AARHUS SCHOOL OF BUSINESS AND SOCIAL SCIENCES

OFFSHORING: NATURE OF THE ACTIVITY

VS. HOST COUNTRY CAPABILITIES
Author: Juan Carlos Pedraza M.
Supervisor: Robson S Rocha, Associate Professor
November, 2011

Master Thesis
Department of Management
Msc. In International Business

Acknowledgements

To my family in Colombia,for their support.

I want to thank my supervisor, Professor Robson S Rocha, for his patience and
for guiding me in key moments of the writing process.

Abstract
In developing countries the new model for competitiveness is the one that explores
the idea that the traditional competitive advantages such as natural resources, and
exploitation of the fertile land were not factors that generate the expected growth.
To that end, the state of affairs is changing towards the development of
competitive advantages built around technological innovation, the generation and
dissemination of knowledge and human capital development. International trade
not only opens up economic opportunities for developing-country exporters, but it
also provides access to foreign capital and technology that, through enhanced
competition and innovation, can offer national and foreign consumers more choice
in terms of quality and price. One development that has fueled the growth of
service exports is the growing trend among companies in high-income countries to
outsource back-office and other service functions to take advantage of the
advanced skills and lower labor costs of specialized service providers. The
offshoring industry has grown significantly and in many cases exceeded
expectations from the early days and at the same time, the geography of offshore
delivery has expanded to include a large number of countries specializing in
different parts of the service-production ecosystem. But there are obstacles on the
road, and one of those is related to the nature of the activity and the degree of
complexity that can be acquired in a period of time.
The main objective of this paper is through a literature review explore the
relatedness between: the nature of the activity offshored and the development of
country capabilities.

Table of Contents
Introduction ................................................................................................................................. 3
1.1 Problem formulation......................................................................................................... 6
1.2 Structure of the thesis...................................................................................................... 7
1.3 Delimitation ....................................................................................................................... 7
2. Methodology ........................................................................................................................... 9
2.1 Motivation ......................................................................................................................... 9
2.3 Literature sampling ........................................................................................................ 11
3. Offshoring ............................................................................................................................. 13
3.1 What goes from Outsourcing to Offshoring ................................................................. 13
3.2 Approach to Offshoring ................................................................................................. 17
3.3 Offshoring market and debates .................................................................................... 20
3.3.1 Political and economic debate ............................................................................... 22
3.4 Offshoring definitions and business models ................................................................ 24
3.5 Drivers of offshoring....................................................................................................... 27
3.5.1 Access to new markets........................................................................................... 28
3.5.2 Enhancing efficiencies: the role of technological developments ........................ 28
3.5.3 Cost saving .............................................................................................................. 29
3.5.4 Emergence of new drivers: access to talent ......................................................... 30
4. The nature of the activity and its relation with offshoring ................................................. 34
4.1

Nature of the activity ................................................................................................. 35

4.1.1 Knowledge ............................................................................................................... 36

4.1.1.1 Codifiability ........................................................................................................... 37
4.1.1.2 Repetition ............................................................................................................. 38
4.1.1.3 Innovativeness ..................................................................................................... 38
4.1.1.4 Process maturity .................................................................................................. 38

4.1.1.5 Modularity ............................................................................................................. 39

4.1.1.6 Complexity ............................................................................................................ 39
4.1.2 Customer contact .................................................................................................... 41
4.2

Types of offshoring activities ................................................................................... 43

4.2.1 Front-office services ............................................................................................... 44

4.2.2 Back office services ................................................................................................ 44
4.2.4 Business Process Outsourcing and Offshoring - BPO&O ................................... 46
4.2.5 Information Technology Outsourcing - ITO .......................................................... 46
4.2.6 Knowledge Process Outsourcing - KPO ............................................................... 47
5. Host country capabilities ..................................................................................................... 49
5.1 Definition ......................................................................................................................... 51
5.2 Types of capabilities ...................................................................................................... 51
5.3 Benefits ........................................................................................................................... 51
5.4 Transition ........................................................................................................................ 51
6. Conclusion and challenges ................................................................................................. 52

Introduction
The last few years have witnessed major changes in business environments of
different industries worldwide. Progressively, there has been a shift away from
national markets as distinct entities, protected from each other by trade barriers,
towards a system in which national markets are merging into a single global
market (Hill and Jones, 2001).
It is no secret that the gradual integration of national economies into the global
market with the gradual deregulation of trade in goods, services and flows of
capitals has generated an increased competition between firms because they
constantly require new business strategies and models in order to achieve
increasing levels of quality and competitiveness. As McIvor (2005) suggested, at
the same time, the boundaries of many industries span internationally with
competitors existing in both home an international markets. Increasing competitive
rivalry has reduced the profits of many organizations and forced them to reduce
costs, improve customer responsiveness and quality.
In developing countries the new model for competitiveness is the one that explores
the idea that the traditional competitive advantages such as natural resources, and
exploitation of the fertile land were not factors that generate the expected growth.
To that end, the state of affairs is changing towards the development of
competitive advantages built around technological innovation, the generation and
dissemination of knowledge and human capital development.
To facilitate these changes the role that developing countries are playing in both
trade of goods and services is fundamental. International trade not only opens up
economic opportunities for developing-country exporters, but it also provides
access to foreign capital and technology that, through enhanced competition and
innovation, can offer national and foreign consumers more choice in terms of
quality and price.
By the same token, for developing countries, services play a key role in increasing
economic growth and productivity as they are essential inputs to many activities
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that help improving financial intermediation, infrastructure, the use of information

technology and communications (ICT), the increase of the quality of education,
health and the efficiency of the public system.
One important economic and social phenomenon that has fueled the growth of
service exports, especially in developing countries (DC) or low cost countries
(LCC) is the growing practice among firms in high-income countries to outsource
back-office and other service functions to take advantage of the advanced skills
and lower labor costs of specialized service providers. Many developing countries
and LCCs have substantial untapped potential to satisfy this demand for business
functions in, for example, the accounting, engineering, IT, and legal service
sectors.
In order for developing countries to catch upand reach per capita income levels
similar to those of the richest economiesproductivity and competitiveness are
crucial. Improving productivity is the most important challenge for Latin American
and Caribbean countries (IDB, 2010), and although the mechanisms for achieving
these goals vary according to country conditions, all of them seem to follow the
same pattern: working to transform the agrarian and industrial economies into
services and knowledge-based economies. And one way to achieve this goal
could be through offshoring only if: both firms (customers and suppliers) and
countries can take specific measures to help clear supply and demand more
efficiently in this nascent global market (Farrell et al, 2006).
The offshoring industry has grown significantly and in many cases exceeded
expectations from the early days. At the same time, the geography of offshore
delivery has expanded to include a large number of countries specializing in
different parts of the service-production ecosystem (AT Kerney, 2011). For
example, service suppliers today need not choose between Asia, Europe or
America for their offshore operations. Instead, they should decide how to balance
operations across regions in order to develop a global package with multiple time
zones, high levels of efficiency and a close proximity to clients (Gereffi et al, 2009).

In the case of Latin America, the segment of outsourcing and offshoring has grown
significantly during the last years. The outsourcing industry in Latin America is
growing faster than any other region. Even in the current economic crisis, it is
estimated that the outsourcing industry in Latin America grew between 5.5 and 6
percent in 2009 (KPMG, 2010). Different factors could explain this phenomenon.
One could be that developing countries are exporting not just traditional services,
such as transportation and travel (or tourism) services, but also modern services,
notably high-value, skill-intensive services, such as computer and information
services and other business services (Groover et al, 2011).
Furthermore, the part of the value chain that can be performed offshore has
increased in value-add and complexity as we continue to see new types of
services being handled remotely and across borders. An increasing number of
corporate functions have become mobile, that is outsourceable offshore. Besides,
the sophistication of these relocable functions has been increasing steadily: not
only simple functions such as entering data or answering simple phone calls are
outsourced to remote countries but also complex tasks such as financial analysis.
In a way, there is a real globalization of white-collar jobs (UNCTAD, 2005)
And this last scenario of increasing complexity and the evolution of the nature of
the activity that is offshored represents a major challenge for developing countries
and developing country firms (DCF) competing to be the preferred destinations for
business development related to offshoring. Since the type of function that is being
offshored determines the location where this can be most effectively provided, the
impact of offshoring on developed countries and emerging markets alike depends
on its potential magnitude and the pace at which it develops (Farrell, 2006). And
this is very important since initially, host countries build their attractiveness for
offshoring (both captive centers and offshore outsourcing) around a relatively
narrow set of capabilities. While offshoring processes are constantly refined,
standardized, or simply are acquiring an important degree of sophistication,
countries would also need to upgrade their capabilities in order to claim foreign
direct investment in an attempt to gain competitive advantages, especially taking
5

into consideration that, while economic crisis potentiate the benefits of investing in
developing countries, low cost is no longer a key differentiator among offshoring
destinations.
1.1 Problem formulation
The main objective of this paper is through a literature review explore the
relatedness between: the nature of the activity offshored and the development of
country capabilities.
This cause-effect relationship opens the possibility to discuss and propose the
following hypothesis:
The nature of offshoring activities might influence the upgrade of the
capabilities of a host country (developing country or low cost country).
The above scenarios are needed to define the following research question:
How might the nature of offshoring activities affect the development
of host country capabilities?
To answer the research question the following sub-questions are going to be
answered:
a. How has the concept of offshoring developed?
b. How can the nature of the activity be defined?
c. What types of activities can be identified?
d. What kinds of activities are considered for offshoring, what are their
characteristics and its relationship to the level of knowledge and level of customer
contact?
e. What kinds of requirements are necessary to carry out certain business
activities?
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f. What is a set of capabilities of a host country?

