Why Problems with Offshore Manufacturing Don’t Exist in the Services Sector

September 29, 2018 | Arnab
Why Problems with Offshore Manufacturing Don’t Exist in the Services Sector

Reshoring and how China became a victim of its own success

In recent years, we have seen the phenomenon of “reshoring” gain traction. Companies like GE and Otis moved their manufacturing operations back to the US, with varying degrees of success in recent years. The Obama administration, in response to recession, had launched the Select USA campaign. There was a concerted push from the government to US companies to adopt a more “Make in USA” attitude rather than “Make in China, Vietnam or Taiwan”. And, to an extent, it has worked too, since problems with the offshore manufacturing concept had started making themselves felt. Ultimately, no process is perfect and the smartest ideas come with their own inherent set of flaws. What makes them tenable is that one benefit which outweighs all else. For offshoring, that benefit has always been money.

In the world of offshoring, there has always been two distinct poles. China and India. While China became the factory of the world, India became the universal support system, cornering over half of the services outsourced offshore. The trajectory of these two offshore hubs followed a similar yet different pattern. Thanks to manufacturing jobs flooding into the Chinese economy since the 80s, China boomed, and how! For most of the first decade of the 21st century, China stunned the world with double digit growth, especially when the developed economies were reeling from successive recessions. Almost overnight, China metamorphosed into an economic super power, creating a huge and sudden new middle class, more high speed railways than the rest of the world combined and developing urban centers which dwarfed pretty much all else. In the last 20 years, China has built three of the ten longest subway systems in the world, including the two longest. For a country which till the 80s was pretty much shut off from the rest of the world, the stats are truly mind numbing. However, this bubble was bound to burst. And so it did. China, in a way became a victim of its own success. A growing middle class, which in terms of population has left the whole of the European Union behind, has seen a steady rise in wages, eroding China’s biggest advantage – cost. So much so, that Chinese manufacturers are now banking heavily on Africa to source cheap labor. Oh, the irony!

A similar yet different story

India, on the other hand, while also experiencing growth second only to China, did so in a very different way. By the turn of the century, it had established itself firmly as the largest offshore services hub.

The phenomenon of reshoring has also been seen in services, especially in contact or call center operations. For instance, British Telecom has shifted a majority of its calling operations back to the UK. However, the trend of offshoring services, especially in IT has only increased and continues to do so, with introduction of new domains and with small and medium businesses profiting from offshore outsourcing too, along with large corporations. Let’s see why the trajectory is so different in manufacturing and services offshoring.

1. Quality of the product

This became a major issue in the US as consumers saw a definite dip in the quality of products that were being manufactured at offshore locations. With corporations making significant savings by offshoring, a dip in quality was quite an unpardonable act and many brands were flushed with complaints. While the initial experience was great, offshore manufacturing inevitably spawned some questionable practices especially that of sub-contracting work. While contracts for manufacturing were being bid for and picked up by established entities, some would simply sub-contract the entire work to a lesser entity, keeping a decent sized cut for themselves. With money further reduced, quality was bound to be affected. This phenomenon existed in the earlier stages of offshore services outsourcing too, especially when it came to call centers and back office operations like data entry, etc. However, with the advent and steady improvement in cloud computing and communication, this has largely ceased to be an issue.

Due to issues related to intellectual property and data protection, clients prefer to keep a tab on the proceedings while outsourcing services, especially in development. There are also airtight legal agreements in tune with latest data protection regimes like General Data Protection Regulation (GDPR) between the client and the vendors offshore which prevent sub-contracting. With the advent of dedicated models, where the client is able to talk directly to the developer or executive on the ground, transparency and direct client supervision has reached optimum levels. Hence, it is also much easier to control the quality of work and, hence, the end product.

2. Excess inventory

In offshore manufacturing, one major issue has always been that of stock inventory. Since goods were being manufactured offshore, they needed more time to reach the intended domestic markets. Hence, companies would always keep large inventories of the product on-shore. This, of course, added to storage costs, but such was the economic benefit accrued from offshore manufacturing that companies hardly cared for these much smaller expenses. What hit them hard though was if, due to market fluctuations or launch of a better product by their competitors, the demand for the product fell. In such a scenario, companies were left with large stockpiles of goods which they either had to sell off at heavy discounts or when even that failed, re-ship them back to their country of manufacture, disassemble and reuse the parts in newer models. Some goods have also been sold off as scrap. All this caused heavy losses to consumer brands in the US, forcing some of them to think about reshoring. In fact, the problem of excess inventory became significant enough for the proponents of reshoring to use it heavily to argue in favor of reshoring. Reshoring Initiative, the organization which is one of the most active lobbyists for reshoring lists “Lower Inventory Levels” as a value proposition for companies to reshore their manufacturing operations.
In the case of services outsourcing, the question of inventory does not even arise. The entire exercise is purely need-based and basically pay-as-you-go.

