Benefits of Offshoring & Guide to Offshoring Strategy

Offshoring is the process of moving some of a business’s operations to a foreign country.

The increasing global expansion of businesses has made offshoring an attractive option for those looking to reduce their costs.

Here’s a quick overview of offshoring advantages and disadvantages:

Pros of offshoring	Cons of offshoring
The advantages of offshoring are: access to new markets access to qualified and low-cost labor increased knowledge and innovation increased resource availability and faster growth	The disadvantages of offshoring are: time zone differences foreign laws and administrative policies high initial investment public image problems and exchange rate fees

In this article, offshoring benefits, as well as disadvantages, will be explored in further detail.

On top of this, the article will also look at what offshore outsourcing is, as well as how to develop a strong offshoring strategy.

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Table of Contents
Types of offshoring Benefits of offshoring Disadvantages of offshoring Example of offshoring How to create an offshoring strategy

Types of offshoring: captive offshoring and offshoring outsourcing

If you’re looking to take advantage of offshoring opportunities, then understanding the difference between captive offshoring and offshore outsourcing is key.

Captive offshoring

Captive offshoring is the process by which a business relocates some of its operations abroad, investing in real estate and foreign employees. 

• Captive offshoring allows your business greater control over its foreign operations, resulting in better knowledge of the local market. This can lead to lower costs in the long run, as better relationships can be built with local suppliers. 

• Similarly, captive offshoring allows you to choose from a range of suppliers, rather than being restricted to the prices of an outsourcing provider. 

• Additionally, it also protects your business’s information from being shared, as no third-parties are involved - all the operations are internal.

Offshoring outsourcing

Offshore outsourcing is the process by which a business hires a third-party outsourcing company to manage a certain part of its operations.

• One of the advantages of offshore outsourcing is that it can save your business time. Important yet time-consuming jobs, such as database building, can be outsourced to a third-party, freeing your business to focus on growth-driving initiatives.

• Similarly, offshore outsourcing serves to fill gaps in your business. For example, if your business is lacking in a strong finance and accounting department, this can simply be outsourced, allowing your business to gain valuable expertise.

• Similarly, another advantage of offshore outsourcing is that it can be more cost-effective in the short-run, as contract workers are cheaper than internal employees and - unlike with captive offshoring - you don’t need to pay the costs involved in relocation.

Benefits of offshoring

There are many advantages of offshoring. Let’s take a closer look.

Entering new markets

A company that establishes a part of its operations abroad enters a new geographical market. This comes with a host of benefits. 

• Firstly, by having a fixed, long-term presence in the foreign market, your company can learn and gather local experience, allowing it to avoid the associated costs of political, cultural and administrative differences. 

• And secondly, a long-term presence is likely to help build better relations with third parties in the local market, leading to a greater understanding of the local consumer. 

Both of these benefits lead to the ultimate benefit of reducing long term costs and helping your business to expand its presence in foreign markets.

Having access to qualified and low-cost labor

One of the main reasons a business decides to offshore its operations is to benefit from lower labor costs. 

The difference in wages between the US and developing countries, for equivalent jobs, is significant. 

Businesses can hire workers with equivalent or even greater qualifications while paying significantly less in wages. 

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On top of this, there is a difference in perception and prestige surrounding equivalent jobs in the US and developing nations. 

• In the US, certain jobs are viewed as less desirable and of low status.

• Conversely, in developing nations, these same jobs are often viewed as respectable and thus desirable professions.

This not only increases the available labor supply for these jobs in developing nations, it also means that workers in these countries will likely have a higher productivity rate, leading to even more economic gains.

In addition to this, having a fixed presence in the foreign market gives your business increased access to better qualified labor, due to better knowledge of the local market.

Gain more knowledge and innovation

As previously mentioned, one of the benefits of offshoring your operations is that it gives your business a permanent foothold in foreign markets. 

This fixed presence allows your business to build relations with other local suppliers and third parties, leading to greater knowledge. 

This knowledge comes in the form of better awareness of local prices, increased access to qualified labor, and a greater awareness of political, cultural and administrative differences, among other aspects.

Additionally, this in-country presence, in comparison to simply outsourcing, reduces the risks involved in knowledge transfer, increasing innovation.

Increased resources available

Another one of the benefits of offshoring is increased resource and price availability.

Your fixed presence within a foreign market, as well as your increased knowledge of this market, gives your business a greater chance of accessing resources for lower prices.

A business using outsourcing can often be restricted to a single third-party supplier of raw materials. The outsourcing company may themselves also be limited in the resources they can offer, as well as not necessarily being the most cost-effective. 