f. How can the concepts of upgrade of competitive advantages and the building of
absorptive capacity facilitate the interaction between the nature of offshoring
processes and host countries?
1.2 Structure of the thesis
This master thesis is divided into six chapters.
Chapter 1: Introduction, Problem statement, Motivation, Delimitation and the
contents of the thesis.
Chapter 2: Includes description of the methodology used to develop the thesis.
Chapter 3: Dedicated exclusively to the concept of offshoring. This chapter
contains a literature review covering the basic differences between outsourcing
and offshoring, followed by a more detailed explanation of offshoring. This chapter
aims to elucidate the evolution of the concept of offshoring as a current reference
both academic and practical level. This chapter also includes the references to
why for offshoring low cost is no longer a key differentiator.
Chapter 4: This chapter contains a review of the nature of the activity, its relation
with the concept of complexity related to offshore processes and their impact on
developing countries, as recipients of the investments related to the progression of
offshoring.
Chapter 5: This chapter is dedicated solely to the host country capabilities, with an
emphasis on its definition and the identifying the types of capabilities with direct
relation to offshoring.
Chapter 6: The final chapter includes the conclusions and challenges.
1.3 Delimitation
This thesis is taking into account the interaction between three different elements:
offshoring as an alternative for companies to generate growth, employment and
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income sources; the nature of the business activities that are offshored (especially
to low cost countries); and finally, the host countries set of capabilities (the ones
that gives countries a degree responsiveness to the changing trends in offshoring).
Figure 1: Relationship model

Source: Own work

Initially, a differentiation between outsourcing and offshoring was made because of

the confusion that these two terms still generate. Once this differentiation is made,
throughout this thesis the topic of offshoring will be treated as a whole, this means
that there will be no differences between the different offshoring business models
(Offshore outsourcing, offshore development centers and Captive Shared
Services).
-

Similarly, through this thesis, offshoring will be discussed from the services
sector perspective and the unique attributes of the business activities.

This work deals mainly with the nature of business activities subject to
offshoring processes. Clarification is made because it is possible to find
literature references to the complexity of sending one process to another
country (referred to as "complexity of transferring functions")

Here it is important to make a clarification regarding the extension of the thesis.

Given that countries represent different operating environments for firms, it is
not possible to give a general view about the effect of the complexity of the
offshoring business processes in specific countries, so

2. Methodology
The main purpose of this chapter is to present the methodology used to develop
the thesis. The central focus is the study of available literature on the subject of
offshoring, including the nature of the business activity and its effect on the
capabilities of a host country; therefore, the methodology used to develop this
study was the literature review. This chapter also includes the explanation of the
tools used for the development of the literature review, based on two authors
specialized in this area.
According to Hart (1998) literature review is defined as the selection of available
documents (both published and unpublished) on the topic, which contain
information, ideas, data and evidence written from a particular standpoint to fulfill
certain aims or express certain views on the nature of the topic and how it is to be
investigated, and the effective evaluation of these documents in relation to the
research being proposed. In the same vein, according to Machi and McEvoy
(2009), a literature review is a written document that presents a logically argued
case founded on a comprehensive understanding of the current state of
knowledge about a topic of study.
2.1 Motivation

The motivation for this thesis has as its starting point the confluence of three
important trends in international business especially in emerging economies from
Latin America (e.g. Andean countries, Chile, Argentina and Uruguay), and one
trend in the offshoring practice (also noted in the literature).
First, there is the increasing influence of the international trade in services in the
region. As Cattaneo et al (2010) explains that the service sector is the key to
economic growth, export competitiveness, and poverty reduction. The trade in
services has grown more rapidly than the trade in goods and the share of the trade

in services in overall trade has been increasing for much of the last three decades.
The potential of the trade in services has remained largely overlooked and
untapped by developing countries. A number of reasons could be evoked,
including the widespread and persistent idea that services, as opposed to goods,
are nontradable. In recent decades, technological obstacles to trade in services
have been removed. The latter can be evidenced in the recent trade agreements
negotiated in the region (e.g. Free Trade Andean Countries and United States),
where the chapter on trade in services has been the subject of interesting debates
and deep negotiations.
Second, the renewed momentum gained by industrial policies to generate growth
and development in Latin American countries. As mentioned earlier, the
governments of South America are working in order to transform the agrarian and
industrial economies into services and knowledge-based economies.
Third, it is possible to identify the growth of outsourcing, and offshoring operations
in the region. Latin America's proximity to the U.S. consumer market serves it well
as a services hub. With a growing Spanish-speaking population in the United
States and English proficiency continuing to grow in Latin America, customer
service activities will naturally increase. Latin America, similar to other regions,
presents a kaleidoscope of skill sets (AT Kerney, 2011).
Beyond trends, another reason for deciding to write on this subject was the initial
literature review on the issues of outsourcing and offshoring. The result indicated
that much of the literature and available studies were focused on the study of
benefits and impacts of sourcing strategies in firms and the effect of wages in both
developed countries (resulting from the outsourcing of white-collar jobs) and in
developing countries. The subjects that were continuously left outside of the
discussions and received little attention are related to the nature of the
processes/activities that are offshored (and their different levels of complexity) and
the ability of developing countries to upgrade their set of capabilities in order to
offer firms a stable but also flexible business environment to respond positively to
market needs.
10

Finally, there is another special motivational aspect in the debate and is that the
economic crisis of recent years changed the perception of business and helped
firms to start the diversification of offshoring possibilities outside traditional
destinations such as China, India and the Philippines. The tendency to seek
destinations that offer quality and low cost is increasing, the geography of
offshoring is shifting and countries in Latin America (i.e. Colombia) can take
advantage of this situation. Although part of the success of this growth as a
destination for offshoring is due to an interesting interaction between the public
and private sector with the aim of upgrade the set of capabilities of the country in
topics such as: financial attractiveness, people skills and availability and business
environment.
2.3 Literature sampling

The thesis is based mainly on a study of the literature on offshoring, the nature
and complexity of processes offshored, the upgrade of the business environment
and the building of absorptive capacity. Literary sources used were primarily
secondary. The main source of information was the website of the State and
University Library (http://en.statsbiblioteket.dk/). The literature search process
followed the steps suggested by Blumberg et al (2005, p. 162) What steps??.
Similarly, I have resorted to using the Social Science Citation Index. For example,
this was a very useful tool since the initial search of articles on offshoring through
the State and University Library yielded a result of 18,155 articles.
When making a more detailed search for articles, I used popular databases such
as EBSCOhost, Emerald, ABI/INFORM Global, Journal of International Business
Studies, ProQuest, among others, with different combinations of keywords,
although all related to the central topics of the thesis (e.g. offshoring, offshore
outsourcing, nature and complexity of offshored processes, offshoring and
developing countries, absorptive capacity, among others). For search strategies, I
commonly used the advanced search options of the search engines to limit results,
and for example, articles in newspapers and book reviews were not taken into
11

account. When it was possible all searches were restricted to academic peerreviewed publications. In order to supplement the search, I expanded it to books
from the ASB Library. For example, in the case of offshoring, being the main topic
of discussion the search resulted in 7 books.
The literature search process shows an interesting finding that fits with what many
authors have written in their articles. Figure 2 shows the growth in the number of
publications in specialized journals on issues related to offshoring. This topic is not
new but its study and importance in the academic and business levels has grown
in interesting ways in the last five years.
Figure 2 Offshoring citation report

Source: Social Science Citation Index/Journal Citation Report

Based on these results, I chose articles that covered the period of increased
activity of publishing (2004-2011) combined with the prominence of article
documented by citations or the source. As Blumberg et al. 2005 explains, the more
an article has been cited, the more it has been appreciated by other scholars.

