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Organizations looking to affordably scale-up their operations have historically relied on offshoring, which refers to the practice of moving certain business processes overseas.
Offshoring has long been the best way for manufacturers to drive down their production costs, so long as the initial outlay of relocating can be covered.
Today, this decision is not so clear-cut. Offshoring isn’t as attractive as it once was thanks to rising foreign labor costs, material price increases, shipping fees, political instability, tariffs, trade wars, disruptive natural disasters, and global pandemics.
Today, organizations must choose between three options:
- Offshoring
- Onshoring (keeping production in their home country)
- Outsourcing
As we examine the differences between offshoring and outsourcing, let’s weigh the pros and cons of each.
What Is the Difference Between Offshoring and Outsourcing?
- Offshoring means an organization sets up its production operations overseas.
- Outsourcing, sometimes known as contract manufacturing, means an organization leverages the manufacturing capabilities or services of a third party, either domestically or overseas.
Organizations won’t necessarily offshore or outsource the entirety of their production operation. These approaches could be used for certain elements of the supply chain.
A manufacturing company, for example, may offshore the production of some components while keeping assembly, packaging, and shipping as domestic operations.
Pros and Cons of Offshoring and Outsourcing
Advantages of Offshoring:
- Reduced labor costs
- Reduced material costs
- More productivity
- Possible tax breaks
- Shorter supply chains if the materials used are native to the offshoring country
Disadvantages of Offshoring:
- Labor costs rising in most countries
- Material prices may fluctuate
- Domestic criticism for sending jobs overseas
- Geopolitical risk — fees, trade wars, pandemics, natural disasters
- Long-distance relationships can present communication challenges
Advantages of Outsourcing:
- Flexibility
- Reduced training costs
- Large talent pool
- Allows the business to focus on their core competencies by hiring out specialist skilled work
Disadvantages of Outsourcing:
- Increased reliance on third-party labor
- Lack of in-house training
- Possible communication issues
- Less quality control or possible data security concerns
The key differentiator is that offshoring is typically done to cut costs, whereas the main benefit of outsourcing is to gain access to skilled workers without the need for in-house training.
How to Choose Between Offshoring and Outsourcing
The main considerations when choosing whether to offshore, outsource, or indeed “offshore-outsource” (contract work out to an overseas third-party), are as follows:
What Is the Nature of the Work?
Offshoring might be the best option if the manufacturing of a product doesn’t require specialized materials, highly skilled labor, and if the finished product is cheap to ship. In this scenario, an organization might be able to take advantage of cheap labor, reduced operational costs, and lower taxes.
On the other hand, when the production process requires specialist knowledge and training, outsourcing is likely to be more cost-effective.
Organizations must carefully weigh the pros and cons and think about long-term gains. For example, are the tax breaks sufficient enough to merit moving production offshore if a local third-party could produce a higher quality product?
Risk vs. Reward
In today’s world, offshoring is regarded as a risky business. Increasingly, countries are taking a more conservative political stance, which means the threat of debilitating tariffs and trade restrictions are very real and could have long-term impacts on an organization’s supply chain. Yes, companies may save money in the short-term by setting up their operations overseas, but they may be forced to shut these down and reshore at great expense if the political situation dictates. The coronavirus pandemic has shown the world how quickly global, just-in-time (JIC) supply chains can collapse and the importance of having contingency strategies in place.
Despite lower financial rewards, outsourcing domestically presents far less risk.
Security
Data security and intellectual property rights are major concerns not least because the frequency and severity of supply chain attacks have increased in recent years. This is a particular concern when operations are outsourced because it’s tricky for organizations to keep track of who has access to sensitive data and monitor the security systems their vendors have in place. Outsourcing overseas presents additional challenges because not all countries apply the same, strict data compliance rules as in the U.S., which means communication networks may be at a higher risk of hacking.
Public Opinion
Public opinion is usually more important to larger brands that sell consumer items. Customers are increasingly apt to boycott or protest against organizations that are seen to be taking advantage of cheap labor in developing countries, don’t prioritize sustainability initiatives, or are perceived as neglecting the domestic job market.
In the wake of the coronavirus pandemic, organizations are evaluating the stability of their complex, global supply chains. As risk mitigation becomes a top priority, it’s possible that the U.S. will see a rise in reshoring and domestic outsourcing.
Image Credit: weerasak saeku / Shutterstock
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