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Offshoring/outsourcing

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The big picture

This model can be used to decide whether organisational activities could and should be outsourced or offshored. Outsourcing is the delegation of non-core operations to an external source that is specialised in the management of that operation. Offshoring is comparable to outsourcing, but in this case the business process – such as production, manufacturing or services – is moved to another country. This decision-making model helps to determine whether it is wise to offshore or not (Figure 20.1).

When to use it

Companies usually choose to outsource or offshore parts of their business for one or more of the following reasons: to reduce fixed costs; to increase focus on core competencies; or in order to use their labour, capital, technology and resources more effectively. The decision to move to another country is taken because there is a cost or skills advantage in doing so, or because there is a need for international focus.

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Figure 20.1 Offshoring

How to use it

The following steps are necessary in deciding which processes to off-shore, and to which country:

  1. Why choose off-shoring? Examples of reasons to offshore may include knowledge that competitors are moving offshore to gain a cost advantage, or that profit margins are under pressure because of higher price competition.
  2. To which countries and with which partners? In selecting an offshore partner, it is important to consider the types of experience, skills and culture that you need from your supplier in order to work together successfully. For example, the factors to consider in each potential country include labour potential, expected quality of production, and the cost advantage. Develop several alternatives for further assessment before making a decision.
  3. What are the costs, profits and risks, and which processes are eligible for offshoring? Step 3 involves a thorough cost–benefit analysis for each of the different alternatives. Important components to consider include wage levels, extra costs and charges, price levels and the effect on the internal value chain of the company. Analyse which parts of the organisation might be offshored, and what the effects on the overall value chain are likely to be.
  4. What happens next? Finally, carry out a detailed feasibility analysis for each country, partner, process, and contract.

At this point, there are still a number of uncertainties. Plans need to be elaborated upon further before any go/no-go decisions are taken. The same four-stage model can be applied to decisions concerning outsourcing, but excluding the international component.

The final analysis

The risk of using this model is in the temptation to skip certain steps in order to move quickly to the implementation stage, e.g. by sourcing potential offshore partners before thinking carefully about the strategic effects and consequences for existing personnel.

Offshoring has been a controversial issue amongst economists. On the one hand, it is considered of benefit to both the country of origin and the destination, by providing jobs and lowering the costs of goods and services. On the other hand, job losses and wage erosion in developed countries will also result. Economists who are against offshoring argue that highly educated workers with higher value jobs, such as accountants and software engineers, have been displaced by highly educated and cheaper workers from countries such as China and India. Furthermore, falling employment in the manufacturing industries has caused fear amongst workers. The controversy emanates mostly from the fear of uncertainty, as the effects of offshoring have not (yet) been conclusively proven. This model rationalises the choices regarding offshoring and outsourcing by helping decision-makers to reduce uncertainty.

Reference

Aron, R. and Singh, J. (2005) ‘Getting offshoring right’. Harvard Business Review 5 (Dec.), 135–143.