Offshoring or nearshoring? The pros, the cons and the differences

In the world of rapidly growing competition and necessity of cutting costs wherever and whenever it is feasible the idea of outsourcing certain tasks to regions with less costly workforce is appealing indeed. Especially with the more and more advanced technology at hand allowing for smooth and easy communication with teams scattered all over the world.

Countries like China, India, Philippines or Poland have become popular offshoring and nearshoring spots for countries with stronger economies and currencies. Numerous companies and projects may serve as examples that outsourcing particular jobs abroad can be a successful business model that combines everything shareholder usually look for: remarkable cost reduction, good quality of products and services and highly-skilled employees with more mitigated financial expectations.

Model types of outsourcing

Typically, companies can choose one of the two models of outsourcing: offshoring and nearshoring. How are they different, what are their main advantages and disadvantages, in short – which of the two options will be better for your business? To answer this question, we should take into consideration many different factors like the type of the project and main goals and targets set by the management. Let us have a closer look at possibilities offered by offshoring and nearshoring, as well as potential risks inevitably connected with outsourcing tasks to a different country.

Offshoring – everything you need to know

What is offshoring? In simple words, it is a type of outsourcing certain jobs abroad, typically to very remote destinations in a different part of the world, usually – to another continent. Most of all, the countries frequently chosen by companies offer very attractive costs of workforce and other overhead expenses, which allows to lower the overall costs of the development. The unquestionable leaders of offshoring services are IT companies from the United States of America and Western Europe. The locations preferred by them include China and India. American dollars, euros and British pounds have great purchasing power in those regions which makes it easier to attract the best employees on the market without going bankrupt.

The very idea of offshoring is not a new one. It all started in 1970s when first auto manufacturers decided to partially subcontract (or: to outsource) making particular parts to others. It proved to be a very efficient business model. The subcontractors turned out to be not only a cost-efficient option. Unlike the big automakers with a very wide range of activities, they had to focus on a more limited task, which resulted in the higher level of quality as they could specialize in the very narrow job. The term ‘vertical dis-integration” was coined to describe this very process. This solution turned out to be successful enough to be developed even further. Nowadays, virtually every auto manufacturer operates in several different countries, with plants specializing in manufacturing, sub-assembling and assembling particular parts and modules.

A natural step in business evolution was to implement this model in other branches. Initially, corporations moved production processes abroad to benefit from much lower costs of workforce and manufacturing. Services were not a subject of international trade at that time for one simple reason – they could not be sent or transported in any way from one continent to another. With the technology becoming not only more advanced but also more affordable, available and widespread, the world of business noticed the great potential lying in services done remotely. Especially those services that do not involve maintaining direct contact with clients and products which can be easily and cheaply delivered by means of the Internet. Alternatively, services that can be performed over the phone, like operating info lines or telemarketing are perfectly feasible when offshored.

Advances of information technologies enabled farming out jobs like accounting, programming, software development, creating of websites and even managing human resources to people living on different continents.

Summing up, offshoring is an attractive business model for two main reasons. The first one is considerable downsizing of costs due to huge purchasing power of western currencies. The second one is – paradoxically – time and legislation differences that allows for 24/7 support. Employees from Asian or African countries are usually very flexible and willing to work also at night. Furthermore, labor laws tend to be more lenient when it comes to employees’ protection and more in favor of the employer.

However, it is good to bear in mind that offshoring also carries certain risks. First of all, the physical distance. Communicating online is not always enough. Oftentimes, the processes have to be monitored on regular basis by the executives. Regular business trips to plants or offices located in a different part of the world are not only very costly, time-consuming and inconvenient. Another issue is the time difference that, on the one hand, might be beneficial, but on the other hand – may cause huge problems with communication. It is difficult to expect managers in the offshored location to be available on the phone or email every day in the times convenient for the company if there is time difference of 12 hours. Communication might be even more challenging due to language barrier. One more aspect that should be considered are cultural differences. What is acceptable and within a norm for Europeans or Americans might be offensive for people from Asia or Africa. Certain behaviors perceived in those parts of the world as normal may feel insulting for a European or American client. International teams cooperating remotely need to learn to overcome those challenges, which is not any easy task and the only thing more difficult than that is managing such a team.

