Offshoring

Offshore may refer to oil and natural gas production at sea; see oil platform.

Offshoring describes the relocation by a company of a business process from one country to another -- typically an operational process, such as manufacturing, or supporting processes, such as accounting. Even state governments employ offshoring.

The term is in use in several distinct but closely related ways. It is sometimes used broadly to include substitution of a service from any foreign source for a service formerly produced internally to the firm. In other cases, only imported services from subsidiaries or other closely related suppliers are included. A further complication is that intermediate goods, such as partially completed computers, are not consistently included in the scope of the term.

Offshoring can be seen in the context of either production offshoring or services offshoring. After its accession to the World Trade Organization (WTO) in 2001, the People's Republic of China emerged as a prominent destination for production offshoring. After technical progress in telecommunications improved the possibilities of trade in services, India became a country leading in this domain though many parts of the world are now emerging as offshore destinations.

The economic logic is to reduce costs. If some people can use some of their skills more cheaply than others, those people have the comparative advantage. The idea is that countries should freely trade the items that cost the least for them to produce.

Frequently used terms

Offshoring is defined as the movement of a business process done at a company in one country to the same or another company in another, different country. Almost always work is moved due to a lower cost of operations in the new location. Offshoring is sometimes contrasted with outsourcing or offshore outsourcing. Outsourcing is the movement of internal business processes to an external company. Companies subcontracting in the same country would be outsourcing, but not offshoring. A company moving an internal business unit from one country to another would be offshoring or physical restructuring, but not outsourcing. A company subcontracting a business unit to a different company in another country would be both outsourcing and offshoring.

Related terms include nearshoring, which implies relocation of business processes to (typically) lower cost foreign locations, but in close geographical proximity (e.g., shifting United States-based business processes to Canada/Latin America); inshoring, which means picking services within a country; and bestshoring, picking the "best shore" based on various criteria. Business process outsourcing (BPO) refers to outsourcing arrangements when entire business functions (such as Finance & Accounting, Customer Service, etc.) are outsourced. More specific terms can be found in the field of software development - for example Global Information System as a class of systems being developed for / by globally distributed teams.

A further term sometimes associated with offshoring is bodyshopping which is the practice of using offshored resources and personnel to do small disaggregated tasks within a business environment, without any broader intention to offshore an entire business function.

Production offshoring

Production offshoring also known as physical restructuring of established products involves relocation of physical manufacturing processes to a lower-cost destination. Examples of production offshoring include the manufacture of electronic components in Costa Rica, production of apparel, toys, and consumer goods in China, Vietnam etc.

Product design, research and the development process that leads to new products, are relatively difficult to offshore. This is because research and development to improve products and create new reference designs requires a skill set that is harder to obtain in regions with cheap labor. For this reason, in many cases only the manufacturing will be offshored by a company wishing to reduce costs.

However, there is a relationship between offshoring and patent system strength. This is because companies under a strong patent system are not afraid to offshore work because their work will remain their property. Conversely, companies in countries with weak patent systems have an increased fear of intellectual property theft from foreign vendors or workers, and, therefore, have less offshoring.

Physical restructuring got its big push when the North American Free Trade Agreement (NAFTA) made it easier for manufacturers to shift production facilities from the US to Mexico. This trend later shifted to China, which offered cheap prices through very low wage rates, few workers' rights laws, a fixed currency pegged to the US dollar, (currently fixed to a basket of economies) cheap loans, land, and factories for new companies, few environmental regulations, and huge economies of scale based on cities with populations over a million workers dedicated to producing a single kind of product. However, many companies are reluctant to move high value-added production of leading-edge products to China because of lax enforcement of intellectual property laws. CAFTA has increased the velocity at which physical restructuring is occurring.

Services offshoring

The growth of services offshoring is linked to the availability of large amounts of reliable and affordable communication infrastructure following the telecommunication and Internet expansion of the late 1990s. This was seen all the way up to the year 2000. Coupled with the digitization of many services, it was possible to shift the actual production location of services to low cost countries in a manner theoretically transparent to end-users.

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. In the late 1990s, India's abundant and cheap software engineering talent combined with massive demand from the Y2K problem helped to move India up the value chain to attract large-scale software development projects for US based customers. This spawned the neologism Bangalored, used to indicate a layoff, often systemic, and usually due to corporate outsourcing to lower wage economies – derived from Bangalore in India, where some of the first outsource centers were located.

