"Offshoring" refers to the business practice of moving processes and jobs from a home country to another country. If a process has always been performed in another country, it has not been offshored. Quite frequently, processes are offshored from high wage countries to low wage countries to cut labor costs, though this is not the sole reason for offshoring.
Manufacturing processes have been offshored for many decades. However, as a colloquial term, "offshoring" is generally concerned with services rather than manufacturing, so services offshoring will be the subject of this article.
Offshoring is often confused with the term "outsourcing." Outsourcing refers to hiring another company to perform a task that is currently performed internally. The vast bulk of outsourcing is done “onshore,” so it is a separate decision from offshoring. Typically, outsourced activities are deemed not central to the mission of a company, or activities that outside vendors can perform more efficiently, with better response time, and/or at better quality. For example, many firms outsource peripheral functions such as their cafeterias, janitorial duties, copy centers, trucking, building maintenance, payroll, etc.
Related terms also include "nearshoring," moving a process to a country close by, and "homeshoring," which alternately can mean moving a process away from direct company oversight to the home of the employee, or moving a process from an urban to a rural location in the same country.
Extent of Offshoring
The interest in and fear of offshoring is largely due to the predictions of what might happen in the future, rather than what has actually occurred. In a forecast report by the Wall Street Journal(Hilsenrath 2004), Forrester Research (2004) estimated 3,400,000 white collar jobs with $151 billion in annual wages will leave the U.S. for low wage countries by 2015. McKinsey & Co. estimated the vulnerable U.S. jobs at 11M. Alan Blinder (2006) opined that 28M-42M U.S. jobs were at risk. The offshoring of white collar jobs seems especially unnerving to many people in developed nations. When manufacturing jobs fled to low wage countries, solace could be taken in the prediction that a new age of the “service economy” was being entered, and that shedding low wage, dull, routine jobs was a precursor to a new economy filled with high wage, interesting, innovative jobs that required educated workers. With the offshoring boom, however, some of those high wage jobs are moving offshore. Some high-end consulting firms are getting their client presentation powerpoint slides made overseas. Stock research for U.S. investment banks is being done in India. Even white collar jobs at venerable U.S. firms seem to be at risk. An internal IBM memo leaked to the Wall Street Journal indicated that up to 4,700 white collar jobs with annual salaries of $75,000-$100,000 were to be offshored to workers in India whose expected salary range was $10,000-$20,000 per year (Bulkeley 2003). Those losing their jobs would be required to train their replacements in the U.S. for several weeks. They would then have 60 days to find another job within IBM, or face unemployment. This mood seemed to be perfectly captured by the Business Week magazine cover page on offshoring titled: “Is Your Job Next?” (February 3, 2003). The precise extent of services offshoring can only be guessed at. No government collects authoritative numbers, and many companies are very secretive about their offshoring practices. Those who report numbers often have an agenda for aggrandizing or minimizing the impact. As noted by the U.S. Bureau of Labor Statistics (2008, p.2) "Current measures of services offshoring are limited by a dearth of relevant data." The estimates of how many jobs have been lost in the U.S. due to offshoring: 400,000 by Forrester Research (Vina and Mudd 2003), 200,000 by the Information Technology Association. How many people are in India and the Philippines answering telephone calls from the U.S.? 250,000 according to the Technology Marketing Corporation, 55,000 according to Warburg-Pincus (Knowledge@Wharton 2004a), while another source cited 160,000 (Basu 2003). The total number of jobs in India doing offshore work? NASSCOM says 171,000 (Vina and Mudd 2003), Fortune magazine quoted 350,000 (Fox 2003). In terms of dollar impact, the numbers are equally diverse. McKinsey Global Institute (2003) stated that $30-$35 billion/year is offshored from the U.S., with Ireland the leader at $8.3 billion and India in second at $7.7 billion. Infosys (2002), a billion dollar per year Indian firm, estimates there are $10.2 billion offshored to India alone. The Gartner Group estimated world-wide offshore Business Process Outsourcing activity at $1.3 billion, but Giga Information Group estimated Indian BPO alone at $1.5 billion (Knowledge@Wharton 2004b).
A Brief History of Offshoring
Offshoring can be defined as performing work for customers in one country in a different country. The offshored unit can be either “captive” (owned by the same firm that did the work onshore) or outsourced. For example, General Electric, American Express, British Airways, Swissair and many other firms have captive call centers in India (The Economist 2003b). The workers in India handle callers from the U.S. (offshoring), but are employees of the American firm.
