Offshoring is a strategic business move where a company relocates part of its operations, functions, or services to a foreign country.  This strategy grants companies various advantages including cost reduction, talent acquisition, filling skill gaps, expanding market share, and increasing profitability.

Offshoring - a necessary strategy in modern world

The world is interconnected today. This interconnection, while providing benefits, also poses challenges to businesses. One primary challenge is increased competition from foreign companies. Therefore, businesses are constantly trying new ways to optimize their operations for competitive advantage. 

Well in pursuit of this optimization, businesses can again reap the benefits of an interconnected world again. It might sound confusing, here is the catch. An interconnected world allows companies to hire talent from far away countries, set up their operation in low cost countries and cut down significant business expenses by moving a portion of their business to another country.

This is how Apple cut down its costs by moving its production to Asian countries. And so is Google by moving operations to India. And Amazon, IBM, Deloitte...and almost all multinational companies.

This practice is commonly called ‘offshoring’ which emerged with globalization has reshaped the global business landscape completely. Like we started, an interconnected world offers both opportunities and challenges and so is offshoring. We will discuss everything in this post. But let's begin with understanding the meaning and definition of offshoring.

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What is Offshoring?

As stated earlier, offshoring is the relocating of specific business functions or services to another country. Generally, this is a strategic move to take advantage of ‘labor arbitrage.’ A company has to consider factors like cost, talent access, infrastructure, market opportunity, and regulatory compliance before this strategic move.

Offshoring: Pros and Cons

Offshoring advantages

Offshoring offers some significant advantages to businesses apart from saving costs. This section explains the various advantages a company gets when it relocates its business processes to a foreign country.

Greater scalability and availability

When companies decide to take their business offshore, they essentially operate in multiple locations and time zones while benefitting from labor arbitrage. So even if they are scaling up, they can keep the expenses low. By establishing services in multiple locations allows companies to target customers worldwide and scale up their operations at a reduced cost. Moreover, they can ensure 24/7customer assistance by having operation centers in different geographical regions.

Better control over distribution

Offshoring allows companies to expand their operations closer to the target market and customers. This also brings the suppliers, vendors, and clients close. This close proximity results in faster turnaround times, improved speed to market, and enhanced distribution capabilities. Importantly, offshored processes can remain internal, allowing companies to maintain control and influence over decision-making in overseas operations.

Cost savings

This is definitely the primary advantage of offshoring. Labor costs are often lower in offshore locations, especially for labor-intensive processes such as manufacturing, customer support, and IT. They can also leverage the availability of cheaper resources and reduce overall operating expenses. This will, in turn, lead to improved cash flow and increased profitability. Increased profitability further allows companies to reinvest in research, development, and growth, thereby leading to a virtuous cycle.

Foreign government incentives

Governments in developing countries offer incentives to attract companies to set up offshore operations in their countries. The incentives can include lower tax rates, subsidized land allotment, production/manufacturing linked incentives and lenient regulations. While this allows the government to generate employment in their countries, companies can utilize these favorable incentives to their strategic advantages.

Access to high skilled talent

Offshoring provides access to a wider talent pool with specialized skills or market insights that may not be readily available in the company's home location. This expanded access to talent can be particularly beneficial for companies requiring employees with specific skills or knowledge to perform certain business functions.

Scalability and global expansion

Offshoring serves as a strategic tool for global expansion. It allows businesses to establish a presence in foreign countries, broaden their reach, expand their customer base, and gain valuable insights into new markets. This global presence can be a crucial factor in a company's long-term growth strategy.

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Offshoring Disadvantages

Cultural and Communication Barriers

Different countries have different languages and different cultures. What is acceptable and normal in one country may not be accepted in another country. While offshoring to a new country, companies have to consider this difference and how it can impact their business. 

Teams in different locations may experience differences in language, culture, and communication styles, leading to misunderstandings and reduced collaboration between onshore and offshore teams. These barriers can result in operational errors, delays, and supply chain complexities, making it difficult to maintain consistent quality control and standards across different locations.

Time zone differences

Operating across different time zones can lead to delays in communication and project timelines. Scheduling meetings, coordinating tasks, and resolving issues effectively between distributed teams can be challenging. These time differences can impact productivity and efficiency if not managed properly.

