HAQ visits Bain & Company’s Seoul office and discusses current trends of outsourcing to and from Korean with Sunny Yi who is currently the managing partner of Bain’s Seoul office.

Mr. Yi is currently the managing partner of Bain’s Seoul office. With an MBA from Harvard Business School, coupled with Korean language skills and 15 years of industry and management consulting experience, he offers unique insight into Korea’s economic growth and change. Some of his thoughts on the Korean economy can be found in two books that he authored, the “Korea Discount” (2004) and, most recently, “Again Korea” (2005).

The cool comfort of Bain & Company's staid 19th floor office, located in one of downtown Seoul 's most distinctive buildings, offered an interesting contrast to the frenetic, seemingly uncontrolled economic activity being played out on the streets of Seoul below. Though this perch, overlooking Seoul 's skyline, may seem removed from outsourcing and the images of factories, call centers, and unemployed workers that the term “outsourcing” conjures up, for Bain's Sunny Yi, it has been the perfect place to observe and influence the effects of outsourcing on South Korea.

HAQ: Thank you for making time today. Recently, outsourcing has become a buzzword. In the Korean context, can you begin by telling us what outsourcing is?

Yi: I think outsourcing became more visible, or controversial depending on which country we're discussing, mainly due to offshoring issues, taking jobs away from domestic to foreign, especially China and India in terms of the United States. For Korea, after 1997 is when outsourcing really took off. Prior to that, if you look at most companies, they tended to do the work internally or give work to their family members. If you look at big chaebols ¹, Samsung or Hyundai, and look at companies in their value chain, whether their advertising companies or even their drivers, they either owned the companies or were run by family members. After 1997, many companies outsourced non-core assets. For example, these days many companies do not hire their own drivers. They usually outsource these jobs. An area for outsourcing in Korea is probably finance/payroll. It is probably outsourced now more than before. Information technology (IT) is a second area, which is potentially huge for Korea. But if you look at Samsung Data Systems (SDS), LG CNS ² or Daewoo Information Systems, they are still owned by their parent companies. So you don't see them operating the same way as IBM or EDS. There is a huge potential in Korea for that market.

In terms of outsourcing capabilities to China, which Kookmin Bank tried before by using ethnic Koreans living in Yanbian³, they moved the call-centers from here to there and it was a disaster. It was a nightmare from a political point of view, since unemployment was high in Korea and they were taking jobs away. Language is always an issue. If we are talking about outsourcing Korean jobs, Yanbian is probably the only location to outsource to.

HAQ: You pointed out some trends. Do we see trends of US outsourcing to Korea and related to that, also Korean outsourcing to other countries? Could you elaborate?

Yi: In many ways, OEM manufacturing is a form of outsourcing. If you look at vendor relationships, it's a traditional form of outsourcing. You always want to produce something better, cheaper, and faster. We can look at manufactured parts for the auto industry, which is huge in Korea. In the past, it was all vertically integrated, Hyundai, Kia Motors, and Ssangyong Motors, but two of the three companies went bankrupt (Kia and Ssangyong) and allowed their parts manufacturing business to be acquired by Delphi. This is a prominent example in auto parts manufacturing because they now provide a huge chunk of parts for Ford and GM. Unfortunately, if you look at Korea's manufacturing base in the last five years, a lot has migrated to China and Korea is losing its edge. A lot of people think that labor costs are differentiating the outsourcing competitive advantage, and that's true to a degree. One thing that is interesting for India is that the cost curve is going up almost 30% a year. So they were cheap like 3 years ago but are going up and up. They are creating competitive advantage beyond labor cost.

HAQ: What are areas that could potentially be outsourced outside of Korea ?

Yi: A lot of software programming tends to be outsourced to India, not necessarily low value added, but service that requires lots of handwork can be done in India far more cheaply. All manufacturing is done in China, probably 90%. It looks like it was made in Korea, but if you look on the back, it's made in China. Much of the manufacturing / industrial outsourcing has already happened. I'm a motorcycle fan so I went to look at motorcycles without my wife knowing about it. If you look at motorcycle parts in Korea, 90% are made in China. The motorcycle is basically made in China with a Korean nameplate on it. Korea just cannot compete in terms of price points.

HAQ: Can you describe the timeline of outsourcing in Korea and the reaction of labor?

Yi: 18% of all Korean laborers are unionized and they are overwhelmingly located in large Korean companies. If you look at areas that were outsourced, many were smaller enterprises that are not unionized. For them it happened slowly but it already happened. If you try to move one of the larger conglomerates like Hyundai, then you hear a lot of noise. The guys with less power, for them, it has already happened.

HAQ: You've given us great information on outsourcing, but now can you discuss the intersection between outsourcing issues and recent government initiatives to transform the Korean economy, such as the push to transform Korea into a hub for finance and logistics.