Currently, India's engineering talent has made India the offshoring destination of American high-tech firms, led by HP, IBM, Intel, AMD, Microsoft, Oracle Corporation, and Cisco. Each of these companies has promised or is in the process of investing at least $1 billion in India, to supposedly retain market share in the face of competition and cost-cutting measures of rivals and industry in general.

As a result of the offshoring boom, India has seen double-digit wage growth for much of the 2000s. Consequently, Indian's operations and firms are concerned that they are becoming too expensive in comparison with competition from the other offshoring destinations listed below. They are now attempting to branch out and diversify to other high-end work in addition to software and hardware engineering. These jobs include research and development, equity analysis, tax-return processing, radiological analysis, medical transcription, and more.

The choice of offshoring destination is often made according to cultural concerns. Japanese companies are starting to outsource to China, where large numbers of Japanese speakers can be found — particularly in the city of Dalian, which was Japanese-occupied Chinese territory for decades (this is discussed in the book The World is Flat). German companies tend to outsource to Poland and Romania, where proficiency in German is common. French companies outsource to North Africa for similar reasons.

Other offshoring destinations include Mexico, Central and South America, the Philippines, South Africa and Eastern European countries.

The Central America Free Trade Agreement (CAFTA) made nearshoring more attractive between the Central American countries of Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic and the US.

Innovation offshoring

Once companies are comfortable with services offerings and started realizing the cost savings, many high-tech product companies started using countries like South Africa, India, Pakistan, China, Mexico, Russia, etc. for innovating products.

Many famed Silicon Valley based companies jumped on this bandwagon not only to cut costs but to shorten their product lifecycle and access the talent pool available in these countries. Less developed countries are usually utilized for this practice.

Transfer of intellectual property

Offshoring is often enabled by the transfer of valuable information to the offshore site. Such information and training enables the remote workers to produce results of comparable value previously produced by internal employees. When such transfer includes protected materials, as confidential documents and trade secrets, protected by non-disclosure agreements, then intellectual property has been transferred or exported. The documentation and valuation of such exports is quite difficult, but should be considered since it comprises items that may be regulated or taxable.

Debate

Template:POV-section Offshoring has been a controversial issue spurring heated debates among economists, some of which overlap those related to the topic of free trade. It is seen as benefiting both the origin and destination country through free trade, providing jobs to the destination country and lower cost of goods and services to the origin country. This makes both sides see increased gross domestic product (GDP). And the total number of jobs increase in both countries since those workers in the origin country that lost their job can move to higher-value jobs in which their country has a comparative advantage.

On the other hand, job losses and wage erosion in developed countries have sparked opposition to offshoring. Experts argue that the quality of any new jobs in developed countries are less than the jobs lost and offer lower pay. Economists against offshoring charge that currency manipulation by governments and their central banks causes the difference in labor cost creating an illusion of comparative advantage. Further, they point out that even more educated highly trained workers with higher-value jobs such as software engineers, accountants, radiologists, and journalists in the developed world have been displaced by highly-educated and cheaper workers from India and China. On May 1, 2002, Economist and former Ambassador Ernest H. Preeg testified before the Senate committee on Banking, Housing, and Urban Affairs that China, for instance, pegs its currency to the dollar at a sub-par value in violation of Article IV of the International Monetary Fund Articles of Agreement which state that no nation shall manipulate its currency to gain a market advantage. Traditionally "safe" developed world jobs in R&D and the Science, Technology, Engineering, and Mathematics (STEM) fields are now perceived to be endangered in these countries as higher proportions of workers are trained for these fields in developing nations. Economists such as Paul Craig Roberts claim that those economists who promote offshoring misunderstand the difference between comparative advantage and absolute advantage.

Not surprisingly, many U.S. executives cite the current unemployment numbers (4.5%)</ref> as proof positive that offshoring has not been deleterious to the U.S. workforce, or to the nation itself. It could be argued that one of the problems in using current unemployment numbers is that the figure does not factor underemployment.

More importantly, the argument does not contemplate, nor predict effects of continued offshore outsourcing that may occur 10–20 years from now, for example the possible raise of labor costs in emerging countries and a change in their economic orientations, as happened for example in Japan and South Korea in the previous decades.

Falling employment in manufacturing has generated much fear among industrial workers, although total employment has been rising in many countries. The effect of this has been shown to be much higher than that of offshoring or foreign investments, which has nevertheless been accused of being the cause of unemployment, since big offshoring projects are more visible than the slow change from an industrial society to a post-industrial society. Even so, job creation was slow and wage growth low during the 2000-2005 period in the US. Some attribute that to offshoring. Long term unemployment, as a percentage of total employment, has been steadily increasing since 1970. 2003 saw 22%+ long term unemployment. By March 2009, 45.6% of those on unemployment insurance exhausted funds and found no job.

