In 2008, before Barack Obama became the 44th President of the United States of America, proponents of the Philippines’ Business Process Outsourcing or BPO industry were up in arms about then Senator Obama’s pronouncements on outsourcing. There were news reports which suggested that Obama would introduce policies that would discourage outsourcing arrangements in order to protect jobs for Americans.
It turns out that Obama’s plans were directed at companies that set up offices or factories in other countries in order to establish presence overseas. These companies included Caterpillar and Nike which opened branch offices and factories in China. Obama was not discouraging outsourcing arrangements but offshoring arrangements.
Although the principles between offshoring and outsourcing are similar, the execution and its repercussions to the economy are different. We are going to explain the main differences of offshoring and outsourcing in this article.
First let us differentiate the two terms.
Outsourcing is the strategy whereby a company contracts the services of another party; an external agency, to manage a set of business processes or a specific project. Alternatively, the external agency is referred to as a “Third Party Service Provider” as the set of business processes or the specific project is related to the arrangement between the client, “The First Party” and the end user or “The Second Party”.
As earlier described, offshoring involves setting up physical infrastructure in another region or country. In outsourcing, there is no physical transfer of assets only the assignment or delegation of services to another party or agency that could be located in another region or country.
For both offshoring and outsourcing, the common motivator is to reduce costs of business by capitalizing on existing comparative cost advantages particularly labor.
But which operating model should you choose for your business?
The Main Advantages & Disadvantages for Offshoring and Outsourcing.
Advantages of outsourcing
1. Reduces Cost of Operations
The cost of hiring an external agency or a third party service provider is lower than setting up in-house operations for a number of reasons:
- An external agency is a separate entity; it is an enterprise that is responsible for its own cost of operations.
- An external agency has the experience to get the job done according to expectation. If you create an in-house department, you will have to invest in the infrastructure and hire the right talent.
- An external agency does not need additional training expenses. An orientation or overview of the project may be required. But if you put up an in-house agency, you will have to invest in training, research and development.
2. Improves Productivity
By outsourcing select business processes you can improve productivity because your company can focus its resources on its core functions.
The cost savings from outsourcing can be repurposed to fund revenue- generating programs of the company. For example, the cost savings can be used to improve business infrastructure or enhance its marketing and promotional program.
3. Increases Flexibility
A company can increase its flexibility with outsourcing by taking advantage of time zone differentials. By simply adjusting work shifts, it is possible to have your business managed for 16 hours by an external agency.
Disadvantages of outsourcing
1. Cultural and Social Differences
For example, if you contract an agency from the Philippines or India you will have to develop an understanding of their deeply rooted spiritual beliefs the dates of which may conflict with your work schedule.
2. Communication Problems
Hand- in- hand with cultural and social differences are communication problems. There arise because of differences in perspectives.
For example, North American companies tend to do business in a straight- forward manner. On the other hand, service providers from the Philippines are more introverted. They tend not to say much and keep to themselves.
For the North American client it may be taken as a sign of aloofness, uncertainty or incompetence. But in reality, it is just part of their nature as a soft- spoken people.
3. Security Issues
Despite the promulgation of the Data Protection Act in several popular outsourcing destinations, security breach and data integrity will remain serious issues.
Even with tight IT networking protocols and safety measures, concerns on security will always come up in the absence of close collaboration.
Advantages of Offshoring
1. Economies of Scale
When a company sets up office or a factory abroad, it is not just capitalizing on comparative cost advantages on labor but also on existing economies of scale.
Other cost items such as power, Internet connectivity, rent may be lower in the host country than the country of origin. In fact, the expectation of most companies that offshore is to realize at least a cost savings of 70%.
A company can also take advantage of the comparative cost advantages by diversifying positions or negotiating for volume discounts when purchasing assets or services.
2. Close Collaboration
Offshoring gives the company greater control through closer physical collaboration.
Shared space collaboration has the advantage of overseeing the conduct of work without the filters or delays associated with technology. While there are software programs and software development companies that allow clients to view the work of its outsourcing partner, latency issues with the terminating carrier can compromise the benefits of real time analytics.
3. Favorable Government Policies
There are some governments that grant special exemptions and incentives to companies that invest in their economy.
These include tax exemptions and access to cheap credit which could improve the bottom- line of the business.
Disadvantages of offshoring
1. Increase Unemployment
The aforementioned companies Caterpillar and Nike have been accused of taking away jobs from Americans and displacing their existing work force in favor of other nationalities.
These companies argue that by offshoring they are able to improve profitability by lowering costs and increasing revenue. Thus, the increased profits can be used to improve facilities and programs of the principal company.
2. Cultural and Social Differences
The client will be immersed in the culture and social practices of the host country. This may have an effect on productivity and communication.
Unlike outsourcing, time zone differentials may work against the offshoring company because production could end up being delayed due to changes in manpower availability.
3. Security Issues
Whenever you are sharing, transmitting data to another party, you are always at risk of security breach and compromised data integrity.
There will always be transfer issues when it comes to data even when there is shared space collaboration.
The decision on whether you should outsource or offshore will depend on the size and complexity of your operations, the scope of work that you need transferred and of course, your resources.
Generally, you will benefit in terms of cost and depending on how operations are managed, you can realize great productivity on either business model. One thing is for sure both offshoring and outsourcing will be popular strategies for business development in the years to come.
Hopefully this article has provided further insight in to the differences between offshoring and outsourcing and the advantages and disadvantages.
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