Why do companies engage in offshoring? 5 strategic motives

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Offshoring is when companies transfer business activities or processes to a distant foreign country, usually a more affordable, developing nation. 

Companies can enter into an offshore outsourcing arrangement with a third party or set up their own offshore business operations. 

But why do companies engage in offshoring?

Sure, affordability is a factor, but there are a few lesser-known reasons companies choose to offshore.

In this article, we’ll reveal five strategic motives for offshoring, as well as three possible drawbacks. We’ll also look at some famous companies that engage in offshoring.

Table of Contents

• 5 key motives for offshoring
• 3 potential drawbacks of offshoring
• 5 successful companies that engage in offshoring

Let’s get started.

5 key motives for offshoring

Thanks to the unstoppable force of globalization, offshoring is here to stay. 

The primary reason companies engage in offshoring is to reduce operational expenses. While you can find cost-saving alternatives without offshoring, there are numerous other positive effects of offshoring that you may not have considered. 

Let’s look at a few ways offshoring could help you gain a competitive advantage in your industry.

1. Facilitates cost-effective business expansion

Some companies don’t have the capital to expand their labor force in their home country, where salary expectations may be high. As a result, many companies choose to offshore to developing countries because of the lower labor cost. 

In addition to lower wages, companies can benefit from reduced operational costs like rental space, equipment hire, etc.

Since setting up in a developing country requires less capital investment. Companies that couldn’t afford to expand their business locally can do so more rapidly by offshoring. 

Companies from North America, Europe, and Australia often offshore their IT (Information Technology) and software development to India, China, or Eastern Europe. These places have an abundance of qualified IT professionals offering their services at affordable rates.

For example, if you’re based in the UK and want to hire a software engineer, it will cost you around USD 7,198 per month. 

Instead, you could recruit an Indian software engineer for USD 399 a month or outsource to an Indian IT company with a team of experienced engineers on their books.

You could also choose to offshore your most labor-intensive business process (for example, human resource management). This will allow your local team to focus on your business’s core activity and prioritize business growth. 

2. Provides access to a wider talent pool

If your company’s growth has been limited because you can’t find the right employees, offshoring lets you cast a wider net. This way, you can quickly fill specialized positions and find employees with technical expertise. 

The UK has approximately 408,000 programmers and software development professionals, whereas India has 2.75 million skilled programmers. As a result, specialized positions like this are harder to fill in the UK. You may even need to hire a head hunter to find the right employee. 

Whether you’re looking for blue or white-collar employees, the recruitment process takes longer in developed countries. According to research by Glassdoor, it takes an average of 27.5 days to fill a position in the UK. In contrast, a job opening in India takes just 16.1 days. 

3. 24/7 business continuity

Offshoring can help your business improve customer service, expand your services, and even operate beyond regular business hours. 

With an offshore service provider or offshore in-house team, your company can work around the clock, regardless of time zone differences.

For example, if you’re New York based and offshore to a company in the Philippines, there’s a 12-hour time difference. So, when your local team signs out at the end of the day in New York, your Filipino team can continue operating. 

Multinational companies can benefit by offering 24/7 customer service for clients in every time zone. And any time-sensitive incomplete tasks can be handed over at the end of the workday from one team to the other, ensuring a continuous workflow. 

Also, since regional holidays differ, when one team observes a local holiday (e.g., Independence Day for U.S. workers), the other team can continue working. 

Continuous business operations will enable your team to deliver better customer service and increase client satisfaction.

4. Provides access to lucrative overseas markets

Whether you outsource to an offshore firm or hire your own offshore employees, your international team can help you gain access to international trade markets.

Here’s how an offshore team can help you save time and money when expanding your service offering offshore: 

• Offshore team members may have a better understanding of their local markets, regional trends, and risks that you may not have considered. 
• Offshore partners can help you identify the most profitable offshore markets and establish first contact with local business owners, saving you time and effort.

Moreover, establishing a base in the same location where you’re expanding your services can help logistically. 

Instead of manufacturing your product locally and dealing with export licensing and international shipping, you could establish an offshore production facility and supply chain. Then you can easily ship your products within the region, saving time and money. 

5. Government incentives and tax breaks

Many foreign governments offer tax breaks and other incentives to companies that set up operations in their country. You can then reinvest the capital saved on taxes back into the business. 

Besides this, government support for offshoring industries can open new doors for business owners from different countries.

Here are a few examples:

• The South African government established the SEZ (Special Economic Zone) to attract foreign investment and create new jobs. It offers fast-tracking of planning requirements, licensing, utilities, and financing. It also assists with environmental compliance certification for the manufacturing sector.
• The Australian government has numerous free trade agreements with countries like Chile, Thailand, and Peru. These agreements make trade and investment easier and ensure smoother supply chains between Australia and these developing countries.
• The Philippine government offers foreign companies attractive income tax breaks of three to six years. 
• The Indian government offers exemptions on certain taxes for startups for the first three years and an 80% rebate for patent filing.

These financial incentives make it more affordable for companies from developed countries to relocate to offshore destinations.

Since your company can accumulate more capital due to tax benefits, it will positively impact your bottom line. 