Level-of-service concerns

With the offshoring of call-center type applications, debate has also surfaced that this practice does serious damage to the quality of customer service and technical support that customers receive from companies who do it. Call centers have sprung up in South Africa, India, Canada and the Caribbean. Many US companies have caught much public ire in the US for their decisions to use Indian labor for customer service and technical support, mostly because of the apparent language barrier that it creates. While India, for example, has a high level of younger skilled workers who are capable of speaking English as one of their native languages, their English skills have caused debate in North America.

Criticisms of outsourcing from much of the American public have been a response to what they view as very poor customer service and technical support being provided by overseas workers attempting to communicate with Americans.

However it has been argued by others that call-centers are just one facet of offshore outsourcing. The outsourcing companies often have high rating and are accepted as dynamic, innovative entities. For example, Infosys has obtained an SEI-CMM level 5 indicating the high quality output of the company. Outsourcing also has grown considerably in magnitude which could not have happened if level of service from outsourcing vendors are of poor quality.

Supply chain concerns

Some claim that companies lose control and visibility across their extended supply chain under outsourcing, creating increased risks. A 2005 quantitative survey of 121 electronics industry participants by Industry Directions Inc and the Electronics Supply Chain Association (ESCA) found that 69% of respondents said they had less control over at least 5 of their key supply chain processes since the outsourced model took hold, while 66% of providers felt their aggregate risk with customers was high or very high. 36% of providers responded that they felt an increased risk of uncertainty compared to their uncertainty risk prior to the rise to prominence of the outsourced model. 62% of respondents described as "problematic" at least two core trading partner management practices, which included performance management and simple agreement on results. 40% of all respondents encountered resistance to sharing risk in outsourced partnership agreements, according to the research.

Competitive concerns

The transfer of knowledge outside a country may create competitors to the original companies themselves. Chinese manufacturers are already selling their goods directly to their overseas customers, without going through their previous domestic intermediaries that originally contracted their services. In the 1990s and 2000s, American automakers increasingly turned to China to create parts for their vehicles. By 2006, China leveraged this know-how and announced that they will begin competition with American automakers in their home market by selling fully Chinese automobiles directly to Americans.

When a company moves the production of goods and services to another country, the investment that companies would otherwise make in the domestic market is transferred to the foreign market. Corporate money spent on factories, training, and taxes, which would otherwise be spent in the market of the company is then spent in the foreign market.

As production increases in the foreign market, qualified and experienced domestic workers leave or are forced out of their jobs, often permanently leaving the industry. At some point, dramatically fewer domestic workers are left who are qualified to perform the work. This makes the domestic market dependent on the foreign market for those goods and services, thereby strategically weakening the "hollowed-out" domestic country. In effect, offshoring creates and strengthens the competitive industries of the foreign country while strategically weakening the domestic country.

However, employment data has cast doubt on this claim. For example, IT employment in the United States has recently reached pre-2001 levels and has been rising since. The number of jobs lost to offshoring is less than 1 percent of the total US labor market. According to a study by the Heritage foundation, outsourcing represents a very small proportion of jobs lost in the US. The total number of jobs lost to offshoring, both manufacturing and technical represent only 4 percent of the total jobs lost in the US. Major reasons for cutting jobs are from contract completion and downsizing. Some economists and commentators claim that the offshoring phenomenon is way overblown.

Educational concerns

Offshoring proponents often say it is necessary to move jobs overseas due to a looming shortage of qualified workers in the domestic market and the booming number of qualified candidates in foreign markets, particularly in China and India. A study by Duke University found that 222,335 engineers graduate annually from American universities, far more than the 70,000 often quoted in the media. Furthermore, the Duke study highlights the conflicting numbers coming out of China, India, and the US. China and India, in their official numbers cited by the media, both count the graduates from three year training programs and diploma holders, equivalent to Associates degrees in the US. The media then compares the China and India numbers to US numbers of four-year Baccalaureate programs. Duke University estimates the total number of engineers with Bachelor's degrees produced annually for the three countries to be 351,537 for China, 112,000 for India, and 137,436 for the US. These figures make the US the per capita leader in producing technology specialists.

However, other studies do point out that the US does not produce as many science and engineering graduates as required, because US students do not show adequate interest in math and science. According to a National Academy of Sciences study, the US graduates far fewer engineers than either China or India. According to a Raytheon study, a survey of 11 to 13 year old students in the US revealed that numerous students would rather clean their rooms, eat vegetables, go to the dentist or empty the trash than do math. About 50% of the doctoral degrees awarded in the US are to foreign born students.

