To start a children’s pajama business, Philip Chigos and Mary Domenico designed their products,…

To start a children’s pajama business, Philip Chigos and
Mary Domenico designed their products, chose fabrics, and searched for low-cost
workers in China or Mexico from an office in the basement below their San
Francisco apartment. Increasingly, such mom-and-pop operations are sending
their clothing, jewelry, and programming work to Sri Lanka, China, India,
Mexico, and Eastern Europe. A firm outsources if it retains others to provide
services that the firm had previously performed itself. Firms have always used
outsourcing. For example, restaurants buy goods such as butter and flour or
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To start a children’s pajama business, Philip Chigos and
Mary Domenico designed their products, chose fabrics, and searched for low-cost
workers in China or Mexico from an office in the basement below their San
Francisco apartment. Increasingly, such mom-and-pop operations are sending
their clothing, jewelry, and programming work to Sri Lanka, China, India,
Mexico, and Eastern Europe. A firm outsources if it retains others to provide
services that the firm had previously performed itself. Firms have always used
outsourcing. For example, restaurants buy goods such as butter and flour or
finished products such as bread and pies from other firms. Outsourcing
increases profits if others can produce a good or service for less than the
firm’s own cost. Many news outlets and politicians in high-wage countries have
been wringing their hands about outsourcing to other countries. The different
factor prices that firms face in low-wage countries may allow them to produce
at lower cost. In the past, most small firms could not practically outsource to
other countries because of the high transaction costs of finding partners
abroad and communicating with them. Now they can use the internet and e-mail to
inexpensively communicate with foreign factories. Mr. Chigos used the internet
to find potential Chinese and Mexican manufacturers for the pajamas that Ms.
Domenico designed. Hiring foreign workers is crucial. Mr. Chigos claims, “We’d
love it to say ‘Made in the U.S.A.’ and use American textiles and production.”
However, if they did so, their cost would rise four to ten times, and “We
didn’t want to sell our pajamas for $120.” One result of easy access to cheap
manufacturing, he said, is that more American entrepreneurs may be able to turn
an idea into a product. The would-be pajama tycoons plan to outsource to U.S.
firms as well. They will use a Richmond, California, freight management company
to receive the shipments, check the quality of the merchandise, and ship it to
customers. They will market their clothes on the internet and through boutique
retailers. They have no manufacturing plant, storefront, or warehouse. As Mr.
Chigos notes, “With the technology available today, we’ll never touch the
product.” Lower communication costs have made it feasible to take advantage of
low foreign costs for outsourced activities. If relative factor prices (and
hence slopes of isocost lines) are different abroad than at home, the manager
of a firm with smooth isoquants should use a different factor mix when
producing abroad, as Figure 6.5 illustrates. However, Q&A 6.3 shows that if
all foreign prices for capital and labor are proportionally lower than domestic
prices so that relative factor prices are the same, the firm should use the
same technology as at home.

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