Global Outsourcing

Abstract

This article discusses Global Outsourcing—the transfer of an organization's internal functions to a foreign country. Outsourcing is often undertaken to procure skilled labor at a lower rate than it is available in developed economies. The transfer of manufacturing functions from developed nations like the United States to developing nations began in the 1950s. Technological advances have accelerated the ability of firms to procure and source products across the globe. Commonly outsourced functions include information technology tasks such as microchip development as well as many business services such as finance and accounting, human resources, data entry, and customer support centers. Global outsourcing has had a tremendous impact on how companies do business. This article examines the evolution of global outsourcing and its effect on business and labor.

Keywords Business Process Outsourcing; Captive Model; Comparative Advantage; Core Responsibilities; Direct Foreign Investment; Global Marketplace; Global Outsourcing; Information Technology Outsourcing; Market Opportunity; Offshoring; Outsourcing; Outsource Model

International Business > Global Outsourcing

Overview

The concept of outsourcing began when large companies decided to eliminate routine work that could be performed by third-parties at a lower cost. Initially, many businesses started outsourcing everything but core business activities to other companies within the same national boundaries. But as the global economy started to evolve, businesses in developing countries began offering services to perform functions that companies had been outsourcing domestically. Transferring an organization's internal functions to a foreign country is known as "global outsourcing," while the entities that are set up to perform these functions are part of what is called "offshoring."

Growth of Outsourcing

Outsourcing continues to be a rapidly growing segment of the global economy in the twenty-first century. In early 2023 the global business process outsourcing (BPO) industry was an approximately $251.1 billion industry and was only expected to grow. It was estimated that US corporations outsource 300,000 US jobs each year. Global outsourcing encompasses a variety of transactions including those focusing on both goods and services. A US firm, for example, can outsource the production of goods, such as car parts, as well as services, including customer service positions. Companies that rely on outsourcing benefit from reduced labor costs and increased profits, while the foreign countries that acquire outsourced jobs are enticed by the economic advancement. Another benefit to global outsourcing is that a company can focus more on its core responsibilities by transferring non-critical operations to a company that is better equipped to handle them. By outsourcing ancillary functions, businesses deliver products and services to the market more efficiently, thus enhancing their profits (Clott, 2004).

Outsourcing Strategies

Generally, there are two basic models used in outsourcing strategies: the outsource model and the captive model.

The Outsource Model

Within the outsource model, functions are transferred overseas and performed mostly by third-party providers. There are two subgroups within the outsource model: information technology outsourcing and business process outsourcing.

• Information technology outsourcing, or ITO, is the transfer of the development and processing of information technology systems such as help desk functions, systems administration, network management and web development.
• Business process outsourcing (BPO) is the transfer of the management and processes of certain business operations like accounting, human resource functions (in particular payroll processing and health benefits management), and customer service call centers (Sen, 2005).

ITO transfers do not require an organization to establish a presence in a foreign country since third-party providers normally perform these functions. BPO transfers, however, sometimes require a company to establish an overseas subsidiary to control the functions being transferred. In addition to establishing a foreign subsidiary, some companies may opt to invest in an overseas company to which functions are being transferred. An investment of 10 percent or more in a foreign enterprise is considered direct foreign investment (Sen, 2005).

The Captive Model

BPO and direct foreign investments form the basis for yet another method—the captive model. Under this model, the outsourcing company establishes a foreign subsidiary, bypassing reliance on a third-party. Under this model, a company maintains control of the operations being transferred, as well as the hiring process and management of the workers performing the work. Because there is less risk for a company to establish a foreign subsidiary, a larger percentage of global outsourcing occurs following this method (Sinnett, 2006).

Global outsourcing has also caused a ripple effect on labor markets throughout the world. As jobs shift overseas, permanent jobs disappear, giving way to an increase in part-time, temporary, and freelance workers.

Applications

Considerations

When a business decides to enter the global outsourcing market, there are several factors that contribute to that decision. These include, but are not limited to risk, cost, and market opportunity.

