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Hjem Blogg From offshoring to nearshoring
From offshoring to nearshoring
By Dmytro Blinda
6 aug, 2020

After people and organization started to specialize in some labour and our world became a global market businesses started optimizing costs through practices like outsourcing, offshoring, nearshoring, re-shoring and even right-shoring. What are they, how do they compare and what factors to use when assesing x-shoring location.

 


 

Outsource different

Outsourcing is a concept we know for decades. Essentially it uses the imbalance in the global labour market to optimize the cost of the product or service. For a company based in the capital it’s usually cheaper to hire a developer from a rural city. If that rural city isn’t in the same country with the client but a ‘rural’ country on the global scale it gets much cheaper. But that doesn’t work for ages.

For example, many manufacturing companies in XX century understood that their core competence is not the crafting of goods itself but the design (yeap, that «Designed in California» label). So they’d benefit from focusing on designing the product and move the production to China and other countries with the cheap workforce. But as the demand for workers and their qualification in China grew the salaries were also climbing.

Time passed and market forces balanced the labour pool. The companies outsourcing business processes to locations in thousands of kilometers away also saw that the lack of face to face communication, time and culture differences put on projects handled by offshore vendors additional risks and costs that weren’t evident at the first sight.

That’s a short story how outsourcing closely associated with offshoring (mainly distant locations) started branching into different X-shoring: onshoring, nearshoring, farshoring, reshoring. This snafu even lead to Capgemini, a huge French consulting and technology outsourcing firm, trademarking the term «rightshore». Further we’ll analyze the pros and cons of the IT offshoring vs nearshoring, risks and how to reduce them, and what parameters are important when finding a right vendor — an attempt to understand what «shore» is right for your business.[/vc_column_text]

Outsource to offshore farshore to later reshore it to nearshore

To start from the same page let’s clarify the definitions.

At first was the light outsourcing. It has to deal with specialization of labour and is described as «contracting-out of business processes to domestic providers» [1]. It’s you who decided not to deal with bookkeeping in the company and outsourced it to an independent entity Bookkeeper LLC.

Then goes the offshoring. It has to deal with the location of a service provider. It’s a situation when certain business process is spun off and outsourced to foreign locations of your company. So when you decide that you don’t want to do tech support inside the company and find an independent provider in the Philippines you’re doing offshore outsourcing. But people commonly call this offshoring.

Then there are other *shorings depending on the distance between client and vendor. Farshoring is untrusting software development (or some other process) to a supplier ‘half of the world away’. And it’s usually synonymous with offshoring itself, because India, a back-office of the world, and China are a go-to destination for outsourcing for decades. And those countries are literally half of the world away from main ‘client’ destinations — North America and Western Europe.

If you think you’ve gone too far, you try nearshoring. To simplify, the term depends on the time difference. For «shoring» to be near the time difference should be roughly two hours or less. So for Norway it would be hiring a software development team in Europe: from the Netherlands to Ukraine.

If you’ve gone that far there is also onshoring. It’s outsourcing to some other company in home country.

Now let’s focus on the main pros and cons in offshoring vs nearshoring.

Offshoring vs nearshoring: the distance arguments

A conflict between those two concepts came in sight over time. 30 years ago the outsourcing market was not that saturated and aware of risks — businesses just saw a possibility in huge cost reduction.

«Services delivered with nearshoring practices have been around for more than two decades, although not directly named as nearshoring since the importance that customers (demand) gave to distance was very limited. We can affirm that it has matured; this was since the involved parties pinpointed some high-impacting risks (which became major issues overtime) with practices related to traditional offshoring in locations far from the demand. With this lessons learned as a valuable component of the manager’s toolbox, offshoring initiatives started to be moved to sites closer to the demand, often with increased costs but also reduced risks». [2]

So the nearshoring was regarded “as a reaction to the main offshore destination, India, which was viewed as ’farshore,’ a very distant destination, many hours to travel, many time zones away, and a very different culture» [3].

That leads us to the differences. Most of them are describe by one word — ‘distance’. Scientist Rostislav Markov, Martin Wiener and Michael Amberg from University of Erlangen-Nuremberg, have assembled [4] the most comprehensive differentiators in terms of distance:

  1. Physical distance — geographic proximity between client and supplier.
  2. Temporal distance — time zone overlaps.
  3. Linguistic distance — language similarities or the ability to adopt English as the language of business.
  4. Cultural distance — similarity of characteristics of national or organizational cultures.
  5. Resource-based — infrastructure and people skills.
  6. Political/economic distance — political and economic stability, favorable policy, and investment friendliness.

Pro: The closer client to a vendor the easier is to organize face to face meetings, which might be critical for communications and team morale. Both parties spent less money on tickets and less time on the flights. It also can often mean less paperwork for visa processing.

Contra: The counterargument is that current telepresence technologies reduce the need for face to face communications. Plus, the task standardization and high labor cost differences mitigate advantages of physical proximity.

Temporal distance

Pro: Major overlap in working hours leads to more real-time communication and collaboration, which leads to fast feedback loops.

