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Why are different services outsourced to different countries?

Outsourcing can be defined as the strategic use of outside resources to perform
activities traditionally handled by internal staff and resources. It is when a company
decides to utilize resources outside the company to manage or complete a service or
task previously handled in-house. Usually, the work goes to a third party, such as a
consultant, freelancer or another business to perform the job on the company's behalf.
Outsourcing is also used to reference the process of a company sending an entire
manufacturing process or call center activity overseas to be performed. Thus,
outsourcing is a strategy by which an organization contracts out major functions to
specialized and efficient service providers, who become valued business partners.
Sometimes outsourcing involves the transfer of employees from the company to the
outsourcing company.
While outsourcing, emphasis is generally placed on production costs such as
computer services outsourced to low wage countries like India and China. However,
production costs cannot alone explain the reason to outsource to a particular country.
Another parameter called as the transaction costs is also very important in determining
the location for offshore outsourcing of services.
A wide variety of services from computer to financial are outsourced to various
countries. This paper analyses the characteristics of countries that has an impact on
transaction costs in an outsourcing relationship. The paper majorly focuses on the
following ways to determine this relationship. They are as follows:

By examining the characteristics of different types of services in the

context of location decisions for offshore outsourcing of services. These
services broadly cover from management consulting to software
development. The study determined that transactions costs are low when
firms outsource routine services, non-complex services and services that
require less interaction between service provider and the customers.

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For example, manufacturing of toys in an assembly line satisfies the

above criteria and hence are regularly outsourced by US major firms like
Lego, Mattel etc. to China.

The second parameter is the importance of institutional quality and

cultural proximity that impacts the transactional costs. The outsourcing
relationship also requires some level of understanding and trust. One way
to

reduce

the

potential

for

misunderstandings

and

to

improve

communication, thereby lowering transaction costs, may be to outsource

services to countries that are culturally similar. In addition to this, wages,
quality of labour, GDP, geographical

distance,

and

Information,

Communication and Technology quality also are important determinants

which has even been proved by CAGE framework.

The third parameter of study is how the interaction of service and country
characteristics affect location of services for outsourcing i.e. firms
outsource more non-routine, complex and interactive services to countries
with better institutional quality and/or greater cultural proximity to minimize
transaction costs.

Thus based on testing the hypotheses over 11 types of services (financial,

insurance, telecommunication, advertising, architectural etc.) to over 31 countries
(Brazil, Canada, Chile, India, Mexico, China, France etc.) it could be concluded that US
firms outsource more routine services, less complex services and less interactive
services offshore. Also, more services are outsourced to countries with higher
institutional quality and greater cultural proximity. Also, among the given parameters ICT
infrastructure and basic production cost are the most important determinants for US
companies.

Hypothesis development
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Offshore outsourcing of services happen when services are provided by

independent foreign providers and not subsidiaries. This paper tries to explain why
certain services are outsourced to a particular country and also tries to understand the
relation between firms who outsource services and firms who provide these services.
This has been done by analysis of various service characteristics and country
characteristics. They are as follows:

Routineness: Repetitive and routine services can be accomplished by

following a set of rules. The more a service can be specified in a set of rules,
the easier it is to explain to foreign service providers without substantial
misunderstandings, and the easier it is to monitor This implies low transaction
costs for outsourcing routine services offshore. The O*NET is used as primary
source of occupational information which provides key job attributes and
characteristics for over 600 occupations. For example, if administrative services,
such as data entry are more routine I nature and can be outsourced. This is the
reason why a boom in the BPO industry was seen in India.

Complexity: The provision of complex services often embodies tacit information

which is difficult to codify and specify contractually. Therefore outsourcing
transactions involving such services are more likely to give rise to problems that
are difficult to rectify. When these situations arise, it is very costly for the
outsourcing parties to adapt. Thus, outsourcing complex services could result in
high transaction costs. For example, if financial services and advertising involve
more judgment or problem-solving then they will be less likely to be outsourced.

Interactiveness: The success of any outsourcing relationship with a high degree

of interactiveness will depend on the ability to communicate effectively between
the parties, so that both parties know what is expected of the service provider.
Misunderstandings between the outsourcing firm and the service provider may
prove costly to the outsourcing firm. Thus we expect that the more interaction is
involved in the outsourcing relationship, the higher are the transaction costs.

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Institutional quality: Better legal institutions tend to ensure the enforcement of

contracts, encourage greater transparency in the business environment, reduce
uncertainty about legal rights should either party renege on a contract, and
generate respect for contracts across the wide spectrum of economic agents in a
country. The better the quality of the institutional environment, the lower are the
transaction costs involved in an outsourcing relationship. Institutional quality has
also been recognized as an important location determinant for mergers and
acquisitions and e-commerce. For example amazon.com refraining to enter
China.

Cultural proximity: A common culture, irrespective of the precise definition,

allows the traders to have common expectations and customs, which enhances
trust and provides a deeper sense of understanding. It mitigates asymmetric
information and has also made an impact on mode of entry choice of service
firms. The measure of this cultural distance was based on Hofstedes four
dimensions of culture power distance, uncertainty avoidance, individualism and
masculinity/femininity.

Production Costs and other Variables: Lower labour costs and good quality of
labour are important since firms are more interested in outsourcing to countries
where the quality of labour is high. As a result, Philippines has experienced a
boom in providing services to outsourcing countries due to availability of skilled
and literate labour at low wages. Along with this the foreign countrys GDP and
geographic distance also plays a vital role. The foreign countrys GDP will affect
the location of service outsourcing, since a large country is expected to have a
larger capacity to provide services. Moreover, the delivery costs for services may
increase with geographic distance by increasing travel time and costs.

Results and Conclusions:

Services that are more routine, less complex or less interactive will be
outsourced more to foreign countries.

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More services will be outsourced to countries with higher institutional quality and

greater cultural proximity.

Non routine, complex and interactive services will be outsourced relatively more
to countries with better institutional quality and closer cultural proximity.
However, cultural proximity is comparatively less relevant as compared to

institutional quality.
Overall, we find that our three service characteristics (routineness, complexity
and interactiveness), two country characteristics (institutional quality and cultural
proximity),and the interaction between these service characteristics and
institutional quality, all of which may influence the transaction costs in an
outsourcing relationship, are significant determinants of offshore outsourcing of

services and are highly correlated.

Policymakers have some degree of influence on production cost variables, such
as wages and the quality of ICT, all of which increase outsourcing to a country.
For example, if policymakers in India could increase its institutional quality to the
level of the UK, our results show that outsourcing of services to India could

increase by approximately 530%.

However the research also comes with a few limitations. They can be listed as:
o Analysis is limited to different service types as defined by the BEA.
Alternative classifications of services based on their strategic importance
to the firm, such as services that represent core competencies and those
that are supplemental will be more useful.
o Study examines aggregated data at the service and national level.
Detailed firm or transaction data should be used.
o Research focuses exclusively on understanding offshore outsourcing of
services, across various types of services and various countries.

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References:

http://www.roseindia.net/services/outsourcing/why-outsource.shtml
http://www.forbes.com/2003/08/27/cx_ld_0827bestcountries.html
http://www.flatworldsolutions.com/articles/top-ten-reasons-to-outsource.php
http://outsourcing.about.com/od/clouds/a/Why-Do-Companies-Outsource.htm
http://en.wikipedia.org/wiki/CAGE_Distance_Framework
http://www.palgrave-journals.com/jibs/journal/v42/n4/full/jibs201061a.html

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