Now that we’ve covered a few strategic benefits of offshoring let’s examine potential disadvantages. 

3 potential drawbacks of offshoring

Here are some of the challenges associated with offshoring that you should be aware of. 

1. Possible cultural and language barriers

Since offshoring involves engaging the services of a foreign team in a distant location, the working cultures, expected standards, and language will likely differ from what you’re used to. 

Fortunately, English is widely spoken in most offshoring destinations. But accents and other nuances may hinder communication and collaboration. 

Moreover, traditions, holidays, etc., in your offshore location will differ from your own. These differences may have a negative effect on the working environment and lead to misunderstandings among team members.

For this reason, it’s critical to consider the nature of your business and the services you’ll be offshoring before choosing the ideal location. If you’re offshoring call center services, choose a location where English is widely spoken. 

You could also consider offering your team in-depth training and a rigorous onboarding process. 

2. Data security and IP (Intellectual Property) issues

Although any exchange of critical business information can put your company at risk of theft, the risk is greater when you share information with offshore locations. 

Your customers’ data will be stored on servers in these offshore locations, in countries with different data protection laws. This may leave you vulnerable to breaches and have a negative impact on your company’s image and reputation. 

It’s important to acquire patent protection in your offshoring destination. Patents obtained in your home country won’t be valid offshore. 

3. Negative corporate image due to loss of local jobs

One of the effects of offshoring is that it can harm your company’s image. Individuals in developed countries are becoming increasingly critical of offshoring because of the perceived loss of local jobs. 

Offshoring critics cite lower employment rates in many developed countries as a concern. They see it as a drain of local job opportunities to places with low wage expectancy and that don’t generate tax revenue.

For example, some Americans have a negative view of companies that offshore because they believe it’s contributing to the job loss crisis in the United States.

So what’s the solution?

Make sure you explain your motives and reasoning to your team and critics. 

You could also encourage clients and the public to see it as a mutually beneficial relationship that also benefits the U.S. economy. 

Also, consider highlighting figures from the Bureau of Labor Statistics reflecting the U.S’s unemployment rate of 3.5%. It’s remained the same since 2019, despite an increase in offshoring by U.S companies.

Now, let’s briefly explore a few companies that decided to offshore and see whether their endeavors were successful. 

5 successful companies that engage in offshoring

Here are a few popular multinational companies that engage in offshoring.

1. Boeing

The famous aircraft manufacturer began offshoring the production of several components to South Korea, China, and European countries, increasing the use of foreign-made components from 5% to 30%. 

The company estimated the cost reduction to be around USD 4 billion. They also hoped it would cut down the manufacturing time of the 787 model from six years to four years. 

Unfortunately, Boeing ran into several problems – brake issues, fuel leaks, and overheating batteries. This resulted in production delays and ended up costing the company billions. 

The lesson here is to be particularly cautious when relocating the production and assembly of highly complex products offshore.

2. Merck

The Merck Group is a German-based multinational firm with a specialization in health solutions, including prescription medicines, vaccines, and animal healthcare products. 

Merck has offshore operations in Beijing, South Korea, and Tokyo. Since 2007, the company has been working with Indian IT services and outsourcing specialist Cognizant. 

In 2015, the company established a USD 5.34 million facility in Algeria to produce diabetes and high blood pressure medication. In that venture, Merck partnered with an Algerian lab, Novapharm.

Instead of one centralized production facility where products are made and then shipped around the world, Merck has hundreds of facilities globally. This enabled them to increase manufacturing capabilities and enter new markets around the world. 

3. Pfizer

Due to the high cost of pharmaceutical production in the United States, companies like Pfizer have been offshoring, primarily to Asian countries.

The pandemic and other factors have intensified drug shortages in the United States, particularly injectable generics and COVID vaccines. In response, Pfizer has relocated parts of its manufacturing facilities to India and China to take advantage of the lower costs in these countries and hopefully amp up production. 

As a result, Pfizer increased its global vaccine deliveries from 1.3 billion at the beginning of 2021 to 2 billion by the end of that year. 

4. General Electric

This American company was one of the first to begin offshoring in the 1970s. When it started offshoring, the company had 277,000 people employed in the United States. By 2019, this came down to 70,000. 

One of its biggest offshore investments was the USD 130 million research and development facility it set up in India. 

Although the company has faced its fair share of criticism for extensive offshoring, in 2004, General Electric saved an estimated USD 30 million due to its offshoring efforts.

5. IBM

Although it has foreign affiliates on almost every continent, IBM has more employees in India than in the United States. 

Today, the company employs 130,000 people in India, handling various tasks from IT support to software development. Amid the struggling global economy, IBM believes its offshore operation in India has been crucial in keeping costs down and ensuring the company’s longevity. 

Other tech giants with similar offshore operations include Dell, Microsoft, and Cisco. 

Check out our complete guide to offshoring companies. 

Final thoughts

If you’re looking to expand your business, you could consider offshoring.

It may help you access a wider talent pool, increase your service offering, participate in the international economy, and take advantage of tax breaks. 

But offshoring also has its challenges. So it’s a good idea to do more research and conduct a thorough economic analysis before deciding when, where, and how to begin your offshoring journey.