What is off shoring and how does it effect economies

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What is off-shoring?

Off-shoring

"The term "offshore" refers to where the work is being performed geographically; "Offshore outsourcing" means that work is being performed by an external company in another country overseas. Many people simply refer to this as "offshoring."" (Aaron Green, 2007). In other word, by the above definition, off-shoring means the company would assign tasks to be performed in other country overseas.

Globalization and Off-shoring

Basically, globalization leads the existence of off-shoring, which is one of globalization phenomenon. Globalization refers to the trend towards an integrated and interdependent world economy, such as increasing the international trade, FDI and emergence of multinational firms. Globalization leads the markets more competitive, hence, multinational firms would find ways to increase its efficiency and reduce the costs. As a result, off-shoring existed. For instance, it allows the production and services being performed in another country.

Countries and Ooff-shoring

Since off-shoring provides several benefits, more and more multinational companies implement the strategy of off-shoring nowadays. For example, some companies would send the knowledge-based or manufacturing tasks to another country to perform. There are several countries which are popular for the firms to send the tasks. According to A.T. Kearney, the top ten countries for off-shoring are:

Global Services Location Index 2009

India (position in 2007 GSLI: 1)

China (2)

Malaysia (3)

Thailand (4)

Indonesia(6)

Egypt (13)

Philippines (8)

Chile (7)

Jordan (14)

Vietnam (19)

Credit: A.T. Kearney

Different companies would have different considerable factors in determining the most suitable country for off-shoring, such as labor costs, operating costs, education level of labor, and availability of skilled labor, information technology skills and infrastructure development. Different countries have its own comparative advantages which attracts the multinational firms for off-shoring.

For example, there are many highly-skilled technicians in China and India, which attracts companies to set up the research and development centre in China and India. Moreover, low labor costs in China and India is another attraction for the multinational companies. On the other hand, firms might send the manufacturing tasks of computers and electronics to Taiwan and South Korea because of the higher quality production and relatively low costs.

Is off-shoring bad for a developed economy with many high-paying jobs?

First of all, developed economy can be defined as a country has a high level in economic growth and security. For instance, it has higher gross domestic product (GDP), standard of living, better quality in infrastructure system. Other than the economic factors, people in developed economy might have better education level and health. The United State, United Kingdom and Japan can be the examples of developed economy.

For those countries with developed economy, the payroll might be higher. However, we cannot say off-shoring is totally bad for those countries. It is because off-shoring also provides some advantages to the country.

When it comes to off-shoring's impact on a developed economy, people might think off-shoring is bad for a developed economy with many high-paying jobs since multinational firms implement off-shoring in order to hire cheap labor and save the labor costs. We might say that people have perception that multinational companies only want to cut the labor costs through off-shoring.

However, according to a study done by the University of Nottingham which took Britain as an example, they found that the multinational firms in the UK would choose the country for off-shoring based on the factors such as distance, the quality of human capital, proficiency in the English language and other aspects of historical ties with the UK. As a result, we can see that cheap labor might not be the main factor or objectives for the multinational firm of having off-shoring.

Off-shoring usually offers long-term advantages to a country rather than short-term advantages as off-shoring normally is a long-run business strategy for multinational firms. It is because firms have to put resources in implementing off-shoring. In other word, they would like to get long-term benefits from off-shoring. Although cheap labor of developing economy would be bad for the develop economy with high-paying jobs, off-shoring still gives several interests to developed economy.

Here are the advantages of off-shoring to a country.

First of all, it would increase export in a country since multinationals firm would send the manufacturing tasks and semi-products to overseas. The increased export might lead trade surplus, which might improve the economic growth and value of international trade.

On the other hand, firms find way to increase its productivity, efficiency of using resources and reduce the costs. Those can increase the range of cutting price and wider range of products and service. As a result, it can bring benefit to the consumers. Consumers might purchase more based on the above benefits, the economy of the country would then be improved.

Off-shoring provides benefits in long-term, however, it might bring short-term and long-term disadvantages to the country. Here are the drawbacks of off-shoring to a country.

