Outsourcing and Offshoring
Offshoring
means setting up operations in a low-cost country for the purpose of hiring local workers at lower labor rates. Offshoring differs from outsourcing in that the firm retains control of the operations and directly hires the employees. In
outsourcing
, by contrast, the company delegates an entire process (such as accounts payable) to the outsource vendor. The vendor takes control of the operations and runs the operations as they see fit. The company pays the outsource vendor for the end result; how the vendor achieves those end results is up to the vendor.
Companies that choose to offshore face the same location-criteria factors as companies that make production-operation decisions.
The advantages of outsourcing include the following:
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Efficient processes (the outsourcer typically specializes in a particular process or set of processes, giving them high levels of expertise with that process)
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Access to specialized equipment that may be too expensive for a company to invest in unless that process is their chief business
India has long been a favorite location for outsourcing services, such as call centers and software testing, because of its English-speaking, highly educated workforce. The labor-rate ratio has been five to one, meaning that a company based in the United Kingdom, for example, could hire five Indian college graduates for the price of hiring one UK college graduate. Given the high demand for their labor, however, Indian employees’ wages have begun to rise. Offshoring companies are now faced with a new challenge. The firms hire and train Indian employees only to see them leave in a year for a higher salary elsewhere. This wage inflation and high turnover in India has led some companies, like ABN AMRO Bank, to consider whether they should move offshoring operations to China, where wages are still low. The downside is that graduates in China aren’t as knowledgeable about the financial industry, and language problems may be greater.
Diageo, the world’s largest purveyor of spirits, used the following criteria when choosing an offshoring-services location. Diageo analyzed nineteen locations in fourteen countries, ultimately choosing Budapest, Hungary, as the location of its offshore shared-services operations. The primary criteria Diageo used were
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a low-cost base, both in terms of start-up and ongoing running costs;
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a favorable general business environment;
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the availability of suitable staff—particularly with regard to language skills;
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a high level of local and international accessibility with good transport links;
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the attractiveness for international staff; and
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a robust regulatory framework.
Sources: Burt Helm, “Diageo Targets the Home Bartender,” BusinessWeek, July 6, 2009, 48. Linda Pavey, “OTC Focus & Solutions,” June 6, 2005, accessed August 6, 2010,
http://www.ideaslab.info
.
Companies save on labor costs when offshoring, but the “hidden costs” can be significant. These hidden costs include the costs of additional facilities, telecommunications, and technological infrastructure. Delays or problems with internal project coordination and the need for redundancy can add even more costs.
Did You Know: Standard Chartered Bank Mitigated Risk by Duplicating Operations in Chennai and Kuala Lumpur
As you can imagine, banks are very concerned about security because of the highly confidential customer information they possess. Some banks try to mitigate the risks by setting up mirror sites. Standard Chartered Bank, for instance, chose Chennai in South India as the hub for its Scope International operations, but some of the tasks are also done in Kuala Lumpur in Malaysia: “Because we run the operations of 52 countries, we have to satisfy information security and business continuity issues in all locations,” says Sreeram Iyer, Group Head, Global Shared Services Centers, Standard Chartered Scope International at the time of the decision. “Kuala Lumpur backs up the Chennai center and vice versa.”
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