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Article Excerpt
I. INTRODUCTION
II. ECONOMICS OF OFFSHORING A. Why Are Companies Offshoring? B. Will Offshoring Improve or Hinder the Economy of a Developed Nation? C. Will Offshoring Further Exploit Developing Nations? III. LEGISLATING TO MAXIMIZE THE WIN-WIN A. Will Protectionistic Legislation Really Help Anyone? B. Can Regulation Minimize the Harms Feared in Offshoring? C. What Enabling Legislation Could Help to Maximize the Value for All ? D. Legislation Recommendations IV. BUILDING A BODY OF SUCCESSFUL OFFSHORING DEALS. A. Why Are Offshoring Deals Complex and Likely to Fail? B. How Can Contracts Have a Viable Tension Between Protection and Flexibility ? C. Contract Drafting Recommendations V. CONCLUSION A. Who Will Win a Disproportionate Share of the Value from Offshoring? B. Final Recommendations
I. INTRODUCTION
A passionate debate is raging world-wide on what the impact will be from offshoring (1) white-collar jobs (2) on both developing and developed nations. (3) Anti-offshoring proponents fear that developed nations will be weakened by the loss of irreplaceable jobs and developing nations will be further exploited. (4) Offshoring proponents argue that a well-functioning, global free market will enhance company productivity and profits. (5) This will propel developing markets to open further and enable developed nations to use repatriated profits to expand their economies. (6) Although neither side has emerged victorious in the debate, the history of the industrial revolution suggests that market forces will cause offshoring to occur. (7) Indeed, the technological advances in communication, the greater process commoditization, and the success of developing nations in improving the education level of their citizens suggest the time is ripe for offshoring white-collar jobs. (8) Major corporations see this opportunity "as both a 'blessing and a curse,' with the lure of cost savings tempered by the fear of deskilling." (9) Yet by 2008, the demand for white-collar service jobs, once considered to be immune to offshoring, to be provided by low-cost developing nations is estimated to reach 160 million jobs (approximately 11% of the projected 1.46 billion service jobs worldwide). (10) Given that offshoring is occurring and will continue to occur, three key questions arise. Will the tactics of the debaters ultimately influence the amount of economic value that will be created? When will the value be created? And which countries will win a disproportionate share of the value? (11)
Nations that structure a win-win dynamic around offshoring, both internally and with other nations, will maximize the economic value they are able to capture. Two core elements of a win-win dynamic are: 1) a positive regulatory environment and 2) a growing body of successful offshoring deals. (12) Currently, these two core elements are at risk in many nations from both protectionist legislation that seeks to prohibit, or at least inhibit, offshoring, (13) and also from immature contracting capabilities, which fail to effectively structure and govern the deals. (14)
To address these risks and strengthen their win-win dynamic, countries should enact legislation that promotes open trade, spurs employment, and ensures that the quality of the services remains stable. (15) Additionally, companies should seek contracts to support their deals which are flexible enough to accommodate continuous improvement and evolution of the service, yet specific enough to enable appropriate governance and dispute resolution from a distance. (16) These recommendations will lead to maximizing the potential win-win economic value of offshoring. (17) The faster countries succeed in achieving these two core elements of a win-win dynamic, the greater their share of the value will be.
This Comment will explore how countries can maximize their economic gains from offshoring by understanding their economic weaknesses, legislating strategically, and ensuring contracts are successful. Part II addresses the economics of offshoring and the implications for countries that purchase and supply offshore services. Part III will examine the existing and emerging national legislation and international treaties that will impact offshoring and make recommendations for improvement. Part IV will analyze why current intracountry outsourcing deals, a typical precursor to offshoring, have had execution difficulties and address how these lessons learned can be applied to enhancing offshoring contracts. Finally, Part V will summarize the findings and draw concluding recommendations.