Since the firms would move activity, which might be a task or even a function of company to another country overseas. For example, if an enterprise move the whole research and development centre to another country. The employees who work for research and development centre in original country would then loss the job. Job losses would lead unemployed workers become stressful. Moreover, increasing unemployment would bring negative effect on the economic growth of a country. Furthermore, if they cannot find jobs, they might seek the help from the government. When burden of the government become higher, the government would raise the tax rate. Finally, it would affect the tax-payers, which is the citizen.

On the other hand, other than the better labor and IT skills overseas, multinational companies might off-shore because of the cheap labor. If this is the main reason of the multinational companies to off-shore, the wages and salary of original country would reduce in order to maintain and attract the multinational firms not to move the jobs to another country. Decreasing salary would bring bad effect on the employees. It is because the standard of living in developed economy is normally higher, their salary might not maintain their living in the developed economy. Consequently, employees might face difficulty in their lives and they would reduce their purchases, which would negatively affect different industries. It will bring negative impact on the whole economy of the country.

We can see that off-shoring provides both benefits and drawbacks to developed economy. It is difficult to determine whether the benefit is over the drawbacks or not. However, it seems off-shoring would bring bad effect on the employees in developed economy while it would bring good effects on the consumers who can enjoy cheaper price and wider range of products and services in country.

How can multinational companies take advantage of off-shoring?

As mentioned before, country would enjoy the benefit of off-shoring. Multinational companies also can take advantage of off-shoring. Here are the benefits of off-shoring.

Availability and flexibility of labor

Moreover, availability of skilled labor is quite high in other countries. Therefore, it is easier for the multinational companies to access to talents in other countries. Through off-shoring, the multinational companies can get highly-skilled and experiences employees, which can help the companies to perform in better way.

Multinational companies can determine the number of employees based on the development of companies under off-shoring without or fewer termination costs. For example, they can increase the number of overseas staff in expansion of the business or they can reduce the number of overseas staff in contraction of the business quickly. It is different with traditional employee relationship.

Costs-saving

As we can see, the top ten off-shoring countries are some developing countries rather than the developed countries. Labor cost can be saved. If multinational companies hire cheap labor, their labor costs can be saved. Even their main objective is to hire the high-skilled labor, such as IT technicians. Since there are large number of highly-skilled and experienced labor in China and India, the firm can save the labor costs in hiring technicians in China and India compared with the United State. Moreover, the welfare and benefits of labor in developing countries would be smaller. Therefore, the labor costs can be saved while the performance can be still maintained.

On the other hand, the cost of recruitment could be saved. If the multinational companies choose to use an off-shoring vendor, the off-shoring vendor would help them to find the employees. Thus, the multinational companies might not pay the recruiting fees to find the most qualified and suitable employees.

Furthermore, in developing countries, they have more attractive investment incentives, such as lower tax rate to the multinational companies. The environmental standard might also be lower than the developed countries, which also can help the multinational companies in saving the costs.

Time-saving

As mentioned above, if the multinational companies choose using off-shoring vendor, the off-shoring vendor would help the companies to do most of the jobs. For example, it would help to interview and select the most suitable employees, provide coaching to the employees and even manage the morale and motivation of employees. Such services not only reduce the costs for the multinational companies, but also the time. We all know that time is more critical than the costs in sometimes. Therefore, time-saving is one of the benefits to the multinational companies.

In summary, several benefits can be brought to multinational companies if they choose implementing off-shoring.

What challenges stand in the ways of multinationals increasing the amount of off-shoring they do?

Since off-shoring provides several benefits to the multinational companies, they might increase the amount of off-shoring. However, increasing the amount of off-shoring would lead the multinational companies face some challenges.

On the negative side, there are significant communication and management issues that arise when you have a team working half way around the world for you. Yes, you can Skype, IRC, Twitter, and IM all day long with your remote team. But often they want to be asleep when you want to be awake.

Long supply chains are susceptible to environmental and political disruptions, force companies to produce larger batches, increase inventory and cost flow requirements and provide less flexibility to adjust to changing markets. The direct and opportunity costs of working with distant partners are usually significant, the differences in cultures, values, and legal systems are sometimes problematic, and there are intellectual property risks.

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. 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.

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.

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