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What Are Outsourcing and Offshoring? Difference and Comparison

July 14, 2021

People commonly confuse between outsourcing and offshoring models as they suppose those terms refer to the same business idea. In reality, there are some apparent differences between them though. Distinguish between outsourcing and offshoring helps business conclude the best suited strategy for certain projects and tasks, especially in the software development sector.

What is Outsourcing?

Briefly speaking, a company will negotiate an outsourcing contract when it authorises an outside vendor to be accountable for certain business functions, such as performing quality assurance (QA) testing, organising a sales campaign, or designing a new corporate identity. In turn, the outsource company pledges to complete assigned missions by the deadline and within budgets. 

The image depicts relevant factors which might affect outsourcing and offshoring process.

Compared to offshoring strategies, the business owner and the outsourcing team have a loose relationship and limited communication. So, mistakes that occur during the outsourcing period are unavoidable. However, the coming of various communication or project management solutions support advanced interactions among participants with fewer oversights, regardless of different cultures and backgrounds.

1. Outsourcing benefits

There are multiple outsourcing business ideas coming up every year. Each of them assists the business owner and senior management to tackle particular obstacles faced by the company. Despite distinctive goals and orientations, those outsourcing solutions will bring the organization several standout advantages as follows:

  • Improved Efficiency: Entrusting a portion of work to outside specialists help business reduce the time needed to train employees and make them attuned to new technology or administration process. Accordingly, this results in more effective work productivity and product quality. 
  • Access to Talent Pool, Innovation and Outstanding Leadership: A third-party service provider will aid your company in allocating cutting-edge technologies, intellectual property, and creative solutions. Thanks to talented and well-functioning teams, your company then can focus on managing essential tasks and completing deliverables. Therefore, attracting more leads to improve business results. 
  • Focus on Core Business Operations: Rather than allocating time and resources to what company has no experience with, business should have a specialized agency execute those jobs, while concentrating on core business functions instead.
  • Fulfillment of Business Demands: Outsourcing activities help with handling capacity problems, augmenting flexibility and scalability. Therefore, business will able to catch up with ever-changing business and market conditions. 

2. Outsourcing IT functions

Both outsourcing and offshoring strategies have a prevailing application in the Information technology and security domain. When it comes to outsourcing alone, traditional IT segments that are regularly outsourced involve infrastructure and applications. 

The former relates to data center supervision, network services, monitored security operations, infrastructure administration, service desk processes and so forth. Numerous companies also outsource software development on condition they plan to build a new application and packaged software, do testing or QA work, improve and maintain legacy systems. Whereas, their in-house IT staff are less capable of implementing those tasks perfectly. 

Demonstrate the act of outsourcing IT function, especially the introduction of cloud-based services.

Nonetheless, digital transformation motivates the introduction of cloud-based services, commonly known as “as-a-service” models. According to the Atlantis Press, two sectors Software-as-a-Service (SaaS) and Infrastructure-as-a-Service (IaaS) account for over 40% of the world’s outsourcing IT market.

This result is deferred after a continuous rise driven by higher demand for online video conferencing and telecommuting solutions. In the future, we predict SaaS and relevant services will become an emerged trend, as well as a favored outsourcing business model from 2021 onwards. 

3. IT outsourcing models and pricing

The appropriate outsourcing model varies as per what kinds of IT functions an outsource company provides. Therefore, the complexity of the project and requirements are the major determinants of how an IT service will be billed. Here are some popular ways to gauge an outsourcing contract’s value:

Time and materials

The most traditional method to estimate the outsourcing cost is taking account of time and materials involved in the business. So far, this pricing plan has been widely applied for long-term software production, service maintenance, project’s specifications, or objectives identification. 

Fixed pricing

When requirements, goals, and scope are clearly set, the business owner may outsource software development at a fixed rate. This outsourcing expense is prescribed in a contract at the beginning of the project. Having a fixed pricing model is beneficial for the company. However, this may put more strain on the outsourcing vendors, in case a number of actual resources used for works outweigh the estimated quantity.

Cost-plus

As the name states, what the outsourcing supplier receives is actual payment coupled with a pre-negotiated portion for a profit. This pricing model does tally with companies that undergo trivial changes in technologies or business objectives. Also, cost-plus is seen to less stimulate the effective performance of the provider than other pricing methods.

Gain-sharing

The gain-sharing scheme is based on how much value the outsourcing vendor strives to produce beyond their accountability. Typically, the agency may get remittances according to an amount of functionality or a number of technological solutions created. This IT pricing model is nothing short of a gamble where one party is putting money at risk while the other attempts to optimize products or services to meet the buyer’s requirements. This will reap a certain percentage of profit from such endeavors. 

