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Why Companies Outsource Offshore
Offshore outsourcing is the practice of hiring an external organization to perform some or all business functions in a country other than the one where the product or service will be sold or consumed. It can be contrasted with offshoring, in which the functions are performed in a foreign country, whether by the foreign subsidiary of the same company or a third party.
It is quite astonishing the extent to which offshore outsourcing is accelerating. There are many key reasons for companies to offshore and some of these reasons change over time.
The principle reason remains cost
The most compelling reason that companies outsource and offshore relate to cost. By now everybody will have heard about Labor arbitrage, which is the difference in the cost of labor from first world countries to developing nations like India, the Philippines and Malaysia. (Arbitrage is where you buy and sell in two different environments and profit from the difference). It is not rocket science when you understand that a call center agent in the Philippines is paid 18,000 pesos (US $360) per month whereas a call centre operator in say Sydney gets paid US $2500 a month. So any company with an eye on its bottom line is obviously going to think long and hard about the compelling proposition of moving its cost structure to another less expensive environment.
Some of the major countries/districts that provide such services are India (Programming and IT), the Philippines (Customer Support and Information Services), Russia (Programming and R&D), Bulgaria (Programming and R&D), Ukraine (Programming and Design), Romania (Programming and IT), Egypt (Customer Support and Programming), China (Programming), Latin America (solution providers) and many others.
The Long Term View
These days, as the market matures there are drivers apart from cost that are getting the attention of senior executives. Recently McKinsey in conjunction with Nasscom conducted a piece of research that showed that companies expectations about the benefits of outsourcing change over time. By year three of a typical project, innovation and flexibility became more important than cost. In other words the experience is that people go for the price but stay for the quality and the benefits.
Of note is that many of the Business Process Outsourcing (BPO) firms in India and the Philippines were not even in existence in 1999. What this is means is that many of these firms were able to come in to the market and purchase the latest technology and systems. They are not be hamstrung by technology that in many first world countries has been superseded, but that companies are now stuck with because of the enormous costs sunk into dated and ageing technology. This is underscored by the recent statistics from Frost and Sullivan that showed that the contact centre outsourcing market is now growing at 25% across the Asia-Pacific and is currently worth US$7.2 Billion. Furthermore Frost and Sullivan expect the market to grow at a compound annual growth rate of 20% to reach US$25 Billion by 2012.
These days the Internet has made geographic location unimportant. We now talk about service without frontiers. Improvements in telecommunications technologies such as VoIP (routing of voice conversations over the Internet or through any other IP-based network) have made it even more economically feasible to outsource offshore.
Stimulated by these factors and a growing awareness of the cost advantages and the abundant availability of skilled labor in India and the Philippines, offshore business process outsourcing firms made their first business endeavors to promote themselves into first world companies. A handful of Asian-based providers, seeing opportunity in extending their service offering and aware of first world companies growing appetite for cost reduction, began to extend their service offering beyond information technology into the same areas of work and processes that big companies were engaged in. Along the way, their investments in systems and scale began to pay off, and the case for BPO grew to encompass not just cost advantage but also increased quality and effectiveness.
Somehow there is an argument going around that first world companies are exploiting desperate workers in developing nations. One of the important reasons why workers can afford to be paid less in these countries is because the cost of living is significantly lower.
The law of one price, or more formerly purchasing power parity (PPP) is a mechanism wherein the purchasing power of different currencies for a given basket of goods can be equalized. This is a method often used to compare the standard of living of two or more countries.
Many observers have long understood that exchange-rate conversions do not account for the true differences across countries. In an attempt to explain the concept of purchasing power parity, the Economist magazine has a regular feature it calls the big Mac index, to show the costs of a McDonald’s Big Mac in different countries. The big Mac index is an informal way of measuring purchasing power parity between different currencies and provides a tongue in cheek test of the extent to which market exchange rates result in goods costing the same in different countries. Big Macs are almost universally available anywhere on the planet. The most expensive places to buy a big Mac are Tokyo, Los Angeles, Chicago, Miami, New York, Sydney and Auckland. At the other end of the scale the least expensive places in the world to buy a big Mac are Manila, Delhi, Buenos Aires, Bombay and Kuala Lumpur. So the logic is that things of equal quality will be purchased in the least cost environment. Hamburgers aside, western companies are really getting onto the concept of quality labor being available at less expensive rates.
A recent review of business reading out of the US shows that there is a more enlightened, strategic view of outsourcing and off shoring that is starting to emerge as managers get a better fix on its potential. Many executives are discovering offshoring is really about corporate growth, making better use of skilled staff, and even job creation at home. It is true, that the Labor savings from outsourcing can be substantial. But it is peanuts compared to the enormous gains in efficiency, productivity, quality, and revenues that can be achieved by leveraging offshore talent.
Big business is on the cusp of a new burst of productivity growth, ignited in part by offshore outsourcing as the catalyst. Obviously companies that deliver products faster at lower costs are better able to compete against anyone in the world. Many management advisers are now talking about the totally dis-aggregated corporation wherein every function not regarded as crucial to do in-house is stripped away and outsourced.
In many first world countries there is a shortage of technically trained workers and this situation is driving employers to seek talent overseas. The people who work in call centers in Manila or Delhi are young university educated with excellent English and other language skills. They are led by world-class management teams some local and some US. They have a strong commitment to excellence and an outstanding understanding of customer service. Compare that to the attitudes of many working in call centers in first world countries and it really is like comparing chalk and cheese.
As competition increases, cutting costs is no longer the only reason why companies outsource. Offshore outsourcing is a strategic shift to a business model that is driven by the high quality of work that can be delivered through a diverse human capital available in an increasing number of countries. The question is not whether or not to move your core business processes offshore, but when and how.
-- Martin Conboy
(Martin Conboy is the Co-founder and President of FooBooOnLine.com. He has extensive knowledge of Asia Pacific market trends and he is one of the most quoted commentators in the call center and outsourcing space in the in the Asia Pacific.)
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