Near Shoring vs Outsourcing- Business Strategies for Global Growth
Posted in Finance Articles, Total Reads: 556
, Published on 04 July 2016
A business entity has to accomplish different tasks to fulfil its objectives. Every task requires various resources. If the business entity does all the tasks itself, it would have to invest heavily in its fixed assets. There are two alternatives- nearshoring and outsourcing. Nearshoring happens when a business organization transfers its non-core business activities to an outside entity geographically located near to the business. E.g. for the businesses in UK, Europe is a nearby area. Outsourcing happens when an organization outsources its business processes to an entity which is located very far from the business. It depends on the requirement of the business which model it should go for.
Nearshoring involves transfer of operations to cost-effective locations having lesser linguistic and cultural differences. Companies prefer nearshoring mainly because of the various data protection laws. Nearness to the vendor company brings the benefits of less expensive travel, more control and fast decision-making. Nearshoring countries generally have similar financial and legal constraints which ensure social and economic stability. As U.S. firms are becoming more concerned about their intellectual property, nearshoring becomes attractive because the risk stealing intellectual capital is decreased. Countries like Canada and Mexico have very good IT infrastructure and skilled and experienced manpower. These countries offer very low cost services. These countries are becoming an ideal choice for U.S. companies due to the proximity. The proximity to these countries have developed better working relationships between the company and its vendor.
One of the best advantages that nearshoring offers is that the company can visit their vendor companies . Due to the proximity between the countries, traveling is quiet cheaper and easier. Proximity provides communication facility between the company and the vendor. There is a better understanding of the transferred functions. Due to similar time-zones, the work can happen at the same time which facilitates better coherence throughout the project. The problem of cultural diversity does not happen much in nearshoring. It makes the communication easier between both the parties. Nowadays many business organizations think that nearshoring provides more stability and there is greater efficiency in the functions.
Outsourcing has its own advantages. The cost of wages in outsourcing locations is lower and since the wages form a significant part of the total cost, the overall production cost can be significantly decreased. Countries such as China and India are the famous examples of vendor countries for the western companies. In India, functions related to straightforward business processes or software development tasks e.g. a C++ subroutine development can be outsourced to companies in Bangalore offering low cost services.
All the non-core functions which the companies generally transfers to the third parties are of two types- Horizontal functions and vertical functions. Horizontal functions can be accomplished through basic back-office skills e.g. recording transactions etc. Outsourcing is a good option for such functions. Vertical functions are significantly related to the core activities of the business. Nearshoring is better than outsourcing for such functions. The Companies in U.K. requires English speaking staff for servicing customer related functions. This requirement makes India as a lucrative destination as India provides good English speaking people at low cost available at various call centers. But for the companies located in Germany require German speaking staff which is not available in India easily. So outsourcing is not possible rather these companies go for nearshoring in countries like Poland etc.
Before deciding between nearshoring and outsourcing, the companies should look towards the attitude of the foreign government. A country providing lesser cost advantages should not be chosen if the government of that country does not allow the foreign company to operate freely. There are high risks that the government of outsourced country might close down the business organizations helping the outsourcing companies. The companies should also look towards the political climate before taking the plunge. The countries like Venezuela have very high political risks posing great risk for the outsourcing companies. There are a lot of risks attached while going for outsourcing but the cost advantages that outsourcing provides can never be expected out of nearshoring. So the companies have to trade-off between cost and the sophistication of the services while making a decision to choose between nearshoring and outsourcing.
Nearshoring and outsourcing have their own advantages and disadvantages. It is very difficult to decide which one is the best. But in the current global scenario, nearshoring is rising as a smart alternative to outsourcing. These days, companies are not just thinking about the costs in long run. The companies are concentrating on other factors too like the overall risk of an existing outsourced project, 24x7 approachability etc.
The initial reasons for moving to outsourcing were the increasing labor costs in U.S and access to the cheap labor abroad. But the scenario is changing now. The wages in countries like China are increasing by 15-20 percent per annum due to labor supply-and-demand imbalance, changes in Chinese labor laws, and higher employee demands. The cost of energy is increasing heavily which has made the transportation costly. The business organizations are looking for nearshoring as transportation forms a major part of the cost of goods. Due to depreciation of U.S. dollars sharply, the companies in U.S. are not finding the manufacturing opportunity in low-cost countries very lucrative. In the global world, the demands of the consumers keep changing. The shorter transit time facility offered by nearshoring helps in dealing with the dynamic market demand very efficiently. At times, there is a need of postponing the final configurations which requires flexibility. Outsourcing can’t afford this flexibility. The cases related to counterfeiting of Intellectual property (IP) are increasing day by day. So the companies are becoming very conscious of protecting their Intellectual property rights. Outsourcing has more risk involved than nearshoring.
The infrastructure forms a significant decision factor when a business thinks of outsourcing. A number of countries which had good infrastructure in the past do not have the same now. For example, Chile had very brilliant and stable infrastructure, but Sebastian Piñera, President of Chile, recently communicated regarding the probable energy crisis in Chile. And there is no guarantee that the countries which showcases good infrastructure today would stand upto their claims in future also. A lot of countries which are good outsourcing destinations are very prone to the natural disasters. E.g. Chile is very prone to earthquakes; Brazil is prone to droughts etc. Not only natural disasters but the political and economic instability is also taken into consideration by the companies which plan to go for outsourcing. E.g. police crackdowns in China, high governance conflicts in Costa Rica and Chile, a number of revolutions in North Africa etc.
All of these factors do not let the outsourcing be a welcome option for the companies. Today India is considered as one of the prominent outsourcing destinations in the world. To take the advantage out of this opportunity, a lot of companies are outsourcing their non-core functions to Indian companies. This clearly suggests that, in future, India would lack sufficient resources. This can happen in case of other countries like China, Philippines and other such locations. Changing the outsourced partner has its own disadvantages. So the business organizations prefer nearshoring to avoid any significant risk in future.
This article has been authored by Uma Bala from IIM Raipur