ABAP nearshore factory Sii

Nearshoring – definition, history, pros and cons

Every business solution evolves with time to adjust in the best possible way to the current demands and needs. Models of outsourcing task are no exception. Culling from the years of experience, companies started to amend their ideas as to how to outsource in the most beneficial way. Thus a new phenomenon emerged – nearshoring. What is exactly nearshoring about and how is it different from offshoring?

The definition of nearshoring is “the outsourcing of business processes, especially information technology processes, to companies in a nearby country, often sharing a border with the target country. Both parties expect to benefit from one or more of the following dimensions of proximity: geographic, temporal (time zone), cultural, social, linguistic, economic, political, or historical linkages. The service work that is being sourced may be a business process or software development.”

The idea behind the decision to move outsourced task to physically and culturally closer countries is that in that way communication and overall control are remarkably easier to carry out. It is becoming more and more popular among American and British IT companies to outsource jobs within their local group, belonging to the same cultural pot. It means that for many American, British or German companies nearshoring equals using services of developers from European countries such as Poland, Croatia, Czech Republic or Ukraine.

The main and unquestionable advantage of nearshoring is reducing the risks considerably for the companies ordering services. European markets, especially Eastern European markets, like Poland boast quite a few important qualities: they are stable, they offer a big pool of highly-qualified specialists and the percentage of available employees speaking fluent English is much higher than in Asia. And the list of advantages continues. In Software development and IT systems maintenance sectors the popularity of nearshoring has been growing rapidly over the last several years. Outsourcing tasks to neighbouring countries rather than to other continents proved to be very beneficial. The main reason for it is the easiness of managing teams being a result of numerous similarities: the team members from nearby countries share the same principles, education, time zone, and sometimes even language, among other cultural aspects. One more crucial advantage of nearshoring is the possibility to hold personal meetings with suppliers or to pay control visits when the journey takes less than a half a day rather than twelve hours. What is more, sales support for the sales teams is far more effective when the central office is located in the same or very similar timezone. Even though it might initially seem that the overall costs would go up due to more money being put into workforce, quite the opposite turned out to be true. Due to such factors as maintaining high standards and fast collaboration the costs of nearshoring are actually lower.

There is one more thing adding to the already high attractiveness of nearshoring. Big companies have been shifting their production oversees for many years. Low-cost countries like China or India have gone through some social changes in this time and the wages there have been on constant growth. That makes the cost-benefit ratio considerably lower. As a result, plenty of companies have taken a decision to decentralize production sites in geographically close countries, and to rely again on local suppliers. The main aim of such actions is optimizing the value creation chain and reducing risks.

In summary – what are the advantages and disadvantages of nearshoring?

What are the benefits of nearshore outsourcing for companies?

  • wider possibilities to hire employees willing to work for lower wages than equally-skilled and qualified workers in their country, this reduction of costs does not entail any sacrifices in quality;
  • employees from neighbouring countries are likely to be really highly skilled, not only when compared to those from Asia or Africa but also those from the main office,
  • small distance between the countries guaranteed by nearshoring allows for cutting travelling costs – not only in the respect of money, but also time. If the business trips need to happen on frequent basis, these savings may be substantial,
  • the same or similar time zones reduce communication problems that might potentially lead to chaos and waste of time and money,
  • nearshoring usually eliminates problems resulting from cultural differences, communication via phone, the Internet and during face-to-face meetings becomes smoother and easier.

There are no flawless solutions and business models in the world and nearshoring is no exception in this regard. What are its disadvantages then?

  • labour costs might be slightly higher, as neighboring countries tend to have similar wage gaps, in this case offshoring is a cheaper solution,
  • flexibility (generally considered to be an advantage) might as well cause problems as delocalization limits the number of potential locations a company can turn to when scouting.

Conclusion

Outsourcing, including offshoring has become an integral part of globalization processes and it developed dynamically since the end of WWII. The quality breakthrough, though didn’t take place until the early 1990s. It was the moment when IT technology started to advance rapidly. Many companies realized at that time that they would not be able to follow the newest technologies unassisted and decided to outsource building their IT systems to specialized companies.

With shareholders pushing for profits increase, there is no better and easier way of reducing costs than delegating costly tasks to outer companies. Just after the WWII about 20% of added value produced by American companies was generated in this way. Nowadays the number has risen to over 70%. Offshoring fever grew after the outbreak of the 2008 financial crisis, when not only American but also European companies cut extensively cut costs whenever and wherever it was possible. However, with the time passing it turned out that many enterprises have actually lost instead of gaining due to losing control over their accounts, manufacturing quality and the looks of the products. In many cases, the result was that the image built for years started to collapse.