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3. Offshoring
3.1 What goes from Outsourcing to Offshoring

The main objective of this first section is to present (a) the basic differences
between the concepts of outsourcing and offshoring, following by (b) a much
broader definition of offshoring and how the concept has developed in recent
years.
a) What is the difference between outsourcing and offshoring?
Before starting it is necessary to briefly mention two aspects that are crucial to
firms today. At first instance, globalization is transforming the economic outlook of
large firms in developed countries; and is driving and enabling firms to develop
global sourcing models and service chains to both remain competitive and tap into
global talent, resources and capital pools; globally distributed R&D structure to
more effectively enter new geographic markets (NASSCOM, 2010). These service
chains and sourcing models are applied to the production of goods and services.
And second, economic crisis re-emphasized the importance of cost savings and
improving efficiency via outsourcing, taking into account the access to qualified
personnel as an important strategic driver and low cost no longer a key
differentiator (NASSCOM, 2010).
Although this thesis deals mainly with the topic of offshoring, it is worth making a
few clarifications. As Chakrabarty (2006) well specified, outsourcing and offshoring
are two of the terms that have become very popular lately, but this two words also
lead to confusion and misunderstanding. Likewise, both terms are regularly used
in public debates and academic research, but they are often weakly defined (Pyndt
and Pedersen, 2006) or a large number of terminologies are already being used,
and as the business world explores and experiences new information system (IS)
sourcing alternatives,

newer terminologies

will

be coined,

terminologies may be subjected to multiple interpretations.

13

and existing

Figure 3 allows us to ascertain at a glance the main difference between the two
terms. The term offshoring is often associated with outsourcing but neither implies
the other (Olsen, 2006). The two basic sourcing strategies are insourcing and
outsourcing. Insourcing implies that the service provider is a client entity, while
outsourcing implies that the service provider is a non-client entity.
It is important to keep offshoring and outsourcing decisions distinct: they are
location choice and mode choice decisions, respectively. A factor that encourages
outsourcing might at the same time discourage offshoring in favor of exporting
from the home country or choosing a third country (Markusen, 2005).
Figure 3 - Relationship of offshoring and outsourcing

Source: Biro Feher, 2005

More deeply, outsourcing involves the sourcing of goods and services previously
produced internally within the sourcing organization from external suppliers. As
defined by Gereffi et al (2009) outsourcing is, therefore, the act of contracting a
special function or service from a legally separate unit (outside the boundaries of
the company) rather than using the companys own internal resources and
capabilities (in-house provision), but with one important condition, whether or not
to outsource is the decision of whether to make or buy (Power et al, 2006). Hill
(2009) observed that historically, most outsourcing decisions have involved the
manufacture of physical products. However, in recent years, the outsourcing
decision has gone beyond the manufacture of physical products to embrace the
14

production of service activities, something that was also noted, transferred and
applied to other activities in the firms by McIvor (2005) when he mentioned that
outsourcing has progressed from involving only peripheral business activities
towards encompassing more critical business activities that contribute to either
maintain the competitive position of the firms or act as a source of competitive
advantage in the long term.
De Vita and Wang (2006) propose taxonomy of the concept of outsourcing is
divided into three phases. These phases capture the traditional basic features of
outsourcing and its key factors are related to: efficiency, cost savings, focus on
core competences, sourcing complimentary capabilities, innovation and adaptation
of flexible solutions for customers, and business process transformation. The most
important development of this taxonomy is that many of the important factors of
outsourcing are shared with the concept of offshoring. Authors like Doh et al
(2009), Youngdahl and Ramaswamy (2008), Dedrick et al (2011), Mithas and
Whitaker (2007) echo these basic features but applied to offshoring. It is also
possible to establish a similarity between the features and offshoring drives.
Offshoring refers to when the service provider is located in a country which is
geographically far away from the clients country (Chakrabarty, 2006), performed
in house (offshoring) or by sub-suppliers (offshore outsourcing) (Pyndt and
Torbesen, 2006). Figure 4 helps us to conceptualize and widen the difference
between the terms, although the definition of offshoring will be expanded in the
next chapter of this thesis.
Offshoring can occur through varied mechanisms including (a) creating a
subsidiary in another country and moving work between organizational units, (b)
contracting directly with individual workers in another country, (c) contracting with
a service firm in another country, (d) contracting with a multinational organization
having offices in the offshoring firms home country with sources of labours across
nations, and (e) acquiring a subsidiary (Kumar et al, 2008 :448).

15

Figure 4: Illustrative matrix of insourcing, outsourcing and offshoring

Source: Olsen, 2006

So far, the types of business activities subject to outsourcing or offshoring have

not been taking into account. The figure 5 shows the different types of services
sourcing types and their strategic value to the firm. It also serves to corroborate
the current capacity of fragmentation and modularization of the activities carried
out by firms/firms in various economic sectors, that can be exploited in various
forms of outsourcing, and that at some point may become offshoring activities.
Similarly, this figure shows how offshoring processes are refined, standardized, or
simply are shape to acquire a degree of sophistication and complexity.
Figure 5: Types of services sourcing types

Source: Javalgi et al, 2008

16

Conventional/tactical outsourcing: often short-term and applied to specific projects

or problems. Tactical outsourcing tends to be function-specific and with the
following characteristics (Verizon, 2007):

Reduces operating expenses

Creates cost predictability

Minimizes risks

Leverages skilled resources

Counteracts poor economic condition

Strategic outsourcing: used to describe a longer-term relationship in which both

parties invest to develop a partnership approach to developing IT services

Improves corporate performance

Achieves globalization

Focuses on core business activities

Enacts major organizational changes

Gains strategic partner

Transformational outsourcing: In transformational outsourcing, firms transform by

comprehensive reorganization and streamlining of its business processes and
technology infrastructure and the outsourcing of IS needs, in order to reduce costs
and improve services (Sparrow, 2003, p. 10).
Thus, the core driver of the latest form of global outsourcing (i.e., both onshore
and offshore) is the heightened organizational and technological capacity of firms
in decoupling and coordinating a network of remotely located in-house and
external suppliers performing an intricate set of activities (Mudambi, 2008).
3.2 Approach to Offshoring

Now that the main differences between outsourcing and offshoring have been
presented, it is time to delve deeper into the nature of the term offshoring. Thus,
the purpose of this section is to answer the following question:
17

b) How has the concept of offshoring developed over time?

The initial observation about the concept of offshoring is that it is a subject that has
had a significant spread in recent years as a field of study, and that also has
become a trend in the business and managerial world, because it affects
company's cross-cutting practices/disciplines such as: international purchasing,
sustainable competitive advantages of firms and countries, comparative
advantages, make or buy decisions, make or buy alternatives, supply chain
management and the concept of core competences. As stated by Lewin and
Couto (2006), offshoring has become mainstream practice across industries and
the adoption of offshoring practices is following an exponential growing pattern.
As Doh (2005) also suggested, the acceleration of offshoring real or perceived
may challenge established theoretical orthodoxy regarding the operation of the
global economy generally, and management practice, in particular. Likewise, the
different number of scenarios in which the concept has spread, make it difficult to
establish a typical definition of this practice. Equally, other topics currently
addressed in articles about offshoring include the implications offshoring has on
organizations innovativeness as well as productivity (C. Jahns et al., 2006).
To understand more about the concept of offshoring, it is necessary to refer to
when global sourcing strategies began to gain relevance for firms in their search
for improving competitiveness, performance and efficiency. According to Kotabe
and Mudambi (2009), in the last two decades, we have witnessed three waves of
global sourcing. The first wave took place in the early 1980s, with emphasis on the
global sourcing of manufacturing activities with a special consideration on the
results of implementing more global and complex supply chains.
The focus of the second wave started under the guise of re-engineering of
processes (C. Jahns et al., 2006), and the research focus were both
manufacturing and services. In the services segment, firms started eliminating or
outsourcing their in-house information technology (IT) departments that had grown
substantially, and this represented the growth of specialized providers. Basically,
18

IT itself had become commoditized and the goal was to reduce costs. During this
period, production was mainly outsourced or offshored to low cost countries (Pyndt
and Pedersen, 2006) since firms located in developed countries often found that
labor costs were high, compared to the value that was added to their products
(Kotabe and Mudambi, 2009).
Finally, as suggested by C. Jahns et al (2006), the focus of the third and current
wave of cost reduction clearly lays on services and the transfer of white collar jobs
to low wage countries. This represents two different scenarios. First, firms want
access to foreign markets in order to tap into new sources of skilled workers
(knowledge

acquisitions

competence

development

concerns),

to

position

themselves in rapidly growing markets (Treffler, 2005., Kotabe and Mudambi,

2009) and second, thanks to the constant transfer of knowledge between firms
(demand-side and supply-side), the offshoring of an increasing number of whitecollar jobs from developed to developing countries presents a significant economic
opportunity to any developing nation having a low-cost and educated workforce
(Mullan et al, 2008). Lastly, during this current wave, firms are seeking the access
to specific resources (specialized components or technical expertise). Future plans
indicate even greater growth in innovation offshoring, since firms are realizing that
in order to remain competitive; they will have to drive the next wave of innovation
by innovating globally (Lewin and Couto, 2006).
The current high level of interest in offshoring is a logical extension of the largescale outsourcing phenomenon that occurred in the 20th and early 21st centuries
(Weber, 2004) although offshoring has existed as an organizational and societal
issue since the dawn of the Industrial Revolution (Davis, 2004). In that respect,
offshoring is not a new phenomenon; it shares many of the underlying issues of
outsourcing that are discussed by economists, international business, information
technology researchers, and others (Davis et al, 2006). Today, economic crossborder transfers do not merely include final goods and services, but increasingly
encompass the exchange of knowledge, people, and various intermediate
activities in the value chain. (rberg Jensen and Pedersen, 2011)
19

