The Impact of Offshoring in the Services Sector - Essay Example

The Impact of Offshoring in the Services Sector The term offshoring can bring up emotions, tales of great savings, and service horror stories. While all these exist in some form of reality, their prevalence is not so easily stated. Because offshoring is a relatively new undertaking, much of the literature is anecdotal and does not give a complete picture of the benefits, costs, and risks. However, it is helpful to gain an insight on the myriad of issues that surrounds offshoring. Previous research on the impact of outsourcing has sought to evaluate the impact that it has had on the company. To a large extent these studies have focused on the positive factors such as lower cost of labour, strategic benefits, greater efficiency, and having the best technology available while ignoring the intangible costs associated with off shoring (Oh, Gallivan, and Kim, 2006, p 273). Anecdotal data on improved technology and a shortage of qualified workers has been dismissed. In an extensive study by Wilding and Juriado (2004, p. 636) noted that, "Poor labour availability or quality within the surveyed organisations is not a considerable driver for outsourcing". The number one driver is cost savings on labour. For a company to realize any benefit from the lower cost of labour, it will require employee displacement. According to Beaumont and Sohal (2004, p. 693), "Outsourcing a function may entail dismissal or redeployment of employees, changes in the work they do or their transfer to the vendor’s employment and its different conditions". All these features impact the employees that are directly affected as well as influencing the attitude of the employees that remain with the firm. Balancing to the lowered cost of labour is the substantial investment that the firm needs to make in the off shore workforce. Training the vendor is a high priority and requires a significant investment to train and retain agents who are skilled and highly motivated (Tas & Sunder, 2004, P. 53). These investments need to evaluated over the long term and not a snapshot in time. One of the risks associated with off shoring is that the firm creates a dependence on the vendor that does the contracting. As the company off shores more of its internal functions the risk grows with it. The direct cost of this risk is the cost of monitoring the vendor which increases as the size of the contract increases (Oh, Gallivan, and Kim, 2006, p. 279). Additional risk comes from long term off shoring contracts, which may be difficult to break in case of a problem. According to Oh, Gallivan, and Kim (2006, p. 299) investors weigh the impact of these risks and state, "Investors will "bid up'' the stock prices of client firms that are able to pursue low-risk outsourcing engagements, while punishing clients that become entangled in outsourcing contracts that pose a high level of risk". Off shoring will have a negative economic return for the shareholders. Offshoring may be the remedy of last resort for a failing business. According to Lacity and Hirscheim (1993). "…outsourcing is being used to salvage a losing enterprise. Is it sound business practice to liquidate the IS department to rescue a firm? Many shareholders believe so -- stock prices systematically rise just after an outsourcing announcement". The remedy for the impact of offshoring on the low skilled segment of the financial services sector may not be realistic. According to Binder (2005, p. 10), "…the jobs of call center operators are clearly at risk, while the jobs of most doctors look safe. The glibly-prescribed remedy for the rich countries is therefore more education and, more generally, an upskilling of the workforce". However, in a capitalist market system there is a saturation point where upskilling results in a market glut of these skills and drives the wage downward. Educating away the cost of offshoring would therefore be counterproductive. Offshoring also places limitations on the complexity of work allowed and may be a constraint that will become an added cost. Financial services that maintain offshore call centres may be of limited benefit. According to Taylor and Bain (2005, p.269), " The types of calls handled tend to be highly standardized, simple in content, tightly scripted and of short duration". However, within this context of calls, there may be some advantage. Hagel (2004, p.22) remarks on a call centre in India and notes that, "It takes eTelecare, on average, 25 percent less time to handle incoming calls than it took its clients’ own call centers or previous outsourcers, and the company also delivers higher levels of customer satisfaction". This may not translate to more complex service scenarios or out of routine processes. In addition the level of service may be only comparative to a previous low level. The language barrier may present customers with a negative service experience when confronted with an offshore agent. "Contradicting the received wisdom, it cannot be assumed that 15 years of English language education at school and university necessarily equips graduates with the ability to communicate to customers, whose