Outsourcing will be an approximately $507 billion global industry in 2014, with significant emphasis on three broad areas: 1) logistics, sourcing and distribution services; 2) information technology services, including the creation of software and the management of computer centers; and 3) business process outsourcing (BPO) areas such as call centers, financial transaction processing and human resources management.
Offshoring, as opposed to outsourcing, covers such a wide variety of nations, products and practices that it is difficult to put a number on the size of the market. A significant share of offshoring revenue is created by contract manufacturing of electronics, laptop computers, tablet computers, cellular telephones and items such as iPods. Another major sector in offshoring is contract manufacturing of shoes, apparel and accessories. Contract electronics manufacturing is estimated at $381 billion for 2014 by analysts at IHS.
Offshore cost savings have become less advantageous, as wages and operating costs have been rising rapidly in the business and manufacturing centers of China and India. Leading offshore services providers, such as IT consulting giant Wipro, have been opening offices and making acquisitions in America and Europe—the locales of some of their leading customers, as offshore firms become more global and mature in nature. In many cases, performance and customer satisfaction are as important as cost.
Products manufactured offshore for corporations that are headquartered in the U.S., Canada, Japan and other developed nations are very often intended for sale in offshore markets—a clear indication of globalization at work. For example, Apple’s extremely popular smartphones are manufactured by offshore contract electronics firms in Asia. While Apple’s products are sold in North America and Europe, a growing portion of their sales is in Asia itself, where the products are made. There are definite advantages to conducting manufacturing close to the rapidly growing business and consumer markets of Asia.
In order to consider the outsourcing and offshoring industry, it is best to define the terms up front, since the words are often used in conjunction and are sometimes used incorrectly:
Outsourcing can be defined as the hiring of an outside company to perform a task that would otherwise be performed internally by a company, organization or government agency—generally with the goal of lowering costs and/or streamlining workflow. Outsourcing contracts are often several years in length. Companies that hire outsourced service providers often do so because they prefer to focus on their core strengths while sending more routine tasks outside for others to perform. Typical outsourced services include the operation of human resources departments, telephone call centers, distribution centers, research needs, computer services and the design and/or engineering of components or end-products.
For example, in addition to selling products such as books via its massive online store, Amazon also offers outsourced services. It provides warehousing and shipping services to businesses, large and small, that want to rely on Amazon for handling and shipping their merchandise to end users. Amazon also provides outsourced computer “cloud” services to firms that do not want to operate their own computer servers.
Offshoring refers to the tendency among many U.S., Japanese and Western European firms to send both knowledge-based and manufacturing work to third-party firms in other nations. Often, the intent is to take advantage of lower wages and operating costs in such nations as China, India, Mexico, Hungary, the Philippines and Romania. The choice of a nation for offshore work may be influenced by factors such as the language and education of the local workforce, transportation systems or natural resources. For example, China and India are graduating high numbers of technicians, engineers and scientists from their universities—thus enabling these nations to attract massive engineering, research and development contracts. In addition, some nations are noted for large numbers of workers skilled in the English language, such as the Philippines and India. In many cases, offshoring utilizes less-skilled labor working for low wages in plants that manufacture such items as shoes, apparel and generic computer components. In other cases, offshore manufacturing contracts go to firms in nations that have developed very advanced technology and industrial bases with highly-skilled and educated workers. For example, final manufacturing of laptop computers and other electronics is frequently offshored to very high quality firms in Taiwan and South Korea. In China, Hon Hai Precision Industry Co. has more than 1 million employees who do contract electronics manufacturing.
Captive offshoring is a term used to describe a company-owned offshore operation. For example, IBM and Microsoft each own and operate significant captive research and development centers in China and elsewhere. The goals of captive offshoring include greater company control through direct ownership, along with lower operating costs and the ability to utilize highly educated local workforces.
