Offshoring – definition and meaning
The term Offshoring refers to relocating some of a company’s operations or activities abroad. The business may move production, accounting, or website maintenance and development abroad. Many large corporations move their call centers or customer service departments to another country.
Why do firms consider offshoring?
One primary reason businesses consider offshoring is lower labor costs overseas. Additionally, raw materials may be cheaper in certain countries than at home.
Another motivator is lower tax rates. If an *employer’s contribution in one country is 25%, and only 5% in another, offshoring can mean significantly cheaper payroll costs.
*Employer’s Contributions refer to the mandatory payments made by an employer on behalf of their employees. These can include contributions to social security, health care, pensions, and other employment-related benefits and taxes.
- Not only businesses
While the practice primarily pertains to business enterprises, charities, non-profit organizations, educational institutions, and research entities also engage in offshoring.
Offshoring – two practices
The term refers to two practices:
– First, shifting a company’s business process or services abroad. However, the workers in that foreign country are employees of that company.
– Farming out business activities to companies and organizations abroad. In other words, the workers in those activities do not work for the company. They work for another employer, and that employer is abroad. We call this offshore outsourcing.
The term ‘global sourcing‘ means seeking goods and services beyond one’s border. It sometimes also has the same meaning as offshoring.
We also call it physical restructuring or offshore production. It is the practice of moving the manufacturing or assembly of goods abroad.
The company then imports the finished products to its home country. In other words, it moves production abroad but sells those goods to its consumers at home.
For example, Ford has many car factories in Mexico. It sells the bulk of its Mexican cars in the United States. Therefore, Ford participates in production offshoring.
If a factory, however, opens abroad to sell goods in that local market, it is not offshore production.
For example, German carmaker BMW has production facilities in the United States. It did not open its US factory to export cars to Germany. It did so to produce cars for American consumers.
Therefore, BMW did not take part in offshoring when it opened factories in the US.
Since the emergence of reliable and affordable communication infrastructure globally, many services have moved offshore.
For example, many call centers, as well as marketing, sales, legal, HR, and accounting services have moved abroad. Specifically, they have shifted from high-wage to low-wage countries.
The US, UK, and other advanced economies have moved many of their services to countries with cheaper labor costs.
Many companies have also moved IT infrastructure, application development, product design, and R&D abroad.
India, which has a large pool of English-speaking workers, has benefited enormously from services offshoring. India also has many workers who are technically proficient.
A growing number of workers in the advanced economies complain that cheap labor abroad suppresses their wages.
Trade unions say that offshoring kills jobs and erodes wages at home. They also complain that most new jobs today are inferior to the jobs they lost. Specifically, the new jobs offer low pay and are not permanent positions.
“High levels of unemployment in Western countries after the 2007-2008 financial crisis have made the public in many countries so hostile towards offshoring that many companies are now reluctant to engage in it.”
What does ‘offshore’ mean?
The term ‘offshore,’ in business and finance, means ‘abroad’ or ‘overseas.’ However, it does not necessarily mean we have to cross the ‘sea’ or leave our ‘shores’ to get to that other country.
For example, to get from the US to Mexico, I do not need to cross the sea. However, in business terminology, Mexico is an ‘overseas’ or ‘offshore’ market for American companies.
Any US company that relocates production to Mexico is practicing production offshoring. That is if the foreign factory sells its goods to US consumers.
Many business terms have the word ‘offshore‘:
- An offshore fund is a fund that exists in another country. Most of these funds operate in tax havens.
- Offshore companies are those that operate in one country but are registered abroad.
- Offshore manufacturing means the same as offshore production. In other words, a company relocates its factory abroad, which continues selling to consumers at home.
Video – What is offshoring?