Mitigating Risks for Outsourcing Buyers in Today’s Emerging Offshore Markets

risk, mitigating.Back in the 1990s when offshoring was new, India was a new, emerging market. Outsourcing buyers had to assess the economic, political, infrastructure, weather, social and exchange rate risks in determining if the labor arbitrage was really worth it.

Today doing business with India is a given. However, rising wages and the increasing cost of the rupee have eaten into India’s economic gains. Western buyers, however, have grown accustomed to the advantages of offshoring, so they are looking for new countries.

“Emerging markets will continue to be a driver for outsourcing growth,” observes Kurt Cavano, vice chairman of GT Nexus, a cloud-based network for global trade and supply chain management. “The new business paradigm is about taking advantages of these ever-changing global trade options anywhere in the world, creating an agile supply network and responsibly delivering quality goods and services at the lowest possible cost.”

What are today’s emerging markets?

Cavano defines emerging markets as “countries whose competitive advantage is primarily low wages.” Today the list includes:

  • Bangladesh
  • Cambodia
  • Pakistan
  • Sri Lanka
  • Sub-Saharan Africa countries

Why even go to emerging markets?

Cavano says enterprises “seek out emerging markets because, while challenging, they still offer significant price advantages. In some instances, they also offer specialized expertise and infrastructure for particular industries that can provide additional advantage.”

What are the best processes to send to emerging markets?

Some manufacturing. For example, wages are so low in Bangladesh “it’s inexpensive to hire thousands of workers,” points out Dr. Yossi Sheffi, the Elisha Gray II Professor of Engineering Systems at the Massachusetts Institute of Technology. Clothing manufacturing “is still worth doing” he says.

But labor arbitrage is becoming less and less important where there’s a lot of automation involved. Dr. Sheffi notes “the advances in robotics are amazing.” Sophisticated manufacturing is actually moving back to the western world for this reason, he adds.

Some emerging markets have become attractive for back office operations such as finance, according to Professor Ilan Oshri, a professor of technology and globalization who heads the Centre for Global Sourcing and Services at Loughborough School of Business and Economics in the UK. A good example is Sri Lanka, now a hub for finance shared service centers. “With an English-speaking workforce, Pakistan is also attracting investments from large multinationals in the area of software development, mainly setting up offshore development centers as captives in Pakistan,” he reports.

Business processes that don’t require customer interface are also applicable. Supply chain in particular is well suited for offshoring to emerging countries, advocates Cavano.

What are the risks and how do you mitigate them?

That said, the Chief Strategy Officer of GT Nexus notes “emerging markets come with significant risks.” These include the usual suspects:

  • Lack of infrastructure
  • Limited control and visibility
  • High capital costs
  • Labor issues on the managerial level
  • Endemic corruption
  • Social issues

Cavano says the best approach to risk mitigation in emerging companies is “to eliminate uncertainty. This might sound obvious, but it’s not what’s really happening.”

Dr. Sheffi suggests calculating infrastructure costs carefully because “costs can rise significantly when the infrastructure is not that great.”

Professor Oshri says clients in both IT and BPO tend to make two mistakes:

  1. Overestimate the cost saving that offshoring will eventually yield
  2. Underestimate the “hidden costs” of managing offshore operations. For example, client firms do not always account for the effort and expense involved in managing an offshore development center, he explains.

Blackouts, for instance, can wreak havoc on computer and production systems. The availability of consistent energy must be a major consideration, adds Dr. Sheffi. Energy costs can serious skew the cost-benefit analysis of these emerging countries because the cost of energy is actually going down in the US due to fracking. Professor Sheffi points out the US is already a gas exporter and predicts America will become a net oil exporter, too.

Dr. Sheffi, an expert at risk analysis and supply chain management, says corruption can become a serious problem because Americans can just not participate because they have to comply with the US’s Foreign Corruption Act while other nationals can just slip cash under the table. “Americans comply because they don’t want to go to jail. But this does increase the cost,” explains the professor.

Another similar issue is corporate social responsibility, according to Dr. Sheffi. He says companies must make sure the manufacturers or outsourcers they hire are not using slave labor or prisoners. “This labor practice is endemic in emerging countries,” he says.

He suggests company executives carefully audit their provider’s workers to ensure they are complying with the stated corporate code of conduct. This extra work also makes offshoring to an emerging country more expensive.

In the supply chain area, Cavano says Western enterprises need “to partner with their trading partners and operate the supply chain as a network. Ensure all parties (factories, manufacturers, logistics providers, banks, customs and outsourcers) have access to all requisite documents, data and updates they need to fulfill their roles. Placing everyone on a network makes uncertainty disappear because then all parties are accountable.”

Dr. Sheffi adds “diligence and follow-up are crucial.”

He notes adds education is a great way to mitigate risks. He says Western enterprises have to train the service providers in these emerging countries how to do procedures like business continuity planning. “These things require personnel development,” says the professor.

Finally, Cavano points out the capital risk in emerging countries: borrowing rates tend to be “significantly higher than in the West. This places a big burden on what is often the weakest link in the supply chain.”

Dr. Sheffi believes all companies should use care when outsourcing to emerging markets. “You don’t want your brand—which you carefully crafted—tied to a disaster. It’s better to outsource to a more established country and pay more,” he says.

 

 

Posted in: Articles, Risk-Reward

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