The relocation of jobs to low-wage countries (offshoring) has been a widely used approach of European companies in search of competitive advantage during the recent decades. Whereas in the past production and manufacturing were affected, now the services industry starts to use this option. IT and telecommunications are among the most important services branches of the Western European economies today. Offshoring is becoming a macro-economic problem in these countries because a lot of jobs will be lost.
This dissertation researches the impact of offshoring on the German IT industry. Furthermore it points out the consequences for project management, quality assurance and human resources management. It highlights the pros and cons for the offshoring companies as well as the concerned employees.
This research starts with a detailed literature review that clarifies important key terms and outlines the key findings of other authors. After that the methodology chapter describes the theoretical framework of this dissertation. Within the scope of this research a survey was conducted among 335 German IT companies. As the surveyed companies are primarily small and medium-sized enterprises (SME) it ascertains the attitudes of this type of firms towards offshoring. The subsequent case study of the telecom supplier Alcatel shows the point of view of a global player on offshoring. At the end, the analysis of the results of the survey and the conclusions from the case study lead to the recommendations for large companies, SMEs and the affected IT employees.
The key finding of this dissertation is, that offshoring is a growing trend that no German IT company can deny regardless of its size. Currently the willingness for offshoring is strongly increasing, which means that many firms are in force to deal with this topic and the German IT employees must cope with changing demands in kind of IT jobs.
Table of contents
List of Figures
List of Abbreviations
Abstract
1 Introduction
1.1 Background and Context
1.2 Research Objectives
2 Literature Review
2.1 Definition of Key Terms
2.2 Prerequisites for Offshoring
2.2.1 Globalisation
2.2.2 Decline of Transaction Costs
2.2.3 Global Sourcing
2.2.4 Process Orientation
2.3 Why Offshoring?
2.4 Opportunities and Threats
2.5 Where to Locate?
2.6 Choosing the Vendor
2.7 Employment Challenges
2.8 Offshoring – The Next Bubble?
3 Methodology
3.1 Design
3.2 Primary Data Collection
3.2.1 Interviews vs. Questionnaire
3.2.2 Structure of the Questionnaire
3.2.3 Sample and Processing
3.3 Secondary Data Evaluation
3.4 Case Study: Alcatel
4 Data
4.1 Results of the Questionnaire
4.2 Case Study: Alcatel
5 Analysis
5.1 Impact on the German IT Industry
5.1.1 How Large Companies Practise Offshoring
5.1.2 How SMEs Meet the Offshoring Challenge
5.1.3 Implications for the German IT Employment
5.2 Impact on Quality
5.3 Impact on Project Management
5.4 Impact on Human Resources Management
6 Conclusions
7 Recommendations
References
Appendix A – Questionnaire
Appendix B – Collected Data
List of Figures
Figure 1 - Outsourcing vs. Offshoring
Figure 2 - Transport and Communications Costs Indexes 1920-1990
Figure 3 - Economics of Offshore Outsourcing
Figure 4 - Attractiveness of Offshore Locations 2003
Figure 5 - 2004 Offshore Location Attractiveness Index
Figure 6 - Dimensions of Rightshoring
Figure 7 - Methodology of Vendor Selection
Figure 8 - Indian Software Industry
Figure 9 - Assumptions on Positivistic and Phenomenological Research
Figure 10 - Classification of Surveyed Companies
Figure 11 - Current Offshoring Destinations of German IT Companies
Figure 12 - Planned Offshoring Destinations of German IT Companies
Figure 13 - Number of Jobs Affected
Figure 14 - Reasons for Offshoring
Figure 15 - Problems with Offshoring
Figure 16 - The Matrix Structure of Alcatel
Figure 17 - Alcatel's Sales, Profits and Employees 1991-2003
Figure 18 - Headcount per Region 2000-2003
Figure 19 - Headcount per European Country 2001-2003
Figure 20 - Headcount in Germany 2001-2004
List of Abbreviations
illustration not visible in this excerpt
Abstract
ANGLIA POLYTECHNIC UNIVERSITY
Ashcroft International Business School
Master of Business Administration
Offshoring of German high tech IT jobs to low-wage countries
SID: 0371500
August 2004
The relocation of jobs to low-wage countries (offshoring) has been a widely used approach of European companies in search of competitive advantage during the recent decades. Whereas in the past production and manufacturing were affected, now the services industry starts to use this option. IT and telecommunications are among the most important services branches of the Western European economies today. Offshoring is becoming a macro-economic problem in these countries because a lot of jobs will be lost.