mother tongue is English…" (Taylor and Bain, 2005, p. 274). Even if the language is standardized, the accent may be an additional challenge that detracts from the value of the service. Taylor and Bain (2005, p. 275) state, "For some people it would be impossible to speak with the neutral accent we require. More applicants fail this hurdle than any other, as it is a very important issue for us and our clients". Language, both the use of wording and thick accents will negatively impact the customer's perception of product quality. Lane and Van der Vyver (2006, p.9) report that, "Indians speak their own dialect of English with pronunciation and idioms which are foreign to IT co-workers in developed countries such as Australia and USA". These are factors that leave a negative impression and reduce the efficiency of the communication. The firm that is considering Offshoring needs to do so with a realistic projection of labour costs in the vendors country for the length of the contract. Wages will naturally escalate and Offshoring may further be a catalyst for increase. Taylor and Bain (2005, p. 276) contend that, "The tendency for call centres to cluster, the poaching of existing staff, the need to pay more to retain employees, and difficulties in finding experienced supervisors and managers, all serve to inflate labour costs". In time, the firm may be facing a situation of the additional cost of again relocating their services either to a lower cost labour market or by home-shoring. Although there are no direct sources of data to accurately reflect the degree of offshoring in the financial services sector, anecdotal evidence suggest that it is still in the beginning stages of acceptance as an alternate method of doing business (Heckley, 2005, p.382). With time and an increase in offshoring, firms will need to be aware of the true costs of labour. While Daniel (2004, p.2) states that labour savings can be as high as 90%, Lyons (2004, p.1) states that current labour savings is approximately 50%. However, others put the savings at as lower amount. According to Overby (2003, p.1) "United Technologies, an acknowledged leader in developing offshore best practices, is saving just over 20 percent by outsourcing to India". In addition to the diminished labour cost savings, there is the additional expense of transition. During the transfer period, the firm will need to operate a mirror department while maintaining the existing unit and this could nearly double the cost of operation during the transition period (Overby, 2005, p.4). There are additional hidden risks in offshoring that will impact any potential savings. Lane and Van der Vyver (2006, p.8) argue that the two of the biggest challenges are the cultural differences and the potential for political instability. Servicing customers with a different cultural value system can be problematic. In addition, the rapid pace of political change in developing countries disallows any form of long term predictions as to stability. Set up costs and an extensive transfer period can eliminate any positive benefit from cost savings. In a case study reported by Lane and Van der Vyver one respondent noted, "There is often no cost advantage to be gained from IT off-shoring because of the significant management costs and upfront establishment costs". Productivity has risen in recent years, but may be suffering from employee alienation. Fredric, Finnegan, and Taylor (2004, p.16) state that 80% of the workers in the UK are not fully engaged in their jobs, they lack real commitment to the employer, and are truly disaffected in the workplace". The value of this disengagement is estimated to be approximately $38 billion for the UK (Frederic, Finnegan, and Taylor, 2004, p.16). Frederic, Finnegan, and Taylor (2004, p. 17) contend that, "The most recent concern for workers is that their jobs will be outsourced to other countries, where the cost of labour is much cheaper". The number of employees that have lost their jobs may be relatively low, but the impact of disengagement due to the perceived threat is widespread. Offshoring may be placing specialized company functions at risk of lying completely outside the firm. Garciano and Rossi-Hansburg (2004, p.4) state that, "…offshoring is not only the result of the relative aggregate supply of skills, but is the result of the competitive sorting of agents with different skill levels into teams". This places an entire skill set in the offshore position, not just numbers of employees. Jiang, Belohlav, and Young (2007, p.888) warn firms about the loss of expertise and state, "…outsourcing may simultaneously erode the firm’s potential for organizational learning and development of new technologies, particularly those skills necessary for the development of new business and core capabilities". However, Baily and Farrell (2004, p. 4) argue that most of the offshored positions would not exist if the opportunity of low wages did not exist in the vendor country. "Without offshoring, for instance, companies would scale back or withdraw services such as round-the-clock customer help. Moreover, technology is putting many US jobs at risk even without