998

Employees outside Denmark

2000

2002

2004

Higher Education
Percentage in age group 45-54 years
Ireland
Japan
Korea
USA
Finland
Norway
Belgium
Sweden
UK
DENMARK
Germany
Hungary
Poland
Malaysia
China
0

10

20

Pct.

Kilde: OECD - Education at a glance 2003

30

40

50

Higher Education
Percentage in age group 35-44 years
Ireland
Japan
Korea
USA
Finland
Norway
Belgium
Sweden
UK
DENMARK
Germany
Hungary
Poland
Malaysia
China
0

10

20

Pct.

Kilde: OECD - Education at a glance 2003

30

40

50

Higher education
Percentage in age group 25-34 years
Ireland
Japan
Korea
USA
Finland
Norway
Belgium
Sweden
UK
DENMARK
Germany
Hungary
Poland
Malaysia
China
0

10

20

Pct.

Kilde: OECD - Education at a glance 2003

30

40

50

Conclusions
1. So far, offshoring has had a modest, but
positive (income) effect on the Danish
economy also in terms of job creation if
offshoring to Denmark is included.
2. The new business model of offshoring is
global value chain configuration
requiring new, global mindsets of managers
and employees (the champions are to be
found outside DK).

Conclusions (cond)
3. The Danish MNCs are likely to benefit from
offshoring also in the long run - but the
national Danish economy as a whole will
probably not
- because human capital in Denmark is
relatively expensive (subject to high taxation)
and is becoming relatively scarce (the
proportion of the Danish population with
higher education is not increasing)

End of AmCham presentation February 3rd, 2006

Ladies and gentlemen

I thank you for your attention!

Panel Discussion
Pete George
Nordic President, Computer Sciences Corporation (CSC)

Ragnar G. Norddahl
Artech-TCS (Tata Group)

Thank You!