March 21, 2016    8 minute read

Outsourcing and Offshoring

   March 21, 2016    8 minute read

Outsourcing and Offshoring

Outsourcing is a rising popular trend in business in recent years. Outsourcing can be defined as hiring by a firm of a third party to do the job that would normally have been done within the firm, internally. There are a number of outsourcing variants. International outsourcing or offshoring involves non-domestic (offshore) creation of services for domestic consumption. Nearshoring relates to outsourcing of work to a nearby country (for example, the job might be outsourced to Canada from the USA). Companies can also set up captive centres to provide internal company services either domestically or abroad. This essay will examine the recent trends for offshoring and explain why firms might engage in this activity.

With the information revolution taking place around the world and rapid developments in technology (with the advent of fibre optic communications, satellites, and increased availability of telephone and Internet) it has become possible to connect different geographical localities more easily. This has ultimately led to an emergence of new business trends. Trade across borders does not only happen in manufactured goods, but it is increasingly possible to trade services across borders. Out of this possibility we can see the emergence of the service offshoring trend, whereby firms are able to outsource non-core ‘off the shelf’ activities and processes to providers in another country, while concentrating on their own core competencies that offer them a competitive advantage. Thus, for example, with more rapid technical progress in telecommunications India has recently become an important destination for IT outsourcing. India first benefited from the offshoring trend as it has a large pool of English speaking people and technically proficient manpower. India’s offshoring industry took root in low-end IT functions in the early 1990s and has since moved to back-office processes such as call centers and transaction processing. Currently, India’s engineering talent has made India the offshoring destination of global firms like HP, IBM, Intel, AMD, Microsoft, Oracle Corporation, Cisco, SAP, and BEA.

Why offshore?

Empirical evidence suggests that most companies engage in outsourcing and offshoring practices with the aim to reduce their costs and to be able to concentrate on the core business. Thus, support activities can largely be outsourced to a third party, specialising in the service, while the firm can then concentrate on the main activities that constitute the core of its value chain. Companies might find it profitable to offshore some activities and services abroad because of the cost savings – to take advantage of lower wages in emerging economies, where the same job can be done with enormous cost savings compared to production in the West. Often, offshoring helps business to get rid of some of the fixed costs in its structure, thereby, reducing its vulnerability to macroeconomic shocks and swings in demand. It might make sense to engage in international offshoring if it offers the firm access to better quality resources or provides an opportunity to take advantage of specialised expertise. Offshoring does not have to be done only for the sake of cutting costs; the decision can be strategic as well.

Often the choice of offshoring destination is made based on the firm’s cultural concerns. Japanese companies are starting to outsource to China, where large numbers of Japanese speakers can be found — particularly in previously historically Japanese-occupied Chinese territories. German companies tend to outsource to Poland and Romania, where proficiency in German is common. French companies outsource to North Africa for similar reasons. USA firms might choose Canada or Latin American countries as a destination for offshoring. Thus, nearshoring trend also provides additional benefits, since it helps the business to avoid a number of cultural, language or time-zone differences.

The winners and losers

Offshoring can have significant benefits for both outsourcing and hosting country. In the countries that engage in offshoring the trend leads to lower production costs, hence, destinations for offshoring are frequently chosen with cost cutting in mind. It is argued that it can than feed back into prices as well, so that goods and services might be then sold cheaper at home. Often people claim that offshoring empowers the outsourcing country to allocate its resources more efficiently, redeploying its capabilities (i.e. displaced labour) in more profitable higher value-added processes, diverting scarce resources to more productive uses. Often jobs that get offshored are the ones that domestic workers are reluctant or unable to do. They may not have necessary skills and expertise or might not want to engage in lower-end jobs. Some argue that offshoring might also lead to higher volumes of exports for an outsourcing country, as in offshoring destinations these exports might be used as intermediate products (Farrell). It is, however, argued that benefits from offshoring might vary from country to country. Farrell stresses that benefits to the USA from offshoring are higher than for Germany because in the USA labour markets are more flexible and workers displaced because of offshoring get employed in other places more quickly. The extent to which the trend is beneficial, therefore, is also a matter of policy and the country’s institutional structure.

The country that hosts offshoring also gets a number of benefits. Hosting offshoring leads to creation of more jobs, reducing unemployment, better living standards. People in these countries (especially in the developing world) benefit from offshoring as it increases their disposable incomes, they can increasingly afford more consumption. The way that they live improves, people have better life chances. The necessity to attract foreigners as an outsourcing destination might also motivate the state to invest in infrastructure, education, and this has positive externalities for everyone – for ordinary people, and for local firms as well. There is also a significant cultural impact, though, whether it is beneficial or not is a highly contestable issue. Thus, people often become exposed to more Westernised lifestyles; there might be an increase in consumerism. Although it does not necessarily directly lead to erosion of local cultures, it might from time to time create a rift between families. Thus, Baumanis explores the Indian case using Hofstede’s framework and finds that Indians become less collectivist over time, and the power distance (the degree to which they accept inequalities connected with status, position or wealth) diminishes.

Some contest the advantages connected with offshoring, arguing that they are overemphasised. Levy argues that offshoring increases unemployment in the outsourcing country. Although some claim that these workers can relocate to more value-adding activities and higher-end jobs elsewhere (Farrell), Levi claims there is mixed data on the benefits of relocation of workers displaced by offshoring. Empirical evidence claims that not all people are able to find jobs relatively quickly and that most suffer decrease in salaries. Moreover, unemployment frequently is a very serious social problem and a disaster for long-term unemployed, and frequently quoted cost benefits from offshoring do not ease the pain of those who lost their jobs because of it.

Levy also argues that the cost advantage of offshoring strategies benefits shareholders of MNEs but not necessarily countries and workers themselves. It is argued that MNEs are, thus, main winners from the offshoring trend and that offshoring does not lead to necessarily more national income, but only redistributes it from one class of people to another (from workers to the owners of MNEs). Empirical evidence, however, suggests that fear of outsourcing leading to a loss of jobs in developed countries is exaggerated, and actual job loss is not significant (Amiti, Wei), while Baumanis suggests that from the point of view of utilitarian ethics it does not really matter how the gains from offshoring are distributed – as long as overall total economic benefits exceed the costs, offshoring can be justified.

This essay has examined the offshoring trend and suggested possible reasons for firms engaging in offshoring. Gains and losses resulting from offshoring were discussed. The essay shows that there are a number of arguments for and against offshoring. The trend has both positive and negative effects. Although it might lead to better standards of living in the hosting country, it is often viewed as the reason for job losses in the outsourcing economy. There is, thus, an increasing concern about offshoring, especially in USA there are great debates about the effect of offshoring of services to India on USA unemployment. Offshoring has been a very salient issue during the election campaign in 2004. Overall, however, empirical evidence suggests that the fear of the job losses is significantly exaggerated while overall the trend is beneficial and can be seen as ethical from the point of view of utilitarian ethics (Baumanis).

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