This dissertation researches the impact of offshoring on the German IT industry. Furthermore it points out the consequences for project management, quality assurance and human resources management. It highlights the pros and cons for the offshoring companies as well as the concerned employees.
This research starts with a detailed literature review that clarifies important key terms and outlines the key findings of other authors. After that the methodology chapter describes the theoretical framework of this dissertation. Within the scope of this research a survey was conducted among 335 German IT companies. As the surveyed companies are primarily small and medium-sized enterprises (SME) it ascertains the attitudes of this type of firms towards offshoring. The subsequent case study of the telecom supplier Alcatel shows the point of view of a global player on offshoring. At the end, the analysis of the results of the survey and the conclusions from the case study lead to the recommendations for large companies, SMEs and the affected IT employees.
The key finding of this dissertation is, that offshoring is a growing trend that no German IT company can deny regardless of its size. Currently the willingness for offshoring is strongly increasing, which means that many firms are in force to deal with this topic and the German IT employees must cope with changing demands in kind of IT jobs.
1 Introduction
1.1 Background and Context
“… Siemens moves headquarters from Munich to Shanghai … Deutsche Telekom to offshore most of IT jobs … SAP relocates European research centre to Bangalore … German government is helpless …”
Notional statements like these seem unbelievable, but when taking some popular German newspapers serious nowadays these statements could become headlines within the next 10 to 20 years. Is this a possible scenario or just cheap propaganda? Is it a threat or an opportunity for European societies? Is it the predetermined way of free market economy or is it worth resisting?
However, the well-developed European countries have been experiencing a major change in the structure of their economies during the last decades. As contribution of the industrial production to the gross national product (GNP) continuously declined the services sector gained importance. This process was accompanied with the relocation of industrial jobs to countries or regions with lower costs. Some examples may underpin this: The textile industry moves to Asia since the 1970s, the automotive industry manufactures in Spain since the 1980s and the computer industry produces in Asia since the 1990s.
It has been the public opinion in the developed countries for a long time that the jobs in the services sector are secured and not subject to relocation. This opinion was driven by an average level of education and knowledge that was much higher than in the developing countries. Meanwhile these countries caught up with the developed countries according to educational level, but keeping the cost low.
The developed countries suffered an economic downturn in the last years that fostered the interest in further cutting operational costs. The companies that are operating globally recognised these circumstances as an opportunity to think about relocation of jobs of the services sector as well. For this type of job relocations the term “offshoring” was formed.
Many economic trends these days emerge in the U.S. Offshoring is not an exception to this. The discussions about offshoring in the U.S. even influence the presidential election of 2004. In Europe, UK is leading the way. In Germany, offshoring was not recognised until end of 2003. At this time Siemens announced plans to offshore some thousand jobs, which caused a big response from the public.
When studying the development of offshoring within the last two years it tells a story of impressive growth rates. So, is offshoring a new phenomenon? Yes and no. The relocation of jobs to regions with lower labour costs has always been a quite normal activity of companies in search of competitive advantage. There are examples from nearly every industry that show such activities in the past. The new thing about offshoring is the type of jobs currently affected and the economic dimensions. That’s why it is valid to take offshoring as a trend.
1.2 Research Objectives
This dissertation’s research question is:
“What is the impact of offshoring for the German IT industry and what are the consequences for project management, quality management and human resources management?”
The dissertation will focus on the German IT industry. This is helpful because labour issues are handled in Germany in a peculiar way that makes it hardly comparable with other countries. Traditionally, the small and medium-sized enterprises (SME) have a great market share in Germany, so for the IT industry. The SMEs have other attitudes towards offshoring than global players. This research points out these differences.