Risk

Some of the risks involved in outsourcing are geopolitical and economic. In certain "hot spot" areas where there is a great deal of conflict and political turmoil, transferring functions to these regions can pose a threat to the health and safety of the employees as well as the economic well-being of the organization (Minevich, 2005). Past terrorist attacks on certain subsidiaries of oil companies and service providers in Saudi Arabia are evidence of the geopolitical risks, just as the nationalization of the oil industry in Venezuela is evidence of economic risk. Other risk factors a business must consider include quality of service, loss of operations control and security of data and stored information (Sinnett, 2006).

Cost

In addition to understanding the risks associated with a particular outsource market, organizations must also consider the cost of outsourcing and must be familiar with foreign wage structures. To be sure, there are skilled workers in many areas of the world who are willing to work for lower wages than workers in the US, but as companies tap into these markets, competition eventually results in turnover as workers in those markets seek higher wages. Other costs include infrastructure costs, taxes, and regulatory fees (Allnutt, 2023). Finally, a company needs to determine market opportunity and identify those countries that provide workers in their industry. A skilled workforce and established infrastructure will allow a company to expediently bring products and services to a market without sacrificing quality. Conversely, a company needs to also be ready to cease the operation if the demand for the outsourced product or service declines (Minevich, 2006).

Market Opportunity

Before entering a global outsourcing market, a business needs to determine what types of products and services are best suited for outsourcing. When global outsourcing first came into play, the production of labor-intensive products and manufactured goods was transferred abroad. At the time, labor-intensive products and manufactured goods were some of the only products that could be produced more efficiently in other countries. However, as time went on, advancements in the overseas economies and technologies made it possible to outsource products and services that required more advanced technology and know-how. This constant shifting and advancement allow for the creation and emergence of other outsource markets that specialize in different types of production. For example, consumer goods and textile manufacturing were some of the first products to be outsourced to China. However, as that market matured and economic development expanded, China as well as other Asian markets became outsource locations for products and services that required more advanced technology. In particular, electronic components, telecommunications equipment, microchips, and computer boards were produced in China, Taiwan, and Hong Kong. This left the textile and other labor-heavy markets for other countries where such products could be produced in a similarly efficient manner.

Outsourcing & the Information Technology Industry

One industry that has been heavily affected by global outsourcing has been information technology. India has become a leader in this area because as demand for technology and its inherent complexities and costs grew, so did India's ability to provide low-cost, but capable assistance. During the 1990s, many US corporations began to increasingly rely on data storage and retrieval systems, and this increased the demand for IT specialists that could implement and monitor these systems. Eventually, the demand for these specialists exceeded the supply, and many firms sought out contract workers, consulting firms and specialists throughout the world. Initially, many of these companies brought workers to the US to work in their domestic information technology and engineering divisions. But over time, the number of skilled workers in foreign countries grew in conjunction with the establishment of offshoring businesses and companies became more comfortable with using third-parties abroad (Clott, 2004).

Policy Adjustments

In response to outsourcing, the US government adjusted its policies on temporary work visas for immigrants. The goal of this policy was to assist businesses in meeting the demand for skilled workers. As more visas were issued, a greater number of workers were brought to America. Many of these workers came from India, because of its large pools of engineering and IT graduates who had the advanced technical skills, English language skills and the willingness to work for lower wages than their American peers. At the same time, India had begun deregulating and modernizing its economy and this spurred investment in its domestic telecom and computer industries. The combination of these events facilitated the growth of the information technology industry and its proliferation throughout the world markets during the 1990s (Clott, 2004).

Proliferation of Technological Advancement

This development eventually triggered further technological advances that transformed the nature of goods and services that could be sourced throughout the world. Because of vast improvements in telecommunications, many services that were considered non-tradable were transformed into services that were capable of being delivered electronically around the globe (Blinder, 2006). The confluence of these factors helped India to emerge as a leader in the outsource market for ITO and later, BPO. Initially, jobs outsourced to India included data entry and minor software development; however, these roles expanded into larger software projects, and even to running information technology departments for many organizations. Though over time it has lost some of its jobs to countries such as the Philippines (which has a more Americanized culture compared to India’s heavy British influence) and Poland (which is more conveniently located for companies headquartered in Western Europe), India remains the world leader in outsourced jobs, especially in IT.

