Offshore outsourcing or off shoring entails the process of delegating services to either an overseas supplier or a foreign affiliate company. In the recent years, partly due to the digital revolution and increased multilateral relationships, many firms from the developed countries are trading their services in overseas markets.
Previously, services such as IT consultancy, e-commerce, manufacturing, and call-centers could not be traded overseas. However, this relatively new phenomenon raises much debate concerning its consequences on the developed economies. In particular, outsourcing raises the possibility of companies undergoing restructuring and move most jobs to low wage countries to cut costs. Much of the discussion focuses on the negative consequences of offshore outsourcing.
However, off shoring is likely to be beneficial to the economies of OECD countries through the reduction of costs of services in the process of restructuring. Moreover, since the developed countries, such as the United States, are, in absolute terms, the largest exporters of services, outsourcing would ensure that domestic firms have access to a larger market. International outsourcing presents more benefits to the United States’ economy and the economies of the developing countries.
Economic Benefits of Outsourcing
Many firms are outsourcing their services to offshore destinations. As the number of companies outsourcing their services increase, the associated risks decrease because businesses become more experienced and develop clearer objectives. Although the opponents of outsourcing cite unemployment as one of the consequences of outsourcing, global outsourcing is only responsible for few job losses in the U.S. (Belcourt 269). Both industrial and developing countries stand to benefit from global outsourcing in many respects.
Outsourcing of services allows industrial countries to specialize in areas of their core competencies. Obviously, the main reason for outsourcing of one or more business processes, particularly in IT outsourcing, is cost reduction.
Outsourcing allows a firm to focus on improving its core competencies such as technological development while delegating its secondary services, such as e-commerce, to a strategic destination overseas. Additionally, through outsourcing, highly specialized personnel can efficiently conduct their operations in a low cost environment. The efficiency implies a reduced market price of a firm’s products, which improves a firm’s positioning in the global market.
The improvement in quality of a firm’s services and products is another important benefit of international outsourcing. Outsourcer companies normally seek vendors offering the best quality services and show more flexibility in their business processes. Additionally, outsourcing creates competition between potential vendors, which results to improved performance and increased flexibility. On that basis, companies outsource services to companies with resources and expertise to offer quality services, reduce risks, and save on costs.
In particular, most companies outsource the technology part to specialized companies that are able to offer technological solutions at lower rates. For instance, in the US, IT companies usually outsource the normally labor-intensive software development to foreign firms in India with IT expertise.
This allows firms to focus on developing their core priorities and competencies and reduce operating costs significantly. Additionally, there is a significant difference in wage levels between the US and India. Thus, outsourcing allows the US corporations to cut labor costs of up to 50% compared to costs incurred when operating in the United States (Shy, and Stenbacka 203).
In the global market, the quality of services and their prices are the key factors that offer a firm a competitive advantage. Thus, the main rationale for outsourcing to middle-income countries is to ensure high quality standards at the lowest costs possible. This gives a company a competitive advantage in the global market.
Additionally, middle-income countries, which offer favorable social and economic conditions, are more preferred for outsourcing. These countries have a relatively skilled labor and at the same time, low domestic wage level, hence an attractive destination to outsourcing companies.
Benefits of Global Outsourcing to Developing economies
Global outsourcing has many potential benefits to the developing economies. Outsourcing contributes to the creation and growth of employment in various outsourced services in developing economies. As aforementioned, most US firms outsource their services, particularly IT services, to India.
According to Feenstra and Hanson, India’s business process outsourcing (BPO) sector dominated by US call centers, content development and administration services grew substantially from 42,000 employees in 1999 to 243,000 workers in 2004 (89). This shows the importance of the outsourcing industry to a country’s economy. Outsourcing also increases tourism inflows from the US to developing nations, hence, a source of foreign revenue.
In addition, outsourcing opens up new exports for the developing economies. Outsourced services such as software development are a potential source of foreign revenue to the developing countries through exports. Presently, India accounts for most of the global business process outsourcing destination. India’s revenue from export of software services and other BPO services to the US in 2004 accounted for 70% of total exports (Shy and Stenbacka 209).
Additionally, developing economies benefit from technology transfer and expertise from the outsourcing firms originating from the US and other developed nations. In India, for example, the Indian companies presently are able to provide value added services and advanced services such as computer chip design, business consulting, and pharmaceutical research among others. This arises partly due to increased investments from the US multinational corporations in research and development.
Disadvantages of Outsourcing
Although outsourcing presents many benefits to the US and other developing countries, it has risks, normally associated with new business ventures. First is the problem of contracting. Most of the vendor firms may not meet the technological, managerial, and legal requirements, hence, presents an outsourcing risk to the multinational corporations.
However, the vendors can become competitive by acquiring appropriate technological and managerial skills relevant to the respective market. The US multinationals should provide decision-support information in order to ensure the vendor’s performance is satisfactory.
Second is the political and economic uncertainty in vendor country. Inflation and fluctuation in exchange rates may reduce profit repatriation to the US; additionally, political instability or conflicts may also affect international outsourcing. However, proper government policies can create a favorable environment for international outsourcing like in India.
From an economic perspective, global outsourcing of businesses from industrialized nations to developing countries inevitably results to some job loses in the developed nations. However, international outsourcing is a form of resource reallocation to more productive destinations that come with economic globalization. In essence, outsourcing accounts for only small job losses in the US, actually, the rapid machine automation and the changing business cycles being the main causes of job insecurity.
Offshore outsourcing has led to increased international competition and has caused major adjustments in the labor market. Through outsourcing, firms in the US can offer quality services at lower rates, which give them a global competitive advantage over in-house production.
The economies of vendor countries benefit from outsourcing through the creation of employment and foreign revenue. Although international outsourcing causes job losses in the US, this can be avoided through labor liberalization in both developing and developed economies.
Belcourt, Monica. “Outsourcing – the benefits and the risks.” Human Resource Management Review 16.2 (2006):269-279.
Feenstra, Robert, and Hanson, Godwin. Foreign investment outsourcing and relative wages. Cambridge: MIT Press, 1996.
Shy, Oz, and Stenbacka, Rune. “Strategic outsourcing”. Journal of Economic Behavior & Organization 50.4 (2003): 203-211.