Offshoring and outsourcing are two of the most powerful and important trade strategies in this globally connected era. They have been critical to the success of many large corporations and businesses we know today, including Amazon and Google.
However, many people still mistake one for the other or, even worse, don’t know the difference between them. While functionally, the two strategies have a lot of similarities—offering businesses the ability to save on costs by using the productivity of foreign entities—the way they fulfill them is fundamentally different.
Offshoring, Outsourcing, and Cost-Efficiency
These two strategies offer businesses a unique way of optimizing their budget for particular processes. Today, let’s take a look at how cost-efficient they are.
Outsourcing, by its technical definition, is when a company goes into a contract with a third-party entity to perform a specific function for them. Typically, companies outsource non-essential activities to focus on developing and improving their primary service or product. Functions commonly outsourced include customer service, IT management, accounting, and marketing.
A company can save a lot of time and money with outsourcing. It removes hiring, onboarding, training, and retention costs from expenses. Usually, these would constitute a hefty portion of the budget when acquiring new employees. So, seeing how much outsourcing can affect your bottom line is plain.
Another significant advantage of outsourcing in cost-cutting is that it allows rapid upward or downward scaling. There are significant drawbacks if you attempt to scale up too quickly and lots of opportunity costs should you cut back at the wrong time. Outsourcing solves that issue by removing those risks.
On the other hand, offshoring is when a company relocates its business operation to a foreign country or place. The company retains complete control of this remote operation and delegates core responsibilities to a new team, acting as an extension of its primary service. This allows the company to take advantage of tax benefits and reduced operating costs in an, ideally, more affordable country.
A McKinsey study, “Offshoring: Is it a Win-Win Game,” has also shown that offshoring creates net additional value for the U.S. economy. To quote from the study:
“From the $1.45 to $1.47 of value created globally from offshoring $1.00 of U.S. labor cost, the U.S. captures $1.12 to $1.14, while the receiving country captures, on average, just 33 cents.” (McKinsey, 2003, p. 9)
A wide range of benefits also opens up depending on the location of your new offshoring facility. Some countries have much lower labor costs, others will have reduced or no import and export tariffs, and you may even shorten your supply chain should you choose a logistically favorable location.
All these advantages can stack on top of each other and significantly lower your overall operating costs, which you can reinvest in your company for expansion or new products—a factor that’s difficult to measure in terms of financial impact.
The two share a few similarities but are significantly different regarding cost. And it mostly has to do with the fact that they have very different objectives and timelines when utilized. It’s imperative that a business thoroughly considers its basis for offshoring or outsourcing business operations. Are they planning to optimize their budget for the long term? Is expansion in the cards? Or do they need an immediate solution to a pressing problem?
Outsourcing will likely yield greater cost savings in the short term with fewer risks. And if they maintain a lucrative partnership with their outsourcing provider, they may be able to keep these cost-savings and extend them to other non-essential processes. However, the strategy that can generate even more savings and more revenue in the future will undoubtedly come from offshoring.
If your company is leaning towards a more long-term strategy, then offshoring will be a much more worthwhile investment. The payoffs of this strategy could catapult your business or company to new heights and bring in new opportunities that would otherwise not be possible.
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