offshoring" (Baily & Farrell, 2004, p.4). Advances in technology, such as automated services would eventually replace the call centre agent. In addition, this effect spills over beyond the employees who are directly affected. Levy (2005, p.690) notes that, "…the creation of global labour markets for specific skill groups reduces the bargaining power of all workers in relation to their employers". Job relocation will pervade a broad spectrum of society. "Job relocations will be resisted by opposition from consumers, workers, and sometimes from politicians" (Levy, 2005, p. 692). The pressures from these groups will come at a material cost to the firm. Firms may be at the juncture of seeing offshoring become a cost rather than a benefit. According to Gentle (2007, p.24), "As offshoring expands and matures, financial institutions must find ways to maintain and improve the cost savings without sacrificing service quality. Firms that get this wrong will likely find their offshore efforts doing more harm than good". Offshoring has a wider impact than simply the lower wage scale. By 2010 as much as 20% of the cost base in financial institutions will be offshore (Gentle, 2007, p. 24). Most firms underestimate the cost that is required to locate, screen, and select a suitable vendor. According to Barthelemy (2001, p.61) this initial cost can be as high as 3% of the total outsourcing budget. As margins of savings are reduced, this will have an even more significant impact on the offshoring decision. Barthelemy (2004, p.69) further noted that, "…operations that were plagued with large hidden costs were never successful". The firm must also consider what recourse there will be in the event of a breach of security. This is a risk that stakeholders and consumers may be unwilling to take. According to Asokan (2006, p.14), "…the offshore country may not have any legal recourse to privacy, security or intellectual property problems". All of a firms trade secrets may be at risk. According to Power, Bonifazi, and Desouza (2004, p. 39) these include business data, trade secrets, intellectual property, trademarks, and copyrights. The cost of protecting these properties may outweigh any potential savings in the future. The customer perception of a remote service location will result in lowered brand loyalty. According to Levy (2005, p. 692), "Electronic communication does not always substitute well for face-to-face communication, and some companies are concerned about quality issues". The microeconomic effects are magnified as a small problem that results in poor service can quickly escalate into an important issue, as most customers are predisposed with a negative view of offshoring (Smith 2006, p.252). As long as a consumer is satisfied and has no reason to evaluate the firm, there is no cost to the firm. Olsen and Johnson (2003, p.187) assert that, "As long as customers are relatively satisfied with the goods and services that they purchase and consume, this stored evaluation serves as an anchor…". This anchor could be eliminated by word of mouth or a negative experience. Customers who have a reduced brand loyalty due to offshoring will be willing to pay less for the product. Krishnamurthi (1991, p.173) argues that there is a tangible value attached to brand loyalty and states, "Because they have no compelling need to buy this particular brand, they will be persuaded to buy the brand only if its price is low enough". The issue of offshoring is a social concern that elicits stories of a bad service experience. Word of mouth can escalate the cost of lost customers by a factor of 3. While a lost customer can cost as much as $1,200, word of mouth advertising can increase this to over $3,000. (Hogan, Lemon, & Libai, 2003, p.204). This figure is realistic on issues that are in the news or at the forefront of topical discussion. However, the story and fears associated with the negative portrayal may not bear up over time. Amiti and Wei (2005, p.338) state that, "Using data on 78 sectors in the United Kingdom, we found that job growth at the sectoral level is not negatively related to outsourcing." They further concluded that, "… the risk of service outsourcing dramatically reducing job growth in the advanced economies has been greatly exaggerated" (Amiti & Wei, 2005, p.339). Yet, even if the facts confirm this the employee attitude will not be altered greatly in the face of this emotionally charged issue. The current literature on the impact of offshoring on the financial services sector points to several issues of interest. There is the overriding consideration of cost savings and the need to arrive at a realistic figure. There is also the impact that offshoring has on share price. Investors may see it as risky or may perceive it as a benefit due to lower cost. The ability to retain customers at a high level of loyalty is another key component of the research. Finally, security is the most vulnerable aspect of offshoring. It places the entire firm and its clients at risk of being compromised. These are the issues that face the financial services sector when considering offshoring. 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