Offshoring vs Outsourcing: What's The Difference?

In 2019, the global market for outsourcing stood at a value of $92.5 billion USD.¹ Offshoring and outsourcing are attractive options for every company looking to lower its costs. 

In this article, the difference between offshoring and outsourcing, as well the pros and cons of both, will be looked at. 

When a company offshores its operations, or engages in offshore outsourcing, there are additional fees to look out for. 

Paying employees and suppliers abroad, dealing with exchange rate fees, managing international cash flow and payments - all of these factors need to be considered, as they can end up costing your company a lot.

Table of Contents
What is offshoring? What is outsourcing Offshoring vs Outsourcing Benefits of offshoring Benefits of outsourcing Risks of offshoring and outsourcing

What is Offshoring?

Offshoring is the process in which a business bases some of its operations abroad. 

This is done most commonly to take advantage of comparatively lower costs and/or a better qualified labor market. 

For example, a US based business involved in manufacturing may have high labor as well as rental costs.

This business could reduce these costs by relocating its manufacturing operations to a foreign country in which labor and rental costs are comparatively lower.In addition to these advantages, there are also many other potential benefits of offshoring.

What is Outsourcing?

Outsourcing is the process in which a business contracts a third party to run a specific part of its operations.

This is often done in order to allow your business to focus on its core services, letting third parties take care of tasks your business does not specialize in. 

For example, the core services of a travel agency are customer relations and travel management. Therefore, a travel agency may want to outsource its accounting department to a third party that specializes in accounting. By doing this, the travel agency would benefit from non-internal expertise which gives them more time and resources to focus on its core initiatives.

Offshoring vs Outsourcing

	Offshoring	Outsourcing
Definition	The definition of offshoring is when a business relocates some of its operations abroad	The definition of outsourcing is when a business uses a third party to manage and provide a certain business function, for example: accounting, human resources, marketing, database building, and so on
Pros	The benefits of offshoring are decreased labor costs, access to an international pool of better qualified labor, potential for increased productivity and increased knowledge of the foreign market	The benefits of outsourcing are worker contract flexibility, cost savings, increased specialization, external expertise, and increased opportunity for faster growth
Cons	The risks of offshoring include political, cultural and administrative differences, poor infrastructure, public criticism and high initial investment	The risks of outsourcing are untrustworthy or inefficient third parties, a lack of communication or understanding between the two business entities and a lack of knowledge of the foreign market (in case of offshore outsourcing)

Let’s take a closer look at the benefits of offshoring vs outsourcing, as well as the risks involved.

Benefits of Offshoring

Here are a few of the key benefits of offshoring vs outsourcing.

1. Access to low-cost labor

The cost of living and the consequent cost of labor is high in the US compared to developing nations. 

Moving part of your business’s operations to a developing country allows you to take advantage of the lower costs of labor for the equivalent job. 

These lower costs can be passed on to your customers in the form of lower prices, making your company more price competitive.

2. Access to better qualified labor

Certain industries within your home market may be lacking in an available supply of qualified labor. 

Comparatively, these industries may be stronger in foreign countries. 

Offshoring these lacking aspects within your business allows you to employ better qualified workers, benefiting from the international pool of talent. 

On top of this, certain jobs carry a higher prestige in developing nations compared to in developed nations. 

Therefore, foreign workers may be more productive, resulting in greater efficiency for your business.

3. Access to better prices and increased knowledge

A permanent presence within a foreign market allows your business to develop better relations with foreign suppliers. 

In addition to this, it allows your business to gain a better overview of local prices, as well as preventing it from being stuck with a single third party supplier. 

These factors give your business the potential to negotiate better prices, saving you money on costs, which can again allow your company to increase its price competitiveness.

Benefits of Outsourcing

Outsourcing is also not without its advantages. Here are some of the primary benefits of outsourcing vs offshoring.

1. Increased specialization and quality of services

Businesses are not experts at every task that needs doing - every business has an area in which they specialize, giving it the competitive advantage that makes them successful. 

That being said, every business has essential yet time-consuming tasks that need to be completed. 

By outsourcing these essential tasks to a third party, your business can better focus on its area of specialization, allowing it to further its competitive advantage, resulting in increased growth.

Similarly, in addition to allowing your business to better focus on its core area of specialization, outsourcing enables you to benefit from external expertise that is lacking in your business. 

This results in better quality work being done, increasing the efficiency of your business, and the quality of services it offers.

That being said, this benefit is not exclusive to outsourcing - increased specialization and quality of services can also be achieved through offshoring.

2. Increased flexibility

Hiring workers translates to increased employee package and salary costs, as well as long-term commitments.

Outsourcing avoids this problem. With outsourcing, labor contracts can be short-term and employee salaries and packages are handled by the third-party. 

This means you can rapidly increase and decrease your labor force as required, allowing you to save costs in the long-run.

3. Cost savings

Relocating your business’s premises offshore comes with a large initial investment cost. 

Similarly, hiring in-house expertise comes with the cost of employee salary and package costs. 

In most cases, your business can save on these costs by simply outsourcing the necessary business function to a third-party.

Risks of Offshoring and Outsourcing

Despite their benefits, outsourcing and offshoring come with different risks.

A risk shared by both offshore outsourcing and offshoring is that of exchange rate costs.

Foreign payments to suppliers and employees abroad, for example, could cost your business a lot in unnecessary, and often hidden, fees.

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The main risk of outsourcing lies with the third party outsourcing company. 

This can manifest itself in different ways. 

• Firstly, if the quality of work provided by the outsourcing company is lacking, this affects the overall quality of your own business. 
• Secondly, if there is a lack of communication or understanding between your business and the outsourcing company, this can also affect the efficiency of and services provided by your business. 
• Thirdly, if the outsourcing company has ulterior motives or simply lacks the necessary security measures, private information relating to your business could be leaked.
• And fourthly, if you utilize offshore outsourcing, your lack of presence in the foreign market could lead to higher resource prices, meaning higher costs, resulting in an overall decrease in price competitiveness for your business.

💡 What is offshore outsourcing?
The definition of offshore outsourcing is that of when a business uses outsourcing (a third party company) abroad. So instead of outsourcing your finance department within the US, for example, you outsource it to a company in India.

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On the other hand, the risks of offshoring come in the form of cross-cultural problems as well as political problems. 

• The difference in culture, politics and administrative policies and laws can result in unnecessary costs. 
• Similarly, foreign red tape as well as lacking infrastructure in developing nations could result in backlogs and other supply chain problems, affecting customer satisfaction. 
• Additionally, companies utilizing offshoring are sometimes accused of taking jobs from US citizens, as well as engaging in unethical practices related to the use of low-cost labor in poor working conditions in developing nations. This is not always necessarily the case, but the association can still tarnish your business’s image. Also, the initial investment, and consequent commitment, in relocating your business’s operations offshore means that there is a higher risk involved in offshoring vs outsourcing.

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Sources:

1. Statista - Global market size of outsourced services from 2000 to 2019

Sources checked 30 March 2022