In addition, this research will look at the pros and cons of offshoring for the companies and the advantages and disadvantages for their employees.
Finally, this research analyses the impact on the German IT industry as a whole.
2 Literature Review
2.1 Definition of Key Terms
In the literature that deals with the relocation of jobs the most frequently used terms are “outsourcing” and “offshoring”. They are sometimes used as synonyms. But as these terms have different meaning it is important to distinguish between them. Robinson and Kalakota (2004:4-5) define three combinations of the two terms:
- Outsourcing is the delegation of tasks to a third-party vendor that may reside in the same country as the outsourcing company but abroad as well. If this activity affects not only single tasks but also whole business processes it is called business process outsourcing (BPO). However, outsourcing means shifting the jobs from the outsourcing company to another company.
- Offshoring is the delegation of business processes to a foreign vendor. This vendor may be an own subsidiary or a third-party vendor. Anyway, offshoring means shifting the jobs from the country of the offshoring company to another country.
- Offshore Outsourcing is a subset of both previously defined activities. It characterises the delegation of business tasks to a foreign third-party vendor. In this case the jobs leave both, the company as well as the originating country.
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Figure 1 - Outsourcing vs. Offshoring
This research will refer to offshoring because firstly this includes offshore outsourcing and secondly the research question is on the impact on German IT jobs. In this context it does not matter if the offshoring vendor is company-owned or third-party.
2.2 Prerequisites for Offshoring
2.2.1 Globalisation
Globalisation is one of the most frequently used economic terms during the past decade. This could imply that globalisation is a new phenomenon, but it is not (bpb, 2003). The World Bank (2000) defines globalisation as a process of linkage of markets and production of different countries due to the dynamics of trade and the flow of capital and knowledge. This process originates in the 19th century when the industrialisation started and the trade improved significantly. Aside the economic development the theoretical understanding of the advantage of trade emerged. In 1817, Ricardo published its groundwork on economy and taxation (Ricardo, 1996). He defined the term of “comparative advantage”. The core statement of this approach is that the international division of labour plus the foreign trade make the pie bigger for all parties involved. This perception was a key driver for the liberalisation of trade in the 20th century. Without that liberalisation and the resulting barrier-free access to foreign markets the globalisation and thus offshoring would not take place.
Beside the approach of comparative advantage that guides the economies on country level there is another approach that is applying on the corporate level: competitive advantage. According to Porter (1998) a firm possesses a competitive advantage over its rivals if it sustains profits that exceed the average for its industry. A competitive advantage exists when the firm delivers the same benefits as competitors but at lower costs (cost advantage) or provides benefits that exceed those of competing products (differentiation advantage). Thus a competitive advantage enables the firm to add value for its customers and superior profits for itself. The goal of most businesses today is to achieve a sustainable competitive advantage. At the beginning of 21st century, globalisation is recognised as the latest development of international trade and interdependence. It created a number of companies that are larger than ever before and make profits on a large scale. Most of these companies originate from the U.S. or Western Europe. Although some critical organisations, like Attac, denounce globalisation as a threat, most economists put emphasis on the welfare benefits.
2.2.2 Decline of Transaction Costs
Coase (1937) gave the first lucid explanation of transaction costs. He concluded that
“... firms are created because the additional costs of organizing them is cheaper than the transaction costs involved when individuals conduct business with each other using the market. Firms should conduct internally only those activities that cannot be performed more cheaply in the market or by another firm. Thus a firm will expand precisely to the point where the costs of organizing an extra transaction within the firm becomes equal to the costs of carrying out the same transaction by means of an exchange on the open market.”
Moore’s Law[1] and Metcalfe’s Law[2] have made many types of transactions cheaper. This has resulted in outsourcing and the disintermediation of many transaction middlemen. This trend is sure to accelerate because digitisation has cut transaction costs all the way to zero in some cases. Once a product or service is in place to be sold on the Internet, for example, there is zero cost for each additional transaction.
