Offshore Outsourcing in Service Sector - Essay Example

Offshore outsourcing in service sector Offshore outsourcing is a win-win strategy Introduction Outsourcing is the decision of a company to acquire services from other providers. Offshoring is a new business phenomenon that entails ability to relocate specific tasks to geographically dispersed locations and networks (Gereffi, 2006). The recent digital revolution and reduction in international telecommunication costs have enabled companies to exploit opportunities presented by highly skilled and low-wage workforce in emerging economies (Gupta, 2008). Recent patterns of offshoring in the service sector Reorganization of the production process has been practiced in the motor manufacturing and clothing industry for the last four decades. Offshoring started in 1960s and 1970s in the manufacturing sector whereby firms moved the labour-intensive tasks to overseas countries that offered cheap labour (Hollinshead, Capik & Micek, 2011, p 171). In the 1980s, offshoring focused on the low level manufacturing sectors and was evidenced by the setting up of call centers that offered back office services. The low-end functions such as accounting and customer services were outsourced to locations such as India, Russia and China while the companies concentrated on the core functions (Hollinshead, Capik & Micek, 2011, p 172). Offshore outsourcing in IT industry gained prominence in mid-1990s , but the creative centres of IT still remain in Western countries. There is significant diffusion of the research and development activities to global locations such as India, but such countries have become autonomous players as their offshoring markets reach saturation levels. In 2000, the offshore outsourcing shifted to software development sector due to emergency of telecommunication networks (Hollinshead, Capik & Micek, 2011, p 173). The introduction of networked computer terminals has led to more decentralization of the routine functions to offshore recipient countries such as China, Russia, India and Ireland. Complex decisions of firms as they reorganize the value chains Firms face complex decisions as they outsource reorganize the value chains as offshore outsource some activities. According to Kehal & Singh (2006), the firms consider the cost reduction, standardisation of product quality, human capital and risks involved in reorganizing their value chains. The reorganization of value chains have tended to retain the knowledge oriented skills in the industrialised nations while the lower value added functions are transferred to developing or less advanced countries (Hollinshead, Capik & Micek, 2011, p 172). Certain industries demonstrate ‘path dependent’ tendencies towards concentration of the processes and people in certain localities of the advanced countries such as the Silicon Valley in California (Hollinshead, Capik & Micek, 2011, p 172). In this case, the geographical concentration is driven by the access to talented software engineers and programmers. The proximity to large pool of sophisticated users also driven the locality concentration of such firms. The firms have realised the economic gains of geographically separating the programming functions to lower cost countries overseas while the introduction of networked computer terminals have added more impetus for relocation of the routine functions (Gereffi, 2006). Another factor that firms consider in reorganizing the value chains is the standardisation of technology that makes the skills portable between firms thus leading to reduction in labour costs (Warren, 2007). Production standardisation has minimized the offshoring risks related to quality of products or services. Moreover, the deregulation of markets have intensified the competitive landscape (Warren, 2007). Offshoring software development in Ukraine is driven by the culture of research and availability of highly talented personnel due to reliance of IT technologies. The increased competitiveness has forced firms to reengineer in order to seek new knowledge and arbitrage costs. However, the geographical separation of activities has led to complex value chains that may hinder the ability of firms to respond appropriately to market changes. Warren (2007), is of the idea that competitiveness of firms is aligned with the ability to reduce time in new product development and order cycle time. For instance, offshoring software development in Ukraine is derived by the search of low costs and human capital since all companies understand the costs per hour in Ukraine. Ukraine has extensive pool of highly skilled employees from the higher institutions of learning especially graduates with mathematical and computational skills. The cost savings, command in English, technical skills and business environment are some major factors that firms considered when relocating to Ukraine. The mobility and need to invest in training will be considered before firms outsource since training takes few months and it is flexible to downsize. Levy is of the idea that offshore outsourcing is linked with managerial and firm-level capabilities that allow the managers to coordinate dispersed network of tasks over a geographical area thus shifting the balance of power among countries, firms and workers. Levy counters Agrawal and Farrell by asserting that reduction in wages does not increase the national income as it transfers such income to the shareholders (Levy, 2005, p 686). Levy refutes the assertion that outsourcing raises incomes for US economy since such happens if only those displaced by outsourcing will shift to employment that is more productive. Levy is of the idea that earning losses from dislocation of jobs persist over a long period as most of the workers shift to lower paying jobs as evidenced by data on past trends in non-manufacturing sector (Levy, 2005, p 687). Firms face complex decisions regarding culture (human capital) of the recipient countries. culture allows firms to use management strategies to leverage on knowledge and skills in the market. Culture (human capital) refers to the norms, standards of behaviour and customs that influence the knowledge and internal reorganization of firms. Traditional hierarchal internal structures block learning and innovation while less hierarchical structures and networked relationships facilitate autonomous subsidiaries (Hardy & Hollinshead, G. (2004). In this case, contemporary management literature points out that firms are creating flatter structures and inclusive cultures due to commercial pressure and need to foster creativity and innovation (Hardy & Hollinshead, 2004, p 5). In this case, firms must negotiate with established behaviours and restructure managerial practices in order to respond to market changes. Although geographical proximity allows for close relationships management, new technologies like video conferencing and work stations have allowed firms to centralize on decentralized geographical basis thus managing the distance. For instance, the cultural proximity of Ukraine is attractive for offshoring and firms can leverage on the high knowledge. Some