Part 1 - Offshoring basics: definitions, benefits, and challenges

By Aaron Green, 9/17/2007

We hear a lot these days about "outsourcing" and "offshoring." But what do these terms mean, and why are we hearing so much about them?

First of all, let's be clear on the terminology:

• Outsourcing - "Outsourcing" refers to the transfer of non-core operations from internal employees to an external organization. This transfer of non-core operations allows the company that outsources the work to focus on its core business. The organization that the work is outsourced to will typically have expertise in a given area, allowing it to add value and provide cost savings. For instance, many companies outsource payroll to one of the many available payroll vendors. The payroll vendors are able to add value in the area of payroll in a way that internal payroll departments can't achieve. Another example is human resources departments that outsource background checks to vendors specializing in this area rather than driving to courthouses and checking criminal records themselves.
• Offshore - The term "offshore" refers to where the work is being performed geographically. In other words, if a task is "offshored," then the task is being performed in another country.
• Offshore outsourcing - "Offshore outsourcing" means that work is being performed by an external company in another country overseas. Many people simply refer to this as "offshoring." Offshoring is taking place all over the world. The more common locations are India, China, the Philippines, Eastern Europe and South America. A derivative of offshore is "near shore" where work from the U.S. is performed in Canada or Mexico.

A trend that is here to stay

The current offshore outsourcing trend started in the 1970s when large multinational companies like General Electric began sending manufacturing overseas. White collar jobs such as programming came next and then companies began outsourcing their call centers to overseas vendors. Offshoring has become much easier to do and as we shall see, now even small companies hire offshore staff in order to achieve their business goals.

A variety of jobs are offshored, including some that many people never could have imagined going overseas. Not only are jobs in finance, information technology, human resources, scientific fields, and graphic design commonly offshored, but now lawyers are doing research and doctors are reading x-rays remotely. The variety is staggering. It seems that any position that can be offshored is being offshored.

Why are companies offshoring and what are the benefits?

There are numerous benefits to firms that engage in offshoring:

• Access to talent - For certain occupations there is a greater availability of highly skilled and experienced employees overseas. The U.S. has 4-5% overall unemployment and for certain in-demand positions there is practically zero unemployment. Offshore outsourcing provides another way for companies to get the job done.


• Cost savings - Companies can save 30-50% compared to the cost of a U.S.-based employee for the same level of performance, and oftentimes the offshore employees are more committed, grateful for the work.


• Speed (ie, filling open positions quickly) - If you are recruiting a U.S. employee, it can take a month or more to fill certain positions. However, given the availability of offshore employees, open positions can typically be filled more quickly.


• Elimination of recruiting costs - Many companies pay recruiting fees to help find the most qualified employee. These fees are eliminated if you are using an offshore vendor to fulfill a certain function.


• Time savings - By using an offshore employee, you eliminate the time you would normally spend on searching job boards, recruiting, interviewing, orientation, managing vacation time and absenteeism, career coaching, and managing employee morale and motivation.


• Reduction of legal exposure - Employee issues can be time-consuming and can escalate into legal liabilities. Using offshore staff eliminates certain legal exposure to employment liabilities.


• Flexibility - Unlike traditional employee relationships, offshoring eliminates hiring and termination costs, allowing companies to quickly expand and contract their overseas staff in accordance with business needs.


• Retention and loyalty - Many times companies are rewarded with higher levels of retention and loyalty from offshore staff because overseas employees typically consider working for an American company to be prestigious.

Offshore outsourcing challenges and considerations

While there many identifiable benefits of offshoring, it does not come without its challenges, as well:

• Cultural issues - Different cultures have different communication styles, different attitudes toward conflict resolution and simply different ways of getting work done. Even words can have different meanings in different cultures. For example, in the U.S. the word "yes" typically means "without a doubt." In certain cultures, "yes" can mean "I'll try." Setting aside the concept of outsourcing for a moment, given the increasingly diverse makeup of the U.S. workforce, it is good practice for companies to embrace cultural differences and train their employees accordingly. As it relates to offshore outsourcing, cultural differences with an offshore provider have the potential to present their own set of challenges.


• Loss of US jobs - Offshore outsourcing is a politically charged issue. Most economists believe that offshoring is good for the economy and ultimately results in additional U.S. jobs. The theory is that the lower-level jobs get outsourced and Americans end up doing higher value work. Even assuming the economists' view is correct, having their jobs displaced is painful to those workers impacted. It might take time to retrain and/or land one of these "higher value" jobs.


• Cost savings that don't materialize - Expected cost savings might not result from offshore outsourcing. The offshore staff might not turn out to be as productive as expected and/or U.S. workers might end up retaining parts of the job you thought would go overseas, thereby costing you more. In addition, substantial cost inflation has occurred in certain overseas countries, namely India. Overseas wage and overhead inflation (i.e, rent, utilities, etc.) in the long run ends up impacting the cost U.S. customers pay offshore vendors.


• Data security issues - You don't need offshore or even offsite employees in order for your data to be compromised (or stolen), and certainly once data leaves your building you are subject to certain risks. And while it is true that these risks are no greater overseas than if you transfer files between office locations or allow employees to work from home, legal protections in foreign countries are not the same as in the U.S. For instance, you would want to think twice about outsourcing work that involved access to valuable intangible property. If you do decide to outsource sensitive work, you will want to set up controls within the workflow process to protect yourself.


• Quality of service - If you are not careful, cost savings can be more than offset by service issues. For instance, Dell closed an Indian call center over customer complaints about the quality of service. To protect yourself against such losses, do a thorough analysis of the functions being considered for outsourcing. You will also want to ensure that the function is suitable for the specific country where you are outsourcing. Finally, perform due diligence on the offshore vendor before moving any function overseas.

A continuing impact

Princeton University professor and former member of the White House Council of Economic Advisors Alan Blinder says, "Economists who insist offshore outsourcing is just a routine extension of international trade are overlooking how major a transformation it will bring and how significant the consequences could be." Like it or not, offshoring will continue to have a significant impact on the way we all work and the way human resource professionals source talent and organize their companies.