3.3 Offshoring market and debates

Offshoring is a phenomenon in constant growth, mainly affected by changes in

technology and process standardization. No one knows how big offshoring will
become because there is no consensus on how to collect data that corresponds to
appropriate definitions of services in this industry (Sako, 2005). The total market
for all offshore service exports is estimated to have been $32 billion in 2001. The
fastest growth is expected in the offshoring of IT-enabled services, which is
forecast to expand from $1 billion in 2002 to $24 billion in 2007 (UNCTAD, 2004).
Generally, countries do not have data for these types of service exports and there
are no specific trade codes to track this information. Additionally, firms have little
incentive to disclose this information (Gereffi et al., 2009)
Paradoxically, the growth of offshoring (slow) has benefited by the current
economic crisis. In several countries the firms have begun to make major changes
in its administrative and operational structures. Many firms have used the
recession as an opportunity to focus heavily on eliminating waste and streamlining
poor process flows (NASSCOM, 2010).
In these circumstances both offshoring and outsourcing have emerged as tools to
connect markets and global economies. In the same vein, the speed of adaptation
and reaction of firms to market conditions has increased considerably, affecting
the product lines and services offered. For associations like the National
Association of Software and Services Firms (India) - NASSCOM, 2010 was going
to be the year of offshoring, as firms emerge out of recession they were going to
look at offshoring as a competitive enhancer. Market segments to consider were:
Banking, Financial Services and Insurance (BFSI), healthcare, retail, remote
infrastructure management (RIM), business process outsourcing (BPO) including
analytics, data modeling, research and legal process work, and finally application
development management (ADM).
This superficially indicates that as firms perfect the decision process on the
activities that are offshored, the activities also gain a greater degree of complexity.
20

The following figure (figure 6) shows that to counter the effects of economic crisis,
the trend in business is to look for destinations both natural and new locations for
the development of offshoring projects. The figure also shows the growth of the
market for Business Process Sourcing, suggesting that the number of activities
had grown in number and relevance.
Figure 6 Global Sourcing Market Size (USD billion)

Source: NASSCOM, 2010

Here it is possible to identify another important trend that explains the rise of
offshoring in the last years: the emergence of new destinations to outsource.
Beyond BRIC (Brazil, Russian Federation, India and China) Tier I (or most
attractive country) sourcing destinations, there are more than 120 developing
countries competing for foreign investments, whether in the form of offshore
captive centers, delivery centers of world leading suppliers or through services
provided by local suppliers (Kotlarsky, 2010).
According to the 2009 AT Kearney Global Services Location Index, eight Latin
American countries, including Argentina, Brazil, Chile, Costa Rica and Mexico, are
among the top 50 most competitive international locations for offshoring services
21

(AT Kearney, 2009b). Other countries such as Colombia, Guatemala, Peru and
Uruguay have been identified as important countries to watch (Gartner, 2009,
Gereffi et al, 2009).
The latter is consistent with the motivation to write this thesis. For example,
Colombia is beginning to be considered as a major destination country for
offshoring activities. This country is now considered to be the 43rd main destination
for services location according to the 2011 A.T. Kearney Global Services Location
Index.
3.3.1 Political and economic debate

Apart from the growth of new destinations, the term offshoring in addition to its
academic and practical relevance has acquired political and economic importance.
Politically speaking, offshoring has generated considerable debate, mainly in the
United States, where 36 of the 50 states of the Union have implemented strong
standards against the idea of offshoring. Politicians are using global services
offshoring as an easy scapegoat for current economic woes and high
unemployment levels in their home countries, stoking resentment against
globalized firms and their foreign host countries (AT Kearney, 2011).
What's more, every day there is growing opposition from pressure groups,
especially Unions. However, in other developed countries like the UK, political
sentiment towards offshoring is much more positive. The political speech is
moderate and more comprehensive as it is understood that offshoring opens the
door for British firms to invest in other countries and benefit them from the positive
aspects of globalization.
About the economic importance of offshoring in the past several authors have
written books and studies that have covered the concept so broad and deep
highlighting both positive and negative aspects of offshoring. Of course the idea is
not to focus this thesis in the discussion of the economic effects that offshoring
brings but these effects are simply set out to help cover the entire concept.
22

Critics were quick to point that the new wave of white-collar offshoring as a major
contributor to the poor performance of the U.S labor market, although the
importance of offshoring relative to productivity growth, the bursting of the IT
bubble, and other forces remains murky owing to incomplete data (Bosworth et al.,
2004). However as pointed by Agrawal and Farrell (2006), focusing the offshoring
debate in job losses misses the most important point: offshoring creates value in
four ways. Cost savings, new revenues, repatriated earnings and redeployed
labor. As pointed by AT Kearney (2011), firms are responding to intensifying costcutting imperatives by moving operations offshore.
The above is explained from the viewpoint of the company and effects, but if one
go deeper from the consumer perspective, it will be possible to find that customers
are not, in general, sympathetic to offshoring. Offshore centers almost have to
outperform the domestic alternative to achieve customer acceptance (Smith,
2006). On the negative side one could mention that the pressure generated by
consumers, the need for excellent service, the log-product delivery cycles, and
political pressure, offshoring has suffered a backlash and the immediate effect is
that in recent years the topic that has taken relevance is: reshoring. Reshoring is
the firm decision to send back to the country of origin business activities that are
not achieving significant growth in terms of cost savings, generation of new
services or customer responsiveness. In the same vein, reshoring could also be
the result of the lack of ability of the firm to control and monitor the flow of
knowledge, information, processes to the vendors and their performance.
Contrary to what occur in other parts of the world, the political debate over
outsourcing and offshoring in Latin America is still very bland. Generally, the topics
of discussions are related to the protection of workers rights, immigration reforms,
intellectual property protection and educational reforms. Despite the growth of the
service trade in the region, the manufacture of products and the agricultural sector
still plays a very important role. For example, in the last years Latin American
countries have been those that have best withstood the first wave of the global
financial and economic crisis and have continued to grow apace, thanks in large
23

part, precisely to the high price they have kept to the raw materials and agriculture
products. A sharp fall could compromise, or at least slow, this remarkable growth.
Following the economic sphere, in Latin America there is great expectation about
the economic benefits the growing influx of firms wanting to invest and develop
projects of offshoring could bring, and despite growing concern about job losses,
the tradable services (or offshoreable) are still growing in countries of the regions
as their economies turns global. There is still plenty to do but in some countries,
these benefits are now a reality, for example, Brazil excels in IT and is a strong
platform location for software developers and systems integrators. Mexico is
becoming a more prominent Business Process Outsourcing (BPO) location, as it
supports the United States with both Spanish and English. Meanwhile, Chile has
emerged as a niche destination for R&D and analytics, while Costa Rica and
Argentina continue to grow their offshore services presence despite facing some
decline in cost-competitiveness (AT Kearney, 2011).
3.4 Offshoring definitions and business models

Offshoring still delivers a very vague and confusing definition, although many
articles agree that prior to the turn of the 21st century, offshoring described the
fragmentation and spread of production processes across many countries (Gereffi
et al, 2009), and its productivity enhancing effects generally are small in
manufacturing plants while being of a somewhat greater magnitude for firms in the
services sector, including areas such as telemarketing services and software
development (McIvor, 2005). For IT firms, offshoring is part of a larger trend
toward the globalization of software under which software products and software
services are created throughout the world and sold throughout the world (ACM,
2006).
There is no universal definition of offshoring (Treffler, 2005) and the term is in fact
used to describe a multitude of scenarios (see Table 1), as it seldom explicitly in
literature. Furthermore, academic research on offshoring often lacks a theoretical

24

framework based on economic theories for argumentation or testing (C. Jahns et

al., 2006).
Table 1 Sample of Offshoring definitions
Author(s)

Definition

Gereffi and Fernandez-Stark

(2010)
Chakrabarty (2006)

The provision of a function or service beyond national, rather

than firm, boundaries.
The service provider is located in a country which is
geographically far away from the clients country, this is also
known as global sourcing. The term offshoring is often
used to broadly imply nearshoring too.
Offshoring occurs when firms move productive activities
overseas, whether they are conducted by separately owned
suppliers or by fully owned (captive) subsidiaries.
Contracting out business activities to foreign providers.
Offshoring refers only to international relocations. The term
offshore outsourcing therefore only covers the relocation of
jobs or processes to an external and internationally located
provider.
Offshoring or offshore outsourcing refers too contracting a
company that is geographically distant. Performing or
sourcing any part of an organizations activities at or from a
location outside the companys home country.
Offshoring is defined as the provision of organizational
products and services from locations in other countries,
whether they are actually overseas or not.
Offshore, including nearshore, involves leveraging lower-cost
regions from which to "source" either project-oriented or
outsourced IT and business services.
Offshoring describe the situation in which a firm relocates
some stages of production abroad, to either one of its
affiliates or an unaffiliated supplier.
Offshoring of services can be defined as the transnational
relocation or dispersion of service related activities that had
previously been performed in the home country.
Disaggregation, relocation, and reintegration of activities and
business processes across borders, also known as
offshoring.