While information technology has been greatly transformed by global outsourcing, technological advances have also made it possible to have workers produce a variety of services from almost anywhere in the world. Because of these advances, business process outsourcing (BPO) is the most rapidly evolving model in the global outsourcing markets (Clott, 2004).

Initially, the types of jobs or business processes that were outsourced under this system were so-called "back-office operations." These operations include payroll, accounts payable and receivable as well as accounting for financial services companies, insurance companies and property management firms. As these operations were outsourced, workers in the source markets became more sophisticated and well trained, leading to further expansion of outsourced services. Initially, outsourced services included data entry, processing, and customer service call center support. Many credit card companies and large consumer finance enterprises transferred their call centers abroad. In the twenty-first century, more complex tasks such as credit card collections, benefits administration, and insurance-claims processing are being outsourced by US businesses (Clott, 2004).

Development of the Global Marketplace

Although outsourcing has become an inevitable process for multinational businesses to effectively compete in the global marketplace, the rapid evolution makes it difficult to determine what effect increased globalization will have on business and labor because sufficient data is not available. Despite this lack of information, the changing nature of the global labor market does have significant implications for companies, workers and countries and there are some general conclusions that can be drawn. First, global outsourcing will continue to create a fluctuating worldwide labor market (Allnutt, 2023). Further, wage rates for some functions will be increased in low wage countries while wage-earners in wealthy nations like the US, Great Britain, and Germany will find themselves competing with workers in developing countries. Finally, supply and demand for skilled workers in outsource markets are not efficiently matched. In some emerging outsource markets, the demand for available workers exceeds the supply while in well-established outsource markets the opposite holds true (Farrell, 2005).

One reason for the inefficiencies in the global outsource markets is the concentration of outsourced functions to a limited number of countries. By focusing on a few regions, many businesses have made investments that have limited their ability to establish themselves in other emerging markets. One possible result of this concentration will be that the demand for skilled labor will be greater than the supply and this will force wages to rise. Of course, wages in these lower wage cost regions will not match wage rates in wealthy nations like the US However, increased wage pressures will impact a company's profitability (Farrell, 2005).

In response to the concentration of global outsource markets in particular countries, there is another emerging trend in global outsourcing. As mentioned above, India has been a leader in the global outsourcing market. In addition to jobs being transferred to India, jobs are also being sourced from India to other countries. Many staffing agencies based in India are establishing offices in other countries where global outsourcing markets are emerging.

In addition to this secondary outsourcing of jobs by India, other markets are emerging throughout the world. In North America, jobs from the US have been transferred to Canada and Mexico, partially the result of the North American Free Trade Agreement of 1994. In Central and South America, outsourcing markets are rapidly developing in Costa Rica, Chile, and Brazil. The production of textile goods has contributed to the expansion of outsource markets in Chile, while Brazil has a large labor pool with solid technological skills. Eastern Europe also has some emerging outsourcing markets, with the top countries including Bulgaria, Lithuania, Estonia, Hungary, and Poland. Regardless of the specific methods that businesses employ to compete in the global marketplace, global outsourcing will continue as companies seek skilled workers at lower wages as well as new markets for their goods, products, and services.

Viewpoints

Global outsourcing can be viewed as a natural progression from the increased connectivity of the world's economies, fostered by the expansion of free trade and technological advances. While there are proponents as well as critics, outsourcing of various functions will accelerate as the nature of work evolves. Essentially, more knowledge-based jobs will be subject to outsourcing. Information and knowledge are the key assets of production in the world markets. As information becomes readily transferred via the global workforce, knowledge and expertise can be transported instantaneously around the world. Considering this transformation, a business can most effectively command comparative advantage through an ability to combine market and technological know-how with the creative talents of knowledge workers, such as those in the life sciences, logistics, and information technology (Clott, 2004).

