Offshoring

This article is about the business process. For other uses, see Offshore (disambiguation).

Offshoring is the relocation of a business process from one country to another—typically an operational process, such as manufacturing, or supporting processes, such as accounting. Typically this refers to a company business, although state governments may also employ offshoring. More recently, offshoring has been associated primarily with the outsourcing of technical and administrative services supporting domestic and global operations from outside the home country ("offshore outsourcing"), by means of internal (captive) or external (outsourcing) delivery models.

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. Another focus area has been the software industry as part of global software development and developing global information systems. 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, sometimes called labor arbitrage, to improve corporate profitability. Jobs are added in the destination country providing the goods or services (generally a lower-cost labor country), but are subtracted in the higher-cost labor country. The increased safety net costs of the unemployed may be absorbed by the government (taxpayers) in the high-cost country or by the company doing the offshoring. Europe experienced less offshoring than the United States due to policies that applied more costs to corporations and cultural barriers.

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 because of a lower cost of operations in the new location. More recently, offshoring drivers also include access to qualified personnel abroad, in particular in technical professions, and increasing speed to market. Offshoring is sometimes contrasted with outsourcing or offshore outsourcing. Outsourcing is the movement of internal business processes to an external organizational unit. Outsourcing refers to the process by which an organization gives part of its work to another firm / organization and makes it responsible for most of the applications as well as the design of the enterprise business process. This process is done under restrictions and strategies in order to establish consistency with the offshore outsourcing organizations. Many companies nowadays outsource various professional areas in the company such as e-mail services, payroll and call center. These jobs are being handled by other organizations that specialize in each sector allowing the offshoring company to focus more on other business concerns . However, 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 or rightshoring, 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, in order to improve products and create new reference designs, require 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 move work offshore 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.

A major incentive for physical restructuring arrived 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, cheap 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.

IT-enabled services offshoring

The growth of IT-enabled 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. Services include administrative services, such as finance and accounting, HR, and legal; call centers; marketing and sales services; IT infrastructure; application development; and knowledge services, including engineering support, product design, research and development, and analytics.

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. This spawned the neologism Bangalored, used to indicate a layoff, often systemic, and usually resulting from corporate outsourcing to lower wage economies – derived from Bangalore in India, where some of the first outsource centers were located.

Currently, India's low-cost labor has made it an offshoring destination for global firms like HP, IBM, Accenture, Intel, AMD, Microsoft, Oracle Corporation, Cisco, SAP, and BEA.

Because of inflation, high domestic interest rates, robust economic growth and increased IT offshoring, the Indian IT sector has witnessed 10 - 15% wage growth in the 21st century. Consequently, Indian's operations and firms are concerned that they are becoming too expensive in comparison with competition from the other offshoring destinations. To maintain high growth rates, attempts have been made to grow up the value chain 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 Eastern European countries, such as Poland and Romania, where proficiency in German is common. French companies outsource to North Africa for similar reasons. For Australian IT companies, Indonesia is one of the major choice of offshoring destination. Near-shore location, common time zone and adequate IT work force are the reasons for offshoring IT services to Indonesia.

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, including some in Silicon Valley, started offshoring innovation work to countries like Belarus, South Africa, India, China, Mexico, Russia and Ukraine. Accessing the talent pools in these countries has the potential to cut costs or even shorten product lifecycles. Developing countries like India are also involved in this practice.

When offshoring knowledge work, firms heavily rely on the availability of technical personnel at offshore locations. In order to secure access to talent, Western firms often establish collaborative relationships with technical universities abroad and thereby customize university programs to serve their particular needs. Examples include universities in Shanghai, such as Tong-Ji University, where German firms and scholars co-sponsor labs, courses, and provide internships. Similar examples of collaborative arrangements can be found in Eastern Europe, e.g. Romania. Additionally, EU companies looking for IT innovation often setup collaboration with universities in countries such as Belarus and Ukraine, which have a high percentage of ICT graduates and overall a very skilled IT labor.

Re-shoring

See also: Insourcing

"Re-shoring", also known as "backshoring" or "inshoring" is offshoring that has been brought back onshore.

John Urry (distinguished professor of sociology at Lancaster University) argues that the concealment of income, the avoidance of taxation and eluding legislation relating to work, finance, pleasure, waste, energy and security may be becoming a serious concern for democratic governments and ordinary citizens who may be adversely affected by unregulated, offshore activities. Further, the rising costs of transportation could lead to production nearer the point of consumption becoming more economically viable, particularly as new technologies such as additive manufacturing mature

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

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 increases 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.