Sako (2006)

Olsen (2006)

Brown and Wilson (2005)

Davis et al (2006)

IDC (2010)

Crin, 2009

Doh, Bunyaratavej and Hahn,

2009
rdberg Jensen and Pedersen,
2011

More specifically, the business practice of offshoring focuses on the relocation of

labor intensive service industry functions to locations remote to the business
center, such as India, Ireland or the Philippines (Power et al, 2006), in this case
offshoring involves the transfer of their production only abroad, either intra-firm,
inside the subsidiaries of the mother-company abroad (captive offshoring), or

25

extra-firm, to other firms (external offshoring). (Margulescu, S and Margulescu, E,

2010).
As mentioned above, offshoring helps the firms capture opportunities offered by
globalization, since it has also been facilitated by economic integration
particularly through liberalization in foreign direct investment (FDI)and by
diaspora networks (Engman 2010). This is closely related to what Farrell (2006)
pointed out: from the emerging country perspective, offshoring is just a new variant
of FDI. In practice, offshoring is a consequence of the international division of
labour and of globalization, which includes economic activities concerning services
to be relocated to regions where investments can yield the greatest returns (C.
Jahns et al., 2006).
When making a thorough review of the definitions of offshoring is possible to
identify different elements related to: geographic location (domestic or remote) and
contractual/legal variations. From the delimitation of these elements come different
models to carry out processes of offshoring, although the most common are: the
business model of internal development or captive offshoring, the model of
acquisitions and the outsourcing model.
The figure (figure 7) below shows the offshoring models synthesized by C. Jahns
et al (2006):

26

Figure 7 Offshoring Business Models

Source: C. Jahns et al., 2006

Then, taking into account the contractual/legal dimension and the geographical
dimension, the three models of offshoring are: offshore outsourcing, offshore
development centers and captive shared services. In turn, these models reflect:
the make alternative (shared services are kept internally but are housed
offshore/captive

shared

services),

the

joint

venture

(partnership

agreement/offshore development centers) and the buy alternative (firms sell

projects to foreign firms to be executed completely offshore with low-cost, local
labour afterwards/offshore outsourcing).
3.5 Drivers of offshoring

Offshoring has become significantly more strategic and is becoming integral to the
conduct and perform of business (Lewin and Couto, 2006). This scenario also has
been potentiated by the continuous shifts of business environments. For example,
three important changes that enable firms to capture the opportunities offered by
globalization are often referred to as political deregulation and the new openness
consensus among political coalitions in developing countries, technological
developments and economic and competitive pressures to reduce costs, and

27

improve productivity (Olsen 2006, Pyndt and Pedersen, 2006, Treffler, 2005,
Metters and Verma, 2008).
The dynamics of the drivers of offshoring is also evident from the firm perspective.
In this regard, Lewin and Couto (2006) suggests that the companies pursuing the
cost-savings benefits are those who have little familiarity and skills with the
development of offshoring strategies, while companies with experience in
offshoring processes and strategies besides cost savings take into account other
factors such as access to qualified personnel, improving business processes and
speed up their access to specific markets.
In addition to the definitions of offshoring and the models that arise from it, another
interesting aspect of offshoring is how its driving forces have evolved over time.
3.5.1 Access to new markets

Over the past thirty years, product and financial markets have been liberalized,
which has given rise to regional trade agreements like the EU (European Union),
NAFTA (North American Free Trade Agreement), ASEAN (Association of
Southeast Asian Nations) and MERCOSUR (Southern Common Market), among
others. In addition, WTO (World Trade Organization) works to eliminate the
remaining obstacles and to secure mutually open, transparent, and nondiscriminating markets for goods, services, capital and technology (Pyndt and
Pedersen, 2006). Despite this positive scenario, annual surveys on offshoring
showed that the weight of access to new market as a driver for offshoring is
decreasing in importance (Lewin and Couto, 2006).
3.5.2 Enhancing efficiencies: the role of technological developments

Regarding technological developments, in the past decade or so, advances in

information and communication technologies have made it possible for more and
more of these services to be produced in one location and consumed elsewhere
they have become tradable (UNCTAD, 2004). Information and communication
technologies (ICT) enables the digitization, encoding and standardization of
28

knowledge and, consequently, the production of a wide range of services which

can be de-coupled, fragmented or modularized, the resulting components being
relocatable, in order to obtain cost or quality advantages, economies of scale or
other advantages. Thus, the arbitrage strategies of various factors on national and
international level have become feasible in the sphere of services (Margulescu S
and Margulescu, E, 2010). At the same level of importance, historically, services
were considered non-tradable and offshoring was confined to the manufacturing
sector. However, the evolution and diffusion of ICT has increased the availability of
offshore services in the global economy in recent years. Face-to face contact
between the client and the provider in traditional trade is being replaced by remote
service centers in the new knowledge era (Gereffi, Castillo and Fernandez Stark,
2009). In general terms, ICT plays an important role in facilitating firms decisions
over both whether to outsource and offshore services (Abramovsky and Griffith,
2006) and also in the type of activities to be developed abroad.
Another major contribution of the development and advancement of ICT has been
the improvement in response times to customers. The evolution of call centers is a
good example; its cost structure has developed during last years enabling the
transformation of the after sales services and the customers services strategies.
The offshoring of tradable services potentially affects firms in all sectors, and may
have wider implications than the fragmentation of manufacturing (UNCTAD 2004).
As an example, what began with the outsourcing of basic information technology
(IT) services to external firms now includes a wide array of activities known as
business process outsourcing (BPO) and higher value services associated with
knowledge-process outsourcing (KPO), such as research and development (R&D),
which were previously considered core functions of the firm (Gereffi, Castillo,
Fernandez Stark, 2009).
3.5.3 Cost saving

In theoretical perspective, transaction cost theory helps to explain why the

offshoring trend/practice has grown significantly in recent years and is now a
29

reference for both managers and academics. This theoretical framework is in

particular useful to understand that in order to achieve efficiency in the processing
of information it is important to take into account not only the asset specificity but
also the specialized governance structures associated to the type of transactions,
the frequency at which transactions are conducted are the uncertainty surrounding
transactions.
Cost saving was considered by early practitioners and for a long period of time the
main trigger of offshoring and the reason behind its growth, and low labor
countries as the main offshoring destinations (Sparrow, 2005; Van Gorp et al,
2007, Cerruti, 2008, Bunyaratavej et al. 2010) since there has been a wave of
reforms aimed at integrating low cost countries into the world economy. But at the
same time this also could be a misleading view for one special reason, 85 percent
of U.S offshoring is with other OECD countries (Treffler, 2006) where there are
similarities in wages and the cost saving is minimal.
Cost advantages can for example be realized through less-restrictive work rules
(e.g. regarding wages and dismissal), lower land and facility costs, cheaper raw
materials (for manufacturing), intermediate parts and components (as well as low
technology costs), host country location, the sourcing model adopted, the
proportion of onshore to offshore work, management overheads and productivity
levels at the offshore company (Cho, 1988, Fagan, 1991, Weidenbaum, 2005, in
Van Gorp, 2007; Sparrow, 2005).
3.5.4 Emergence of new drivers: access to talent

Today firms are looking beyond issues related to cost reduction through labor
arbitrage and relocation of operations in developing countries. Offshoring is now
motivated by a combination of environmental pressure, efficiency, and competitive
pressure (Tate et al, 2009) also, partly by a change in the mindset of managers
and strategies of firms to access high labour turnover in local facilities, access to
specialist service providers, access to qualified personnel, improve speed to