Data security

Offshoring often involves sharing sensitive data with external partners, which can raise significant data security and privacy concerns. Companies must implement robust measures to protect intellectual property (IP) and ensure effective privacy safeguards. Failure to do so can result in unauthorized use, disclosure, or infringement of proprietary information.

Compliance challenges

Navigating the complex landscape of labor laws and commercial regulations across different countries can be time-consuming and challenging. Each country has its own set of rules and requirements, and failure to comply with local laws can result in severe legal and financial consequences. Businesses must ensure compliance with all applicable regulations when offshoring in foreign countries, which can be a significant undertaking.

Hidden costs

While cost savings are often touted as a major benefit of offshoring, companies may encounter unexpected expenses as they establish operations in new locations. These hidden costs can include setup expenses, employee training, travel costs, and unforeseen challenges that can negatively impact a company's overall offshoring budget. It's crucial for businesses to carefully consider and account for these potential hidden costs when planning their offshoring strategy.

Industries most widely using offshoring model

While offshoring practices can be found across various sectors, some industries have been particularly quick to adopt this strategy:

• BPO (Business Process Outsourcing): Functions such as human resources, accounting, and data entry are commonly offshored to streamline operations and reduce costs.
• Information Technology: Software development, IT support, and data management are frequently offshored due to the availability of skilled tech professionals in countries like India and the Philippines.
• Manufacturing: Many companies have moved their production facilities to countries with lower labor and operational costs, such as China, Vietnam, and Mexico.
• Customer Service: Call centers and customer support operations are often offshored to countries with large English-speaking populations, like India and the Philippines.

Also Read: An Essential Guide to Understand Knowledge Process Outsourcing

Offshoring vs. outsourcing

Often used interchangeably, offshoring and outsourcing are different in many ways. The common ground of entrusting a third party for business functions with an objective to cut down costs is why people perceive both as similar.

But diving deeper, one can easily find the difference between offshoring and outsourcing. While outsourcing involves contracting to a third party vendor, offshoring is practically relocating the business processes to another country. 

Offshoring is a long term business strategy that may not generate immediate returns for companies. Contrary to that, outsourcing is considered when companies look for short term results and returns. 

Offshoring involves setting up a subsidiary in another country under the parent company’s umbrella. This helps companies to expand businesses to new markets. However, outsourcing helps in filling the capacity, skill or knowledge gap.

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Successful offshoring case study

General Electric case study

General Electric or GE was one of the first multinational companies offshore its business functions to India in the 1990s. That was the time when India decided to liberalize its economy and open its borders to globalization. GE opened its offshore center in Gurugram (then called Gurgaon) and named it GECIS (GE Capital International Services). The primary function of this center was to provide back office services such as finance, accounting, and customer support services.

What challenges did the company face?

The company faced several challenges in the beginning. Finding the right talent, providing the IT and communication infrastructure, integration with its global operations, and bridging the cultural gap between the Indian workforce and its native corporate culture are some of the notable challenges.

How did it overcome the challenges?

India has always had a high English proficiency compared to other countries. Hence finding English speaking professionals was not a hurdle for the company. Therefore, GE invested heavily in training the local workforce through development programs. The efforts paid off well and the workforce was aligned with its global standards soon. 

While GE continued its training programs, it soon invested in Innovation and growth as well. That made GECIS into an innovation hub from just a back-office support center. This hub later contributed to GE’s global research and development efforts. 

What did the company gain?

The offshore office in India significantly reduced operational costs for GE, which then helped the company achieve greater profitability. The initial investment by GE to develop GECIS as a hub for growth and innovation provided hefty returns later. 

“Jack Welsh, former CEO of GE had admitted that GECIS was a key driver of GE’s growth between 1998 and 2001, and it helped in reducing operating costs by USD 1 billion during the period.”

GECIS, which started with 20 employees in 1997, later evolved to become a multinational business process service provider - Genpact, with over 120,000 employees in 2023.

Future of Offshoring

The global economy keeps changing and so do the ways how companies guide their businesses through all the phases. Recently the AI boom has had a noticeable impact on offshoring practices. AI has taken over a certain business process such as customer support and data entry.

Even latest geopolitical developments have forced companies to consider reshoring - a practice of taking the offshored task back to the native country.

Conclusion

Offshoring is definitely an effective business model for significant cost optimization, talent access and flexible scalability. It also helps in tapping new markets and staying compliant to foreign laws and regulations. But companies must assess all pros and cons while making their offshoring strategy.

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