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(originally published by Booz & Company)


Is Backshoring the New Offshoring?

Another force in offshoring’s favor is the dramatic rise in fuel prices — and, more generally, in the inflationary pressures that are nipping at the heels of most developed economies. Rising fuel costs will undoubtedly cause companies to reconsider the economic merits of offshore manufacturing because of potentially prohibitive transportation costs. But these same forces will also, we believe, cause the demand for the offshoring of services to increase. Soaring commodity prices will hit not just manufacturers but all industries, making it more important than ever for companies of all types to cut costs rapidly without significant new investments. For example, airlines will be especially harmed by fuel cost increases and will almost certainly conclude that one of the few ways to earn a respectable return with little capital outlay is to offshore service operations. In addition, high oil prices tend to push down emerging countries’ currencies, further highlighting the advantages of service offshoring.

The same cost-cutting pressures will affect innovation strategy. Company research and development will increasingly be shipped to low-cost countries to reduce expenses and increase speed in launching new products — or new versions of old products — in highly desirable emerging markets. It’s an activity that could determine the difference between survival and collapse for many businesses. Some companies will find themselves betting their future on major innovations — for example, alternative-fuel automobiles or energy-efficient motors and appliances. And because many of these products will be targeted at the growing middle class in developing countries, companies will be more willing to move their crown jewels — product development and R&D — offshore, a less expensive alternative with close links to the customers they want to reach.

Nonetheless, it is possible that continuing pressures on global exchange rates will affect the offshoring strategies of U.S. companies. If the dollar continues to slide, cities like Spartanburg, S.C., or Tuscaloosa, Ala., could find themselves becoming homes for onshore service centers and selectively taking over some of the work currently performed overseas. But it is important not to conflate isolated moves of this sort with news about Indian companies such as Wipro and TCS scaling up their operations in the U.S. and declare that the nature of offshoring has changed.

No matter how these various scenarios play out, we believe offshoring will maintain its fundamental viability. Service providers have made significant investments to build up their businesses. After decades of being stymied by bureaucratic restrictions, they have finally begun to compete on the world stage. The combination of deregulation and technology (in the form of inexpensive, high-bandwidth global telecommunications) has enabled them to break through. Having tasted success, service providers are determined to stay in this game for the long haul, and they will take steps to remain competitive — even if it means sacrificing a portion of their margins during a short-term transition period. The economic attractiveness of service offshoring will remain — much more so than for manufacturing offshoring, which is more susceptible to energy pricing shifts because of transportation and logistics costs.

But service providers should not count on price alone to keep their customers. The next few years will be a period of reckoning for offshore service providers — and that will be good for this industry. Their customers will increasingly be Western companies under duress. These companies will demand a rapid and real payback, trouble-free transitions, and consistent service with a minimum of goofs — a reality that, for more than a few providers, has proven elusive. This, more than any other factor, could drive a new wave of maturation within the offshoring industry. Few things can promote discipline more effectively than price-sensitive buyers who are themselves on the edge. As the world demands more from its offshore providers, those providers may well cross a new threshold of capabilities. 

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  1. Amy Bernstein, editor, Outsourcing Thought Leaders: Managing Business without Borders (strategy+business Books, 2006): Executives of outsourcing providers and companies that outsource discuss the latest trends.
  2. Vinay Couto and Ashok Divakaran, “How to Be an Outsourcing Virtuoso,” s+b, Autumn 2006: Details the ways in which the outsourcing industry is becoming ever more sophisticated and, for many customers, indispensable.
  3. Vinay Couto, Mahadeva Mani, Arie Y. Lewin , and Carine Peeters, “The Globalization of White-Collar Work: The Facts and Fallout of Next-Generation Offshoring” (PDF), Booz & Company white paper, May 2008: Discusses results of an offshoring survey and argues that outsourcing is no longer about moving jobs elsewhere; it’s about sourcing all types of jobs everywhere.
  4. Vinay Couto, Arie Y. Lewin, Mahadeva Mani, and Vikas Sehgal, “Offshoring the Brains as Well as the Brawn: Companies Seek Intellectual Talent Beyond Their Borders” (PDF), Booz & Company white paper, September 2008: A survey of global companies finds that innovation is increasingly a target of offshoring.
  5. Kevin Dehoff and Vikas Sehgal, “Innovators without Borders,” s+b, Autumn 2006: Companies offshore their innovation engines to take advantage of global talent and proximity to burgeoning markets.
  6. Arie Y. Lewin, Silvia Massini, and Carine Peeters, “Why Are Companies Offshoring Innovation? The Emerging Global Race for Talent” (PDF), Solvay Business School, CEB Working Paper No. 08/009, March 2008: Researchers in the U.S., U.K., and Belgium argue that more companies are offshoring research and development not just to trim labor costs but for greater efficiency and speed to market. 
  7. Offshoring Research Network Web site: The ORN project at the Fuqua School of Business at Duke University provides stats and other data on offshoring, with links to outside research and analysis.
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