3. Skills and manpower

Developed economies like the US, UK and EU face a major skill shortage when it comes to white collar jobs. The supply simply isn’t able to keep pace with the demand. Since domains like software development, server support, legal, etc. require very specific skillsets, the percentage of the workforce qualified to do the job will always be a small one. Such severe shortage has obviously pushed up wages significantly, with large corporations competing against themselves to land the right talent. This has also meant that talent is also mostly concentrated in large metropolises or urban clusters like the Silicon Valley.
For the small or medium enterprise, especially those situated in the hinterlands, this has been, what can only be called, disenfranchising. They find themselves either having to settle with a second, and often third rate, work force or having to outsource the work to a vendor inshore and typically located in or near these centers which attract the maximum talent. And outsourcing to such agencies can be a very costly affair. Outsourcing to vendors in India where skilled resources are plentiful resolves this issue and saves a lot of money in the bargain.

Of course, a solution to this shortage is to invite a highly skilled workforce from abroad, which already happens. Unsurprisingly, India exports the overwhelming majority of skilled workforce to the US, almost half the H1B Visas annually. However, even then, the shortage in resources remains. While allowing more people to come and work in the US, UK and EU is an option, immigration as an issue is controversial and subject to national and global politics.

However, the issue of available manpower is not really a problem area as far as manufacturing is concerned. US, UK and EU has enough workforce to man a majority of the manufacturing jobs, were they to be reshored. Of course, costs incurred due to increased wages will come into play. But if we speak just in terms of available human resource, there is enough, especially since manufacturing jobs can be categorized as mostly unskilled or semi-skilled.

4. Perception

While offshoring of any sort is culturally frowned upon by a majority of the polity, the fact remains, and as was highlighted by the previous point I talked about, that job flight has been felt more acutely in the manufacturing sector. If one were to point out one symbol of job flight, they would inevitably point towards Detroit and America’s rust belt around the Great Lakes. Nobody would point to California or Houston for that matter. And yet, if offshoring of services were to cause any great harm, it would have to these places. And the policy makers know that. Hence, the focus has firmly been on “Make in America”, which points to a willingness to bring back manufacturing jobs. It’s hard to conceive of a similar stance against outsourcing IT and related services to India or other offshore locations, except maybe call center jobs, which have a much higher social visibility and hence becomes a bigger political issue.

5. Knowledge transfer

Knowledge transfer has always been a sensitive issue. Economies are loathe to give up their control over technology that easily, or sans the right price. But if one needs to manufacture offshore, knowledge transfer is a must for your own sake. While access to resources and manpower are essential for embarking on a manufacturing venture as a vendor, knowledge of the product or in-depth technology isn’t. That is expectantly provided by the parent company. This opens the door for technology duplication and potential competition in the future. This has been perfectly demonstrated by the rise of Chinese brands which basically started as manufacturer of knockoffs of American, European and Japanese goods.
With services though, the requirement is exactly the opposite. In-depth knowledge of the domain and process is a must. While transfer of knowledge and technology does happen, it does so on a much smaller scale, and often, and unlike manufacturing, it’s a two-way traffic. Also, despite so much data being shared across the world and ideas being laid bare, safeguards ensure that the intellectual property remains with the firm commissioning a project. So, regardless of an app having been built in India, the app will always belong to the parent company in the US, UK, EU, etc. and won’t be stamped with the legend MADE IN INDIA, unlike in offshore manufacturing. And we know how the game of perceptions play out!

The near and distant future

How things play out is a wait and watch game. Personally, I would say that policy makers will find it difficult to interfere too much with offshoring of services, especially since it has started to benefit small businesses in a major way. The amount of interest in Indian firms providing remote assistance is to be seen to be believed. Automation and AI has already cut into call center jobs- the most visible and perhaps controversial element of business process outsourcing. In the next decade, call center jobs are going to go down rapidly and many companies who currently have centers in Philippines and India might find it feasible to maintain small contact centers locally and package it as premium customer service for their customers. Where IT and other IT enabled services are concerned, a collaboration of the best talents globally is the only way to go, and offshoring does achieve that to a great extent. With remote assistance and related trends making the concept of an office more abstract, we will have progressively more companies which will truly be multinational, not necessarily only in terms of business, but also in terms of day-to-day operations.

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