Going offshore; a favoured route to internationalisation
By Catherine Walker
For the past seven years, Professor Henk Volberda has been at the forefront of a long-term international study tracking the remarkable rise in the global sourcing of business services.
In 2004 Volberda joined Professor Arie Lewin of Duke University in a major research initiative which now involves researchers from 18 countries, including Japan, Korea, Australia and the US. Via an annual survey of more than 10,000 multinational firms, the Offshoring Research Network (ORN) is monitoring what types of processes and functions corporations are either moving offshore or plan to move, examining the drivers for such strategic decisions and how the strategies are being implemented.
For Volberda and his colleagues, the extensive ORN database now offers unprecedented opportunities to study the growth of offshoring. Some of his latest research findings were published last month in a special issue on global sourcing in the International Business Review which he has also co-edited with his research collaborator and co-author, Arie Lewin.
In this interview he reflects on how the offshoring of business services is developing, what trends are emerging in how companies choose to offshore, and the implications this may have for the Netherlands and other developed countries.
What’s behind this growth in the offshoring of business services?
|It’s important to recognise that the development of offshoring depends not only on the actions of firms in the developed economies, it’s also shaped by ongoing development in the emerging economies like China, India and Brazil, and in the supplier firms. In that sense we can see it as being a ‘co-evolutionary’ process. Research has typically focused on the demand-side – and we argue that to understand this phenomenon we need to consider also how developments in supply (in the capabilities and service capacity of providers) influence the extent to which companies perceive a particular task as viable for offshoring. When you look at the type of activities now being offshored, you cannot explain the expansion using traditional theories. Those would suggest that only activities that can be standardised can be offshored, whereas it now seems that even if you can’t standardise, activities can still be offshored. Increasingly knowledge-intensive activities like R&D or product development are being outsourced – for example, Philips has relocated the R&D for its lighting division to China. Ten years ago I’d have said that was not a wise decision but now firms everywhere are locating not only peripheral activities offshore but also some of their core ones.|
What makes so many companies decide to offshore? And is it proving successful for them?
At the start the motives were mainly ones of cost reduction. But as firms develop further, we see a significant shift in strategic motivation from cost focus to resource focus – access to personnel and knowledge workers and closeness to markets.
There’s also an element of ‘herd behaviour’. Companies in the developed economies want to offshore more and more activities not only because they think it to be a wise strategy but because they are copying the strategies of their competitors. And here in the Netherlands, many companies are also responding to pressures from shareholders for greater cost-efficiency. There starts to be a risk that companies who don’t go down the offshoring route will be perceived negatively – so they may change their strategy accordingly.
Yet we know from our research that only a few are actually successful in offshoring high-added-value activities because they have problems integrating these activities with their home-country activities. Our studies showed that 85% of firms were not successful in offshoring – they predicted 35% cost reductions but failed to achieve them because they incurred all kinds of new and unexpected costs such as coordination problems, additional logistics costs, cultural difficulties between the countries, language problems, etc.
The 15% of firms that were successful typically already had experience of either relocating or managing joint ventures and were able to absorb the knowledge from the emerging economy and internalise it within their home operations. When that happens, that can improve the firm’s capacity to innovate. That’s another area we have been looking at in detail.
What changes can be seen in how companies are offshoring?
One of the big issues for companies is which mode of governance to go for: should you cooperate with a service provider or start up an operation which is mainly company-owned – what we call a ‘captive’ centre.
The main preference is for captive offshoring but as the volume of offshoring has increased, we’ve seen also that over time firms tend to move towards outsourced offshoring. In the first instance they want to keep control in the home country – primarily to overcome internal resistance to offshoring, particularly with regard to loss of process knowledge or intellectual capital. But as time goes on, they find that that risk lessens, that perhaps managing various tasks and processes offshore is not the organisation’s core competence, and that they get a greater variety of input from these emerging economies if they cooperate with external service providers. They realise that these people have a lot of local knowledge and that the company will benefit by giving more room to the service provider.
What implications do you think the rise in offshoring has for nurturing talent in the developed countries?
That’s an important debate we have been having with the Ministry of Economic Affairs here in the Netherlands. As a well developed country we want to specialise as a knowledge-based economy, yet more and more of our knowledge-intensive activities are being relocated to emerging economies – especially R&D, engineering and product design. And company investment in R&D in the Netherlands is shrinking. The nightmare scenario would be that we are left with companies that retain only their marketing and sales operations in the home country, or their fiscal seat, but relocate all the essential functions to service providers in the emerging economies. Those would be truly ‘hollow corporations’.
If this move towards a global economy continues, then the only real way for developed economies to compete is to try and attract companies from emerging economies to the developed economies. That’s why we in the Ministry’s ‘top team’ are advising the government on how to attract inward investment from Asian companies – looking particularly at how to persuade them to site their European headquarters here.
‘Co-evolutionary Research on Global Sourcing: Implications for Globalization, International Strategies, and Organizational Designs’, edited by Arie Y Lewin and Henk W Volberda, was published in June 2011 as a special issue of the International Business Review.
Henk Volberda is Professor of Strategic Management and Business Policy at the Rotterdam School of Management, a Fellow of ERIM, and Scientific Director of the top institute INSCOPE: Research for Innovation.