Another field of declining transaction costs is logistics and communication. Here, the progress was remarkably in the past decades, e.g. the price for a three-minute telephone call from London to New York lowered by the factor 100 within 60 years (UNDP, 1999).
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Figure 2 - Transport and Communications Costs Indexes 1920-1990
Source: UNDP, 1999:30
This development makes logistics and communication costs a factor that is not that relevant anymore when deciding to go offshore.
2.2.3 Global Sourcing
In the IT context, global sourcing is less focussed on raw materials and goods as in other industries. Instead, it is targeting at services and knowledge. Therefore, the educational level of people is a key driver for global sourcing in the IT industry. For a long time it was difficult to find enough skilled people in offshore regions. This is radically changing. Some of the offshoring destinations (see chapter 2.5), especially India, China and Eastern Europe have significantly improved the education of their people. Today, they offer a large skilled workforce at low labour cost. These people plus the improvements in telecommunication and IT enable offshoring at all.
Another dimension in human resources management is the global recruiting approach. Many companies committed to recruiting the best people independently of their origin. Developing countries offer a large pool of human resources that no global player can deny.
2.2.4 Process Orientation
In the 20th century three major revolutions took place according value chain. The first step was the standardisation and specialisation also known as Taylorism, first introduced by Ford. The product diversification was very limited and the productivity improved because every worker was a specialist in performing a very small number of tasks. The next step was the process orientation of the producing industry. This theory was founded by Ohno (1988) and was first realised by Toyota. This approach made effective outsourcing possible the first time because a company that is clear about its processes is able to easily identify the processes that are worth outsourcing. The third step in value chain improvement was the emergence of network and virtual organisations. The idea of this approach is that a company acts like a spider in the net. It only holds intellectual property and pulls the strings to be utmost flexible. However, outsourcing is most efficient if the work tasks are clearly differentiated processes (Deutsche Bank Research, 2004).
In general, every business process is subject to outsourcing that does not belong to the core processes. Core processes are the instances of the core competencies of the corporation (Prahalad and Hamel, 1990). These core competencies are the source of competitive advantage and enable the firm to introduce an array of new products and services. Furthermore, the most important management tasks are not subject to outsourcing because they include strategic and leadership tasks. All other processes like support processes, preliminary and downstream processes and the management of infrastructure are suitable for outsourcing.
Deutsche Bank Research (2004) specifies four levels of IT outsourcing.
The lowest level is named selective outsourcing or outtasking. This includes the partly outsourcing of business tasks. A common example is the hosting of web pages, which today is preformed by specialised providers but rarely by the publishing company itself.
The next level is called business process outsourcing (BPO). Here, a complete business process including IT is outsourced. These processes most of all have no strategic importance and are fairly standardised. This method is most commonly used. Examples are the outsourcing of accounting or IT support. BPO requires IT systems that are compatible between the customer and the vendor because the vendor delivers the service but the customer promotes it to its customers.
The next more complex level is named comprehensive outsourcing. At this level the complete IT is outsourced. This includes IT support as well as IT infrastructure management, application management and the development of new IT solutions. This method is normally based on a tailored contract because the vendor must get ready for individual customer demands.
The most extensive method of outsourcing is business transformation outsourcing (BTO). Here, the vendor acquires the complete IT and significantly improves it. This might even lead to new products of that both, the vendor and the customer benefit.
2.3 Why Offshoring?
The reasons why companies relocate jobs are manifold but a set of reason is most dominant and prevailing.
Cost Savings
The prime motivation for offshoring is cost reduction. Companies that are operating on a global scope cannot ignore the large differences in the labour costs. The wages paid for equivalent skills between the EU and countries like India or Slovakia differ by a factor of 10. The equivalent of a software developer who costs 60 € an hour in Germany costs only 6 € an hour in India (McKinsey, 2003).
