Offshoring Without Guilt

The new hot topic being debated in board-rooms, at meetings and in Internet discussion groups is “offshoring,” the practice among U.S. and European companies of migrating business processes overseas to India, the Philippines, Ireland, China and elsewhere to lower costs without significantly sacrificing quality. At first blush this would seem like nothing new, but the development of a powerful communication infrastructure is making offshoring an increasingly viable and commonly taken option: Nearly two out of three software companies are already involved, and in a number of industries, IT-enabled back-office business processes are prime candidates for such a shift.

At the heart of the debate is the issue of jobs and wages. As networking technologies have enabled companies to tap into the global marketplace for talent more easily, offshoring has put downward pressure on domestic salaries. What’s more, we seem to be emerging from the current recession with no net increase in professional, higher-wage jobs, because many of these have migrated overseas. Unlike layoffs triggered by poor performance, these job shifts are mainly due to the availability of comparable talent elsewhere at lower cost. The public outcry about this practice has engendered so much corporate guilt that very few companies are keen to go on record publicly in this arena. This guilt, however, is misguided. Offshoring should be seen for what it is — a key element of the next-generation business model.

The Third Wave

The shifting geography of business processes is, in fact, the third wave of geography-related change in the design and operation of corporations. During the first wave, the improving transportation infrastructure of the 20th century enabled corporations to seek effective production capabilities in increasingly far-flung locations that provided access to new markets and tangible resources — land, local factories, mines and production workers. During the second wave, as capital markets became global and interconnected in the latter half of the 20th century, corporations began to capitalize on vibrant global financial markets for both debt and equity.

Now we are in the midst of the third wave — in which digitized business processes like order processing, billing, customer service, accounts and payroll processing, and design and development can be carried out without regard to physical location. As with the first two waves, the only relevant question for companies now is how to deliver maximum value to customers and shareholders.

Global realignment of jobs across different skill levels is continuous and dynamic. We have recently seen a major shift in the employment patterns of skilled white-collar jobs. In the early 1990s, middle-management jobs were restructured to take advantage of the increased power of computer and communication technologies. Jobs lost due to reengineering in large corporations were compensated for by job creation due to the Internet revolution and supported by venture-capital inflow. Indeed, the feeling at that time was that we needed to import high-skill labor to cope with the shortage. The rallying cry then was the “war for talent,” yet just a few years later we are crying about the need to protect jobs. The challenge at hand is not to protect domestic jobs through tariffs or quotas but to recognize and exploit the emergent global network of such competencies.

When this question is framed as “offshoring,” it misses the larger point. Despite the public relations backlash, offshoring is not synonymous with the use of sweatshop labor or the flouting of environmental laws. It is the creative and careful leveraging of new and available pools of skilled labor and exploiting the power of communication technologies to create new sources of competitive advantage. The true power of the Internet will be to alter the global footprint of business operations, blurring national and physical boundaries.

Leading the Shift

Within the next few years, this single issue has the potential to change the competitive cost structure in many settings for companies of all sizes. For example, for some time now managers have been asked to focus on their core competencies. Dell Inc. and Cisco Systems Inc. are just two of many companies that have begun to address successfully whether there are activities inside the firm that would best be carried out by someone else (out-sourcing) or somewhere else (offshoring). Each company orchestrates a global supply chain for product delivery comprising many different companies and competencies — partnering, for example, with two electronic manufacturing services companies, Solectron Corp. (based in Milpitas, California) and Flextronics Corp. (headquartered in Singapore) for assembly, as well as FedEx Corp. and United Parcel Service Inc. for shipping.

Beyond the question of what is core, many companies are simply asking themselves which of their processes are location-independent and where those processes would best be located. HSBC, for instance, carries out credit card and loan processing from India and both Allstate Corp. and Prudential Property & Casualty Insurance Co. have application designers and call-center personnel working out of Ireland. General Electric Co. — arguably one of the pioneers in understanding this shift — has over 15,000 people in India alone carrying out a variety of knowledge-work business processes.

Once companies have decided, on the basis of core competencies and optimal location, on their offshoring strategy, the question of optimal governance of these processes arises. GE, Intel, J.P. Morgan Chase and Motorola all have opted for internal governance. They use their global reputation to attract talented professionals to work for them. Internal governance ensures that their offshore components strictly adhere to corporate worldwide procedures and rules. For other companies it is more attractive to contract with local service providers in India, Ireland, Malaysia and elsewhere. BP Plc, for example, has formed relationships in different parts of the world to take advantage of the vibrant competition among the service providers. The main advantages of this approach are flexibility and scale of operations. But this flexibility creates the need for investments in relationship management. (BP, for instance, has developed a set of Web-enabled tools for effective governance, including performance dashboards and stakeholder maps for managing relationships.)

Regardless of which form of governance is chosen, thinking through how work will be both distributed and integrated is essential to assessing the benefits and costs of offshoring. For most companies, coordinating a far-flung network of business processes presents new challenges and they need to design management processes that will capture value on a sustained basis.

A New Frame of Reference

The location of factories, the physical machinery of production and the percentage of local content in products were all considerations that shaped industrial-age thinking, when companies were seen primarily as portfolios of product offerings. In the current age, however, when companies are best seen as portfolios of capabilities and relationships positioned within a global network of business processes, it is those processes and the dynamic creation of value within the entire network that frames our thinking. In that context, offshoring is but one of the critical challenges companies face. Job shifts and relocated operations are but aspects of the larger challenge to design the next-generation organization. This is not an issue merely for CIOs. It is a business strategy issue and managers would do well to think rationally — not emotionally — about it.