30

market, risk management, and optimization of processes (McIvor, 2005,

NASSCOM, 2010).
Clearly, this does not only benefit firms on the demand side but also directly
benefits the countries that are traditional destination for offshoring, encourage the
emergence of new offshoring destinations and firms in the supply side. And as
McIvor (2005) pointed out, greater competition from offshore product and service
providers can act as a stimulus for local providers to achieve productivity
improvements and higher levels of innovation. These levels of innovation and
productivity management are the prime example in the growth of technology
centers in developing countries.
This is directly related to the aforementioned competitive pressure. Moreover, if
one want to see the impact of offshoring in the services market it is possible to find
that it has become highly competitive, and differentiation of service offerings and
leverage of inherent advantages, including cultural and language affinities, set the
scene for keen competition between offshoring destinations (Kotlarsky, 2010).
Other factors associated with competitive pressures include wage differentials,
interest rates, development of capital markets and capital costs. In addition to
repatriated earnings and cost savings, Farrell (2005) argues that offshore
outsourcing helps developed countries to increase their export sales (and
therefore employment), since it stimulates the macroeconomic growth of
developing countries and therefore increases also their imports.
If one discuss about the type of environmental pressure, one might find that the
factors that drivers of offshoring are related with are: the education level of
employees in the supply side, including age, social structure, and skill in using
foreign languages.
One of the drivers that most developments have had in recent years is definitely
the access to qualified personnel. For the firms strategically speaking, the ability to
offshore depends on there being a pool of well-educated job candidates offshore,
a sizable gap between their pay expectations and those of their peers in the
31

employers home market, robust distributed communications technology, a set of

liberal trade rules, and growing confidence among firms in the stability of emerging
markets (Farrell, 2006). For the host country, have a qualified pool of candidates
has a direct influence on national policies for education and innovation. In practice,
countries should respond to the needs of the market with investment in education
programs specifically targeted at sectors of the economy that that can be positively
influenced by flows of offshoring. In general terms, the offshoring of an increasing
number of white-collar jobs from developed to developing countries presents a
significant economic opportunity to any developing nation having a low-cost and
educated workforce (Mullan et al, 2008).
On the other hand, when mention the topic of efficiency is valid to say that is
related to the use and development of technological, communications and
transport infrastructure of a host country. These factors serve to reduce the
geographical distance as a result of forward international outsourcing process, and
also allow the firms to enhance efficiencies, improve service levels and improve
response times to customers. Similarly, it may also offer reduced time to market,
access to foreign markets, facilitate, and create business opportunities for the
development of new products for niche markets. International outsourcing allows
firms to focus on what they do best, freeing up capital to be reinvested in research
and development and more productive activities (Engman, 2010).
In the 2007 Service Provider Survey Report from The Duke Center for
International Business Education and Research (CIBER) and the International
Offshoring Research Network (ORN) it was mentioned that offshoring is no longer
just about lowering costs by moving manufacturing and back-office operations to
labor-efficient locations like China and India. Nor is it about modularizing and
outsourcing transaction intensive IT operations and business processes. More
than ever, offshoring is about sourcing the talent needed to sustain the innovation
engine of a company. Figure 8 shows the influence of different drivers for
offshoring in the companys decision to offshore.

32

Figure 8 - Drivers for offshoring

Source: Duke Offshoring Service Provider Survey 2007 2009 in NASSCOM, 2010

The confluence of new drivers such as access to talent, increasing speed to the
market, offshoring as part of a growth strategy, offshoring as a way of access to
new markets and offshoring as a way to improve service levels suggests that for
the firms offshoring is no longer perceived as a strategy to generate profits and
grow in the short term, and has evolved into an important tool to achieve strategic
benefits in the long-term (Lewin and Couto, 2007).
From a country perspective, it is important to know if the confluence of new drivers
are the result of the adoption of a structured and methodical model to capture the
benefits of offshoring to secure benefits and growth of a particular segment of the
economy of the country, or simply a short-term plan to potentiate quick wins, but
more importantly, to determine whether the search for strategies to foster the
growth drivers is the result of a replica of positive offshore model/experiences
(other countries) or the adoption of a model adjusted to the reality of the country.

33

4. The nature of the activity and its relation with offshoring

We have seen how different elements linked to the concept of offshoring have
evolved and how the concept of offshoring has become a crucial strategy for firms.
In like manner, offshoring is also a major challenge for host countries, institutions
and policy makers. This becomes clear when countries start down the path to
grow as a preferred destination for offshoring activities, while at the same time,
understand and manage the increasing sophistication of the range and volume of
work done offshore. As an example of this challenge, among the key emerging
markets, e.g. Middle East and Africa, Central and Eastern Europe (CEE), South
America and Asia, some attract more high-value activities, such as research and
development (R&D) and knowledge-intensive processes, while other are
competing mainly on labour costs, struggling to differentiate (Kotlarsky, 2010).
One of the main points of departure for discussing the influence of the nature of
business activities subject to offshoring is the reconfiguration of value chains of
firms.

In

developing

countries,

the

effect

of

the

reconfiguration

(also

disaggregation) opened new fronts for business activities that previously had no or
less option of being offshored in as many different segments (i.e. procurement, call
centers, legal and financial operations, R&D, reverse innovation, among many
others). This suggest that there is a highly competitive market for countries whose
offer includes an interesting mix of cost, access to talented workforce and stable
external environment for firms.
In support of this observation, Offshoring Research Network 2006 survey findings
indicate that the choice of offshore locations varies greatly by the function or
process to be offshored and much less so by the industry of offshoring firms
(Manning, Massini, and Lewin, 2008).
From the point of view of the firm, it has been argued that when the processes are
complex they are unlikely to be offshored, and when the activities have acquired a
degree of maturity, stability and modularity they are likely to be offshored. At first
34

instance, this argument would seem very simple, but it is worth to go deep in the
background to realize the impact of the nature of the activity within the context of
offshoring. In the same order, as the following chapters unfold it will possible to
see how the nature of the activity also becomes a factor of special consideration
for the host countries.
Thus, the key subjects to be analyzed in the following paragraphs are: the growing
diversity of services, and the effect of that diversity in developing countries. In that
order, the main purpose of this chapter is to answer the following questions: a)
How is the nature of the activity defined?, b) What kind of activities are considered
for offshoring, what are its characteristics and its relationship to the level of
knowledge and level of customer contact?, and c) What kind of requirements are
necessary to carry out certain business activities?

4.1

Nature of the activity

c) How is the nature of the activity defined?

One important gap in the literature of offshoring was the generalization that was
made on the business activities and their nature. Once the review of the definitions
of offshoring was completed, it was possible to find expressions such as: tasks,
activities, processes, business processes, services and operations, among others,
without finding significant differences between them. In recent years, several
authors have begun to highlight the differences between activities with a common
point: the importance of knowledge (Maskell et al, 2007, Manning et al, 2008,
Neely et al, 2011, Youngdahl and Ramaswamy, 2008 and 2010, rdberg Jensen,
2009, Doh et al, 2009)
Within the literature on offshoring, the nature of the activities is considered to have
special weight as a factor influencing the decision process of offshoring (Doh et al.
2008, rberg and Pedersen, 2010, Dedrick et al. 2011). This is fully referenced in
the "Foundational conceptual model of offshore sourcing factors" proposed by
Dedrick et al (2011). Along with firm-level management practices and capabilities,
35

and the economic drivers, the authors referenced the nature of the activity being
considered to be sent abroad as an important feature for firms with offshore
operations.
In this section, the author will make a more detailed account of each of the
elements that determine the nature of the business activity, based primarily on the
following literary classification:
Figure 9 Literary classifications to understand the nature of the activity

Source: Own work

4.1.1 Knowledge

For Youngdahl and Ramaswamy (2008) the nature of the activity is defined by two
essential elements: the knowledge that is embedded in the work, and how much
contact offshore service providers have with customers. Starting with knowledge,
the authors made a distinction between tacit knowledge, i.e. the type of knowledge
that cannot be codified and applied in repetitive activities; and explicit knowledge,
which is easily transferable at any point where the activity occurs. Similarly, the
36

authors establish a relationship between the level of knowledge and skills

necessary to perform an activity, i.e., transactions that contain a high level of
knowledge embedded will generate solutions with a significant degree of
innovation and transformation capacity, while transactions will be more simple with
a low or null component of change and innovation when the activity has any
knowledge embedded.
This differentiation between the levels of knowledge embedded that is necessary
to perform business activities makes it essential to look for different sources of
talent that are not available locally, and that is why this simple relationship
between demand and supply of knowledge could explain why, today, access to
talented human capital is one of the main drivers of offshoring.
4.1.1.1 Codifiability

The codification of knowledge is a facilitator of the flow and transfer of information

throughout the service value chain (Dedrick et al. 2011, Mithas and Whitaker,
2007). However, throughout that chain of information it is possible to find some
drawbacks, such as the transfer of tacit knowledge. Due to the nature of tacit
knowledge, the information can be found in the form of mind maps, past
experiences and beliefs that reside in the minds of individuals, and therefore are
difficult to transfer to others. Tacit knowledge is a great tool to interpret information
and is used by firms or organizations to develop high value-added activities and
generation of innovation.
On the other side of the balance is the explicit knowledge, which by its nature is
formal, codified, and can be easily shared. This knowledge can be transmitted
through formal language and in a structured way.
Despite having different characteristics, the two types of knowledge are
complementary. When knowledge is transmitted in a structured manner through
written instructions, formalization of processes, or flow charts, it could be possible
to understand processes that may be considered as complex. Finally, coding
facilitates the analysis and transformation of business activities, because it
provides input that allows the creation of knowledge and innovation.
37

4.1.1.2 Repetition

Following the ideas proposed by Peter Hill (1999), Doh et al (2009), proposes a
new typology of offshoring service attributes in which the repetition is part of the
dimensions of interest. The key of the repetition is the undifferentiated nature of
services. Standardized activities tend to have low embedded knowledge, and
could also be classified as explicit knowledge activities. Business processes with a
high degree of repetition require a stable political and business environment, as
well a sound legal system to protect their normal development. Activities related to
back-office processing and call centres contain a high degree of repetition.
4.1.1.3 Innovativeness
It

is a key element in understanding how the of the activity influences in the

process of offshoring. The capacity of innovation is the border that reminds us that
offshoring is not only cost savings but also is generating new knowledge. Doh et al
(2009) the location of specific offshoring business activities is highly influenced by
innovation and at the same time, innovation is related to the development of
business activities highly specialized that require highly qualified personnel.
According to the 2007 Service Provider Report, this relationship between the
capacity of firms to innovate, knowledge services and the access to qualified
personnel is offering the highest profit margins to service providers and the highest
savings to clients.
4.1.1.4 Process maturity