The ongoing price deflation forces firms to adopt the offshoring model in order to aggressively lower costs and thereby set lower prices. These lower prices set in motion a deflationary cycle that ruins weaker companies. This cycle meanwhile affects nearly every industry and is called the “Wal-Mart syndrome” (Cook, 2004).
Another cost savings reason for offshoring is that the offshore locations often have low taxes to allure foreign direct investments. A company can save a lot of money if it has to pay less tax. For example, Slovakia has 19% taxes on income, while Germany has an average 37% taxes on income (Manager Magazin, 2004).
Lets look in detail at the economics of offshoring, i.e. how much costs typically can be saved. Both, Robinson and Kalakota (2004) and McKinsey (2003) use a similar model to explain the economics of offshoring. This model does not only take cost savings due to low labour costs into account but looks at the total costs of offshoring (TCO). The model defines the cost base in Europe as 100%. Then the cost savings due to low-cost labour are subtracted. After that the costs of offshoring (additional transaction and monitoring costs) are added. This results in the offshore cost base. McKinsey (2003) extends this model to show how costs can be even lowered by reengineering of business processes.
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Figure 3 - Economics of Offshore Outsourcing
Source: McKinsey, 2003
The cost savings due to low labour costs can sum up to 65% of the labour costs in Europe. The costs of offshoring can be split into additional transaction costs and additional monitoring costs. Additional transaction costs include for example costs of vendor selection and legal costs and make up 10%. Additional monitoring costs comprise of telecommunication costs and costs for travel and contract management and make up 10% as well. Therefore the overall offshore costs amount to 55% of the costs in Europe. This means the cost savings amount to 45%. As this number is already very impressive additional cost savings of up to 20% can be achieved by task and process level improvements. While the vendor becomes familiar with the offshored tasks the skills of its employees improve and the tasks consolidate. If the vendor performs similar tasks for other clients (economies of scale) or reengineers the business process the overall cost savings can amount to 65% of the European level.
The model is quite optimistic and relies on some basic assumptions that may not always be true. It assumes that the cost savings can be achieved from the first day on. Different sources like Overby (2003) or Computerwoche (2003) report that at the beginning of a project the productivity reduces by 20%. Overby estimates that it needs up to a year for ironing out cultural differences, while Computerwoche assumes a transition period of up to three years. Communication costs can also endanger an offshoring project especially when languages differ. Communication costs does not mean telecommunication costs but the costs for the time-consuming negotiation and monitoring of contracts and the ironing out of cultural differences. An analyst of Gartner Germany reports in an interview with Computerwoche (2004a) that all Gartner studies prove that communication costs for offshore cooperation are immense. Another false assumption of the model is that these cost savings are stable over many years. While the wealth in the offshore countries increases the cost savings potential lowers. Financial Times Deutschland (2004) states that it is a rolling system: it runs well for about 2 to 3 years; after that, another location needs to be searched. This is the situation that Ireland is currently facing: call centres are relocated from Ireland to India because labour costs in Ireland have reached average European level. But even India is facing relocations to China because Chinese labour costs are a bit lower than that in India. Another hidden costs of offshoring should not be underestimated: costs for layoffs. The cost savings of offshoring can only be fully achieved if the expensive European employees are dismissed. This can involve expensive social plans especially in Germany where it is a requirement by law that the employer negotiates a social plan with the union. For instance Alcatel, a European telecommunication equipment supplier, funded 2 billion € for such plans in the last three years (see Alcatel case in chapter 3.4).
Concentration on Core Competencies
Since the late 1990s many IT companies are pushing the concept of a virtual organisation to new limits. They outsource most of their back offices to offshore vendors. Steadily lowering transaction costs contribute to this approach. It enables these companies to focus only on what they can do best, for instance basic research, product development, branding or sales. All other work is subject to offshoring, first of all IT but also customer care, payroll, HR and of course production. A good example for a virtual organisation is Palm Inc., the Silicon Valley based developer of personal digital assistants (PDA). The following statements are taken from the 2003 annual report of Palm (2004):
“We build awareness of our products and brands through mass-media advertising, targeted advertising, public relations efforts, in-store promotions and merchandising, retail advertising and our branded Internet properties.
