Offshoring: Definition, Pros, Cons & Examples
What is Offshoring
Offshoring is where a firm re-locates its business, or part of its business, overseas. For example, many American manufacturers have offshored their production to foreign locations such as Mexico and China. Instead of continuing to produce in the US, firms such as Ford, General Electric, and Microsoft, have moved production abroad.
Many manufacturing firms had production facilities in the US, but it has proven cheaper to move production to low-cost nations such as India and China. When the likes of Ford close down a US factory and open up another in Mexico – this is known as offshoring. The existing production facilities close and move to a foreign country.
This creates new jobs in the foreign nation, but at the cost to domestic jobs at home. However, whilst specific manufacturing jobs may be lost, the prices of goods is lowered due to lower costs. In turn, offshoring can increase the domestic nations purchasing power. With the savings from lower prices, consumers can afford to purchase more goods from elsewhere. This may then boost jobs in the domestic market – albeit in a different industry.
- Offshoring is the process where firms shift production from the domestic market to abroad.
- Offshoring differs from outsourcing whereby a separate entity is hired to conduct a specific job for the firm.
- Offshoring can be classified into two types, which are manufacturing offshoring and service offshoring.
Some examples of offshoring include:
In 2017, Ford took the decision to move production of its Focus to China. Whilst originally built in the US, Ford was set to move production to Mexico. However, the firm had a change of heart and has since moved production to China. This was largely driven by declining sales in the US market which fell by 20 percent in 2016.
Nevertheless, these vehicles are transported back to the US for distribution. The cost savings are so great, that it makes economic sense to have large motor vehicles transported thousands of miles across the sea. Instead of being made and sold in the US, the vehicles are made and assembled in a factory in China.
2. General Electric
General Electric has invested over $130 million in setting up offshore operations in Bangalore, India. It created a separate subsidiary called GECIS (General Electric International Service), which deals with finance and bookkeeping, customer verification, and other IT services.
Its offshore business employs thousands of people in India, which saves the company millions in wages each year. Instead of hiring US workers at 10 times the salary, they are able to hire qualified professionals at a fraction of the price. At the same time, the region has become increasingly proficient with IT services which has made it easier to access the required talent.
Microsoft is another large firm which has offshored much of its IT operations to India. In collaboration with Infosys Technologies, it has offshored much of its internal IT operations such as finance and bookkeeping, technical assistance, and management of databases.
Similar to General Electric, Microsoft has offshore facilities in Bangalore, India – where the firm has access to a large pool of skilled IT professionals. This allows the firm to be able to provide 24/7 technical support to people across the world.
IBM is another firm which has offshored much of its business to India where it employs over 100,000 people. The subsidiary firm – IBM India Private Limited, performs consulting services, software development, research and development, and cloud-based computer systems.
Advantages of Offshoring§x Although offshoring has gained a bad reputation due to the resulting unemployment, it presents many advantages. These include:
1. Lower Costs
The main driver for offshoring is generally the large cost savings. These come mainly from lower labor costs, but also other operational expenses. For instance, it costs far more to build a new factory in the US than it does in China. In addition, the cost to run that factory is also cheaper.
There is also the factor that many of the firm’s inputs come from the region it is offshoring to. For instance, many smart phones require parts such as batteries and cameras which are largely built in Asia. By moving facilities close by, it is able to save on shipping those inputs half way across the world.
2. Access Skilled Workers
Due to the growing popularity of offshoring, some regions have become increasingly skilled. For example, India has had significant inflows of capital investment from IT firms. This has led to training of local residents and has advanced the skills of many in the area.
Furthermore, there are regions which have more specific skills, whether cultural or through education. Tasks which require accuracy and precision may be better suited to nations such as the Philippines. However, tasks which require a regimented workforce may be better suited in China.
3. Time Zone Coverage
Many firms offshore their IT operations to nations across the world. This is so that it is more efficient to offer 24/7 service to its customers wherever they are. On top of this, employees in regions such as the Philippines are willing to work outside of usual working hours. Not only does this provide universal coverage, but it can help provide a smooth transition of tasks. For example, once workers in the US are finished, that task can be passed onto workers in the offshore location.
