Study: U.S. Companies Prefer “Farshore” to Nearshore Outsourcing, Send Higher Value Work Abroad | Article

For all the talk of the new allure of nearshore or even stateside outsourcing, most U.S. companies today still prefer to base their service operations half a world away, according to researchers at the Center for International Business Education and Research (CIBER) and the International Offshoring Research Network’s (ORN) Project at Duke University’s Fuqua School of Business.

While outsourcing to Latin America is growing, according to the results of ORN’s 2011 global corporate client survey, clients prefer locations such as India, China and the Philippines, particularly for IT infrastructure and application development and maintenance (ADM) functions. In finance and accounting, the percentage of operations located in Latin America did increase from 10 percent in 2009 to 16 percent in 2011, according to the survey, and ADM services sourced rose from 7 to 12 percent over the same period. But ORN found that a whopping 76 percent of offshored IT infrastructure operations are located at least nine time zones away versus 70 percent in 2000, while 70 percent of offshored ADM work is undertaken in similarly faraway geographies versus 66 percent in 2009.

Part of the reason for the continued preference for distant delivery locations may be the relative maturity and size of the outsourcing industry in Latin America, say the ORN researchers. But it also may be a result of familiarity. IT service buyers have spent the last decade or more laying down roots offshore with IT operations, business process offshoring sites and contact center facilities as well as developing better processes for managing distant service providers along the way. Forty-three percent of U.S. offshoring operations in IT infrastructure, ADM and innovation services are currently located in India, according to ORN’s most recent data, which offers mature service providers significant knowledge of most industries in addition to a talent pool. Another 12 percent of corporate America’s offshore operations sit in Eastern Europe, while 10 percent reside in China.

Most U.S. companies see little justification to bring that work closer to home. “Relocating to a nearshore location or back to the U.S. is not cost free. It requires planning, management effort, possible disruption to operations [and other] transition costs,” says Arie Lewin, Fuqua professor of strategy and director of CIBER. “And companies have actually learned to manage these remote relationships.”

In addition, decisions about where to source IT and business process services are no longer made in isolation, based solely on cost. Offshore labor arbitrage, Lewin and his ORN research team have found, dissipates over two to three years. Instead, the choice of location may be driven by larger business strategy—such as expansion in a particular market–which also may help to explain the continued penchant for trans-global sourcing. Offshore location choice may be more likely to be driven by top-line growth plans than bottom-line considerations today. Among the biggest drivers for those companies making offshoring decisions in 2011 were the company’s larger global strategy (from 40 percent in 2009 to 67 percent in 2011), corporate growth strategy (up from 49 percent to 66 percent), location-specific advantages (up from 28 percent to 57 percent), and access to new markets (up from 24 percent to 48 percent).

“As they move to increase top-line growth in China and India, they use the offshore capabilities to serve their growing markets in these countries—[a kind of] nearshore support,” says Lewin.

To compete in—or capture—those new markets, American companies are sending more functions and higher value work abroad, particularly in the areas of IT infrastructure, ADM and innovation services. According to the ORN 2011 survey, 43 percent of such offshore operations now involve the entire function-related processes and responsibilities rather than discrete tasks, up from 32 percent in the previous survey. Access to qualified personnel—which may be scarce domestically—along with internal employee resistance to long-term assignments abroad may be part of the reason, says Lewin. But the increasingly sophisticated nature of the work and processes being offshore may also be less suited to disjointed, dispersed delivery chains. Of the IT infrastructure, ADM and innovation services tasks being done offshore, 43 percent involve “creating new capabilities or competitive advantage,” according to the 2011 survey, and 64 percent involve complex “tasks that are assigned to multiple individuals or teams and are technically highly interdependent.”

Yet, despite the trend of offshoring work higher up the value chain, U.S. companies would rather hand off this work to third parties than set up their own captive centers overseas. ORN researchers found that captive centers consistently generate greater cost savings and operate more efficiently than offshore outsourcing relationships; during the first year of launch, captive operations generate savings of 38 percent compared to 24 percent for outsourced relationships, according to the survey. Ongoing captive operations delivered average annual savings of 34 percent versus 22 percent for third-party delivery centers. And American companies operating captive models reported better performance on average than third-party sourcers—a trend that held true regardless of company size, according to Lewin. Nonetheless, U.S. customers are more likely to opt to outsource; since 2007, two out of three newly launched operations were farmed out to a service provider, according to ORN.

In the context of the bigger picture, that preference makes sense, says Lewin, corresponding with the growing importance respondents placed on strategic business drivers for offshoring across the board. Outsourcing to a third party may mean faster speed to market and better access to qualified personnel that setting up a captive shop. Offshoring is not just about cost cutting anymore.

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