Firms find easy to offshore mature and stable processes as opposed to unstable
processes that cope with constant changes and requests from customers (Dedrick
et al, 2011). The stability of a business activity generates benefits for the business
and reduces the risk of failure. Process maturity could be linked with high
performance because it is constantly challenging the firm to deliver its customer
solutions with high standards, reliable, predictable, but most of all, efficiency. In
the same order of ideas, process maturity could be achieved after a continuous
process improvement conducted intra-firm by removing unnecessary load of work,
identifying bottlenecks and increasing control throughout the whole value chain of
the business activity.
38

4.1.1.5 Modularity

Tanriverdi et al (2007:283) define process business modularity as the extent to

which a business process is loosely coupled, mature, and standardized enough to
be separated from a firms other business processes, executed independently, and
recombined without loss of functionality. There must be control mechanisms (i.e.
use of standardized interfaces) to ensure the flow of information in order to identify
early problems or bottlenecks, or simplify the communication between modules
with specific inputs and outputs before they are recombined.
Modularity has a positive inference in the reduction of transaction, production and
coordination costs. The key in the reduction of production costs is that with
modularity it is possible to source processes from markets, since vendors offer
standardized services reaching economies of scale. Coordination costs are
reduced due to the action of specialized interfaces that serve as synchronization
methods between processes. Finally, transaction costs are reduced due to the
sense of lack of interdependence between vendors and firm.
4.1.1.6 Complexity

Complexity is a very interesting area of study because, somehow, comprises

almost all the factors that determine the nature of the business activity. The issue
of complexity has been widely discussed from the standpoint of product
manufacturing, as well as its influence on the buying and selling decisions of the
firm. The opposite has happened for the services segment, where the literature is
scarce. According to Standish (2008), the concept of complexity has two key
features: complexity in terms of quality and complexity in terms of quantity.
Complexity in terms of quantity is related to the number of parts of a system and
the relationships (connectivity) that emerge between them (parts). Another
element that is taken into account when speaking of complexity is terms of
quantity is the amount of information embedded in the system, meaning that, the
more information circulates around the system, more complex will be considered.
An additional element of study appear when the parts of the system performing a
business activity through their different types of relationships exchange
information. The message containing the information is the key to understand
39

better the nature of the activity being sourced because it contains codified
knowledge. Then, a relationship is observed between this additional element of
study within the complexity in terms of quantity and the encoding of information in
a way that can be transmitted easily across firm boundaries and geographic
distance.
Complexity in terms of quality refers to the presence of emergence in the system,
or the exhibition of behaviour not specified in the systems specification (Standish,
2008). Here one can perceive a close relationship with another element that
determines the nature of business activity subject to offshoring. When a business
activity comes to a state of maturity and stability is easier to predict its behaviour
along the value chain mainly because in the medium/long term obstacles to
develop the activity are clearly and easily recognized. When a system is unstable
or there are many requests the customer, it is more difficult to manage offshore,
and therefore less likely to be moved (Dedrick et al, 2011).
Novak and Eppinger (2001) also studied the relationship between product
complexity and the supply chain. Specifically, they identified three main elements
in product complexity: a. the number of product components to specify and
produce; b. the extent of interactions to manage between these components, and
c. the degree of product novelty. The authors applied these elements to examples
in the automotive industry. In reviewing these elements it might be possible to
establish a relationship with the factors that determine the nature of business
activity.
The first element, the number of product components needed to produce is related
to the effects of adding new components to an activity and the need to monitor its
performance as part of a system or process. In offshoring the modularity is key
concept in the linking of different activities performed independently. The authors
mention that adding more parts (in an assembly line) adds to the coordination
needed to ensure vehicle development. In offshoring the modularity calls for close
and frequent coordination in order to solve problems in a short period of time.

40

The second element in product complexity is the interaction between components

and their interconnections. Once again, modularity seems to be the direct
relationship with the factors that define the nature of the activity, due to the ability
of modularity in the regulation of relations of interdependence between the parts of
a system and the flow of knowledge activities. When modularity is high, offshore
strategies are easier to perform, whereas when the modularity is low, knowledge
activities are difficult to separate and execute in remote locations. On the other
hand, the interaction between components of a system could be considered as
interactions between customers and vendors and the different requirements that
are suggested by customers to implement different business activities.
Finally, the third element in product complexity is the degree of product novelty.
Following the application in the automotive industry, the authors suggest that a set
of interactions is needed every time there is a new interface or technology inside
the system. This position is very similar to the one observed in the first element
and the need to establish coordination mechanisms to ensure that the work done
in one part of the process is not going to affect the next stages.
4.1.2 Customer contact

The second essential element that helps define the nature of the activity is the
service contact. Hill (1999) suggests that among consumers and producers
reciprocal relationships exist due to the nature of services: one cannot exist
without the other and a service must be provided to another economic unit (i.e.
buyer-supplier relationships, or HQ-subsidiary relationships).
Doh et al, 2009 also look after this analysis by mentioning that international
offshoring and international services trade are related to the extent that the output
of offshoring activity provides a service to an internal or external customer. This
flow of information between supplier and customer is affected by operating
conditions in host countries. Factors such as infrastructure, technology and level of
interaction with a foreign language are required to support real-time person to
person information interactions.

41

Clemens and Aron (2004) raised an interesting debate about the need to change
the idea that complex business activities should be developed only within the firm.
The logic of maintaining the complex processes within the firm is related to the
risks associated with the execution of the activity and the risks associated to the
relationships between the parts of a system.
First, strategic risks are those that result from interactions between vendor and
customers, and are presented in three ways: opportunistic renegotiation, poaching
and principal-agent problem.
Poaching is the result of lack of control mechanisms for information flows in a
vendor-customer relationship. The absence of these mechanisms facilitates the
loss of control of intellectual property and reuse of information for the benefit of the
vendor. The reuse of information means that key parts of processes that contain a
high percentage of information can be used by the vendor to generate profits,
either by selling it to the same or new ones. The authors explain it in a very clear
way, the reason that outsourcing complex tasks appears more dangerous is that
simple operations do not teach the vendor much, but complex operations may
teach the vendor a great deal in terms of pricing strategy, trade secrets or
classified information (Clemens and Aron, 2004).
Opportunistic renegotiation refers primarily to relations of interdependence and
their levels of vulnerability. Interdependence is generated by the type of
investments that make the parts of a system. For example, when one activity is
considered for offshoring, investments are needed for the training of the workforce
to understand and develop the activity. These investments will regulate the
contractual relationship between the parties.
Principal agent problem refers to the different attitudes taken by vendors when
developing an activity. Many times the customer's objectives are not aligned with
the objectives of the vendor and instead of being a collaborative relationship
between the parts; the relationship deteriorates when the quality of the result is not
expected.
42

Second, the operational risks or those associated with the implementation or

execution of the activity. Clemens and Aron (2004) explains that they are the
inevitable result of the difficulty of coordinating complex operations across great
distances, with imperfect information, and with limited understanding due to
cultural differences, language differences, or lack of shared context and
experience.
This approach suggests that operational risks seem to be more aligned with the
capabilities of a host country, whereas strategic risks are related to the elements
that determine a relationship between vendor and customer. In this regard, the
framework proposed by Clemons and Aaron (2004) serves to perfectly fit the
elements that define the nature of business activity and have been exposed in the
preceding paragraphs. For example, coordination costs are greatly influenced by a
country's ability to provide stable infrastructure to promote the exchange of
information between the parts of a system, likewise, the process of offshoring are
greatly affected by the difficulty of having a staff with sufficient technical
knowledge and educational preparation for development of activities with different
loads of embedded knowledge. The authors also emphasize the importance of
cultural differences between vendors and customers in terms of knowledge and
management of a common language that benefits the transit of the activity and its
message through the value chain.
4.2 Types of offshoring activities

d) What kinds of activities are considered for offshoring, what are their
characteristics and its relationship to the level of knowledge and level of
customer contact?
According to UNCTAD (2004) there are three sectors (figure 10) representing the
main categories of services offshoring: call contact centers; IT services centers;
and shared services centers. These three categories implicitly suggest customer
contact and knowledge integration the same way as proposed by Youngdahl and
Ramaswamy (2008).
43

Figure 10: Definitions of export-oriented FDI projects related to offshored services

Source: World Investment Report, UNCTAD (2004)

From the study of the interaction between vendor and customer, several authors
have identified different types of classifications of services. One of the most
important is that proposed by Chase (1978), which provides a differentiation
between front-office services and back-office services, the major difference being
the level of contact maintained by the service providers with customers.
4.2.1 Front-office services