Retraining concerns

One solution often offered for domestic workers displaced by offshoring is retraining to new jobs. Some displaced workers are highly educated and possess graduate qualifications. Retraining to their current level in another field may not be an option due to the years of study and cost of education involved.

Effects of factor of production mobility

According to classical economics, the three factors of production are land, labor, and capital. Offshoring relies heavily on the mobility of two of these factors. That is, how offshoring affects economies depends on how easily capital and labor can be repurposed. Land, as a factor of production, is generally seen to have little or no mobility potential.

The effects of capital mobility on offshoring have been widely discussed. In microeconomics, a corporation must be able to spend working capital to afford the initial costs of offshoring. If the state heavily regulates how a corporation can spend its working capital, it will not be able to offshore its operations. For the same reason the macroeconomy must be free for offshoring to succeed. Generally, those who favor offshoring support capital mobility, and those who oppose offshoring call for greater regulation.

Labor mobility also plays a major role, and it is hotly debated. When computers and the Internet made work electronically portable, the forces of free market resulted in a global mobility of work in the services industry. Most theories that argue offshoring eventually benefits domestic workers assume that those workers will be able to obtain new jobs, even if they have to obtain employment by downpricing themselves back into the labor market (by accepting lower salaries) or by retraining themselves in a new field. Foreign workers benefit from new jobs and higher wages when the work moves to them.

History

In the developed world, moving jobs out of the country dates to at least the 1960s and has continued since then. It was characterized primarily by the transferring of factories from the developed to the developing world. This offshoring and closing of factories has caused a structural change in the developed world from an industrial to a post-industrial service society.

During the 20th century, the decreasing costs of transportation and communication crossed with great disparities on pay rates made increased offshoring from wealthier countries to less wealthy countries financially feasible for many companies. Further, the growth of the Internet, particularly fiber-optic intercontinental long haul capacity, and the World Wide Web reduced "transportation" costs for many kinds of information work to near zero.

With the development of the Internet, many new categories of work such as call centres, computer programming, reading medical data such as X-rays and magnetic resonance imaging, medical transcription, income tax preparation, and title searching are being offshored.

Before the 1990s, Ireland was one of the poorest countries in the EU. Due to Ireland's relatively low corporate tax rates, US companies began offshoring of software, electronic, and pharmaceutical intellectual property to Ireland for export. This helped create a high-tech "boom" and which led to Ireland becoming one of the richest EU countries.

In 1994 the North American Free Trade Agreement (NAFTA) went into effect. As concerns are widespread about uneven bargaining powers, and risks and benefits, negotiations are often difficult, such that the plan to create free trade areas (such as Free Trade Area of the Americas) has not yet been successful. In 2005, offshoring of skilled work, also referred to as knowledge work, dramatically increased from the US, which fed the growing worries about threats of job loss.