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Contra: If we take Western Europe as a client destination, which has 4,5 hours difference with India, there is still an overlap for communication. But for North America it’s 10,5 to 13,5 hours. In that case scientists suggest to use it as an advantage and build the work process using ‘follow the sun principle’. Then the development team in New York in the evening hands over the tasks for the morning shift in Bangalore.

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Linguistic distance

Pro: For Europe nearshoring may be considered favorable only in the case, that it’s easier for vendors to find an employee with knowledge of the client native language.

Contra: English knowledge became one of the reasons for India’s success as an outsourcing destination. And if the clients considers offshoring they won’t have problems with English.

Cultural distance

Pro: Generally people think that Oriental cultures are very different from Western ones, which will lead to intra-team tensions, misunderstanding, increase overhead costs etc. Europeans, from Portugal to Ukraine, tend to be more familiar with each other culture peculiarities.

Contra: The view above would be deffinitely true if we were in the XIX century. But the globalization, international migration and declining cost of travel blurred the cultural boundaries. Moreover, IT cultures in far away countries tend to be even more similar.

Resource-based distance

Pro: Resource-based distance refers to differences in infrastructure and people skills. Nearshore countries likely to be more developed in general and have better business infrastructure and educational system.

Contra: Farshore countries try to overcome infrastructure disadvantages by creating technology parks. Even if we agree on lower quality of education and the as a result lower percent of high-skilled workers, India and China easily solve this problem with the amount of IT workforce available.

Political/economic distance

Pro: Nearshore countries are generally believed to draw advantages from more stable political atmosphere and macroeconomic conditions compared to farshore countries (Carmel and Abbott, 2007; Deutsche Bank Research, 2006; Kvedaravičien÷, 2008). The inexistence of comparable legal regulations in some developing countries may increase the client’s reluctance to engage in farshoring (Rao, 2004; Kvedaravičien÷, 2008). This is because such regulations may relate to critical issues like data privacy and security of intellectual property, for which liability cannot be transmitted to the offshore supplier.

Contra: In economic terms, nearshore countries offer cost saving potentials as a result of the lower wages in those countries. However, the associated cost advantage is typically less than in developing countries like India. While the cost advantage of any offshore country may be affected by currency volatility, nearshore countries are particularly much more prone to the negative effects of that volatility because of the smaller wage differentials.

Those are some arguments between the «near» and «far» shore sides. And the truth is not somewhere in between (sorry, Middle East). It just depends. And it changes over time. Let’s look at what companies say is really important for them in choosing the offshore partner.

What’s important?

In 2019 Swiss researchers Florian Keller and Benedikt Zoller-Rydzek from ZHAW School of Management and Law in Zurich surveyed [5] 56 Swiss IT service firms. 46 firms (82%) were actively engaging in nearshoring in various destinations in Europe. About 41% of all firms had more than 100 employees and a quarter have revenues exceeding $50 mln.

The survey indicated that the supply of skilled IT workers is the most important factor for the outsourcing decision of firms — average importance score of 6.33 out of 7. It is much more important than labour costs, which have an average importance of 5.86. «The reachability and cultural closeness are almost equally important for IT firms when choosing their nearshoring location. Direct economic factors, such as the possible market size are less important», — conclude the scientists [5].

They’ve also interviewed a number of experts who gave their scores on importance of different groups of factors while choosing the nearshoring destination. The results were closely aligned with the company’s survey. Experts put labour group of factors as most important with 23,85% and ranked the economic factors as least important with 17,35%.

That’s why in an a Nearshoring Index, calculated by Keller and Zoller-Rydzek, the best destinations for Swiss IT firms are the Southern UK around London and Western Germany. The former is due to the high availability of IT workers, while the latter is due to the good reachability and social closeness to Switzerland.

On the other hand global consulting firm ATKearney, which publishes Global Service Location Index for the last 15 years, puts other factors on the first place. Best locations for IT and business processes outsourcing in the rating are determined by counting in next factors:

As we see labour pillar is put on the second place together with the outsourcing destination business environment.

As for results in the rating, three leaders of the rating: India, China and Malaysia haven’t changed their position in 15 years. The first ten spots are occupied only by farshoring countries. But nearshoring destinations dominate in the second ten and demonstrate considerable growth.

Highlighted in red are farshore countries, green — nearshoring destinations.

This

1. Meyer, Thomas, Deutsche Bank Research (2006). Offshoring to new shores: Nearshoring to Central and Eastern Europe.

2. Guedes, J. F., Pereira, L. (2016). Proximity Offshoring Generating Considerable Savings with No Significant Increase of Risks or Losses in Quality—Nearshoring Playing a Key Role on a Business Transformation Program. Eurasian Studies in Business and Economics.

3. Carmel, E. and Abbott, P. (2007). Why ‘nearshore’ means that distance matters. Communications of the ACM, 50, 10, 40- 46.

4. Markov, Rostislav; Wiener, Martin; and Amberg, Michael (2011). Distance Advantages in IS Nearshoring: Do They Matter?

5. Florian Keller, Benedikt Zoller-Rydzek (2019). European Nearshoring Index – Is Eastern Europe Attractive for Swiss IT Firms?. Central European Business Review 3:35-53.