4. Focus of Core Business
Most firms have some form of IT, finance, or pensions business. However, these are largely irrelevant to the firm’s core business. By offshoring these parts of the business, it is able to benefit from greater resources abroad, thereby increasing efficiencies and allowing it to divert greater resources to its key functions.
Management can focus on the business’s goals and strategies, whilst its offshore facilities take care of functions such as IT and finance. This streamlines the business process and ensures management have time to focus on activities that add greater value.
5. Save Funds for Capital Expenses
Some firms are faced with large capital outlays. For example, a manufacturing firm needs to build a new factory. Instead of building it in the US, it may decide to build it in Mexico or China, where the cost is but a fraction. In turn, there are savings that can be made both in the short-term as well as the long-term.
Furthermore, if the firm offshores in partnership with a foreign business, it may very well avoid these up-front costs altogether. So instead of paying $10 million for a factory, it may be pay $1 million each year for its use. This helps to free up capital which would have been spent on that factory, thereby diverting it to areas which are more lucrative.
Disadvantages of Offshoring
The disadvantages of offshoring are generally well known, but there are also some others which include:
1. Lost Jobs
From the point of view of the domestic nation, when firms offshore, they tend to take the jobs with them. In recent times, this has seen thousands of manufacturing jobs move from Western economies such as the US, and towards emerging ones such as China and India.
2. Loss of Intellectual Property
Some emerging markets require firms to work with a local subsidiary, or for a local firm to have a stake in the venture. This comes at the risk of the offshore partner taking away the firms intellectual property. As legal rights of intellectual property are not as strong in China and the like – such entities are able to get away with such theft.
3. Poor Customer Service
A large number of banks and other service-based industries offshored a large number of their customer services to the likes of India. However, many have faced a fierce backlash and claims of poor customer service. When considering public opinion tends to view offshoring negatively, poor customer service becomes heightened. In turn, this has led many firms to ‘re-shore’ their customer service operations back to the domestic nation.
4. Public Opinion
One of the common disadvantages of offshoring is that it is notoriously unpopular among the general public. It is seen to take jobs away from others, with businesses pocketing the profits. At the same time, poorer quality service can also impact on consumers perception of offshoring, which has becoming increasingly unpopular.
5. Loss of Control
Although offshoring allows firms to concentrate of their core business, it can come at the cost of lost control. This is because the offshore firm is located in a different location – usually on the other side of the world. If there was a problem at a domestic location, management could easily visit the location and identify the issue. However, they would have to travel to the other side of the world if they are to solve an issue at their offshore location.
Offshoring vs Outsourcing
Offshoring and outsourcing are very similar in some regards, but different in others. Whilst offshoring refers to moving the business, or part of the business, abroad, outsourcing is where a third party is hired to run part of the business. For example, a US company offshoring may open a new factory in China. By contrast, if that same company was outsourcing, it would hire a firm to conduct a specific task. For instance, the firm may outsource its pension administration. A separate company would be paid to deal with that specific part of the business.
There is some overlap between outsourcing and offshoring. For instance, a firm could outsource part of its production to another in a foreign country. That way, the firm is both offshoring away from its domestic market, but also outsourcing to a third party.
FAQs on Offshoring
Offshoring is the practice of relocating a business operation or service from one country to another to take advantage of lower costs, such as labor, materials, or taxes.
Offshoring is where a firm moves part of its business to another country. For example, many firms have offshore their IT to India where there are highly skilled and trained professionals.
Offshoring is where the firm moves its production facilities abroad, but still has ownership over those. However, outsourcing is where a third party is hired to conduction the firms business.
Offshoring is used by a wide variety of large corporations. Examples include Apple, IBM, Microsoft, GE, and Ford.
Companies offshore their operations to take advantage of lower costs, access to specialized skills and expertise, and new markets.
Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others.