Literature

• Ashok Deo Bardhan and Cynthia Kroll, "The New Wave of Outsourcing" (November 2, 2003). Fisher Center for Real Estate & Urban Economics. Fisher Center Research Reports: Report #1103. http://repositories.cdlib.org/iber/fcreue/reports/1103
• Alan E. Blinder, Offshoring: The Next Industrial Revolution?, in: Foreign Affairs, Vol. 85, No.2, March/April 2006, 113-128.
• Vinaj Couto, Mahadeva Mani, Vikas Sehgal, Arie Y. Lewin, Stephan Manning, Jeff W. Russell, Offshoring 2.0: Contracting Knowledge and Innovation to Expand Global Capabilities Offshoring Research Network 2007 Service Provider Report.
• Georg Erber, Aida Sayed-Ahmed, Offshore Outsourcing - A Global Shift in the Present IT Industry , in: Intereconomics, Volume 40, Number 2, March 2005, 100 - 112, [5]
• Thomas L. Friedman, The World is Flat: A Brief History of the Twenty-First Century 2005 ISBN 0-374-29288-4
• Gary Gereffi and Vivek Wadhwa, "Framing the Engineering Outsourcing Debate: Placing the United States on a Level Playing Field with India and China" (2006) http://memp.pratt.duke.edu/outsourcing
• Ron Hira and Anil Hira, with forward by Lou Dobbs, Outsourcing America: What's behind Our National Crisis and how we can reclaim American Jobs. (May 2005). ISBN 0-8144-0868-0.
• Bradford Jensen and Lori Kletzer (September 2005), "Tradable Services: Understanding the Scope and Impact of Services Outsourcing", Institute for International Economics Working Paper No. 05-9 Template:SSRN
• Mark Kobayashi-Hillary, 'Building a Future with BRICs: The Next Decade for Offshoring' (Nov 2007). ISBN 978-3-540-46453-2.
• Mark Kobayashi-Hillary & Dr Richard Sykes, 'Global Services: Moving to a Level Playing Field' (May 2007). ISBN 978-1-902505-83-1.
• William Lazonick, Globalization of the ICT Labor Force, in: The Oxford Handbook on ICTs, eds. Claudio Ciborra, Robin Mansell, Danny Quah, Roger Solverstone, Oxford University Press, (forthcoming)
• Arie Y. Lewin and Vinaj Couto, Next Generation Offshoring: The Globalization of Innovation Offshoring Research Network 2006 Survey Report.
• Mario Lewis, IT Application Service Offshoring: An Insider's Guide, Sage Publications, ISBN 0761935258, ISBN 978-0761935254
• Catherine Mann, Accelerating the Globalization of America: The Role for Information Technology, Institute for International Economics, Washington D.C., June 2006, [6], ISBN paper 0-88132-390-X
• Stephan Manning, Silvia Massini and Arie Y. Lewin, "A Dynamic Perspective on Next-Generation Offshoring: The Global Sourcing of Science and Engineering Talent", in: Academy of Management Perspectives, Vol. 22, No.3, October 2008, 35-54.[7]
• McKinsey Global Institute; “Offshoring: Is It a Win-Win Game?”, August 2003
• Bharat Vagadia, "Outsourcing to India: A Legal Handbook", August 2007, Springer, ISBN 978-3-540-72219-9
• Atul Vashistha and Avinash Vashistha, The Offshore Nation, ISBN 0-07-146812-9

See also

• Anti-Globalism
• Business process outsourcing
• Call center security
• Decline and Fall of the American Programmer
• Globally Integrated Enterprise
• Globality
• Homeshoring
• Information technology consulting
• Inshoring
• Offshore software outsourcing
• Offshoring IT Services
• Offshoring Research Network
• Outsourcing
• Personal offshoring
• Restructuring
• Runaway production
• Legal outsourcing
• Programmers Guild
• Follow-the-sun

External links

News

• http://www.bls.gov/eag/eag.us.htm
• BusinessWeek online on "Let's Offshore The Lawyers"
• Offshore Outsource Savings Can Be Elusive, Survey Shows
• Don't be afraid of offshoring - by Diana Farrell
• Ensuring India's offshoring future - Article by Diana Farrell, Sascha Stürze & Noshir Kaka based on a 12-month research project conducted by the McKinsey Global Institute on the "Emerging Global Labor Market" (see Research section below)
• Latin America: Outsourcing's New Hot Spot
• GE ex-CEO Welch blasts opponents of offshoring by Anupama Chandrasekaran, Forbes.com
• At Mysore We are Running a US Law Firm by Shelley Singh (Economic Times)
• Fortune 500 firms driving LPO industry by Praveen Bose (Business Standard)
• U.S. corporates outsource legal work to India by Anjali Prayag (The Hindu Business Line)
• New York Firm Takes On India... "Very Nice!" by Heather Greenwood Davis (The Globe and Mail -- Lexpert Magazine)
• LPOs add more punch to India action by Sushmita Mohapatra & P P Thimmaya (The Economic Times)
• Now, for some LPO action by Sachin Malhan (The Hindu)

Research

• Offshoring Research Network
• Book:: Offshoring IT Services : A Framework for Managing Outsourced Projects
• Report from the BCS on offshoring and outsourcing with regard to IT
• Report by McKinsey and Nasscom regarding skills and quality of Indian workforce
• Essay on the "Fear of Offshoring" by Alan S. Blinder, Princeton University
• Zinnov Report on Product Innovation: Growing up the value chain
• Outsourcing and Offshoring: Companies immersed in a complex environment,, Project work by Mario Toledo Dominguez at the Institute of Technology and Innovation Management of Hamburg University of Technology.

Internet articles

• Nearshore outsourcing is more cost efficient than offshore outsourcing - By H. Boersen, W. Gils (van) & M. Zantinge
• Risks, Rewards, Challenges and Opportunities in Offshore Outsourcing By Akshay Upadhye
• Offshore Outsourcing of Data Services by Insured Institutions and Associated Consumer Privacy Risks (www.fdic.gov)
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