For example, for the front-office services customer participation is much more
active both in the process of production and development of the business activity,
even until the time of delivery (Youngdahl and Ramaswamy, 2008). This includes
the concept of empowerment of employees of the vendor, in order to facilitate
contact with the customer. The ultimate goal is to achieve flexibility, reliability and
quality in real-time decisions to be taken, and to do it is important that employees
have excellent training and possess the knowledge necessary for the continuity of
service.
4.2.2 Back office services

In the case of back-office services, approach differs in terms of the activities

performed by employees and the level of contact with the customer. Normally the
activities are characterized by the high level of standardization, maturity and
stability. Likewise, the modularization of activities is easier with this type of
services.
44

The result of the merger and evolution of knowledge and customer contact
produces a fundamental change in the behavior of service providers and the
environment or context in which they operate. The task execution routines are
quickly replaced by the ability of the foreign affiliates or the foreign suppliers to
solve problems and develop more complex processes that require a high
percentage of knowledge and that often result in solutions with a high burden of
innovation. This is exactly the moment when the ideas of offshoring for lowering
costs transform into solution-creating.
Figure 11 - Offshoring opportunities across the organization/Increasingly complex
transactions

Source: MGI (2003) and C. Jahns et al (2006)

Figure 11 shows how the combination of knowledge and contact with the customer
helps to identify different offshoring opportunities throughout the organization.
These opportunities are the result of growth in the complexity of the activities of a
firm on the demand side, as well as the combination of employee skills and core
competencies of a firm in the supply side to generate new knowledge creation and
innovation to reduce the possible negative effects of that complexity.
Considering the relation knowledge-customer contact arise other activities that are
part of the offshoring value chain. These activities are characterized by two
45

elements: the industry is first subdivided into services that can be provided across
all industries (horizontal services) and those services that are industry specific
(verticals) (Gereffi and Stark, 2010).Horizontal services are those that due to their
nature support non-common business activities and could also support activities
with high levels ok knowledge and value embedded. To develop these types of
activities is necessary to have an average level of education, therefore the level of
human capital development and training levels play an important role.
In contrast, vertical services include a variety of activities that are offshored by
different industries but are not related to general business functions and require
specific industry knowledge. As with firms searching to lower costs in non-core
business activities, firms are seeking out low cost locations for low value services
and high talent locations for high value services (Gereffi and Stark, 2010)
Taking into consideration the horizontal and vertical integrations, the activities are
known as: Knowledge Process Outsourcing (KPO), Information Technology
Outsourcing (ITO) and Business Process Outsourcing (BPO).
4.2.4 Business Process Outsourcing and Offshoring - BPO&O

Business process outsourcing (BPO) involves the transfer of management and

execution of one or more complete business activities, business processes, or
entire business functions by a customer to an external outsourcing or offshoring
services provider. The BPO vendor is part of the decision-making structure
surrounding the outsourced process or functional area, and performance metrics
are primarily tied to customer service and strategic business value. Strategic
business value is recognized through such results as increased productivity, new
business opportunities, new revenue generation, cost reduction, business
transformation, and shareholder value improvement (IDC, 2010).
4.2.5 Information Technology Outsourcing - ITO

ITO is the internationalization of functions associated with information technology,

both in infrastructure and applications. The ITO segment is made up of four
categories. The first category is software R&D, the second is IT consulting, the
third is software and includes activities such as ERP (Enterprise Resource
46

Planning -software development for Enterprise Resource Management activities),

applications development, applications integration and desktop management,
while the infrastructure category is composed of applications management,
network management and infrastructure management (Gereffi and Stark, 2010)
4.2.6 Knowledge Process Outsourcing - KPO

KPO are activities with a great level of complexity that require high level of
education and judgment. KPO refers to horizontal activities such as: Business
consulting, business analytics, market intelligence and legal services.
e) What kinds of requirements are necessary to carry out certain business
activities?

To go into more detail on the evolution of business activities, it is worth reviewing a

proposed model also by Youngdahl and Ramaswamy (2008, 2010), where it is
possible to elucidate elements related to the capacity of countries to adopt certain
types of business activities according to their capabilities.
The most important idea is that the required level of knowledge increases over
time as the role of the offshore operation evolves (Youngdahl and Ramaswamy,
2010). The model consists of three phases, where according to the characteristics
of business activities, it is necessary to set different parameters to define an
economic location that meets the ideal requirements.
For the first stage/ scenario (figure12), dominated by back-office activities and
tasks with a high degree of routine, the most important thing is to have reliable
communication infrastructure, and stable. The emphasis of human capital should
be the domain of foreign languages to facilitate the exchange of information with
customers.

47

Figure 12: Process and contact centers

Source: Own work, based on Youngdahl and Ramaswamy, 2010

The second stage (figure 13), also known as solution centers proposed solutions
to customers arise from a mixture of learning from past experiences and
knowledge.
Figure 13

Source: Own work, based on Youngdahl and Ramaswamy, 2010

The relationships between customers and suppliers are much more dynamic
which leads to an almost-permanent contact between the parties. In previous
paragraphs the author had mentioned that the service contact was governed
mainly by the presence of a stable infrastructure and human talent capable of
developing high value added activities.
48

Cultural differences that could impact an offshore operations ability to reach this
level of sophistication include factors such as willingness to take risks, ability to
work with authority, and time orientation.
Finally, the third stage (figure 14) also known as global service centers is
characterized by the high degrees of innovation circulating throughout the system
that demands creative talent with a higher level of knowledge base.
Figure 14

Source: Source: Own work, based on Youngdahl and Ramaswamy, 2010

The key idea linked to this stage is that the mature set of capabilities is reflected in
the working environment of the companies.

5. Host country capabilities

So far we have seen that offshoring strategies play an important role in the
development of growth strategies of firms. But, what happens with countries?
Increasing complexity and the evolution of the nature of the activity that is
offshored represents a major challenge for developing countries and developing
country firms (DCF) competing to be the preferred destinations for business
development related to offshoring. Since the type of function that is being
offshored determines the location where this can be most effectively provided, the
impact of offshoring on developed countries and emerging markets alike depends
on its potential magnitude and the pace at which it develops (Farrell, 2006). And
49

this is very important since initially, host countries build their attractiveness for
offshoring (both captive centers and offshore outsourcing) around a relatively
narrow set of capabilities.
I take my own country, Colombia, as an example of the evolution of the set of
capabilities of a country. The motivation of the paper is also drawn from the
current dynamic forces in the Colombian outsourcing and offshoring industry. In
2007, the Ministry of Commerce, Industry and Tourism of Colombia officially
launched the Productive Transformation Program (PTM), which was seen as a
policy of long-term growth. Basically, the program aimed to modernize and/or
upgrade the country's production system to the conditions and requirements
necessary in order to consider it an active part of the global context all under a
sector (segment) approach. During that period of time one of the economic
segments that gained more attention was BPO&O Business Process Outsourcing
and Offshoring.
The segment has grown in many interesting ways to the point that, for example,
Colombia is now considered to be the 43rd main destination for services location
according to the 2011 A.T. Kearney Global Services Location Index. Growth in the
rankings suggested me that taking into account that host countries build their
attractiveness around a relatively narrow set of capabilities, the nature of the
activity and its level of complexity coerces the external environment to be more
dynamic and less static, in order to be able to offer companies the skill sets
required to develop a higher number of functions, ranging from largely limited
activities to high value-added functions.
Thus is observed an interaction of home country firms propensity to offshore
projects and host nations propensity to attract offshore work (Kumar et al, 2008).
The same authors stated that the competition between countries to attract offshore
work and the industrial location decisions that follow has direct impacts on
economic and social welfare, besides nations international rankings on various
dimensions such as market size, level of infrastructure development, human
capital, etc.
50

5.1 Definition
f) What is a set of capabilities of a host country?
Murtha and Lenway (1995:115) define capabilities as functions of national
institutional arrangements that vary relatively widely across countries, but relatively
little over time. These institutional arrangements concern property rights
allocations between countries public and private sectors, and interorganizational
transactions allocations between authoritative planning and market institutions of
governance. Kogut (1991) suggest that high-value added activities are not
adopted across borders mainly is because countries differ in their prevailing
technological and organizational capabilities and that organizational capabilities
diffuse more slowly than technologies.
Location-specific advantages are based on resources, networks, institutional
structures or other advantages that are specific to a geographic entity and are
immovable (Graf and Mudambi, 2005)

5.2 Types of capabilities

5.3 Benefits
5.4 Transition

51

6. Conclusion and challenges

I was principally interested in the reaction capacity of host countries to the
dynamics of the nature of the activities that are repeatedly the subject of location
change. But I found that the lack of research on the interdependencies of the
nature of the activity and its effect on country capabilities was completely
unexpected. What I learned is that host countries build their attractiveness around
a relatively narrow set of capabilities, the nature of the activity and its level of
complexity coerces the external environment to be more dynamic and less static.

52

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