II. ECONOMICS OF OFFSHORING
Business strategy has been moving towards offshoring white-collar jobs such as information technology, finance, and customer service call centers for the last fifteen years. (18) The management fad of business process reengineering, (19) in the early 1990's, started companies down the path of consolidating these functions across multiple business units to gain economies of scale. (20) To be successful, processes were streamlined, standardized, and automated using customized or packaged software and work-flow tools like SAP and PeopleSoft. (21) Additionally, these processes were transformed into services, complete with charge-back pricing and leadership that was independent of the business unit to ensure maximum standardization and accountability. (22) Grouped together, these services often became known as shared service centers. (23)
Once well encapsulated, independent, and commoditized, the transition of these services to outsourcing was an easy management step to further lower costs. (24) Company leaders also saw it as a way to free-up leadership time and energy that could then be focused on the core functions that supplied their competitive advantage while at the same time locking in year-on-year cost reductions promised by the outsourcers. (25)
Outsourcers achieved the cost savings by further consolidating these services across companies to gain even more economies of scale, by implementing technological innovations faster than the companies could have, and by locating them in low labor cost areas. (26)
The relative success of outsourcing has led many companies to become even more aggressive by "develop[ing] ... new and more expansive models of outsourcing such as vertical outsourcing, Business Process and Business Transformation Outsourcing and the use of offshore companies to provide services at lower labor costs." (27) The most lucrative trend in outsourcing is international outsourcing, defined as offshoring of services to developing nations as part of an international labor arbitrage strategy. (28) This occurs when services that are provided by a company or its outsourcer are transferred to developing countries in order to capture significantly lower labor costs for skilled work. (29) To understand the magnitude of this labor arbitrage opportunity, consider the example that "U.S. architects are paid about ten times what architects in Vietnam are paid." (30)
The acceptance of outsourcing and the movement towards offshoring has been staggering, leading one British corporate director to comment in an interview that "[offshoring is] an accelerating trend too--it used to be offshoring to manufacturing, but now it's services, higher skills--it's no longer just the trailblazers but also conservative companies." (31) Gartner Group expects "that up to 80 percent of leading enterprises will include outsourcing in their business strategies by 2005." (32) The United States accounted for $101 billion in outsourcing revenue in 2000 and was predicted to grow to $160 billion in annual revenue by 2005. (33) "A 2004 United Nations survey of Europe's top 500 companies reported that, while nearly one-half of respondents plan to offshore more work in the next few years, fifty percent of European Union ('EU') jobs offshored thus far have gone to firms in other EU countries." (34) Likewise, early adopters of offshoring are taking massive steps to capture the value. For instance, one survey found that "the world's 100 largest financial services firms expect to 'transfer $350 billion of their cost bases abroad' by 2008." (35) Looking across all sectors of the economy, McKinsey Global Institute, in the most comprehensive and in-depth study undertaken to date, found that by 2008, the demand for white-collar service jobs to be provided by low-cost developing nations is estimated to reach 160 million jobs (approximately 11% of the projected 1.46 billion service jobs worldwide). (36) In sum, offshoring will have a dramatic influence on the economic landscape of many countries and companies for years to come.
A. Why are Companies Offshoring?
Multinational companies will be forced into offshoring over time to remain economically competitive. (37) For example, "[o]ne UK bank located more than five thousand jobs offshore between 2001 and 2003--and has generated annual savings in excess of 250 million euros. This reduced its cost-to-income ratio by almost six points." (38) This degree of return can shift the company from being a laggard to being best in class for the industry. (39) Additionally, companies successful at offshoring will be able to reduce prices--further putting pressure on others to follow suit or differentiate themselves from their immediate competition. (40)
Offshoring generates economic value through three main sources: lower labor costs, improved productivity, and expanded scope of services. (41) The value that offshoring can potentially generate is tempered by backlash from customers, unions, and national governments, as well as by companies' ability to successfully execute this business restructuring-type strategy. (42) Companies must address both issues.
B. Will Offshoring Improve or Hinder the Economy of a Developed Nation?
For the developed countries who host the companies now purchasing offshore services, the passionate debate on what is in the nation's best interest with regard to offshoring still rages with good reason. (43) Studies by the McKinsey Global Institute find that given the current labor re-employment rates and the regulatory environment of a particular country, the economic value to a developed nation can vary from enhancing the nation's economy to weakening it. (44) According to the survey, the United States stands in the best position to win economically by capturing a disproportionate share of the value generated by offshoring. (45) McKinsey Global Institute's research results in 2005 found that "for every dollar of corporate spending on services that American firms move to India, the U.S. economy as a whole gains $1.14 to $1.17 in return." (46) The gains are directly derived from three sources: cost savings within U.S. companies, increased consumption by India of U.S. goods and services, and repatriation of profits from U.S. investments in India. (47) Beyond this, re-employment of displaced U.S. workers is estimated to generate an additional benefit of 57 cents. (48)
Three main drivers impact whether a nation's economy will grow or shrink as a result of offshoring: language constraints, ability to export and repatriate profits from offshore supplier countries, and re-employment rates. (49) First, language constraints determine the places where developed countries may offshore. (50) Given major differences in the flexibility of the labor market and availability of new jobs within the developed country, the offshoring infrastructure within the developed country, and the cost of labor in the developing country, the impact on the overall savings and the success of the transition can be significant. (51) Unlike the United States, whose economy improves with offshoring, (52) other nations are currently not so lucky. (53) For example, France and Germany both lose potential economic value from offshoring. (54) France earns back only 0.86 [euro] for every 1.00 [euro] spent on offshoring and Germany only recoups 0.74 [euro] for every 1.00 [euro] it applies. (55) France and Germany are at a significant competitive disadvantage because there are fewer French and German speaking workers than English speaking workers in developing countries. (56) As a result, rather than offshoring to India or China, who have the largest pool of skilled workers and an established infrastructure for offshoring, (57) France and Germany often have to resort to less prepared and more expensive Eastern European and North African countries. (58) "While offshoring to India and China brings cost savings of 85 percent to 90 percent, offshoring to North Africa cuts costs by about 70 percent, and to Eastern Europe by just 55 percent to 75 percent." (59) Because several Eastern European countries have joined the European Union, fewer risks and constraints to offshoring now exist. (60) However, the cost of labor in Eastern Europe is still higher than other areas, and the infrastructure is not as mature as what the United States and the United Kingdom are achieving in India and parts of Asia. (61) This is causing German and French companies to save less and experience more implementation problems than other nations. (62)
Second, nations with language constraints are unable to use major export markets, like India and China, as their outsourcing partners; and as a result, are unable to extract a quid pro quo for placing their offshoring deals in these markets. (63) This impacts both the expansion of that nation's exports and its ability to repatriate the additional earnings. (64) Since American firms now dominate high tech exports that are required to build the necessary infrastructure for offshoring, countries like Germany and...
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