Until the credit crunch took hold, offshoring looked set for continued growth. The global offshore outsourcing market for IT and business services exceeded $55bn in 2008 and some estimates had 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, is succeeding in finding high-value but niche work. All the BRICs seek new business, but more than 120 non-BRIC countries are also competing with them.
The criteria used to locate mainstream businesses are similar when locating offshore suppliers. 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 the 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 during recessionary periods, making them attractive businesses for growing economies. A highly competitive global services market presents opportunities for countries that can compete on costs, service reliability and a secure location.
Non-BRIC locations with well-education workers often provide excellent BPO platforms, leaving ICT ‘engine rooms’ to India or China. Take, for example, the Czech Republic acting for Germany or Mexico acting for the US.
India and China are now turning to non-BRIC locations for more labour and lower costs themselves. Among the top contenders are Romania, Bulgaria, Poland, Slovakia, Czech Republic, Belarus, Morocco, Tunisia, Costa Rica, Mexico, Venezuela, Vietnam, Egypt and thePhilippines.
Non-BRIC locations offer different risk-reward ratios. Professor Paul Collier of Oxford University emphasises that for many countries, globalisation and agglomeration mean that “export diversification has become more difficult because of China and India”. Some risks are higher, but some rewards compensate.
Comparative London School of Economics and Political Science research indicates that offshoring and outsourcing markets will remain dynamic for BRIC and non-BRIC destinations. Research by the university indicates seven pressure points:
-- Large Indian players moving up the value chain, bestshoring, acquiring and moving into new sectors, with the recession making acquisitions more likely;
-- Large players offering ‘multi-tower’ BPO – IT, HR, procurement, finance or administration;
-- Client pressure toward multiple suppliers that are better managed and bound in;
-- Many more countries developing outsourcing services;
-- World economic and business pressures exerting a continuing downward pressures on costs, but also on innovation, exacerbated by the recession between 2008-11;
-- Managing the sub-contracting – and its hidden costs;
-- An unending search for new sources of skill and better labour models – while still being able to lower costs.
Confluence on sustainability
There is a confluence among offshoring clients on a number of sustainability issues. These are mainly concerned with customer relations, lower volatility on costs, the wider green agenda and political risks.
Criteria covering customer relations will range from costs to scalability to adaptability. One of the key considerations for clients outsourcing is that they want sustainable relationships. Increasingly, clients are recognising that cultural fit can be more important than low cost.
Clients will also want to avoid long-term cost volatility. Many purchasers do not seek the lowest cost. They instead seek low cost with low volatility because price volatility is a management and planning headache. The lowest-cost provider may be no good if all it does in the long run is create high-cost volatility. Currency exchange rates may affect some short-term cost changes, but a long-term emphasis by suppliers on cost control matters.
Green issues are becoming more complex as customers and employees become more alive to the green agenda. The questions they have will often not be 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 its carbon emissions?
Laws around green issues mean 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 is entirely possible that carbon ‘anti-dumping’ wars could exceed trade ‘anti-dumping’ wars in complexity and ferocity.
Political risk is increasingly important. Global sourcers have found that global supply chains mean they are connected with global risks often far from their core business – child labour, indigenous people’s rights, forestry, intellectual property, conservation or biodiversity, to name but a few areas. Finance workers union UNI Global Union has drafted a code to help guide offshoring managers. It sets out principles of sustainable offshoring covering issues such as early involvement of employees, open communication policies and respect for labour standards.
The priorities when considering offshoring decisions are still people, business environment, market access, infrastructure and general competitiveness. A quick review of offshoring criteria shows where pressure is mounting:
-- Low-cost base – pressure constantly increasing;
-- Scalability – for example, high-quality technology graduates, language graduates or those with skills for call-centre work. Mounting unemployment in countries that are part of the Organisation for Economic Co-operation and Development increases first-world supply and pressure on cost differentials;
-- Clear environmental compliance – growing regulatory and bureaucratic burdens;
-- Clear intellectual property rights – BRICs score poorly on this;
-- Good basic infrastructure – for example, good transport links, energy, water and telecommunications. Increasing demands from growing populations mean a need to run just to stay in place;
-- Fundamental economics – for example, good growth potential, good regulation, good demographics – are difficult to maintain in a global slump;
-- Cultural fit – for example, language fluency and capability, and legal compatibility;
-- Low physical risk – for example, terrorism, kidnapping, corruption, basic crime;
-- Positioning – for example, time zones and geography; these are immovable.
Offshoring entrepreneurs are also keenly following the US’s recent $787bn stimulus package, which has billions earmarked for investment in IT – an area usually ripe for offshore suppliers. It remains to be seen, though, whether the American public’s opposition to offshoring rules out non-US suppliers.
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 may harm good customer relations if cost volatility occurs because short-term expediencies backfire. Cost pressures may encourage people to take risks with green sustainability issues: hiding a discharge here, lying about treatment there. Cost pressures will encourage the deferment of long-term sustainability projects.
As an industry, offshoring 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 – that is, compete directly with Western companies, and exploit their own markets, not just Western ones.
It is also possible that differentials will widen, but that implies that offshoring destinations will do worse in the global slump than advanced countries. If offshore countries suffer more in the slump, political risks will grow. In short, trying to take a long-term view of sustainability during a global downturn makes decisions harder.
Dr Michael Mainelli is executive chairman at Z/Yen Group and Dr Leslie Willcocks is head of the Information Systems and Innovation Group at the London School of Economics and Political Science.