Insourcing refers to situations where an outsourced services provider moves into, and sets up shop in, a client company’s facility. For example, it is common for major companies to sign agreements with IBM Global Services, HP and other outsourcing firms whereby these companies take over and operate a client’s internal computer department. Here’s a non-technology insourcing example: ARAMARK Corporation builds and operates snack bars, employee cafeterias and executive dining rooms within a client company’s facilities.
China, India and similar mature offshore work centers will remain moderate-cost providers of services and manufacturing for the foreseeable future. At the same time, as their economies grow, their business structures and middle classes will grow, and they will offer lucrative markets for intellectual property, goods and services sold by firms based in the U.S., Europe, Japan and elsewhere. In some cases, such goods will be imported. In others, they will be created locally at facilities owned by foreign firms. (For example, Kraft has significant manufacturing plants and thousands of employees within China, where it makes processed food products that have been adapted to suit the needs of Chinese consumers.) Meanwhile, these developing nations face immense challenges, including the need to: build infrastructure such as dependable electricity networks, roads and highways; extend their education systems; control pollution; enhance access to basic health care services; and provide greater opportunities to residents in rural and remote areas. In fact, rapid growth in business centers in China and India has created myriad shortages and problems.
Many Chinese cities are experiencing significant difficulties with pollution and road traffic. The most popular Indian business centers, such as Bangalore and Gurgaon, are experiencing daunting shortages of infrastructure of all types, including electricity, while competition for workers is driving wages higher and higher. Despite the recent construction of new highways in India, traffic delays and inefficiencies are an immense burden. The offshoring boom does not touch all residents in India or China, despite impressive growth in the middle classes. Income inequality is a significant problem. For example, the Asian Development Bank estimated, in 2012, that 1.7 billion people in Asia and the Pacific region lived on $2 U.S. (on a PPP or purchasing power adjusted basis) daily or less, a vast number of them earning small amounts from low-tech agriculture. Clearly, there is room for substantial investment in education, transportation and development of rural industries.
China, since its far-reaching business and economic reforms were launched in 1978, has been a bigger beneficiary of foreign investment than has India. This is one reason why China’s economic growth has been so impressive. China’s exports grew ten-fold to $1 trillion annually in the years from 1978 through 2006, later soaring to $4.1 trillion by 2013. At the same time, personal income has made great strides in China. World Bank figures show that more than 600 million people in China have risen above poverty since 1981.
The Federation of Hong Kong Industries reported that Chinese factory wages rose 18% to 20% annually starting in 2009. The Economist Intelligence Unit reported Chinese average nominal wage per hour of just over $3 in 2012, and projected hourly labor costs to reach $4 in 2014. This means that many workers will be earning $10,000 to $12,000 yearly with overtime, in addition to the factory-provided housing and meals that many of them enjoy. By 2014, Chinese firms in many cities were facing worker shortages, while strikes, government regulations and worker unrest have forced employers to boost wages significantly.
The biggest advances in developing nations are yet to come. Hundreds of millions of people will enter the middle class in emerging economies in Asia, Africa and Latin America between now and 2025, rising above poverty for the first time.
One offshoring trend that has continued to be strong is the hiring of thousands of high-quality engineers and researchers to work in the offshore offices (particularly in India and China) of major tech firms. IBM first opened a research lab in India in 1998. By 2010, IBM’s headcount in India had grown to more than 80,000, and by 2012 it reached 112,000. In mid-2010, IBM announced that it would open a major research center in the emerging nation of Brazil.
Fully developed nations such as the U.S. have been shifting to knowledge-based economies for decades, as automation takes over domestic factory floors (displacing factory workers) and much of the rest of manufacturing shifts overseas. The challenge for developed nations such as the U.S. and Japan is to maintain their leads in such areas as intellectual property, investment in R&D and higher education. There is fierce competition among nations to foster advanced education, develop well-trained and motivated workforces, boost productivity and create high incentives for entrepreneurship and investment. Nations that succeed in this regard will invent the new technologies, services, consumer goods and business processes that can be sold to businesses and consumers in other nations. Offshoring and outsourcing will continue to play a pivotal role in the fields of research, manufacturing and business services.