Most service jobs can never be offshored. Serving a meal, making a bed, fixing a flat tire on the highway, and the vast bulk of service jobs must be done in person. However, the scope of jobs that are able to be offshored is wide. Basically, any task that is either transmitted electronically or can be shipped is a candidate for offshoring. “Transmitted electronically” encompasses data sent via computer, voice and video communication, as well as scanned documents.
Services offshoring has existed in small amounts for several decades. Business Week (1982) published an article stating that a back-office can be anywhere due to the "new" technology of satellite communication. In one corporate response, American Airlines moved processing airline tickets from Omaha, Nebraska to Barbados 1983, cutting wages by 50% (Metters 2008).
By the mid-1990’s it is estimated that 10,000 workers in the Caribbean, 3,000 in Ireland, and 10,000-20,000 in Asia were performing offshored service work for U.S. firms (Wilson 1995). Largely, this was paper processing work. Paper was physically flown in and dumped in the in-boxes of workers, who might turn around the work in a few weeks. The main task these workers performed was factory-like keypunching of data that was not time sensitive. The reason for moving this work offshore was the enormous cost advantage: At the time, the price per 1000 verified keystrokes was $1.50-$3.50 in the U.S, but only $0.90-$1.25 in the Philipines (Wilson 1995).
In the late 1990's/early 2000's technology transformed the type of work that could be done and the response time it could be done at. Voice communication technology changed abruptly. In the past, it was operationally infeasible to locate a call center overseas. In 1966 there were so few telephone connections between the U.S. and Europe that only 138 simultaneous trans-Atlantic conversations were possible (Frank and Cook 1995, p.48). The first trans-oceanic fiberoptic cable, in 1988, could by itself carry 40,000 conversations, but it was still cost prohibitive to call overseas. In the late 1990’s, however, the amount of fiberoptic cable was increased, and the call carrying capacity of any one fiber was drastically increased by the technological advances of multiplexing (putting multiple calls on the same line) and optical switching (replacing old electronic telephone switching equipment with light-based switches). Between 2001 and 2002, the capacity of fiber-optic lines from the U.S. to India increased nearly sevenfold. As of early 2004, the cost of a trans-oceanic line capable of handling 128 simultaneous calls had plummeted to $11,000/month, one-fourth of what it was only two years prior (Drucker, 2004). Within the short span of a couple years, the entire cost structure of the call center industry has changed. Third-world labor has always been drastically cheaper than in developed countries, but the technology cost barrier has crumbled.
Technology has also had a profound impact on paper-based offshoring. As noted previously, offshoring paper-based work such as accounts receivable, payroll, etc., involved actually physically transporting the original documents overseas, which involves time delays. Given current bandwidth, original documents are scanned in the home country, and the scanned images can be sent electronically overseas, reducing both shipping costs and response time.
A substantial portion of offshore services involves computer programming, and “technology” played an important role there, as well. In the late 1990’s, it was feared that many older computer codes would cause substantial problems for businesses when the year 2000 occurred. Although computer RAM and hard disk space is rarely a constraint today, it was a major problem at the dawn of the computer era. To save space, a significant amount of software written through the 1980’s assumed that any yearly date would begin with 19 and only required the last two digits as input. Of course, in the year 2000, these programs would view the year as either 1900 or 19100. It was feared that this problem would create havoc throughout computer systems, so the old computer code had to be rewritten. There was too much work to do for domestic programmers, so much of this task was sent out to places like India. The results of this collaboration of necessity helped convince developed nations that lesser developed nations could produce timely, accurate, and cheap code, and writing code continues to be the largest outsourced task today.
Strategic Benefits and Disadvantages
While the extent of offshoring is debatable, there are clear reasons to offshore. The reason that gets the most attention is comparative labor rates.
However, the differential wage rates are misleading, as there are other costs involved. In many offshore service locations it is not unusual for employers to provide free transportation to and from work and heavily subsidized cafeterias. Expenses related to security can be high. On a visit to an Indian call center the author of this article had his car searched for bombs merely to enter the parking lot, then had to pass through several heavily armed guards to enter the facility. In lesser developed countries, infrastructure is not as well developed, leading to higher costs. For example, it is not unusual for electrical or telephone service to shut down. In response, offshore service providers often purchase their own electrical generators and have duplicative technology for telephone access.
Training can be much more extensive and expensive. Especially in call centers, where an offshore employee must interact in real time with someone from another culture. American Express puts their Indian employees who speak to U.S. customers through 3-4 months of training.
Besides labor cost advantages, a possible advantage in some businesses can involve response time. One can exploit time zone differences to get work done more quickly, known as playing “beat the clock.” A request e-mailed at the end of the normal work day in the Western Hemisphere will arrive at the beginning of the normal work day in the East. So, by the time the normal work day starts again in the West, a number of work hours can be dedicated to the request.
