Offshoring is defined as the movement of a business process done at a company in one country to the same or another company in another, different country.This includes any business process such as production, manufacturing, or services. Almost always work is moved due to a lower cost of operations in the new location.

Offshoring is sometimes contrasted with outsourcing or offshore outsourcing. Outsourcing is the movement of internal business processes to an external company. Companies subcontracting in the same country would be outsourcing, but not offshoring. A company moving an internal business unit from one country to another would be offshoring, but not outsourcing. A company subcontracting a business unit to a different company in another country would be both outsourcing and offshoring.

Offshoring can be seen in the context of either production offshoring or services offshoring.Offshore outsourcing, a type of business process outsourcing (BPO), is the exporting of IT-related work from the United States and other developed countries to areas of the world where there is both political stability and lower labor costs or tax savings. Outsourcing is an arrangement in which one company provides services for another company that could also be or usually have been provided in-house. Offshore simply means “any country other than your own.” The Internet and high-speed Internet connections make it possible for outsourcing to be carried out anywhere in the world, a business trend economists call globalization. In general, domestic companies interested in offshore outsourcing are not only trying to save money in order to be more price-competitive against each other, but also to enable them to compete with businesses in other countries.

After offshoring’s accession to the WTO in 2001, China emerged as a prominent destination for production offshoring. After technical progress in telecommunications improved the possibilities of trade in services, India became a country leading in this domain though many parts of the world are now emerging as offshore destinations.Initially India was seen as the first choice in the outsourcing. Probably that is correct but the trend changed easily in which the Philippines now emerged as the first choice and not as the second choice anymore.

The economic logic is to reduce costs. If some people can use some of their skills more cheaply than others, those people have the comparative advantage. The idea is that countries should freely trade the items that cost the least for them to produce.

Related terms include nearshoring, which implies relocation of business processes to (typically) lower cost foreign locations, but in close geographical proximity (e.g. shifting United States-based business processes to Canada/Latin America); inshoring, which means picking services within a country; and bestshoring, picking the “best shore” based on various criteria. Business Process Outsourcing (BPO) refers to outsourcing arrangements when entire business functions (such as Finance & Accounting, Customer Service, etc) are outsourced.

A further term sometimes associated with offshoring is bodyshopping which is the practice of using offshored resources and personnel to do small disaggregated tasks within a business environment, without any broader intention to offshore an entire business function.

• Production offshoring

Production offshoring of established products involves relocation of physical manufacturing processes to a lower-cost destination. Examples of production offshoring include the manufacture of electronic components in Taiwan, production of apparel, toys, and consumer goods in China, Vietnam etc.

Product design, research and the development process that leads to new products, are relatively difficult to offshore. This is because research and development to improve products and create new reference designs requires a skill set that is harder to obtain in regions with cheap labor. For this reason, in many cases only the manufacturing will be offshored by a company wishing to reduce costs.

However, there is a relationship between offshoring and patent system strength. This is because companies under a strong patent system are not afraid to offshore work because their work will remain their property. Conversely, companies in countries with weak patent systems have an increased fear of intellectual property theft from foreign vendors or workers, and, therefore, have less offshoring.

Production offshoring got its big push when the NAFTA made it easier for manufacturers to shift production facilities from the US to Mexico. This trend later shifted to China, which offered cheap prices through very low wage rates, few workers’ rights laws, a fixed currency pegged to the US dollar, (currently fixed to a basket of economies) cheap loans, land, and factories for new companies, few environmental regulations, and huge economies of scale based on cities with populations over a million workers dedicated to producing a single kind of product.

• Services offshoring

The growth of services offshoring is linked to the availability of large amounts of reliable and affordable communication infrastructure following the telecommunication and Internet expansion of the late 1990s. Coupled with the digitization of many services, it was possible to shift the actual production location of services to low cost countries in a manner theoretically transparent to end-users.

India first benefited from the offshoring trend as it has a large pool of English speaking people[1] and technically proficient manpower. India’s offshoring industry took root in low-end IT functions in the early 1990s and has since moved to back-office processes such as call centers and transaction processing. In the late 1990s, India’s abundant and cheap software engineering talent combined with massive demand from the Y2K problem helped to move India up the value chain to attract large-scale software development projects for US based customers. This spawned the neologism Bangalored, used to indicate a layoff, often systemic, and usually due to corporate outsourcing to lower wage economies – derived from Bangalore in India, where some of the first outsource centers were located.

Currently, India’s engineering talent has made India the offshoring destination of American high-tech firms, led by HP, IBM, Intel, AMD, Microsoft, Oracle Corporation, and Cisco. Each of these companies has promised or is in the process of investing at least $1 billion in India, to supposedly retain market share in the face of competition and cost-cutting measures of rivals and industry in general.

As a result of the offshoring boom, India has seen double-digit wage growth for much of the 2000s. Consequently, Indian’s operations and firms are concerned that they are becoming too expensive in comparison with competition from the other offshoring destinations listed below. They are now attempting to branch out and diversify to other high-end work in addition to software and hardware engineering. These jobs include research and development, equity analysis, tax-return processing, radiological analysis, medical transcription, and more.