Yi: Korea has the potential to become a large destination for outsourcing. The major issue for Korea is English. We just cannot find enough people with language capabilities. As economies move to become more service-based, outsourcing is going to happen. If you look at manufacturing outsourcing, that has already moved to China. The next wave is service outsourcing, which will happen and the only way to participate is to have the language. The problem with the hub is that in order to attract foreign companies, you need to have more than business, you need education and other infrastructure for expatriates. I was talking to Jeffrey Jones, the former head of the American Chamber of Commerce in Korea, and he said the biggest problem with living in Korea is the 911 service, since there is no English 911 service. Little things like that are big issues and for foreigners that's an obstacle. Another example is ATM service - even as recently as two years ago English service was not widespread. So language is a big thing.

HAQ: Beyond language, do you think the human capital / skill level is already in place in Korea?

Yi: I think it has to do with labor inflexibility. Companies have to be able to manage labor as it relates to business needs, if you cannot do that then when the business goes down companies have to absorb the difference. The second is infrastructure, and in terms of IT, electricity, and other basic stuff, Korea is probably the best. I saw a report a few months ago that measured infrastructure capability, and Korea was ranked very, very high. Other than that, the skill set is there but the problem is more with labor.

HAQ: Do you feel outsourcing is getting the proper attention from the government? What are some possible policy recommendations?

Yi: I think the problem is that manufacturing and services are not propelling themselves to the next higher value-added sector fast enough. The reason outsourcing happens is because a country is advancing. So whatever you used to do at cost X, someone can do at cost x-y, that's the whole idea. The challenge Korea is facing is that in many industries, Korea hasn't advanced enough, and that is creating some problems. If you look at reinvestment levels over the last few years, Korea hasn't invested a lot. R&D investment is low. R&D divided by GDP is still very, very low. In order for Korea to cope with outsourcing it has to do more R&D. Also, IT is probably the best area for Korea 's capabilities. There are many big companies with potential but they are part of chaebols and cannot go outside their own chaebol area. For example, SDS arguably has more Ph.D.'s per employee index than any other company, yet it's not a global company. If you look at Samsung Electronics, that's a global company. Which makes one wonder why can't SDS, which spends 70% of its time working with Samsung Electronics, rise to that level? SDS can be an outsource company but they're stuck. The challenge is to do more projects outside of their own parent company. It's really a management issue.

HAQ: Conceptually that sounds nice, but in your opinion is that a realistic possibility?

Yi: It's an ownership issue. Let's say a private equity fund owns the company and delivers a mandate that 50% of revenues has to come from outside of Samsung then they'll try to find more business. Right now, they don't have to do anything. The reason they are doing nothing is because Samsung Electronics is so profitable these days… As soon as they are not profitable things will change. Like I said, outsourcing took off in Korea in 1997 when people were dying for cash and they had to look for jobs outside their parent company. That's why outsourcing boomed because companies had to find better, cheaper, and faster. Theoretically, you can always find people that can do the job better, cheaper, and faster.

HAQ: Touching on your earlier point about R&D rates, what are your feelings regarding Korea 's ability to maintain competitiveness, given Korea 's low R&D investment rate?

Yi: My true answer is that Korea will never be an R&D powerhouse. If you look at R&D, there are three cycles: research, development, and T&E (testing & evaluation). Not many countries do research, probably around 5 because there has to be a relationship with a university. Companies usually can't do it all by themselves and need great universities with Nobel Prize winners. Korea doesn't have a great university. Places like MIT and Johns Hopkins drive research. The next cycle is taking research from an idea to a commercialization process. Korea is getting better but is still far off…What Korea is really good at is process development, for example, car manufacturing is something Korea does better. Regarding testing & evaluation, Korea doesn't have many recall systems, but if there are more recall systems, like in the US, then we should see some improvement. If you look at the above cycles, there is probably a need to invest more money for the research and development cycle. That is the challenge.

HAQ: Since we're running out of time, in conclusion, looking forward 20-30 years, what is your prognosis for Korea given the rise of China, India, and the continued economic strength of Japan ?

Yi: There are two powers coming on-line, China and India, with China coming on very fast. Historically, Korea has always played a balancing game between China and Japan. In recent history, Korea has focused on the US a lot more, and there is an extra complexity now with China's rise. I don't think socially, politically, and economically Korea knows how to play the game well. Though I'm not sure what the answer is, Korea 's effectiveness playing that game will affect its course of action.

ENDNOTES

1 Chaebol is the Korean word for conglomerate. The largest chaebols in Korean include Samsung, LG, and Hyundai.

2 LG CNS does not have one fixed meaning but is meant to convey the idea that LG CNS provides a broad range of technology services, including technology consulting and solutions for networks and systems.

3 Yanbian Korean Autonomous Prefecture, located in northeastern China, borders Russia and North Korea. It is home to nearly 1 million ethnic Koreans living in China, most of whom have been there for decades.