However, there are many factors that militate against offshoring. Projects that require constant communication or refinement, seasonal or temporary services, services of insufficient size, services where local knowledge or tacit knowledge are important, where cultural differences are salient, or where cultural biases are present are poor candidates for offshoring. Even if the offshore unit is not outsourced, the physical distance can create problems: There may be an increased risk of loss of customer empathy and loss of career paths. Country risk needs to be considered when offshoring.
• Communication Requirements. The prior section ended with a possible increase in productivity and response time: Play “beat the clock” and magically get work done while you sleep. Frequently, a substantial amount of communication is required to get a job done correctly. For tasks that require a substantial interplay between customer and service provider time zone differences can cause problems.
• Cultural Bias. An important political issue is customer tolerance to offshoring. This is a political issue that is of great concern to many customers, just as the “made in America” campaigns caused customer anger at foreign manufactured goods years ago. There may be entirely xenophobic reactions by customers hating all offshoring, or customer objections might have an underlying racial element. For example, a customer may be quite angry at the thought of offshoring to India, but if the call is answered in Ireland, it’s “OK.”
• Country Risk. If international relations between countries become tense, governments may impose trade constraints, which could effectively shut down a business if all its back-office operations were being performed in that country. Some of the bills being considered in the U.S. Congress could shut down the medical transcription offshoring industry and the offshoring of many financial processes due to data privacy concerns.
• Cultural Differences. Potentially more important are the cultural and language differences between customers, domestic employees, and offshored employees. Although offshored workers assisting U.S. customers generally must understand the English language, there may be differences between how the workers and customers use language, leading to problems. Cultural problems also manifest themselves in terms of behavior, specifically humor or rudeness. What is merely “direct” in one culture is “rude” in another
• Local Knowledge/Tacit Knowledge Requirement. Other types of services where offshoring makes little sense are services where local knowledge or tacit knowledge are key. This type of knowledge has long been the “official” reason for giving travel agents free trips to resorts. Someone who has actually “been there and done that” is a better resource than someone looking at a description on a computer screen. Local knowledge can allow someone to say “I’ve seen a lot of people wearing that color in downtown Chicago this year,” or “if you’re rafting the Stanislaus River this May, you might also want a wet suit – the water is about 36 degrees.” Offshore employees just wouldn’t make the sale.
• Lack of Scale, Seasonality, and New Businesses. Scale is helpful – offshoring small tasks is more trouble than it can possibly be worth. Starting up an offshore destination often involves hiring an intermediary between the domestic and offshored workers, having executives travel and observe the offshore destination, and having a team “qualify” potential offshore suppliers, there is a large fixed cost to starting an offshore operation. This large fixed cost cannot be overcome unless the size of the job to be offshored is sufficiently large.
A similar problem with overcoming setup costs accrues to seasonal tasks and start-up operations. Seasonal work, like staffing retail oriented call centers during the Christmas season, is difficult to do in offshore environments due to the length of training offshore workers require. Similarly, start-up operations are usually both small and uncertain – their operations may change significantly, or even be shut down. The higher fixed cost of operating offshore is difficult to justify in these cases.
Academic Work in Services Offshoring
Services offshoring has garnered considerable research attention of late. Special issues of Journal of Operations Management (2008), Journal of International Business Studies (2009), and MIS Quarterly (2008) have been dedicated to the topic, as well as special issues of at least eight other academic business journals starting in 2007. Services offshoring also has been the sole focus of a conference held annually at the Fuqua School of Business, Duke University, since 2006.
The terms “outsourcing” and “offshoring” are used interchangeably by some, but they are very different concepts, with very different risks and benefits.
The vast majority of outsourcing is domestic, rather than offshore. Services outsourcing is commonplace and used by many businesses to cut costs or keep up with technological advance. However, it should not be entered into blindly. While there are many situations that call for outsourcing, there are also many situations that are best served by keeping tasks in-house. Services offshoring, while still small, has received enormous attention. This attention derives from labor rate differentials and the range of services moving offshore. White-collar, professional work, thought by workers in developed countries to be their exclusive domain, is now being offshored to less-developed nations. And those offshore workers have salaries as little as one-tenth of the workers they are replacing. A prevailing feeling among many is that no job is safe. However, there are many risks and downsides to offshoring. The loss of local and tacit knowledge, the cultural conflict, and the additional country risk associated with offshoring argue that many information-oriented jobs will remain onshore.
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