The choice of offshoring destination is often made according to cultural concerns. Japanese companies are starting to outsource to China, where large numbers of Japanese speakers can be found — particularly in the city of Dalian, which was Japanese-occupied Chinese territory for decades (this is discussed in the book The World is Flat). German companies tend to outsource to Poland and Romania, where proficiency in German is common. French companies outsource to North Africa for similar reasons.

Other offshoring destinations include Mexico, Central and South America, the Philippines, South Africa and Eastern European countries.

CAFTA made nearshoring more attractive between the Central American countries of Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic and the US.

• Innovation offshoring

Once companies are comfortable with services offerings and started realizing the cost savings, many high-tech product companies started using countries like South Africa, India, China, Mexico, Russia, etc. for innovating products.

Many famed Silicon Valley based companies jumped on this bandwagon not only to cut costs but to shorten their product lifecycle and access the talent pool available in these countries. Less developed countries are usually utilized for this practice.

• Transfer of intellectual property

Offshoring is often enabled by the transfer of valuable information to the offshore site. Such information and training enables the remote workers to produce results of comparable value previously produced by internal employees. When such transfer includes protected materials, as confidential documents and trade secrets, protected by non-disclosure agreements, then intellectual property has been transferred or exported. The documentation and valuation of such exports is quite difficult, but should be considered since it comprises items that may be regulated or taxable.

Why are companies offshoring and what are the benefits? There are numerous benefits to firms that engage in offshoring:

• Access to talent - For certain occupations there is a greater availability of highly skilled and experienced employees overseas. The U.S. has 4-5% overall unemployment and for certain in-demand positions there is practically zero unemployment. Offshore outsourcing provides another way for companies to get the job done.
• Cost savings - Companies can save 30-50% compared to the cost of a U.S.-based employee for the same level of performance, and oftentimes the offshore employees are more committed, grateful for the work.
• Speed (ie, filling open positions quickly) - If you are recruiting a U.S. employee, it can take a month or more to fill certain positions. However, given the availability of offshore employees, open positions can typically be filled more quickly.
• Elimination of recruiting costs - Many companies pay recruiting fees to help find the most qualified employee. These fees are eliminated if you are using an offshore vendor to fulfill a certain function.
• Time savings - By using an offshore employee, you eliminate the time you would normally spend on searching job boards, recruiting, interviewing, orientation, managing vacation time and absenteeism, career coaching, and managing employee morale and motivation.
• Reduction of legal exposure - Employee issues can be time-consuming and can escalate into legal liabilities. Using offshore staff eliminates certain legal exposure to employment liabilities.
• Flexibility - Unlike traditional employee relationships, offshoring eliminates hiring and termination costs, allowing companies to quickly expand and contract their overseas staff in accordance with business needs.
• Retention and loyalty - Many times companies are rewarded with higher levels of retention and loyalty from offshore staff because overseas employees typically consider working for an American company to be prestigious.

Offshore outsourcing challenges and considerations While there many identifiable benefits of offshoring, it does not come without its challenges, as well:

• Cultural issues - Different cultures have different communication styles, different attitudes toward conflict resolution and simply different ways of getting work done. Even words can have different meanings in different cultures. For example, in the U.S. the word “yes” typically means “without a doubt.” In certain cultures, “yes” can mean “I’ll try.” Setting aside the concept of outsourcing for a moment, given the increasingly diverse makeup of the U.S. workforce, it is good practice for companies to embrace cultural differences and train their employees accordingly. As it relates to offshore outsourcing, cultural differences with an offshore provider have the potential to present their own set of challenges.
• Loss of US jobs - Offshore outsourcing is a politically charged issue. Most economists believe that offshoring is good for the economy and ultimately results in additional U.S. jobs. The theory is that the lower-level jobs get outsourced and Americans end up doing higher value work. Even assuming the economists’ view is correct, having their jobs displaced is painful to those workers impacted. It might take time to retrain and/or land one of these “higher value” jobs.
• Cost savings that don’t materialize - Expected cost savings might not result from offshore outsourcing. The offshore staff might not turn out to be as productive as expected and/or U.S. workers might end up retaining parts of the job you thought would go overseas, thereby costing you more. In addition, substantial cost inflation has occurred in certain overseas countries, namely India. Overseas wage and overhead inflation (i.e, rent, utilities, etc.) in the long run ends up impacting the cost U.S. customers pay offshore vendors.
• Data security issues - You don’t need offshore or even offsite employees in order for your data to be compromised (or stolen), and certainly once data leaves your building you are subject to certain risks. And while it is true that these risks are no greater overseas than if you transfer files between office locations or allow employees to work from home, legal protections in foreign countries are not the same as in the U.S. For instance, you would want to think twice about outsourcing work that involved access to valuable intangible property. If you do decide to outsource sensitive work, you will want to set up controls within the workflow process to protect yourself.
• Quality of service - If you are not careful, cost savings can be more than offset by service issues. For instance, Dell closed an Indian call center over customer complaints about the quality of service. To protect yourself against such losses, do a thorough analysis of the functions being considered for outsourcing. You will also want to ensure that the function is suitable for the specific country where you are outsourcing. Finally, perform due diligence on the offshore vendor before moving any function overseas.