Professor Michael Mainelli, Executive Chairman, The Z/Yen Group
Professor Leslie Willcocks, Head of Information Systems & Innovation Group, London School of Economics and Political Science
[An edited version of this article first appeared as "Offshoring Navigates An Uncertain Course", Foreign Direct Investment, Financial Times Limited (June/July 2009), pages 100-101.]
Grow Till It Crunches
Until recent credit crunch events, offshoring looked set for continued growth. The global offshore outsourcing market for IT and business services exceeded US$55 billion in 2008 and some estimates suggested an annual growth rate of 20% over the next five years. The BRIC countries (Brazil, Russia, India and China) seem well placed to offer business process outsourcing (BPO), information communications & technology (ICT), and back-office services. Non-BRIC market share in 2008 was estimated at 10%, while BRIC market share in 2008 was estimated at 2% for Brazil, 7% for Russia, 72% for India and 9% for China. China and Brazil could do more to leverage their potential, while Russia, despite a lack of government support, succeeds in finding high-value but niche work. All the BRICs seek new business, but over 120 non-BRIC countries are in competition.
Traditional criteria for locating mainstream businesses do not differ much from offshoring decisions. The five key criteria are ‘People’ - the availability of good personnel and the flexibility of the labour markets; ‘Business Environment’ – regulation, tax rates, levels of corruption and ease of doing business; ‘Market Access’ - levels of trading, as well as clustering effects from having many firms of one type together in one centre; ‘Infrastructure’ - the cost and availability of property and transport links; and finally ‘General Competitiveness’ - the concept that the whole is ‘greater than the sum of the parts’.
Offshoring and outsourcing often retain their scale through recessionary as well as growth periods, making them attractive businesses for growing economies. A highly competitive global services market presents opportunities and revenues for countries able to offer the right mix of strong cost, reliable service, and secure location. Non-BRIC locations are interesting. First, non-some BRIC locations offer nearshoring opportunities, e.g. Czech Republic for Germany, or Mexico for the USA. Non-BRIC locations with good education often provide excellent BPO platforms, leaving ICT "engine rooms" for India or China. Second, India and China are turning to non-BRIC locations for some solutions, for example to secure lower costs or labour availability. Amongst the top contenders are Romania, Bulgaria, Poland, Slovakia, Czech Republic, Belarus, Morocco, Tunisia, Costa Rica, Mexico, Venezuela, Vietnam, Egypt and the Philippines. Third, non-BRIC locations offer different risk-reward ratios. Professor Paul Collier emphasises that for many countries globalisation and agglomeration mean that "export diversification has become more difficult because of China and India." [Collier, 2007, page 120] Some risks are higher, but some rewards compensate.
Comparative London School of Economic research [Willcocks et al, 2009] indicates that offshoring and outsourcing markets will remain dynamic, both for BRIC and non-BRIC destinations. LSE research indicates seven pressure points:
Pressure 1: Large Indian players moving up the value chain, bestshoring, acquiring, moving into new sectors, with recession making acquisitions more likely;
Pressure 2: Large players offering ‘multi-tower’ BPO - IT, HR, Procurement, Finance or Administration;
Pressure 3: Client pressure toward multiple suppliers that are better managed and bound in;
Pressure 4: Developing outsourcing services in many countries - alternative, improving supply from over 120 increasingly ambitious centres around the world;
Pressure 5: World economic and business pressures exert continuing downward pressures on costs, but also innovation, exacerbated by recession 2008-11;
Pressure 6: Managing the sub-contracting….and its hidden costs;
Pressure 7: Unending search for (a) new sources of skill (b) better labour models (c) at more attractive prices.
Confluence On Sustainability
There is a confluence among offshoring clients on a number of sustainability issues from customer relations to lower volatility on costs, the wider green agenda and political risk. Client interest in each of these four is worth examination in turn.
Most traditional criteria lists include a number of items about customer relations, ranging from costs to scalability to adaptability. However, as customers build outsourcing and offshoring into their long-term strategies, the implication is that customers are concerned with sustainable relationships that will last. Increasingly, clients recognise that cultural fit can be more important than low cost. In competitive centres, costs might be subordinate to longer term indicators of success, with R&D expenditure, innovation and customer service levels as key signals.
Longer term cost volatility is an often unremarked liability. Many purchasers do not seek least cost. Many purchasers seek low cost with low volatility. There is little point in an offshoring relationship with today’s least cost provider. A least cost provider that periodically jumps higher may be the lowest cost over a period of time, but the volatility is a management and planning headache. Arguably, today’s least cost provider has a greater likelihood of being today’s high cost volatility provider. To some degree, global companies find that exchange rates drive many short term cost changes, but equally, a long-term emphasis by suppliers on cost control also matters. For many suppliers, customer emphasis on low future cost volatility means that investment in longer term cost control can pay significant dividends. Today’s training or call centre technology or senior management courses or advanced software engineering development tools can signal low longer term cost volatility.
Green issues are becoming more complex. Until recently, offshoring could mean just throwing green issues ‘over the wall’. Now employees question the green issues involved in offshoring, as do customers, a soft green agenda. The answers are not simple. For example, by offshoring to Asia has a purchaser substituted dirty coal for clean nuclear? Has an offshore supplier genuinely borne the costs of carbon emissions? Do offshore suppliers operate from an environmentally responsible country? The hard green agenda means that offshorers will be subject to increasing scrutiny over the implications of offshoring decisions. Looking ahead, carbon markets may increase the complexity of green issues. It’s entirely possible that carbon ‘anti-dumping’ wars could exceed trade ‘anti-dumping’ wars in complexity and ferocity. Further, carbon anti-dumping would cover services in ways that have hitherto remained outside trade anti-dumping disputes for products.