cultures embrace cooperative relationships and sharing of knowledge across regions. Another complex decisions that firms make is whether to minimise the risks for body shopping or investing in human capital. Many firms try to avoid ‘body shopping’ through investing in training the human capital and ensuring collaborative teams through person-to-person meetings and video conferencing (Hardy & Hollinshead, G. (2004). In order to meet client’s needs, the software firms in Ukraine invested in training and trust building within the organisation thus it becomes harder for the firms to move the production facilities. In this case, outsourced operations lie on the bottom of value chain since teams can easily be hired and psychologically encouraged to form part of teams for a specific project (Hardy & Hollinshead, G. (2004). Attractive offshoring destinations should allow for easy training of employees and management of workforce through flexible contracts Offshoring as a win-win strategy Offshore outsourcing leads to cost savings that can be directed to other value-added activities in the company thus leading to high customer value and increased distribution to the shareholders (Farrell, 2005, p 676). In addition, the outsourcing providers charge lower margins and tax rates in those countries are low thus leading to cost saving for the companies that offshore outsource the services (Farrell, 2005, p 676). A case example is the software development outsourcing from Ukraine whereby Senior managers have concluded that world class engineers and state-of-the-art processes can attain high quality software products, reduce operating costs and timelines by more than 60 percent through offshoring those activities to Ukraine. Offshore outsourcing offers high business mobility since no sunk costs and only related costs are the training costs that are incurred if the company plans to shift the operations to other lower-cost countries (Hollinshead, Capik & Micek, 2011, p 172). Flexibility Offshore outsourcing benefits companies through increased flexibility in responding to changes in market conditions. Companies are capable of adjusting to political changes and legal framework that restricts employee layoffs. Offshore outsourcing will provide such companies with the flexibility that is required to implement risky ideas and take advantage of lenient foreign labour laws whereby the wage rates are determined by supply and demand of labour in the markets (Farrell, 2005, p 677). New revenues Offshoring in the service sector contributes to service export growth. For instance, call centers in Asian countries such as India may have Siemens telephones, Dell computers and Microsoft software thus increasing the amount of exports to that country. The scenario explains why US exports to India grew from $ 3.7 billion in 2010 to a high of $ 5 billion in 2003. German gains three cents of euro to the new exports that are associated with outsourcing to India or Eastern Europe companies thus boosting the competitiveness of the country (Farrell, 2005, p 677). Repatriated earnings and cheaper capital equipment and investment Many of the outsourcing providers are partly owned by US companies and four cents of every dollar generated on offshoring services in India is returned to US economy in form of repatriated profits. Offshore outsourcing entails low-cost investments. For instance, American express outsources the software development and reconciliation of accounts at a cost of only $ 5,000 (Farrell, 2005, p 677). On the contrary, the company could have parted with several million dollars if it was to either purchase or make own database software. According to McKinsey, every dollar of offshoring spend in India will lead to $ 0.33 Indian economy gain and $ 1.44 US economy gain thus confirming that offshoring is a win-win strategy. Offshoring as not win-win strategy The opponents of offshoring assert that it only shifts balance of market power among firms and developing countries suffer from loss of market power. Levy is of the idea that offshoring is a emerging phenomenon that relocates specific tasks thus leading to global commodity markets for certain skills and shifts in balance of market power among the workers, firms and countries involved in offshoring (Levy, 2005, p 685). According to Levy, offshore outsourcing has generated concerns as certain jobs in industrialised economies are threatened thus leading to backlash and political reactions in Europe and USA. Although offshoring affected low-skilled jobs in the 1970s, almost all manner of jobs can be performed in countries such as India for a fraction of the wages. Twenty-first century outsourcing has put highly skilled jobs at risk since global telecommunications infrastructure has allowed multinationals to outsource activities like software development, accounting and engineering tasks. Levy suggests that only firm-level capabilities and efficiencies such as unique resources and barriers to competition will lead to higher productivity. Levy claims that the recent wave of offshoring threatens high-income workers through affecting the value chain tasks since workers are separated from production process. For instance, X-rays are transmitted through the internet and professors are located in overseas due to distance learning (Levy, 2005, p 690). Levy suggests that offshoring is driven by firms’ desire to create barriers of market entry and commodize services and this suggests that high value added activities do not accrue profits to workers, firms or countries. The studies from Mexican textile industry has suggested that only the small elite in developing countries benefit from their access to supply chain activities thus increasing the income inequalities in developing countries (Levy, 2005, p 692). Conclusion I believe that offshore outsourcing is a win-win strategy that leads to cost reduction, higher incomes and growth of related industries. Firms also gain flexibility and agility in new product development and competitive edge in the market. Reference list: Farrell, D. (2005). “offshoring: value creation through economic change”, Journal of management studies, Vol 42 (3), May 2005, pp 676- 682. Gereffi, G. (2006). The new offshoring of jobs and global development. Geneva: ILO. Gupta, A. (2008). Outsourcing and offshoring of professional services: business optimization in a global economy. London: IGI Global Snippet. Hardy, J & Hollinshead, G. (2004). “The embeddedenss of software development in the Ukraine: an offshoring country perspective”, Study of software development offshoring in Ukraine. pp 1-13. Hollinshead, G., Capik, P & Micek, G. (2011). “Beyond offshore outsourcing of business services”, Journal of competition and change, Vol. 15 No. 3, August , 2011, pp 171-176. Kehal, H.S & Singh, V.P. (2006). Outsourcing and offshoring in the 21st century: a socio- economic perspective. Hershey: Idea Group Publishers. Levy, D.L. (2005). “Offshoring in the new global political economy”, Journal of Management studies, Vol 42 (3), May 2005, pp 685-692. Warren, K. (2007). Strategic management dynamics. New Jersey: John Wiley. Read More