A business utlising their offshoring advantage avoids this issue. 

Local market knowledge gives your business access to multiple suppliers, leading to increased access to a wider range of resources, as well as better prices.

Faster growth

When offshoring your business’s operations, you can save time by offshoring non-essential tasks. 

This frees you to focus on the core of your business, allowing you to scale for faster growth.

Disadvantages of offshoring - what to look out for

Despite the pros of offshoring, there are some potential drawbacks to consider.

Time zones

The difference in time zones can be an inconvenience when managing and communicating with your offshore employees. 

This will likely result in some very late night or early morning calls, as well as a delayed response time when waiting for replies.

Foreign laws and policies

Differences in political, administrative and business laws and policies can lead to confusion, delays and unnecessary costs. 

Running in to these hurdles is an inevitable part of the offshoring process.

High initial investment

While offshoring can allow your business to benefit from reduced costs associated with cheap foreign labor, the initial investment is higher than with offshore outsourcing. Investment in

• premises, capital, employee contracts and benefits,
• as well as the other associated costs of relocation, make it an initially costly option

This means that the financial risk involved in offshoring is higher than that of outsourcing.

Contrastingly, with offshore outsourcing your business has more flexibility and is not permanently attached to its outsourcing company. Captive offshoring is a greater commitment, carrying increased risk.

Public image

Despite the economic benefits of offshoring, it does come with a slightly tainted reputation. 

Businesses taking advantage of cheap foreign labor, especially for manufacturing roles, are often accused of engaging in an unethical practice. 

This is due to the fact that working conditions can be poor and wages are significantly lower than in the business’s home market. Such an association could of course be detrimental to your business’s public image. 

That being said, if working conditions are maintained and foreign employees are well cared for, then this can be avoided.

Exchange rate

Relocating your business operations abroad means that you’ll have to convert your money in order to pay for foreign costs. 

This can come with a significant amount of additional costs associated with the exchange rate, such as mark-up fees.

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Example of offshoring

One of the main benefits of offshoring is that it allows your business to focus on its core initiatives. 

This is exactly how Whatsapp used offshoring to spur its growth. 

When the company was first launched in 2009, it offshored its software development department to Eastern Europe.

By doing this, Whatsapp’s American-based team could direct its focus to customer-oriented tasks, such as customer support and relations, allowing a greater degree of in-house specialization.

Needless to say, Whatsapp is an extremely successful company, having been acquired by Facebook for $19 billion.¹

How to create an offshoring strategy

1. Choose an activity to offshore

The first step in building your offshoring strategy is identifying the processes in your business to offshore. 

The most commonly offshored parts of a business are:

• back-end processing
• accounting
• and call centers

These aspects are all highly digitisable, and local labor can be quickly and easily trained to meet the tasks. 

The offshored tasks are often essential but time-consuming, thereby allowing your business to focus on its core growth-driving initiatives. 

Similarly, other areas of your business, in which there is a corresponding lack of skills in your home market may also be worth offshoring. By doing this, your business will benefit from a more qualified labor force. 

2. Choose a location where the activity will be offshored to

Once you’ve decided the areas of operation you wish to offshore, the second step is deciding on the location they will be offshored to.

In making this decision, you need to identify what the key considerations are specific to the tasks you’ll be offshoring. 

• For example, if you’re simply looking to benefit from better cost-effectiveness, then conducting a wage as well as real estate price comparison across potential host countries would be the next step.

• Similarly, if you’re looking to gain access to better raw material prices, via local knowledge of the market, then selecting a country that exports these raw materials would be a key consideration.

• Additionally, you may want to consider cultural and political differences, as well as the distance between your potential offshore nation and the US - all of these can affect the smoothness of relocating.

3. Decide if offshoring or outsourcing is more beneficial

At this point, the next step is deciding whether offshoring or outsourcing is the best method of realizing your business interests. 

• If your business is looking to establish a permanent presence in a foreign market, as well as leverage better control of its foreign operations, then offshoring would be the best option. 

• On the other hand, if your business lacks the funds for the initial investment required in relocation, or wants to benefit from time-saving and/or cheap worker contracts while maintaining flexibility then outsourcing would be the better option. 

Understanding the different drawbacks of offshoring compared to outsourcing is key to deciding which one best suits your business goals.

💡 What is outsourcing?
Outsourcing occurs when a business hires an outsourcing company to provide a specific service for its business operations. Understanding the differences between outsourcing vs. offshoring is essential for tailoring the right business strategy.

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Sources:

1. Alcor - Successful and bad offshoring examples

All sources checked 13 March 2022