Political risk is increasingly important. Global sourcers have found that global supply chains mean that they are connected with global risks often far from their core business – child labour, indigenous peoples’ rights, forestry, intellectual property, conservation or biodiversity, to name a few. UNI Global Union started a "Making Offshore Outsourcing Sustainable" project in 2004. The project, coordinated by the UNI-Europa Industry, Business Services & Information Technology trades union, drafted a code guiding offshoring managers. Principles of sustainable offshoring as set out by the code cover issues such as early involvement of employees, open communication policy, respect for minimum labour standards, and the application of professional standards with respect to personal integrity, corruption and environmental protection. Further, for any large multinational with public relations pressure points, offshoring decisions can become linked by NGOs to unrelated policies in the offshore country on, for example, waste disposal, water supply, minority rights or democracy. For NGOs the ends justify the means. For offshorers, exposure to large numbers of non-business issues is problematic.
In offshoring decisions the priorities are still people, business environment, market access, infrastructure and general competitiveness, but rankings and points of detail change. A quick review of offshoring criteria shows where pressure is mounting;
low-cost base – pressure constantly increasing;
scalability, e.g. high quality technology graduates, and language graduates or skills for call centre work – mounting OECD unemployment increases first-world supply and pressure on cost differentials;
clear environmental compliance – growing regulatory and bureaucratic burdens;
clear intellectual property rights - an area where the BRICs score poorly;
good basic infrastructure, e.g. travel to&from, energy, water, and telecommunications – increasing demands from growing populations mean a need to run just to stay in place;
fundamental economics, e.g. good growth potential, good regulation, good demographics – difficult to maintain in a global slump;
cultural fit, e.g. language fluency and capability, legal compatibility, tolerance – an increasing point of differentiation;
low physical risk, e.g. terrorism, kidnapping, murder, corruption, basic crime – a perennial;
positioning, e.g. time zones and geography – immovable.
One further conflict may lie in the major USA market. On 17 February 2009, US President Barrack Obama signed into the law the American Recovery and Reinvestment Act of 2009. This bill commits $787 billion to "for job preservation and creation, infrastructure investment, energy efficiency and science, assistance to be unemployed, and State and local fiscal stabilization." This bill potentially has enormous impact on both the IT industry and global sourcing of IT work. The funding for IT initiatives include $19 billion for health information technology, $7.2 billion for broadband and wireless Internet access, nearly $1 billion to update government IT platforms, and $650 million for educational technology. Other parts of the bill will create IT opportunities, such as the $11 billion funding for an electric "smart grid". The question remains whether the IT jobs created by this bill will remain in the USA or go abroad. The bill does not have specific requirements to prevent offshore outsourcing, but anti-offshoring sentiment in the US public consciousness has been high. The bill creates a huge debt for the American tax payer, and companies who use this money for offshore outsourcing of IT (or BPO) services will undoubtedly come under public fire. US-based global suppliers such as IBM, HP, and Accenture should have huge advantages over offshore suppliers, though these US-based global suppliers could indirectly offshore US contracts through their global delivery networks.
Looking forward, offshorers face conflicts between low cost and sustainability. While it is true that sustainability is likely to mean lower costs in the very long term, most offshoring decisions are initiated by, and based on, cost reduction. During a global downturn, cost pressures will only increase. Cost pressures will impede developing good customer relations. Cost pressures could increase cost volatility as short-term expediencies backfire. Cost pressures will encourage people to take risks with green sustainability issues, hiding a discharge here, lying about treatment there. Cost pressures will encourage deferring longer-term sustainability projects.
Offshoring, as an industry, is built on cost differentials. During a global slump, these differentials shift and change. If relative differentials are maintained, the industry may well continue on its two decade growth path. If differentials narrow, offshoring companies will have to develop value-added products, i.e. compete directly with western companies, and exploit their own markets rather than just western markets. It’s also possible that differentials widen, but that implies that offshore countries do worse in the global slump than advanced countries. If offshore countries suffer more in the slump, political risks will grow. In short, taking longer-term views of sustainability during a global downturn makes decisions harder.
COLLIER, Paul, The Bottom Billion: Why The Poorest Countries Are Failing And What Can Be Done About It, Oxford University Press (2007).
MAINELLI, Michael and MALLINSON, Roland, "Intellect And Investment", Foreign Direct Investment, pages 76-77, Financial Times Ltd (February 2009/March 2009).
WILLCOCKS, Leslie, GRIFFITHS, Catherine and KOTLARSKY, Julia, "Beyond BRIC - Offshoring In Non-BRIC Countries: Egypt – A New Growth Market", An LSE Outsourcing Unit report (March 2009).
About the Authors
Dr Michael Mainelli is Executive Chairman of the City of London’s leading commercial think-tank, Z/Yen, which publishes the City of London’s Global Financial Centres Index and Taylor Wessing’s Global Intellectual Property Index. Michael has numerous publications to his credit and has been deeply involved in offshoring strategies for major purchasers, particularly global banks and technology firms. Michael is Professor of Commerce at Gresham College and Visiting Professor at London School of Economics and Political Science.
Dr Leslie Willcocks is Professor of Technology Work and Globalization at London School of Economics and Political Science, in the Department of Management, where he is Head of the Information Systems and Innovation Group and Director of the Outsourcing Unit. He is internationally recognized for his research and advisory work on global sourcing, organizational change and IT strategy and implementation. He has published 32 books and over 180 refereed journal papers in journals and has advised numerous corporations and government agencies around the world.