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How Real Estate Choices Affect Offshoring Decisions

When companies are deciding where to set up an offshore captive operation, the first thing they typically look at is the labor arbitrage advantage. Next they examine the skill sets needed for the job at hand. But there’s also one underlying factor no one can ignore: real estate. If you’re opening an office offshore, you need an office.

A new study by Jones Lang LaSalle, a global real estate firm with operations in 100 countries, found that locations like Sao Paulo, Brazil and Buenos Aires, Argentina may “compare favorably with current offshoring favorites such as Delhi and Shanghai when companies expand their locational criteria beyond labor cost reductions.”

“Reducing labor costs is still the main goal driving offshore strategies,” says Bruce Rutherford, Managing Director. “But for some business processes, issues like infrastructure are becoming a bigger part of the equation.”

The October 2004 study, entitled “Deciding Where to Outsource,” uses an objective business tool it developed called the Global Offshoring Index to help companies compare cities on a global basis. Rutherford says Jones Lang LaSalle collected 10 years of experiences with clients and used the learnings to create the tool.

The Index contains data for 45 variables that affect the choice of cities for various offshoring activities. The real estate researchers grouped these variables into six sets of drivers:

  • Cost: labor, business, real estate, telecommunications, and utilities
  • Human capital: labor supply and quality
  • Business environment: innovation and competitiveness
  • Market: growth and population
  • Infrastructure: physical and telecommunications
  • Real estate: structure and availability

“As criteria for making decisions expand, companies may find that the best places to locate operations are different from what they expected,” Rutherford says. “As offshoring evolves to higher-level back-office functions, cost becomes just one of many factors that influence the location decision. We anticipate corporations will have to spread a much wider net in order to achieve the right combination of factors in selecting an appropriate offshoring location.”

Determining the Best Location Based on Three Scenarios

The study created three scenarios and weighted the six elements differently in each scenario. While cities in Asia, India, and the Philippines top the list for the cheapest cities for offshoring, cities in Central and Latin America, Central and Eastern Europe, and Africa “show surprising strength when other factors are taken into account,” says the study.

Scenerio One centered on cost.

Not surprisingly, Delhi topped the list, followed by Manila, Chennai, and Bangalore.

Scenario Two focused on quality.

The study says access to a plentiful and qualified workforce is a “major driver” for more sophisticated BPO activities like specialist legal processing, dispute resolution, corporate finance, software development, and contact centers dealing with complex or technical issues.

The real estate researchers put more emphasis on human capital in this scenario, highlighting the size of the labor pool and the quality of the labor. According to the study, cities in Latin American and Asia have the best labor supply. But when it comes to labor quality based on specific labor skills, Manila, Moscow, and Budapest ranked the highest.

In this scenario, Manila achieved the top ranking based on its access to a large pool of well-qualified English-speaking workers. Sao Paulo, Mexico City, and Buenos Aires ranked No. 2, 3, and 4. Delhi didn’t appear on the list until No. 5.

“Latin American is getting more attention as an offshoring destination, especially for operations seeking Spanish language or multi-lingual skills,” Rutherford explains. Geographic and time zone proximity to the US and the availability of educated workers also “contribute to the appeal of Latin American cities,” he adds.

Scenario Three taps into another major offshore driver: the ability to take advantage of opportunities in a local marketplace. Given the current global tariff barriers, it’s often cheaper to establish an offshore presence in a foreign country in which a company wants to do business by first exporting from the foreign country back home. After some time, the company can begin producing for domestic consumption in the foreign country. Jones Lang LaSalle calls this scenario “market driven.” The best known examples of the market driven scenario are in the consumer goods and auto industries.

Rutherford says in this scenario the ability to access new markets is more important than cost savings. “Some companies are using offshoring as their first experience in a particular foreign market before they graduate to a global geographic expansion,” he explains.

Due to their projected economic growth, Indian and Chinese cities claimed the top eight rankings.

Future Trends

The study also took a stab at future predictions. Another big trend brewing is what the real estate firm calls “the offshoring of the offshored.” The study says India-based outsource providers will establish facilities closer to key US and European markets; Indian’s Big Three service providers have already done so. The firm calls the next trend “polarization.” For lower-order activities, the study says cost will continue to be the main driver. To get the best costs, companies will have to go to “second and third-tier India cities such as Chandigarh, Kolkata, Jaipur, Cochi, and Ahmadabad.” But companies needing to offshore “higher-order, less cost-sensitive activities will increasingly turn to non-traditional offshoring locations including Central and Latin America and Eastern Europe,” says Rutherford.

In addition, the study expects companies will want to spread the risks of offshoring by choosing a number of different cities spread across national boundaries.

Rutherford predicts South and Central America will host the second wave of offshoring activity. “Spanish, not Mandarin, is the world’s most commonly spoken language,” he explains. “American companies are acutely aware of their Spanish-speaking markets. Similarly, companies are turning to Tunisia or Morocco to service French-speaking customers.”

One thing that remains certain is that offshoring will continue to thrive. The study says “offshoring has become less of an option and more of a business imperative.” Rutherford believes the number of jobs in the service sector moving offshore will “expand dramatically” in the next three years. “The size of the expansion was a surprise for us,” he says.

The study also found 65 percent of the companies that offshored achieved the savings they expected.

The US is still the “predominant” country in the offshore arena. Rutherford says the study found the US represents 70 percent of global offshoring activity. Asia to Asia offshoring compromises another 20 percent. Europe rounds out the last 10 percent.

The firm’s October Corporate Real Estate Impact Survey found 30 percent of its respondees have already offshored some activities. The participating firms expected that number to double to 67 percent by 2007. Rutherford says the study predicts that low-cost areas in the US that currently provide back office services like North Dakota or West Texas will contract at one percent a year.

Real Estate Considerations

Rutherford says some of the office buildings in major Indian metropolitan areas have building code violations that make it impossible for western companies to occupy them. “Right now most of the good buildings are fully rented, so companies will have to build,” he reports. Companies looking at secondary cities will find few if any buildings that meet their needs, he adds. He says companies will also have to build their own facilities in northern Africa and eastern Europe.

On the other hand, Latin and Central America have better rental options. “If you go to Costa Rica, you can find good buildings for a lower rental rate,” he reports.

Infrastructure can be an issue. He says one client occupied space in Gurgeon in 2001 that will not be connected to the electrical grid until 2005. It uses diesel generations for power until then.

Rutherford says most buildings in India use water for their air conditioning units. Without water, there’s no AC. It’s not a problem during the monsoon season but can be challenging at other times.

“Water, telecommunications, and electricity–you have to focus on these three aspects of infrastructure, too,” he concludes.

How the study was done: Jones Lang LaSalle Research colleted data on 20 competing offshore markets across four global regions. The authors ranked the cities according to their overall performance and then on their performance on each of the six drivers. Then the researchers built the three scenarios.

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