We believe that customer service and technical support are essential to the sales process within our industry . … Our customer support is provided by outsourced service providers as well as internal personnel.
Our product development efforts are focused on both improving the functionality of our existing products and developing new products. We believe the innovation and design of our products plays an important role in our success. … We utilize third parties to design, develop and manufacture certain products, after we have completed product definition.
We currently outsource all of our manufacturing and much of the hardware design of our devices to third party manufacturers. This outsourcing extends from prototyping to volume manufacturing and includes activities such as material procurement, final assembly, software development, test, quality control and shipment to distribution centers. The majority of our products are assembled in China and Mexico.
We rely on a combination of patent, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. … While we rely on these methods to protect our intellectual property, we also believe that factors such as the technological and creative skills of our personnel, new product developments and enhancements are essential to establishing and maintaining a technology leadership position.
We believe that the public perception of our brand and trademarks is instrumental to our success.”
This example shows how an organisation works that straight concentrates on its core competencies, in case of Palm Inc., branding, marketing and product definition. All other processes are outsourced and often offshored.
Quality and Performance Improvements
Whereas in the developed countries many of the offshored jobs are seen as relatively undesirable or of low prestige, in the countries they are offshored to they are often considered desirable and attractive. As a result, employees in low-wage countries often have higher motivation and outperform their counterparts in the developed countries in terms of performance measures (McKinsey, 2003). The offshored tasks are most of all standardised. The offshoring vendors have developed skills to perform these tasks efficiently and with high quality. As most of the offshoring vendors are quite young they use state-of-the-art quality assurance systems. Many of them are certified by accepted organisations and comply with international quality standards.
Business Process Reengineering
In the last years the European IT industry suffered from consolidation and changing customer demands. A lot of firms vanished because their business models were not sustainable. Even the market players that survived the shakeout had to rethink their business processes. Many of them took the chance to reorganise themselves. The pressure to keep costs under control pushed them as well. While many companies have no expertise in business reengineering a lot of offshoring vendors offer such services. They combine the business transformation with relocation and lower labour costs and thus help the European IT companies to find a way out. If offshoring and business process reengineering are put together the cost savings can be maximised (see previous chapter).
Enter New Markets
When a company wants to enter a new market it is often necessary to be present on site. This means not only having sales forces there but includes product development and other responsible tasks as well. As the growth for many multinational companies is coming from emerging markets, it is necessary to establish offshore presence to attract workers and consumers (Robinson and Kalakota, 2004). Governmental regulations are another reason for using offshoring for new market entrance. China is the most famous example for it. Before China joined the WTO in 2001, it was a requirement for foreign firms to invest in China, if they wanted to sell in China. As the Chinese market is that huge and emerging, no global player could ignore it. The Chinese government used its power in a way that fostered foreign direct investment. The entering companies needed to offshore some of its operations to China to get some market share there.
2.4 Opportunities and Threats
The previous chapter outlined cost savings as the most prevalent driver for offshoring. But only in a few cases the offshoring decision is made on the basis of a purely examination of labour costs. More often there are other opportunities and of course threats that should be taken into account too.
A lot of offshoring locations offer low taxes and limited regulation. In addition, the majority of offshoring vendors offer high quality that is controlled and certified using objective quality models like Six Sigma or Capability Maturity Models (CMM) and therefore complying with highest international demands. The motivation of the offshore employees is often higher compared to that of European employees because the pressure to do less prestigious job is higher than in Europe. Another chance of offshoring is the offering of 24/7 services, which means that the customer can contact a representative every day and all the day. These always-on services compensate the problems of different time zones. If a company does not use an offshore vendor but establishes an own subsidiary offshoring offers the chance to recruit well-educated people. Although the pool of human resources seems inexhaustible in India and China it is the best interest of many companies to find outstanding talents that improve corporate culture and bring in new ideas. Global companies cannot ignore this latter chance if they want to be successful in the long term.