Comparative Advantage

Comparative advantage is a fundamental economic theory that explains why it is beneficial for two parties—whether they are countries, regions, or businesses, to trade their goods and services. A key factor in determining comparative advantage is how readily the two regions can produce different goods that will subsequently be traded. If the US can produce certain goods or services at lower cost than a foreign country, and if the foreign country can produce other goods and services at a lower cost than the US, both countries may gain from trading each other's relatively inexpensively produced goods and services (Blinder, 2006).

Global Economic Growth

One result of continued outsourcing will be the expansion of global economic growth, and this has the potential to raise the standard of living in certain countries. Multinational businesses will derive benefits by continuing to rely on ITO and BPO, which will ultimately lower the cost of doing business and increase organizational productivity as goods and services are delivered to the global markets more efficiently. At the same time, outsourcing poses challenges and risks for both wealthy and developing nations and there are labor and ethical issues that must be considered. As businesses in wealthy nations continue to seek lower wage markets, the availability of skilled labor markets in these outsource markets may not meet demand and this will result in a larger wage gap between skilled and unskilled workers (Clott, 2004).

Further, the wage rates in wealthy nations will be suppressed because workers are competing with others in foreign nations who are willing to work at a lower rate. Also, to remain competitive, many workers in wealthy nations are performing functions on a part time or contract basis. This has resulted in a loss of job stability as well as traditional benefits such as health insurance. In addition to the challenges facing workers, businesses must also be able to respond to the challenges of globalization by changing the way that they are structured. Businesses that are not able to make innovative changes to the way they provide services and develop new products and services will not survive (Clott, 2004).

These challenges will require society to adapt. The US, for example, enjoys a comparative advantage in knowledge-based jobs due to its well-established health and education services, professional and business services and leisure and hospitality services. However, the US will need to reorganize its workforce to maintain this advantage. These transformations, in turn, will require changes in the country's educational system to prepare workers for jobs that are available within the country (Blinder, 2006). Another possible development is a retreat from the free trade agreements that have been implemented over the last 50 years in an attempt by countries to maintain their position in the global markets and retain jobs by implementing protective tariffs (Clott, 2004).

In the end, global outsourcing will continue to be a method employed by multinational businesses to remain competitive in the world economy. The question remains as to how ready business, society and governments are to respond to the challenges of the globalization of the world's economies.

Terms & Concepts

Business Process Outsourcing: The transfer of a business process to a foreign third-party provider that is guided by a set of performance standards determined by the outsourcing entity.

Captive Model: The model of outsourcing that involves an overseas business operation that is directly owned by the outsourcing entity and that does not involve a third-party.

Comparative Advantage: That strong suit which makes a business individual and unique in delivering a product, good or service within the world markets.

Direct Foreign Investment: The investment by an outsourcing company into a foreign enterprise equal to or greater than 10 percent.

Global Outsourcing: The delivery of services and other functions that can be performed by a firm in another country. Outsourcing involves shared management and control; a cooperation between divisions of a company that are in different countries.

Information Technology Outsourcing: The transfer of the preparation of some or all of the IT systems to a foreign service provider.

Market Opportunity: The future growth capacity of a country as an outsource market and its ability to readily deliver quality products to the market.

Offshoring: The establishment of third-party entities in developing nations for the purpose of performing functions being outsourced by businesses in developed nations.

Outsourcing: The transfer by a business of ancillary jobs functions to a third-party to lower costs and improve efficiency and to focus on core responsibilities.

Outsource Model: Model of outsourcing strategy that involves the outsourcing of functions to a third-party provider.

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Suggested Reading

Bean, M. & Meyer, M. (2005). Career strategies for the age of global outsourcing. Certification Magazine, 7, 16-44. Retrieved on February 21, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=15692584&site=ehost-live

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Manning, S., Larsen, M. M., & Bharati, P. (2015). Global delivery models: The role of talent, speed and time zones in the global outsourcing industry. Journal Of International Business Studies, 46(7), 850–877. Retrieved on December 3, 2015, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=108995959&site=bsi-live

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Schwartz, E. (2006). Salesforce goes to India. Infoworld, 28, 11. Retrieved January 22, 2007, from EBSCO online database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=23542996&site=ehost-live