Shared risk/reward

Both buyer and vendor jointly finance and govern the production of a new application, packaged software, or service. The outsourcing agency may contribute innovative ideas and share financial risks with the business owner. In turn, it’ll get rewards for the collaboration. However, this pricing plan might require the decent management of both parties to accomplish the desired outcomes. 

See more: A fundamental guide to Software Outsourcing

What is Offshoring?

Offshoring refers to the act of transferring business operations to a foreign country where available labor forces are much cheaper. Businesses that apply this model don’t intend to advertise or raise their international recognition. Rather, this application aims to lower manufacturing costs and relevant expenses. Relocating some parts of their working process abroad benefits those organizations in terms of tax and other regulatory policies. Moreover, this promotes the economic development of both jurisdictions.

An illustration of operating offshoring models to multiple foreign countries in the world.

The ever-increasing globalization has also facilitated the adoption of outsourcing activities from foreign vendors. This may be the main reason why outsourcing and offshoring are interchangeably misused. Understanding their applications, particularly in digital and technological solutions, helps companies pick the most advantageous service for their business needs. 

1. Benefits of Offshoring

Outsourcing and offshoring strategies exert similar and different impacts on all involved participants. Like outsourcing, the company opts for offshoring strategies aim to stay focused on their core business objectives, while minimizing labor costs as well as other overheads. But the business still ensures a skilled workforce and exceptional leadership to drive everything on the right track. Further, offshoring its work accompanies several merits as follows:

  • Risk Reduction: Operating multi-nationally will mitigate default risks, or worse, insolvency when the world enters new economic upheavals.
  • Tax and Other Benefits: Many countries, especially developing nations, provide tax benefits and other incentives to attract foreign direct investment (FDI) from offshoring companies.
  • 24/7 Service: Establishing branches globally allows 24/7 operations in different time zones, which seems impossible to those merely working domestically.
  • Improved Management: Offshoring supports the company to better monitor and regulate all its operations.
  • Streamlined Process: The management of a dedicated team from foreign countries ensures production to occur seamlessly and effectively.
  • Talented Workforce: Offshoring teams with expertise and contributions assist the head company to track each phase of the production closely. Therefore, resolve problems of your business more creatively and efficiently.

2. Types of Offshoring

Offshoring comes into two varieties: production offshoring and services offshoring. Choosing either strategy relies much on your business objectives, demands, capital amounts, and more.

Production Offshoring 

A company conducts production offshoring by building factories and manufacturing units in different jurisdictions, then importing and selling end products in the domestic market. Tesla Inc. is such a typical offshoring company. It relocates the production and assembly of components of Tesla vehicles to China where the workforce is cheaper and qualified. 

An illustration of a product offshoring work in a manufactory.

Services Offshoring

When the company adopts services offshoring, it’ll establish subsidiaries in foreign nations. Those will perform operations associated with services such as auditing, marketing, information technology, customer care, and so on.

For example, a software company like Apple Inc. opens customer care units in different countries to directly handle complaints from customers or offer technical support them when products get faults. 

Offshoring Disadvantages

Inevitably, relocating the business work to other countries is occasionally challenging. There are various obstacles the offshoring company has to confront and overcome to operate well out of the country’s boundary:

  • Language and Culture Barriers: This is an inherent drawback faced by those going abroad. Nothing ensures foreign teams know the company’s native language and English well enough to boost effective communications between parties. Moreover, different cultural backgrounds may compound interaction-related problems. Also, it takes the offshoring company and foreign teams a long time to get accustomed to each other’s cultures. 
  • Distant Locations: Long geographical distance makes the headquarter struggle with administering the work performance in foreign branches and visiting those units so often.
  • Political or Geographical Issues: The business has to face political instability, armed attacks, protests, and other political crises, which are heavy tolls on its offshoring units’ operations.
  • Safety and Security Problems: Enterprises, especially software companies, should be aware of such serious issues as technology theft. This may prevail in several countries with high rates of crime. Otherwise, the organization may be compelled to close its offshoring units if locals consider its manufacturing harmful to their environment and life.
  • Ethical Issues: Those matters may arise when the organization refuses to give offshoring workers satisfactory remunerations or guarantee good working conditions.

Outsourcing vs Offshoring: Which One Is Better?

Numerous enterprises apply Outsourcing and offshoring models to cope with non-core business activities or share a part of business operations. Regardless of some downsides, these two strategies still prove efficient in fostering business productivity, diminishing overhead costs, and conveying high-quality products or services to the clientele. 

Given the distinctive properties of outsourcing and offshoring, the company should make an intensive analysis of both solutions. Hence, your company could determine which one is more advantageous for its projects over a certain period of time. Otherwise, the business will face more losses in terms of finance, human resources, and even reputation than gains. For more complicated tasks, the management can combine these two models to reach the best outcomes for the firm. 

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