Every business holds some risks and threats. Offshoring has some specific threats that must be balanced with the opportunities. The micro-economic risks of offshoring are continuously decreasing because quality and management standards at offshore locations are steadily improved. Nevertheless problems emerge due to the geographic distances. Although most of the offshored processes are based on cutting-edge communication technology these processes require regular feedback, improvement and control. Therefore these processes must be standardised, clearly structured and modular. Processes that are very critical and business specific are not to be considered for offshoring because the threat of additional communication and safety costs can outweigh cost savings. In addition to economic risks offshoring most of all involves specific country risks. Most of the favourite offshore destinations lack political stability, a reliable legal system and a developed infrastructure. The threat of industrial espionage and the insufficient protection of intellectual property are especially problematic for the IT and telecommunication industry. Cultural and language barriers are less tangible but not less serious. For instance, Indian workers expect different instructions than European employers typically formulate. These problems can be avoided if a local provider is interposed.
How the opportunities and the threats can be balanced and how the decision finding can be supported? Deutsche Bank Research (2004) proposes to use a decision table. Such a table lists every opportunity and every threat. Then every item is attached a weighted factor between 0 and 10. The threats are signed with negative numbers. After that, every criterion is evaluated according to its significance in an offshoring scenario and in a scenario that employs own facilities. The weighted numbers are summed up and the scenario with the higher score represents the favourable decision. A decision table like this makes the fundamentals of the decision transparent and contributes to an objective decision instead of one on gut feeling.
2.5 Where to Locate?
Once the decision for offshoring is made the next question typically is, where to locate. A.T. Kearney (2003) has developed a quantitative evaluation tool to help finding the most attractive offshore destination. They found the most important criteria to be costs (labour, infrastructure and tax), environment (economic and political risk, infrastructure, geographic proximity, security of intellectual property) and people (experience and educational level, size of the labour market, cultural compatibility, language barriers and employee retention). The key findings of the 2003 study are illustrated in the figure below.
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Figure 4 - Attractiveness of Offshore Locations 2003
Source: A.T. Kearney, 2003
As A.T. Kearney is a U.S. based consulting company this figure is from the U.S. point of view. For U.S. companies India appeals attractive due to low costs and same language, while Canada and Mexico are nearby. For European companies the attractiveness of Latin America is much lower. Instead, Ireland and Eastern Europe are much more attractive, although the wages in Ireland are reaching the average European level meanwhile. However, each company should weight the different scores according to its needs, having in mind that this process does not stop with committing to one location but continues with looking for opportunities across the next border. Two examples may support this approach:
- On 1st May 2004, 10 Eastern European countries (Hungary, Poland, Czech Republic, Slovakia, Slovenia, Latvia, Lithuania, Estonia, Cyprus and Malta) acceded the EU. These countries are very interesting according to offshoring in the near future. They have committed to EU rules and regulations thus the legal safety will increase and the trade barriers will be removed according a predefined schedule. Some of these countries (Hungary, Poland, Czech Republic, Slovakia and Slovenia) are attractive offshore destinations especially for German companies. The wages are significantly lower than in Germany, the time zone is the same, the distance is small, the culture is similar and language skills are well developed. Földes (2001) reports that in Eastern Europe German is the most frequently spoken foreign language. Furthermore more than 20 million people currently learn German there. The European Commission expects the costs in these countries reaching Western European level within the next 10 to 20 years. For the time being these countries serve as attractive offshore locations but companies should keep monitoring the attractiveness continuously.
- In the above A.T. Kearney diagram China ranks last. This may be confusing as China is praised to the skies by the press. Having a deeper look the low numbers in the environment category are caused by the still regulated trade and the political risk. After joining the WTO in 2001 China must open its borders step by step (WTO, 2003). This process is slow and the political risk is continuing next time. The people category has low numbers due to the different culture and the lacking language skills. The Chinese will not adapt their culture, which they are very proud of, but Beijing Review (2003) reports that currently more Chinese learn English than people live in the U.S. In sum, most experts agree on China will become one of the most attractive offshore destinations in the near future.