Some time ago outsourcing to remote countries cost Toyota more or less the same as capitalization of Ford: over 50 billion dollars. This is how much the shares of this Japanese company lost in value when it turned out that through the alleged fault of braking system the users are in danger of accident. Even though the investigation carried out did not prove that Toyota was to blame, the company went to the expense of checking about eight million cars. What is even worse, the flawless image of Toyota as an always-reliable-car has been damaged. That was the result of outsourcing of manufacturing process of most parts, including braking systems, to remote countries which inevitably led to the loss of control and possibility to react quickly enough.

Another example of a company experiencing problems connected with offshoring was Steiff – a German company selling high-quality toys, especially soft toys. Steiff had to face serious completion from much cheaper products manufactured in South-East Asia. A decision was made in 2004 to partially outsource the production process to China. And that is when the problem started. It turned out that the devil is in the details and seemingly insignificant things may ruin everything. Small differences like the face expression on the teddy bears’ faces, texture of the fabric or durability of the toy apparently play crucial role for clients and failure to meet their expectations in this regard quickly destroys the reputation of the company built through several generations. Even though Steiff managed to lower the production costs from 50 to 15 Euro, they quite unexpectedly had to face competition of even cheaper toys available on the market as the clients saw no reason to pay more for Steiff’s products.

With so many potential problems inevitably connected with offshoring and outsourcing to companies from Asia and Africa, it comes as no surprise that companies started to look for a better solution. Moving production processes to a cheaper country but one still lying in the same time, cultural and climate zone – nearshoring – drastically reduces the risk of losing control over the key aspects of the business.

For companies from the Western Europe countries like Poland are becoming more and more popular location of nearshoring. They can offer costs still remarkably lower than e.g. in Germany and at the same time high-class specialists speaking not only English but also languages like French, German, Spanish, Norwegian and many others.

In conclusion – offshoring and nearshoring have both proven to have a great business potential for reducing operating costs and gaining greater operational scalability for while maintaining a high quality of customer service.

For many years, an India- or China-based model has been the preferred option for outsourcing, due to very low costs of operating in there. However, many companies have started to experience the many challenges connected with offshoring (e.g. time zone and cultural differences, language barriers, etc.), and have decided to go for a nearshoring alternative. It is not only closer to home, but also significantly cost-efficient.

Both models have their advantages and disadvantages, but the visible growing trend of nearshoring suggests that this might be the thing to consider.

Summing up, here are the four reasons why nearshoring seems to beat offshoring in the long-run:

1. Time and geographic proximity

Similar time zone and physical proximity are a significant advantage over more distant locations, such as Asia or Africa. Many companies deciding for offshoring found managing business operations over great distance and with great time differences challenging and posing a strain on the teams. One of the problems that they had to deal with was a high staff rotation who did not find it satisfactory to work night shifts constantly.

In contrast, the option of nearshoring offers real-time service, which allows the employees to work during standard business hours which results in the best of the staff staying with the company for a longer time. What is more, shared services jobs allowing to work closely with other cultures and languages are very attractive for the millennial generations which helps attract the talents.

Geographic and time and proximity also result in a much more collaborative operating model. Communication in any form – be it via the Internet, on the phone or in person – is much easier, especially when it comes to solving problems or discussing untypical issues or wherever and whenever standard procedures cannot be applied. That is especially important in case of urgent matters, when real-time cooperation is crucial. Nearshoring enables the teams to work together in efficient and coherent way.

2. Cultural similarities

Lying in the same culture zone also encourages bigger integration of teams located in different countries. Similar business culture, pop culture and social customs result in better alignment and help avoid potential misunderstandings and thus delays in delivering the final product or service in accordance with the requirements of the client.

3. Talent pool

Nearby countries offer a large pool of highly-qualified employees educated in systems similar to the ones of the main business activity country. Young people are striving for success and perceive being employed by a foreign company as a major step forward in their career. What is more, their languages skills are usually remarkably high.

4. Reduced costs

Although typical offshoring locations like India or China continue to offer the lowest labor costs in the global perspective, it is worth bearing in mind that such remote location entails different types of costs and risks. Neighboring countries are also much cheaper when it comes to workforce and operating expenses when compared to e.g. Western Europe and at the same time – they are more stable and safer.