What is offshoring? Pros and Cons.

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In recent decades, due to globalization, a trend has been created in the field of production, according to which, in order to reduce costs and obtain other advantages, large and medium-sized western companies began to transfer part of their business to developing countries like China, India, Russia, Turkey and etc.

What is offshoring?

Offshoring is a term used to describe the delocalization that a company makes when it moves its production chain to another country.

This type of delocalization can be compared to outsourcing, where another company, but in the case of offshoring set up in a different country, becomes a service provider to reduce the costs of certain stages of the production chain, business processes and even research and development. The displacement of the production seeks to take advantage of the low labor cost, tax relief and a number of other benefits that this model can provide.

The first countries to initiate the offshoring process were North American companies, later followed by European companies, which were forced to implement this model to create competitive advantage and lower production costs.

Types of offshoring

From a business model point of view there are three types:

  • production: factories and hiring of a cheap labor force.
  • services: call centers and technical services.
  • research and development: relocation of know-how, product development, design and engineering.

Examples of offshoring

Among the countries best known and used by international companies for delocalization, we can highlight China, which offers offshoring not only in textiles, but also in construction products.

India, instead, is known and most used to lower costs in the pharmaceutical and software development industry.

A very high number of international companies that operate in the territory of Spain go to Latin American countries for the offshoring of customer service, technical service and commercial processes.

Offshoring vs. Outsourcing

Offshoring

Offshoring is the process by which the company itself transfers part of its production to another foreign country and hires the manpower to manufacture its product or carry out a service. It is common for this scheme that the company also transfers some local employees to the offshoring site to control the production process, promote the values of the company and implement the know-how. This is done in those cases when skilled labor is needed and for demographic reasons hard to find in developing countries. In the case of offshoring, the quality controls of the product or service are carried out by the same company and all employees are part of its staff.

Businesses with significant sales overseas, that dislocate their headquarters abroad, such as Apple Inc. or Microsoft, are known for taking the opportunity to keep related profits in offshore accounts in countries with lower tax burdens.

Outsourcing

In the case of outsourcing, it is an independent company that operates in a country other than the original company and that is responsible for the production of the product, the hiring of workforce and quality controls. This company is subcontracted by the multinational to cover some parts of the production chain or specific service.

The reasons why many companies prefer outsourcing over offshoring are experience and knowledge of some specific nuances of the country chosen for delocalization. Thanks to them it is easier to get the highest quality of the product at a good price. In addition, outsourcing offers the flexibility to choose only the services that are really necessary for production and to pay strictly for them.

The main disadvantage of this model is the loss of control over the quality of the product and rights to it.

Advantages 

  • The possibility of lowering labor costs.

We all know that wages in developing countries are much lower than in Western countries. Due to this trend, many international companies are targeting the labor markets of China, Vietnam, Turkey, Mexico, Indonesia etc. Offshoring allows a company to reduce the budget directed towards labor costs.

  • Lower manufacturing costs.

Building a factory, maintaining it and buying the raw material for the production of a product can be 50% cheaper if it is done in an offshore territory (outside the country of registration of the company). By choosing this option, the manufacturer can sell its product for a lower price and increase sales by achieving a competitive advantage.

  • Tax benefits and customs duty.

Tax regimes in different countries offer certain tax cuts and custom duty reductions to attract Western companies to their territories. For example, many countries generally allow companies to import products at low prices allowing them to generate more savings. In order to reduce unemployment and improve the quality of the abundant labor the governments of these countries are forced to create these favorable regimes.

  • Ease of operation.

The laws of many countries used for offshoring have looser regulations in terms of labor aspects, quality certificates, status of facilities, import and export. This factor makes operating a company in a foreign country easier and more flexible.

Disadvantages 

  • The possible drop in product quality.

Keeping product quality at a low cost is the challenge most offshoring companies face. It is very important to know how to transmit the know-how that turned this company into a multinational to employees from abroad and to know how to implement it in all stages of production.

  • Negative company reputation

Moving part of your business or the entire production to another foreign country can cause the rejection of your clients towards your company and more in case it is a well-known company, because creating employment in other territories as a result increases the unemployment level of the local economy. Furthermore, many still associate the term "offshoring" with the term "offshore" creating the image in their mind of a company that seeks tax invasion and not just readjustment of production costs.

  • Barriers in communication.

The difference in languages and accents leads to misconceptions if your employees in the other country do not clearly understand the needs of your company. For example, in China, the country that Apple chose for offshoring, there are more than 292 living dialects and many Chinese can`t even communicate among them in the same language. In addition, the ways we express ourselves can vary depending on the nationality. The people of the East are not as direct and open when it comes to communicating their ideas as an American employee can be.

  • Logistic complications and distance

Having the part of your company thousands of miles away from headquarters can save you a lot of money. However, you will have to spend a lot of time visiting the plants and control the quality of direction and final product. Make sure you create a good team that will be able to carry not only the manufacturing side, but also the technology, establish company values, and create a productive environment.

Conclusion

As we can see, offshoring is still an efficient option if a company is looking for low cost labor and a distributed business.

Obviously, there are factors against offshoring, but if you analyze all the pros and cons associated with this business model you will see that it is very beneficial for many market members.

When choosing the country for offshoring, it is always recommended to evaluate the objectives of your company's commercial strategy and develop a detailed plan with all the inconveniences associated with displacement that could affect your operations.