The 2004 study of the Offshore Location Attractiveness Index (A.T. Kearney, 2004a) shows the offshoring market is still in its infancy. Some countries have made significant progress others slipped off. China has made the biggest step forward and ranks second after India, the undefeated offshoring leader. The emerging Eastern European countries especially Czech Republic and Poland became more attractive after acceding the EU. Malaysia also made significant progress and will challenging India’s leading position. The group of the countries that were losing ground includes Mexico and Ireland. Mexico suffers from U.S. companies more often choosing India as their favourite offshore location while Ireland is short of employees thus wages are rising and meanwhile nearly reaching average European level.
The study was expanded from 11 countries in 2003 to 25 countries in 2004. This points out the topicality and importance of offshoring. The table below shows the results of the 2004 study.
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Figure 5 - 2004 Offshore Location Attractiveness Index
Source: A.T. Kearney, 2004a
Some experts argue that choosing one offshore destination is not as advantageous as trying to get a good mixture. The IT consultants of Cap Gemini Ernst & Young recommend to not simply follow the trend of offshoring but to pursue the approach of “rightshoring” (Cap Gemini Ernst & Young, 2004). Rightshoring is about creating an effective globally distributed service portfolio. The following figure illustrates that rightshoring includes but is not limited to offshoring.
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Figure 6 - Dimensions of Rightshoring
Source: Cap Gemini Ernst & Young, 2004:12
2.6 Choosing the Vendor
Once the decision is made to offshore to a third-party vendor, one of the most important tasks is vendor selection. Offshore partnerships are long-term in nature thus careful vendor selection is critical to success. The search for a suitable vendor can be long and exhausting but taking the time for a due diligence at this stage is well worth it. At the beginning the company needs to understand what it wants to accomplish with offshore outsourcing. This will help to define what type of vendor to choose. Robinson and Kalakota (2004) name three types of vendors.
Transaction providers offer a narrow scope of process to outsource. They perform this task efficiently but do not re-engineer the process. This is the quickest way to offshore a well-defined task. Common examples are payroll and customer billing.
Process providers take responsible for multiple, related processes. Typical examples are call centres and application software development.
Full-service providers handle several business processes, like whole IT. They take full responsibility for the process they manage and usually offer to re-engineer complete value chains to make it more efficient.
If cost savings is the strongest driver for offshoring, it is advantageous if the vendor manages similar processes for other clients thus achieving economies of scale and possessing already a sophisticated learning curve.
DiamondCluster (2004) reports that surveyed companies ranked costs, industry expertise, quality certifications and size among the most important criteria for evaluating potential providers. Although size is still important some SMEs recognised that it is better to choose a smaller or same-size partner to be at an equal level.
As with any important decision, the selection process should follow a well-established methodology. Robinson and Kalakota (2004) suggest following these steps:
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Figure 7 - Methodology of Vendor Selection
Source: Robinson and Kalakota, 2004:244
2.7 Employment Challenges
In good times many companies tend to not control costs very strictly. In tough times these companies are not used to cost savings because they did not practice it. When cost savings are on the agenda the first look is often at wages. In the developed European economies the wages are high and the working hours are low compared to that of offshore locations. It is clear that Europe cannot compete with offshore locations according to labour costs (Bundesministerium für Wirtschaft und Arbeit, 2003). Therefore offshoring is very attractive for many companies. This attitude makes sense from the micro-economic point of view and is expected by the shareholders, but what about the macro-economic perspective and the social responsibility of the companies?
[...]
[1] In 1965, Gordon Moore stated, “Every 18 months, processing power doubles while cost holds constant”. (Intel, 2004)
[2] Robert Metcalfe stated, “The usefulness, or utility, of a network equals the square of the number of users”. (Wikipedia, 2004)
- Citation du texte
- Dipl.-Ing., MBA Andreas Birkholz (Auteur), 2004, Offshoring of German high-tech IT jobs to low-wage countries, Munich, GRIN Verlag, https://www.grin.com/document/32533
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