Impact on jobs in western countries

The Economist reported in January 2013 that: "High levels of unemployment in Western countries after the 2007-2008 financial crisis have made the public in many countries so hostile towards offshoring that many companies are now reluctant to engage in it." Economist Paul Krugman wrote in 2007 that while free trade among high-wage countries is viewed as win-win, free trade with low-wage countries is win-lose for many employees who find their jobs offshored or with stagnating wages. Two estimates of the impact of offshoring on U.S. jobs were between 150,000 and 300,000 per year from 2004-2015. This represents 10-15% of U.S. job creation. U.S. opinion polls indicate that between 76-95% of Americans surveyed agreed that "outsourcing of production and manufacturing work to foreign countries is a reason the U.S. economy is struggling and more people aren't being hired."

The increased safety net costs of the unemployed may be absorbed by the government (taxpayers) in the high-cost country or by the company doing the offshoring. Europe experienced less offshoring than the U.S. due to policies that applied more costs to corporations and cultural barriers.

Legal implications in Japan

Japanese companies often exploits the foreign labors, particularly Chinese and Vietnamese, by violating the Employment Security Act, and Labor Standard Act set by ministry of health and labors in Japan using the name of offshoring.

Article 44 of Employment Security Act in Japan implicitly bans the domestic/foreign workers being supplied by unauthorized companies regardless of their operating locations. Law will apply if at least one party of suppliers, clients, labors reside in Japan, and if the labors are the integral part of the chain of command by the client company, or the supplier.

No person shall carry out a labor supply business or have workers supplied by a person who carries out a labor supply business work under his/her own directions or orders, except in cases provided for in the following Article.

— Employment Security Act

Those deemed to violate will be punished with

A person who falls under any of the following items shall be punished by imprisonment with work for not more than one year or a fine of not more than one million yen

— Employment Security Act states, Article 64

as well as the punishment defined by the article 6 of Labor Standards Act in Japan,

Unless permitted by act, no person shall obtain profit by intervening, as a business, in the employment of other

— Labor Standards Act

Victims can lodge a criminal complaint against the CEO of the suppliers and clients in the Labor Standards Inspection Office (only applicable to Labor Standards Act) or Public Prosecutor's Office of the respective company location. Due to the risk of the CEO's arrest, Japanese company accustoms to the private settlement with financial package in the range between 20 and 100 million JPY (200,000 - million USD).

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. Many companies have caught much public ire for their decisions to use foreign labor for customer service and technical support, mostly because of the apparent language barrier that it creates. While some nations have 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 and Europe.

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.

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 before 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.

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 because of the years of study and cost of education involved. Anecdotal evidence also suggests they would be rejected for being overqualified.

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 manufacturing jobs out of the country dates to at least the 1960s while moving knowledge service jobs offshore dates to the 1970s 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. Because of 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.

See also

• Tax haven
• Anti-Globalism
• Call center security
• Globally Integrated Enterprise
• Globality
• Homeshoring
• Inshoring
• Offshoring Research Network
• Outsourcing
• Personal offshoring
• Restructuring
• Runaway production
• Programmers Guild
• Follow-the-sun
• Decline and Fall of the American Programmer
• Job migration

By sector:

• Business process outsourcing
• Information technology consulting
• Legal outsourcing
• Offshore software R&D

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
• 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 SSRN 803906
• Mark Kobayashi-Hillary, 'Who Moved My Job?' (2008). ISBN 978-1-4092-7107-9.
• 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 0-7619-3525-8, ISBN 978-0-7619-3525-4
• Catherine Mann, Accelerating the Globalization of America: The Role for Information Technology, Institute for International Economics, Washington D.C., June 2006, 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.
• Stephan Manning, Joerg Sydow and Arnold Windeler, "Securing Access to Lower-Cost Talent Globally: The Dynamics of Active Embedding and Field Structuration”, in: Regional Studies, Forthcoming (2011).
• 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
• Wolfgang Messner, "Intelligent IT Offshoring to India. Roadmaps for Emerging Business Landscapes", Palgrave Macmillan, ISBN 978-0-230-24626-3
• Toledo Mario, "Outsourcing and Offshoring:Companies and governments immerged in a complex environment" a Research Project for Global Innovation at Hamburg University of Technology, August 2007, [1]
• Rosemary Coates, '42 Rules for Sourcing and Manufacturing in China (2nd Edition): A practical handbook for doing business in China, special economic zones, factory tours and manufacturing quality' (July 2013). ISBN 978-1-607730972